Puerto Rico benchmark 2035 bond gets Trumped (Image: Bloomberg)
The White House has swiftly moved to contradict US President Donald Trump, after he made comments on Tuesday night that he would move to wipe clean Puerto Rico's debt to Wall Street.
Trump's comments initially panicked Wall Street, sending the price of Puerto Rico municipal bonds plummeting, with the Puerto Rican General Obligation Bond falling to just 37 cents on the dollar. Last month it was trading at 56 cents to the dollar.
White House director of the Office of Management and Budget (OMB), Mick Mulvaney, said: "I wouldn’t take it word for word with that," after Trump's statement.
"We are not going to deal right now with those fundamental difficulties that Puerto Rico had before the storm. Puerto Rico's going to have to figure out how to fix the errors that it’s made for the last generation on its own finances."
In an interview with Fox's Geraldo Rivera, Trump mentions that much of the debt is held by Wall Street, and appears to look directly into the camera, stating: “I don't know if it's Goldman Sachs, but you can wave goodbye to that.”
Before Hurricane Maria, Puerto Rican national debt stood at around US$73bn. More than 850 bond mutual funds have a stake in this debt, with Goldman Sachs alone holding around $400m.
A government bond works as a debt security issued by a government to support national spending. Before investing in government bonds, risks are assessed in the country of interest such as the political stability, inflation, interest rates and credit.
When there is greater demand for bonds, the price goes up and the return goes down compared to a lower price. So investors go after low-risk bonds when there is world instability.
While most government bonds are risk-free, for instance US bonds, others around the world are subject to political and economic variables that make risk far more severe.
One of these is Puerto Rico, despite its close relationship with the US.
Trump's suggestion that the bond debt held by Wall Street could be "waved goodbye" spooked the related bond market, which stands to lose billions of dollars.
Other countries that have tinkered with bond debt adjustments have suffered from investors who've either fled or taken legal action.
This happened to Argentina as it slipped into financial crisis starting in the late 90s and by 2001 the country was technically insolvent. Argentina restructured debt in 2005, that year allowing it to resume payment on 76% of the $82bn in sovereign bonds that it defaulted on in 2001.
By 2010 it had continued to default on payments and was forced to restructure its debt for a second time in five years. Bondholders who agreed to the settlement lost around 70% of their face value investments, while around 7% took the country to court instead demanding their full payments.
Because the Argentinians drafted repayment agreements through a New York intermediary, holdout bond investors who'd taken legal action were unable to seize sovereign assets in exchange.
By 2012 the situation was deadlocked with the holdouts eventually winning their legal case and Argentina was forced to agree to pay all bond debt, with the 7% receiving support for their full amount due.
This to-and-fro meant that Argentina faced legal action from both the holdouts and the renegotiated creditors, and then the country told creditors it could not afford to pay the $100bn the bonds were now worth.
The country is now technically in default, according to S&P Global Ratings, and in restricted default by Fitch.
In 2016 Argentina said it had settled with additional creditors for $475m but still faces an uncertain future regarding its treasury bonds. This means capital continues to be a challenge to access in the Latin American country.
Greece was also frozen out of the bond market in the midst of the global banking crisis but eventually returned in 2017. Investors remain hesitant and although its July 2017 €3bn bond auction was welcomed as “significant step” by Prime Minister Alexis Tsipras, investors remain ambivalent.
But the major issue for Puerto Rico, should it default on its debt, is facing a series of options, none of which are positive in the short term for the island which was hit by Hurricane Maria and left with billions of dollars in damage.
It has already restructured debt, but can't devalue its currency because it uses the US dollar.
Many countries impose austerity as Greece did as a method to recover from the financial crisis. Others, such as Iceland, let its largest banks collapse in 2008 rather than bailing them out with foreign money.
While Iceland's action is regarded as a case of success, 50,000 people lost their savings. However, by 2012 its economy was growing at more than 3% again and economists believe this could be a model for recovery when facing uncertainty and short-term economic ruin.