The money poured in by the millions, then by the hundreds of millions, and finally by the billions. Over weak coffee in a conference room in Midtown Manhattan last year, a half-dozen Puerto Rican officials exhaled: Their cash-starved island had persuaded some of the country’s biggest hedge funds to lend them more than $3 billion to keep the government afloat.
There were plenty of reasons for the hedge funds to like the deal: They would be earning, in effect, a 20 percent return. And under the island’s Constitution, Puerto Rico was required to pay back its debt before almost any other bills, whether for retirees’ health care or teachers’ salaries.
But within months, Puerto Rico was saying it had run out of money, and the relationship between the impoverished United States territory and its unlikely saviors fell apart, setting up an extraordinary political and financial fight over Puerto Rico’s future.
On the surface, it is a battle over whether Puerto Rico should be granted bankruptcy protections, putting at risk tens of billions of dollars from investors around the country. But it is also testing the power of an ascendant class of ultrarich Americans to steer the fate of a territory that is home to more than three million fellow citizens.
The investors with a stake in the outcome are some of the wealthiest people in America. Many of them have also taken on an outsize role in financing political campaigns in the aftermath of the Supreme Court’s 2010 Citizens United decision. They have put millions of dollars behind candidates of both parties, including Hillary Clinton and Jeb Bush. Some belong to a small circle of 158 families that provided half of the early money for the 2016 presidential race.
To block proposals that would put their investments at risk, a coalition of hedge funds and financial firms has hired dozens of lobbyists, forged alliances with Tea Party activists and recruited so-called AstroTurf groups on the island to make their case. This approach — aggressive legal maneuvering, lobbying and the deployment of prodigious wealth — has proved successful overseas, in countries like Argentina and Greece, yielding billions in profit amid economic collapse.
The pressure has been widely felt. Senator Marco Rubio, whose state, Florida, has a large Puerto Rican population, expressed interest this year in sponsoring bankruptcy legislation for the island, says Senator Richard Blumenthal, Democrat of Connecticut. Mr. Rubio’s staff even joined in drafting the bill. But this summer, three weeks after a fund-raiser hosted by a hedge-fund founder, Mr. Rubio broke with those backing the measure. Bankruptcy, he said, should be considered only as a “last resort.”
And this past week, House Republican leaders said any financial rescue for Puerto Rico may not come until the end of March.
The fight over the island’s future is stretching from the oceanside neighborhoods of San Juan, where a growing number of wealthy investors and financial professionals have migrated in recent years to exploit generous tax breaks, to Capitol Hill. Their efforts are being closely watched by financial institutions, labor unions and policy makers on the mainland, where many ordinary investors own Puerto Rican bonds through mutual funds.
Some warn that Puerto Rico could be a test case for the rest of the country, paving the way for troubled states like Illinois to escape unsustainable debts.
Stephen J. Spencer, a restructuring expert representing Puerto Rico bondholders including some hedge funds, said letting the government renege on agreements with hedge funds and other investors would set a dangerous precedent, undermining the integrity of the bond market.
“It’s really a wealth transfer from the bondholders to the municipalities,” Mr. Spencer said.
Others fear a different precedent: A handful of wealthy investors, they argue, are trying to rewrite the social contract of an entire United States territory. Puerto Rican officials say they have already cut public services and slashed central government spending by a fifth to keep ahead of payments to the hedge funds and financiers.
“What they are doing, by getting all the resources for themselves, is undermining the viability of Puerto Rico as a commonwealth,” said Joseph E. Stiglitz, the Nobel Prize-winning economist. “They want their money now, and they want to get the rules set so that they can make money for the next 20 years.”
A Bet on Resurgence
Along Ashford Avenue in San Juan’s Condado district, newly renovated hotels gleam beside shops like Gucci and Cartier. Slightly to the west are new high-rise condominiums, known as WeCo, or West Condado, by an enterprising real estate agent originally from Manhattan. Still farther west, not far from the Capitol in Old San Juan, a new development named the Paseo Caribe makes a more explicit pitch to potential buyers: “The Puerto Rico Advantage: Sun, Sand and Zero Taxes,” the development’s website promises.
This was supposed to help solve Puerto Rico’s problems. The commonwealth has been in a depression for over a decade. Pharmaceutical companies and manufacturers have fled the island, followed by young Puerto Ricans looking for jobs, draining the island’s work force and tax base. Forty percent of the island’s residents live in poverty.
Three years ago, in a bid to lure financial services firms and other employers, Puerto Rico’s governor at that time, Luis Fortuño, a Republican, signed laws intended to turn the island into a domestic tax haven. Americans who relocated to Puerto Rico, spent at least half a year there and brought their company with them would pay no federal income or capital gains taxes.
Private-equity magnates, hedge funds and investment advisers began moving to the island. They settled in Condado and a handful of coastal enclaves like the Dorado Beach Resort, where the billionaire investor Toby Neugebauer, who provided $10 million to the presidential campaign of Senator Ted Cruz of Texas, bought a home.
John Paulson, the hedge fund investor and leading Republican donor, snapped up resort properties and fading resort hotels, betting on a resurgence. Puerto Rico, Mr. Paulson told an investor conference last year, would become “the Singapore of the Caribbean.” This spring, at his urging, the island even rented a booth at the hedge fund industry’s annual conference at the Bellagio casino in Las Vegas, where two attractive women pitched Puerto Rico’s charms to guests.
It was not the first time that Puerto Rico had turned to Wall Street for help. For decades, the island had been borrowing money to pay its bills. Puerto Rico’s bonds were particularly attractive to mutual funds because they were exempt from federal, state and local taxes in all 50 states. But in 2013, after the island’s general obligation bonds were downgraded, they caught the attention of a different sort of investor: hedge funds specializing in distressed assets.
These funds began buying up the debt at a steep discount, confident that this was a bet they could not lose. Not only were the bonds guaranteed by the Puerto Rican Constitution, but under a wrinkle of federal law, the island’s public corporations and municipalities — unlike those of the 50 states — do not have bankruptcy as a recourse.
When the investment bank Lazard hosted a discussion for investors on Puerto Rico in October 2013, so many people showed up that some had to stand. By the next spring, as the island’s economic situation worsened, virtually no one else was willing to lend to Puerto Rico.
A round of spending cuts and tax increases by Gov. Alejandro García Padilla, the Democrat who succeeded Mr. Fortuño, had not produced enough cash to keep up with the island’s earlier debts. A prospectus circulated for the March 2014 bond offering — which raised the $3.5 billion that Mr. García Padilla hoped would buy time for a recovery — warned in boldface type of “significant risks.”
Nevertheless, some of the biggest hedge funds kept buying, drawn by the promise of what was a 20 percent return, based on the interest rate coupled with the tax exemption. Mr. Paulson’s firm purchased bonds in March 2014, as did Appaloosa Management, founded by David Tepper; Marathon Asset Management; BlueMountain Capital Management; and Monarch Alternative Capital, said Puerto Rico officials involved in the sale.
The recovery never arrived. The $3.5 billion ran out. And Puerto Rico now owes its creditors in excess of $70 billion, a bigger debt load than all but two states. As much as a third of it is owed to hedge funds, according to some estimates.
There were plenty of reasons for the hedge funds to like the deal: They would be earning, in effect, a 20 percent return. And under the island’s Constitution, Puerto Rico was required to pay back its debt before almost any other bills, whether for retirees’ health care or teachers’ salaries.
But within months, Puerto Rico was saying it had run out of money, and the relationship between the impoverished United States territory and its unlikely saviors fell apart, setting up an extraordinary political and financial fight over Puerto Rico’s future.On the surface, it is a battle over whether Puerto Rico should be granted bankruptcy protections, putting at risk tens of billions of dollars from investors around the country. But it is also testing the power of an ascendant class of ultrarich Americans to steer the fate of a territory that is home to more than three million fellow citizens.
The investors with a stake in the outcome are some of the wealthiest people in America. Many of them have also taken on an outsize role in financing political campaigns in the aftermath of the Supreme Court’s 2010 Citizens United decision. They have put millions of dollars behind candidates of both parties, including Hillary Clinton and Jeb Bush. Some belong to a small circle of 158 families that provided half of the early money for the 2016 presidential race.
To block proposals that would put their investments at risk, a coalition of hedge funds and financial firms has hired dozens of lobbyists, forged alliances with Tea Party activists and recruited so-called AstroTurf groups on the island to make their case. This approach — aggressive legal maneuvering, lobbying and the deployment of prodigious wealth — has proved successful overseas, in countries like Argentina and Greece, yielding billions in profit amid economic collapse.
The pressure has been widely felt. Senator Marco Rubio, whose state, Florida, has a large Puerto Rican population, expressed interest this year in sponsoring bankruptcy legislation for the island, says Senator Richard Blumenthal, Democrat of Connecticut. Mr. Rubio’s staff even joined in drafting the bill. But this summer, three weeks after a fund-raiser hosted by a hedge-fund founder, Mr. Rubio broke with those backing the measure. Bankruptcy, he said, should be considered only as a “last resort.”
And this past week, House Republican leaders said any financial rescue for Puerto Rico may not come until the end of March.
The fight over the island’s future is stretching from the oceanside neighborhoods of San Juan, where a growing number of wealthy investors and financial professionals have migrated in recent years to exploit generous tax breaks, to Capitol Hill. Their efforts are being closely watched by financial institutions, labor unions and policy makers on the mainland, where many ordinary investors own Puerto Rican bonds through mutual funds.
Some warn that Puerto Rico could be a test case for the rest of the country, paving the way for troubled states like Illinois to escape unsustainable debts.
Stephen J. Spencer, a restructuring expert representing Puerto Rico bondholders including some hedge funds, said letting the government renege on agreements with hedge funds and other investors would set a dangerous precedent, undermining the integrity of the bond market.
“It’s really a wealth transfer from the bondholders to the municipalities,” Mr. Spencer said.
Others fear a different precedent: A handful of wealthy investors, they argue, are trying to rewrite the social contract of an entire United States territory. Puerto Rican officials say they have already cut public services and slashed central government spending by a fifth to keep ahead of payments to the hedge funds and financiers.
“What they are doing, by getting all the resources for themselves, is undermining the viability of Puerto Rico as a commonwealth,” said Joseph E. Stiglitz, the Nobel Prize-winning economist. “They want their money now, and they want to get the rules set so that they can make money for the next 20 years.”
A Bet on Resurgence
Along Ashford Avenue in San Juan’s Condado district, newly renovated hotels gleam beside shops like Gucci and Cartier. Slightly to the west are new high-rise condominiums, known as WeCo, or West Condado, by an enterprising real estate agent originally from Manhattan. Still farther west, not far from the Capitol in Old San Juan, a new development named the Paseo Caribe makes a more explicit pitch to potential buyers: “The Puerto Rico Advantage: Sun, Sand and Zero Taxes,” the development’s website promises.
This was supposed to help solve Puerto Rico’s problems. The commonwealth has been in a depression for over a decade. Pharmaceutical companies and manufacturers have fled the island, followed by young Puerto Ricans looking for jobs, draining the island’s work force and tax base. Forty percent of the island’s residents live in poverty.
Three years ago, in a bid to lure financial services firms and other employers, Puerto Rico’s governor at that time, Luis Fortuño, a Republican, signed laws intended to turn the island into a domestic tax haven. Americans who relocated to Puerto Rico, spent at least half a year there and brought their company with them would pay no federal income or capital gains taxes.
Private-equity magnates, hedge funds and investment advisers began moving to the island. They settled in Condado and a handful of coastal enclaves like the Dorado Beach Resort, where the billionaire investor Toby Neugebauer, who provided $10 million to the presidential campaign of Senator Ted Cruz of Texas, bought a home.
John Paulson, the hedge fund investor and leading Republican donor, snapped up resort properties and fading resort hotels, betting on a resurgence. Puerto Rico, Mr. Paulson told an investor conference last year, would become “the Singapore of the Caribbean.” This spring, at his urging, the island even rented a booth at the hedge fund industry’s annual conference at the Bellagio casino in Las Vegas, where two attractive women pitched Puerto Rico’s charms to guests.
It was not the first time that Puerto Rico had turned to Wall Street for help. For decades, the island had been borrowing money to pay its bills. Puerto Rico’s bonds were particularly attractive to mutual funds because they were exempt from federal, state and local taxes in all 50 states. But in 2013, after the island’s general obligation bonds were downgraded, they caught the attention of a different sort of investor: hedge funds specializing in distressed assets.
These funds began buying up the debt at a steep discount, confident that this was a bet they could not lose. Not only were the bonds guaranteed by the Puerto Rican Constitution, but under a wrinkle of federal law, the island’s public corporations and municipalities — unlike those of the 50 states — do not have bankruptcy as a recourse.
When the investment bank Lazard hosted a discussion for investors on Puerto Rico in October 2013, so many people showed up that some had to stand. By the next spring, as the island’s economic situation worsened, virtually no one else was willing to lend to Puerto Rico.
A round of spending cuts and tax increases by Gov. Alejandro García Padilla, the Democrat who succeeded Mr. Fortuño, had not produced enough cash to keep up with the island’s earlier debts. A prospectus circulated for the March 2014 bond offering — which raised the $3.5 billion that Mr. García Padilla hoped would buy time for a recovery — warned in boldface type of “significant risks.”
Nevertheless, some of the biggest hedge funds kept buying, drawn by the promise of what was a 20 percent return, based on the interest rate coupled with the tax exemption. Mr. Paulson’s firm purchased bonds in March 2014, as did Appaloosa Management, founded by David Tepper; Marathon Asset Management; BlueMountain Capital Management; and Monarch Alternative Capital, said Puerto Rico officials involved in the sale.
The recovery never arrived. The $3.5 billion ran out. And Puerto Rico now owes its creditors in excess of $70 billion, a bigger debt load than all but two states. As much as a third of it is owed to hedge funds, according to some estimates.
by Jonathan Mahler adn Nicholas Confessore, NY Times | Read more:
Image:Christopher Gregory
