This is such a well written article by Rodney Johnson that I wanted to include it in this week’s email in its entirety. There is not much to comment on because I believe the article says it all. All I can say is I just don’t understand how they get away with it. You would think the bond holders mentioned in the article could sue to recover their money and the law would be on their side. Maybe they will in the end, but it doesn’t seem that way right now. Read below and join me in my feelings of utter disbelief. -Greg
By Rodney Johnson, Senior Editor, Economy & Markets
We all know the U.S. is not a republic. If it were, then law would prevail when conflicts arise, and they’d apply equally to everyone. Although we know that’s not the case, this latest example from government officials confirms it, yet again.
If you stole a hundred bucks from someone, you might try to avoid them for a while. If you stole $100,000, you might even consider moving across the country. But what if you stole $3.5 billion? Would you move to Bolivia, or some other remote locale with no extradition treaty?
Nah. That’s way too much work. Especially if you’re an elected official.
If you’re in government and steal from investors, you can simply do what Melba Acosta-Febo did. Keep climbing the government employment ladder, with all the perks and benefits that come with a high-ranking title.
Acosta-Febo is currently the President of the Puerto Rico Government Development Bank, which is a clearinghouse for government financing in the Commonwealth. But her previous day job was Secretary of the Treasury for the island government. In that capacity, she signed off on the $3.5 billion general obligation bond that Puerto Rico issued in 2014.
In the offering statement (OS) for that bond, Acosta-Febo went to great lengths to explain that Puerto Rico faced severe financial risks, so investors should proceed with caution. So far, so good. Then she highlighted the section of Puerto Rico’s constitution that guarantees general obligation bond payments will be made before all other payments.
This section reads:
The law establishes the order of priorities as follows: first, the payment of the interest on and amortization requirements for public debt (Commonwealth general obligations, including the Bonds, and guaranteed debt for which the Commonwealth’s guarantee has been exercised); second, the fulfillment of obligations arising out of legally binding contracts, court decisions on eminent domain, and other unavoidable obligations to protect the name, credit and good faith of the Commonwealth; third, current expenditures in the areas of health, protection of persons and property, education, welfare, and retirement systems; and fourth, all other purposes.
In addition, the OS explains the legislative actions giving the Commonwealth officials the authority to issue the bonds, and goes to great lengths to illustrate how, even with the new bonds, Puerto Rico will remain under its legal debt ceiling. There’s even a section where legal counsel states these bonds are duly issued and fit the parameters (general obligation) designated by Acosta-Febo.
At this point we could all, as investors, be forgiven for thinking these bonds were properly issued general obligation bonds to be paid before all other commitments. After all, that’s exactly what the OS stated. But no… Now, Acosta-Febo and Puerto Rico Governor, Alejandro Garcia Padilla, want to trash this legal contract between bondholders and the Commonwealth. Their new stance is that the entire bond issue, all $3.5 billion, was illegal.
According to a report from the newly formed Public Credit Comprehensive Audit Commission, this bond issue violated Puerto Rico’s debt ceiling. They disagree with Acosta-Febo’s math that showed the bonds were compliant when issued, and their remedy is simply to renege. They think not paying the bondholders a nickel is the way to go.
If the commission has it right, and Acosta-Febo has it wrong, there must be a reason. Maybe she wasn’t smart enough, or educated enough, to understand all the factors. But that seems unlikely. She’s an accountant, and a lawyer. She has an MBA from Harvard. She was a Corporate Counsel at Puerto Rico’s largest law firm, and a Tax Consultant at Price Waterhouse. Before her stint as Treasury Secretary, she held several positions at R&G Financial Corp, including Chief Administrative Officer, Corporate Risk Manager, and Chief Financial Officer.
There’s no doubt she’s plenty smart enough, and if the bonds were duly issued, then the commission is lying. If the bonds weren’t authorized, then Acosta-Febo is lying. The Governor of Puerto Rico has already explained he will not pay bondholders ahead of salaries and pensions, even though his constitution explicitly requires it, no matter what. Everyone seems to agree that the bonds can just blissfully be ignored.
Everyone, that is, except the bondholders. Remember them? The people who, based on the contract offered by the Puerto Rican government, coughed up $3.5 billion. Now they’re told, “Too bad.”
If the contract is invalid, then the restoration of both parties to their original position should be mandated. This would require Puerto Rico handing $3.5 billion back to bondholders, who would have to give back any interest received. But that’s not what the Puerto Ricans want. They want to keep all the money and have no responsibility whatsoever. How is that equitable or fair?
And what about the outright lies in the offering statement provided by Acosta-Febo or the unconstitutional acts of the governor? Where are the indictments against these people? Why is it that government officials can lie, break the law, steal from investors, and get off scot-free?
When these Puerto Rico bonds were issued in 2014, I told readers to stay away. At the time, I thought the island was broke and would default. How quaint. Default implies the government was trying to make good. Instead, they resorted to outright theft.
This happened in Detroit just three years ago, using the same ruse. The city claimed over $1.5 billion of bonds were illegally sold, and therefore bondholders had no claim. As city and state budgets around the country stretch thin, expect more of this sort of thing. Government officials will look for any way to keep constituents from paying the cost of their misdeeds, even if it means stealing from investors.
At a time when more investors are snapping up municipal bonds for yield and safety, it is imperative that you do your homework.
If you don’t, you might wind up owning the next Puerto Rico. And nobody wants that.