Trump Speaks and a $3.8 Trillion Market Hears an Existential Threat

  • The idea that states could stiff investors spooks Wall Street
  • Puerto Rico bonds take record plunge after ‘Hannity’ interview

Trump Cannot Eliminate Puerto Rico's Debt, Says Rattner

Even before Wall Street awoke, Wednesday looked like a wild day for the nation’s $3.8 trillion municipal-bond market.

Few might have predicted just how wild things would get.

President Donald Trump had suggested late the previous night on “The Sean Hannity Show” that the beleaguered U.S. commonwealth of Puerto Rico -- bankrupt even before Hurricane Maria hit last month -- might simply wipe out its $74 billion of municipal debt. On Wednesday, Puerto Rico’s beaten-down benchmark bonds plummeted from an already unprecedented 44 cents on the dollar to as little as 30.25 cents. 

“It may possibly be the end of the municipal bond market as we know it,” Harry Fong, an analyst at MKM Partners, wrote as the securities fell and fell.

That doomsday scenario, of course, is contingent upon Trump’s actually being able to cancel all of the commonwealth’s debt, amassed over decades and enabled by a yield-hungry Wall Street. There’s no indication he has a plan to do so. Administration officials, as they’ve done throughout his presidency, quickly walked his comments back.

It was a remarkable turn of events in the normally staid muni market, where the prices of many bonds rarely fluctuate even a cent or two a day -- if they even trade at all. Few could recall the last time any municipal bonds tumbled so much, so fast. They didn’t plunge like this even when Puerto Rico’s governor declared its debts unpayable in June 2015.

"I first saw it this morning, and I wake up pretty early at 4:30 in the morning or so,” said David Tawil, president and co-founder of Maglan Capital LP, who no longer holds Puerto Rico debt. “My first reaction was this can’t be good for bonds, but, like many things Donald Trump says, he doesn’t know the full details of the situation and probably doesn’t care about the limits of his power." 

Trump’s budget director Mick Mulvaney on Wednesday appeared to walk back the president’s comments, and many market analysts dismissed Trump’s suggestion as unworkable. 

But even the suggestion that Puerto Rico might somehow leave creditors high and dry nonetheless injected new uncertainty into the long, fraught process of trying to put the island’s finances back in order. It also raised the specter of other distressed states, localities and territories (think Illinois, Hartford, Connecticut, and the U.S. Virgin Islands) following the path to paying zero.

Trump’s comments, in full, are unlike anything the muni market has ever heard.

“We have to look at their whole debt structure,” Trump said. “They owe a lot of money to your friends on Wall Street. We’re going to have to wipe that out. That’s going to have to be -- you know, you can say goodbye to that.”

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Isaac Boltansky, an analyst at Compass Point, said borrowing costs for cities across the country would rise, a direct hit to taxpayers, if markets have to price in risk that Trump would speak out against bondholders.

“The most powerful tool President Trump has in the Puerto Rico debt discussion is the bully pulpit, and he is clearly willing to use that power unlike any of his predecessors,” Boltansky said.

Puerto Rico’s response to the disaster has been hindered by the long-term debt crisis that led it to declare a form of bankruptcy this year.

Many traditional municipal-market investors sold their debt years ago. Now, even firms that deal in distressed debt are getting out. MatlinPatterson, a firm that wagered big on Puerto Rico’s securities, is unwinding its distressed-credit investments after its largest investor decided to yank cash. Its $500 million of assets included a dedicated fund to invest in the commonwealth’s obligations.

Puerto Rico’s own officials aren’t pushing for a complete bondholder wipeout; perhaps they’d like to borrow again one day. At a press conference in San Juan on Wednesday, Governor Ricardo Rossello dismissed Trump’s remarks and said Puerto Rico will resolve its debt through the bankruptcy process.

“As far as the comments made about wiping the debt clean, that is the opinion of the president. Puerto Rico is already involved on a judicial front,” he said.

Puerto Rico’s resort to its special bankruptcy was -- and remains -- contentious. Until the commonwealth’s crisis, it was viewed as an ironclad rule that U.S. territories, like states, can’t seek court protection. That’s one reasons investors lined up to borrow for so long even as the territory’s finances spun out of control.

Now, thanks to President Trump, a court restructuring, where recoveries are up for grabs, suddenly looks positively calming by comparison.

— With assistance by Rebecca Spalding, Justin Sink, Jennifer Epstein, Sridhar Natarajan, Sonali Basak, Danielle Moran, and Felice Maranz

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