in

Puerto Rico’s Bankruptcy Reverberates Across US Municipal Bond Markets

One of the reasons I talk about the territories is just because I find them interesting; they are the furthest flung parts of the US with cultures pretty distinct from that of the United States, and most people don’t know anything about what goes on in them.

But the other is because what’s happened to the territories is what’s going to eventually happen to the mainland United States if we continue down the fiscal and economic path we’re currently on.

Case in point:

Puerto Rico’s debt crisis is taking a toll on the mainland municipal bond market.

Market participants say the ripple effects from the biggest municipal bankruptcy have shaken investor confidence in lower-rated states and cities, legal promises and credit ratings in general. Of particular concern is a ruling by Title III Judge Laura Taylor Swain that upset expectations regarding special revenue bonds, which had continued to generate payments in previous bankruptcies.

In her ruling on Jan. 30 in a case involving the bonds of the Puerto Rico Highways and Transportation Authority, Convention Center District Authority, and Infrastructure Finance Authority, Swain said the fact the bonds were special revenue bonds didn’t require the issuers to continue paying in a Chapter 9 bankruptcy.

Swain’s decision has “cast doubt” on the norms of the market, says Wells Fargo Securities managing director Natalie Cohen. “The fact that an automatic stay does not apply to special revenues and that payments should continue to bondholders has been accepted as common knowledge by the investing public,” Cohen points out that a federal website of the Administrative Office of the U.S. Courts summarizes a part of Chapter 9 saying, “Holders of special revenue bonds can expect to receive payment on such bonds during the Chapter 9 case if special revenues are available.”

Municipal bond participants have become more cautious about purchasing bonds from distressed issuers since Puerto Rico’s bond meltdown over the last several years.

The clouds from Puerto Rico’s default have cast a shadow over Chicago’s bonds.

On Feb. 13, one of the historically biggest holders of Puerto Rico debt, Franklin Templeton Investments, said it had learned its lessons from its experience of the islands’ slide into multiple defaults. “As a result of lessons recently learned, the Franklin municipal bond group generally does not purchase general fund appropriation debt from cities, counties or states that in our view are facing unsustainable structural budget situations,” two co-directors of the group wrote in “Fundamental Changes That No Muni Investor Should Ignore.”

People who have read my recent postings on Guam’s fiscal woes will understand that when Puerto Rico defaulted, it immediately cast doubt on the sustainability of the debts held by the other US territories, leading to a series of downgrades by the ratings agencies.

These downgrades were a major contributor in provoking a fiscal crisis in both the US Virgin Islands and Guam, who found themselves suddenly unable to borrow at favorable rates, leaving the territorial governments to scramble desperately for cash.

But it’s not just Puerto Rico and the other US territories suddenly having cash flow problems after loading up on debt for years. It’s also cities like Detroit and Chicago, and states like Illinois and California. Buyers of municipal bonds long assumed this debt was safe, and would be backstopped by the US government if nothing else. Increasingly, though, it is becoming obvious that this is not the case.

The smarter bond traders are beginning to regard these debts as too high risk and are avoiding them, in part as a consequence of the Puerto Rico bankruptcy. This could start to lead to increased borrowing costs for these cities and states, which could trigger more defaults just like in the territories.

If a US state like California or Illinois goes bankrupt and the bondholders aren’t bailed out by the US government, I think it will not be long before the federal government finds itself being downgraded and facing a huge debt crisis. This nightmare scenario is still some years away, but we can now see the edge of the cliff approaching whereas before, it was just something that was coming “some day.”

 
Doomberg

Written by Doomberg

I am Doomberg, one of the original founding members of Sparta Report, and have been here since the beginning. I am an insatiable news junkie and enjoy reading and writing about the US territories, the Caribbean, video games, smartphones, and of course conservative politics in general.

I also really like pictures of gas stations and claim full responsibility for the silly gas station motif. I'm presently trapped behind enemy lines in a blue state with no hope of escape! The ride never ends.

Leave a Reply

Loading…

The Wreck of The Titanic (Ego)

The Revenge of The Reswampocrats