Livi'n La Vida Broke-A: How Puerto Rico Found Its Muni Mojo

Those who follow the travails of Puerto Rico and its debt problems saw a Commonwealth, let’s call it a CW from now on for our Twitter TWTR +0.00%users, which cried for accommodations, workout agreements, changes in the bankruptcy law and bailouts. None represented a long-term solution, but rather, a long-term battle in which the CW was negotiating from weakness.

What the CW seems to have finally realized is that it has the upper hand in all these matters precisely because there are no legal ways to force them to pay up via mandating legislation, forced asset sales or rate increases. They are a sovereign government. They can be sued and judgments issued against them that they can ignore until they can’t. The “can’t” means until their need for new financing requires an accommodation with the market. In their case, the market is probably no larger than the hundreds of hapless institutions currently holding the bulk of their present debt. People who have, up to now, acted as if they had the upper hand because they represented the market and because the CW listened to its Wall Street-oriented advisors.

While the CW does have need for debt issuing capacity to smooth out revenue receipts with monthly cash needs, without debt service this becomes a manageable problem. They can always invoke the California solution, i.e. issue scrip or the Illinois solution, delay payments. It takes some practice, but these things work.

Its latest negotiation proposal begins with a five year plan which outlines the finances of the CW and by definition, defines the limits of what hardships they are willing to impose on themselves. Left unsaid is how much debt service and debt reduction this leaves for bondholders. It sets a CWs negotiating position by defining the size of the pie and then letting the debtholders squabble over who gets how much. What often happens in this situation is that bonds trade at ever decreasing prices and more of them end up in the hands of speculators, who’s cost basis allows them to show a profit at some value well below par.

As Argentina has shown, most bondholders eventually end up taking sizeable haircuts. The CW saga has years ahead of it during which bondholders will incur millions of dollars of legal expense while seeing their bond prices edge ever lower. Look back at the history of the Argentina default to see how this game is played.

Richard Lehmann,Contributor

Livi'n La Vida Broke-A: How Puerto Rico Found Its Muni Mojo