Puerto Rico Bonds Bankrupcy

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inbox788
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Puerto Rico Bonds Bankrupcy

Post by inbox788 »

Just came across a headline that "Puerto Rico Declares a Form of Bankruptcy".

https://www.nytimes.com/2017/05/03/busi ... -debt.html

1) What does this mean for Puerto Rico bonds and bondholders?
2) How does this impact total bond funds like VBMFX/BND vs others? How small if any is the holding?
3) What does this mean for other Muni bond funds that some folks have in taxable accounts? Direct effect for ? percentage holding and indirect effect from next distressed territory/state. What are the more distressed muni localities?

I have been resisting putting funds into Muni's in taxable accounts, and this was one of the concerns. I dipped my toes into short term corporate bonds as a start, but trying to figure out where to keep them long term.

http://www.etf.com/sections/features-an ... rico-bonds
psteinx
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Re: Puerto Rico Bonds Bankrupcy

Post by psteinx »

1) The situation in P.R. has been trending down for years. The underlying financials of P.R. started eroding a long time ago - maybe early-mid aughts? But the weakening underlying situation didn't really catch the attention of the investment community until a prescient Barron's cover story circa August '13 (I think this is it).

P.R. bond prices have fluctuated up and down, but of course been trending down in the years since. I assume bondholders will likely take some sort of haircuts to principal and/or interest, and funds that hold P.R. bonds will experience (and have experienced) some losses, in proportion to what they hold.

A fund with 1% P.R. exposure has 1% maximum loss due to this. While P.R. bond issuance is large, the situation is not without historical and current parallels, including Detroit's situation a few years ago, and the ongoing slide in the Chicago and Illinois financial situations...

2) I'm not an expert on the contents of various bond funds, but I doubt Vanguard's Total Bond product has much, if any direct exposure to these. Broad bond funds tend to be segregated into taxable and muni.

3) You could check direct price effects on various Vanguard or other muni bond funds (MUB is one standard ETF in the sector). Many of the larger players cut or eliminated direct P.R. exposure a while back.

In general, you are paid to be exposed to risk. Sometimes the downside risk shows up. But hopefully you've been paid enough in the meantime to more than offset the occasional bump. I don't see the P.R. situation as one that should cause an investor who otherwise would invest in munis (i.e. in the right tax rate scenario) to abstain from them...
Last edited by psteinx on Wed May 03, 2017 12:05 pm, edited 2 times in total.
PFInterest
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Re: Puerto Rico Bonds Bankrupcy

Post by PFInterest »

This is not new. People have seen this coming.
Did you look up the prospectus for total bond and int term municipal? Im not as worried.

Also why would you use corporates as a substitute? They are not the same.
alex_686
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Re: Puerto Rico Bonds Bankrupcy

Post by alex_686 »

I mostly agree with Psteinx but...
psteinx wrote: A fund with 1% P.R. exposure has 1% maximum loss due to this. While P.R. bond issuance is large, the situation is not without historical and current parallels, including Detroit's situation a few years ago, and the ongoing slide in Chicago and Illinois financial situation...
Detroit went down a well defined path of bankruptcy. Yeah, it was big but the process has been tried out before. P.R. is different - this is the first time something like this has happened. P.R.'s constitution states it has to pay back in full some of the loan regardless of the fact that P.R. doesn't have the funds to do so. So this is new. The level of uncertainty is higher.
psteinx wrote: 2) I'm not an expert on the contents of various bond funds, but I doubt Vanguard's Total Bond product has much, if any direct exposure to these. Broad bond funds tend to be segregated into taxable and muni.
I don't think Total Bond has any state or muni debt, to your point about separation of taxable and muni debt. Total Bond in fact skips many bond types, like high yield.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
jrbdmb
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Re: Puerto Rico Bonds Bankrupcy

Post by jrbdmb »

Standard muni funds like Vanguard's VTEAX / VTEB would currently only have a minuscule investment (if any) in low rated bonds like those of Puerto Rico. If these funds did lose money on Puerto Rican bonds it was in 2014 and 2015 when these bonds were being downgraded from investment grade to speculative and many funds sold them.

Note that currently VTEAX has 0.9% invested in non-rated bonds, 0.0% in bonds rated BB or lower, and 0.0% in bonds issued by Puerto Rico.
Dirghatamas
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Re: Puerto Rico Bonds Bankrupcy

Post by Dirghatamas »

Well I am a perma bear on Bonds (never own them, always afraid of them), so I read the article out of curiosity.

This is NOT the same as Detroit but a precursor to more serious things. First, till now states and territories didn't have a means (as far as I know) to go bankrupt. Entities within states like towns could but not entire states or territories. Chipping away at that tradition creates a precedent for states declaring bankruptcy.

The other thing that is new is breach of constitution. A fair bit of these bonds were protected and guaranteed by the Puerto Rico Constitution. So, by law they have to be paid. Looking further down into the article, those "guaranteed" bonds are now trading at 61 cents to the dollar :shock: so someone took a massive haircut.

Both of these are new: State/territories declaring bankruptcy and explicitly rejecting constitutional guarantees.
alex_686
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Re: Puerto Rico Bonds Bankrupcy

Post by alex_686 »

Dirghatamas wrote:Both of these are new: State/territories declaring bankruptcy and explicitly rejecting constitutional guarantees.
I think this is a little unfair. The ban on states declaring bankruptcy is (probably) in the US Constitution. Territories are explicated outside this constitutional protection.

P.R.'s constitutional guaranty is based on P.R.'s constitution. I can't see how precedent set in P.R.'s case would apply to the States.
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Dirghatamas
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Re: Puerto Rico Bonds Bankrupcy

Post by Dirghatamas »

Well, my memory may be foggy but I don't think there is any Federal law that prevents states. In fact if I recall, there probably was 1 perhaps a hundred years back when Arkansas (I think) defaulted. So, this has happened before but is extremely rare so far.

Remember we are a federation of SOVEREIGN states. So, not allowing a bankruptcy for a state can't possibly be in the federal constitution because it would imply one sovereign (our federation) telling another sovereign (a state) what to do. This (Sovereignty) is in fact part of the reason why Munis can't be taxed by our federation and why treasuries can't be taxed by states.

As for constitutional guarantees, that's what I meant (Puerto Rico's constitution not US). My point was that if a territory's explicit guarantee in it's constitution can be breached, doesn't it set a precedent for state constitutional guarantees in future to be breached? Note that neither have anything to do with the US constitution.
alex_686
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Re: Puerto Rico Bonds Bankrupcy

Post by alex_686 »

Dirghatamas wrote:Remember we are a federation of SOVEREIGN states. So, not allowing a bankruptcy for a state can't possibly be in the federal constitution because it would imply one sovereign (our federation) telling another sovereign (a state) what to do. This (Sovereignty) is in fact part of the reason why Munis can't be taxed by our federation and why treasuries can't be taxed by states.
You have to the crux of the issue but I think you are reaching the wrong point. Bankruptcy is overseen by a federal judge. A state can't put itself under federal oversight because then it would no longer be so sovereign. P.R. does not have this problem because it is not sovereign. Or at least that was the way to was explained to me. So the Federal path is bared.

Plus there is the Contract Clause in the Constitution. States can not retroactively change contracts. Bonds are governed by contracts. So the states can't independently repudiate the bonds. So the State path is also blocked.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Dirghatamas
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Re: Puerto Rico Bonds Bankrupcy

Post by Dirghatamas »

Well we are going into the weeds (we are pretty much in agreement on the substance) about states vs. territory and who is more sovereign. By many measures, PR was treated more as a sovereign entity than a normal state. Consider that only "sovereign countries" send teams to Olympic Games. No state in the US does. PR has consistently sent Olympic teams under the PR flag. That would imply a higher level of sovereignty.

Also consider federal taxes. Income in every state is taxable by the federal govt. However, income in PR was NOT taxable by the federal govt. That implies PR at a higher level of sovereignty than ordinary states.

Anyway, I am done because I don't really a substantive disagreement with you. I just find this stuff curious.
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Phineas J. Whoopee
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Re: Puerto Rico Bonds Bankrupcy

Post by Phineas J. Whoopee »

alex_686 wrote:...
I think this is a little unfair. The ban on states declaring bankruptcy is (probably) in the US Constitution. Territories are explicated outside this constitutional protection.
States can't avail themselves of bankruptcy protection because they are sovereign. If somebody like you or me or GMAC can't pay our debts the sovereign, in the US bankruptcy law is federal per the US Constitution, has the power to relieve us of our financial obligations. There is no power higher than a sovereign to do such a thing. Sovereigns can default, but can't be protected from their creditors. Historically wars have occasionally resulted. Imagine being ordered to kill people who had nothing to do with it to force some neighboring country to pay its bills.
alex_686 wrote:P.R.'s constitutional guaranty is based on P.R.'s constitution. I can't see how precedent set in P.R.'s case would apply to the States.
I agree. Puerto Rico is not a state and is not sovereign. The "form of bankruptcy" referenced in OP was created in the congressional act PROMESA. It doesn't apply to states at all. There is no precedent to be set.

Subdivisions within states, like for example San Bernardino, aren't sovereigns and Congress provided Chapter 9 for them.

State sovereignty was hard won. I suspect no state will agree to give it up just to avoid a bond default.

PJW
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Phineas J. Whoopee
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Re: Puerto Rico Bonds Bankrupcy

Post by Phineas J. Whoopee »

Dirghatamas wrote:... By many measures, PR was treated more as a sovereign entity than a normal state.
I believe that to be incorrect. I explain below.
Dirghatamas wrote:Consider that only "sovereign countries" send teams to Olympic Games. No state in the US does. PR has consistently sent Olympic teams under the PR flag. That would imply a higher level of sovereignty.
The International Olympic Committee can do as it pleases. It does not bind any sovereign under statutory or customary international law.
Dirghatamas wrote:Also consider federal taxes. Income in every state is taxable by the federal govt. However, income in PR was NOT taxable by the federal govt. That implies PR at a higher level of sovereignty than ordinary states. ...
There is no such implication. Congress specifically exempted P.R. municipal bonds from taxation by statute. Congress can change the law whenever it likes. Furthermore, interest paid by foreign sovereigns to US taxpayers is federally taxable.

PJW
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oldcomputerguy
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Re: Puerto Rico Bonds Bankrupcy

Post by oldcomputerguy »

alex_686 wrote: I think this is a little unfair. The ban on states declaring bankruptcy is (probably) in the US Constitution.
Not that I'm a Constitutional scholar, but upon a quick perusal and a text search, I didn't find any such prohibition in the U.S. Constitution. Article I, Section 8 does lay out the authority for Congress to make bankruptcy law on a Federal level:
The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;

To borrow Money on the credit of the United States;

To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;

To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;

To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

To provide for the Punishment of counterfeiting the Securities and current Coin of the United States;

To establish Post Offices and post Roads;

To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;

To constitute Tribunals inferior to the supreme Court;

To define and punish Piracies and Felonies committed on the high Seas, and Offences against the Law of Nations;

To declare War, grant Letters of Marque and Reprisal, and make Rules concerning Captures on Land and Water;

To raise and support Armies, but no Appropriation of Money to that Use shall be for a longer Term than two Years;

To provide and maintain a Navy;

To make Rules for the Government and Regulation of the land and naval Forces;

To provide for calling forth the Militia to execute the Laws of the Union, suppress Insurrections and repel Invasions;

To provide for organizing, arming, and disciplining, the Militia, and for governing such Part of them as may be employed in the Service of the United States, reserving to the States respectively, the Appointment of the Officers, and the Authority of training the Militia according to the discipline prescribed by Congress;

To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Magazines, Arsenals, dock-Yards, and other needful Buildings;—And

To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof.
No explicit prohibition of an individual State declaring bankruptcy. In fact, I might argue that, since an explicit prohibition is not present in the Constitutional language, Amendment X might be relevant:
The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.
Now, none of this is to say that Congress can't pass (or indeed hasn't passed) a law prohibiting such bankruptcies. And (did I mention I'm not a Constitutional scholar?) I can't even venture a guess as to whether such a law would conflict with the Constitutional language above.
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Re: Puerto Rico Bonds Bankrupcy

Post by Dirghatamas »

Phineas J. Whoopee wrote:
Dirghatamas wrote:Also consider federal taxes. Income in every state is taxable by the federal govt. However, income in PR was NOT taxable by the federal govt. That implies PR at a higher level of sovereignty than ordinary states. ...
There is no such implication. Congress specifically exempted P.R. municipal bonds from taxation by statute. Congress can change the law whenever it likes. Furthermore, interest paid by foreign sovereigns to US taxpayers is federally taxable.

PJW
No no you misunderstood what I said. Obviously we all know that Munis are not taxed by the federal Govt. This is true for all states so fine PR also somehow made it by some act of congress. That is not the curious part.

The bigger difference always was ordinary income. If you live in any random state; the state decides to have sales tax, income tax or neither or both. Note that in all cases, in every US state you live in, you pay federal taxes on your personal income. My understanding is that PR was the only odd man out in that people living there paid NO FEDERAL TAXES on income within PR. This was to my understanding a very unique situation.

Why do I know this? It randomly showed up as an article in my news feed a few years ago. I am always looking for tax optimization so the Google bot recommended it and I read it. I have no idea how this was made legal (you pay no federal taxes) but to me it implied a higher level of sovereignty than ordinary states.
Theoretical
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Re: Puerto Rico Bonds Bankrupcy

Post by Theoretical »

The territories are under a significantly different standard than the states. The 10th Amendment, even under the O'Connor-Rehnquist courts, would not allow state bankruptcies. It's basically a dead letter as far as constitutional law is concerned 99% of the time, and would especially be for something with these implications. Default, on the other hand, is quite possible and might be a real mess.

The default risk in municipals looks to be getting picked up by the market.

Highest yield 20 year AAA munis on Fidelity are barely lower yielding than AAA 20 year corporate bonds and barely higher than GSE bonds despite being tax-advantaged. Even at median yields, long munis are very close to GSE yields nominally.
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Re: Puerto Rico Bonds Bankrupcy

Post by TIAX »

inbox788 wrote: 2) How does this impact total bond funds like VBMFX/BND vs others? How small if any is the holding?
I believe the only Vanguard fund that has any uninsured Puerto Rico bonds is the High-Yield Tax-Exempt Fund, and such bonds represent only 0.6% of its holdings. It appears that, of these bonds, the Governor's letter only applies to the Puerto Rico GO bonds, which were already in default as of the date of the linked annual report.

Unless you're invested in a fund that has a high exposure to Puerto Rico bonds, there's nothing to worry about.
informal guide
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Re: Puerto Rico Bonds Bankrupcy

Post by informal guide »

Another interesting aspect of the P.R financial debacle is the various bond insurers. Bonds insured by some fiscally strong insurers are rated investment grade and are trading in he low investment grade price range; there are other bond insurers that are barely solvent (in insurance speak, under rehabilitation). Here is a 2016 quote from a Vanguard's Chris Alwine, head of Vanguard's municipal bond group:

"Impact on Vanguard funds is small
Vanguard municipal bond funds have little exposure to Puerto Rico debt instruments. Of the approximately $134 billion in Vanguard's municipal bond fund assets, as of May 31, 2016, only 0.10% was invested in Puerto Rico debt.

Of this exposure, only Vanguard High-Yield Tax-Exempt Fund holds uninsured Puerto Rico bonds. All other fund holdings are insured by firms able to make timely payments on claims if the situation warrants.3 Insured Puerto Rico bonds are held in Vanguard Intermediate-Term Tax-Exempt Fund, Vanguard Long-Term Tax-Exempt Fund, Vanguard New Jersey Long-Term Tax-Exempt Fund, and Vanguard New York Long-Term Tax-Exempt Fund."


I own a small P.R bond insured by one of those less solvent bond insurers. When P.R. defaulted, I got paid less than 25% of the interest due on the bond over the last three semi-annual interest payments. It is currently trading at around 60% of par, with a 5.5% coupon and a 2019 maturity.
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Re: Puerto Rico Bonds Bankrupcy

Post by TIAX »

informal guide wrote: I own a small P.R bond insured by one of those less solvent bond insurers. When P.R. defaulted, I got paid less than 25% of the interest due on the bond over the last three semi-annual interest payments. It is currently trading at around 60% of par, with a 5.5% coupon and a 2019 maturity.
Sorry to hear that. Can you link us to the EMMA (or some other) page where it shows these reduced payments? Did the insurer provide an explanation as to whether they plan to make full payments in the future?

Is it possible to see what payments an insurer is making on EMMA?
Tier1Capital
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Re: Puerto Rico Bonds Bankrupcy

Post by Tier1Capital »

States can definitely default and enjoy sufficient sovereign status to restructure their debt. It's happened before. Congress has floated the idea of a new, voluntary, state bankruptcy code on more than one occasion in recent years. If ever created, it would likely face a 10th amendment challenge, but it might work because it would be voluntary. I believe the motivation is political cover for the tough decisions that would need to be made between bondholders and pension liabilities.

Territories were created by federal gov't, not the other way around like the original states. PR was a situation for the federal gov't to address, which it did with passage of PROMESA.
wolf359
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Re: Puerto Rico Bonds Bankrupcy

Post by wolf359 »

Is anybody current living in or traveling to Puerto Rico? What is the practical effect of this bankruptcy in day-to-day life, or for someone who has retired there? Is it now someplace to avoid?

What actions should be taken to protect yourself from this bankruptcy? As far as I can tell the Vanguard Municipal Bond fund has no PR holdings, but I don't know if the broader municipal bond market will be affected.

This has been a long time coming, so much of it has been already figured into market valuations.
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Re: Puerto Rico Bonds Bankrupcy

Post by Admiral »

wolf359 wrote:Is anybody current living in or traveling to Puerto Rico? What is the practical effect of this bankruptcy in day-to-day life, or for someone who has retired there? Is it now someplace to avoid?

What actions should be taken to protect yourself from this bankruptcy? As far as I can tell the Vanguard Municipal Bond fund has no PR holdings, but I don't know if the broader municipal bond market will be affected.

This has been a long time coming, so much of it has been already figured into market valuations.
I was in PR in 2015; did not go in 2016 due to Zika risk. The economy there is GRIM. We were in a resort but did leave it on a number of occasions, and it was very, very depressing. The the PR govt was, at that time, trying to encourage high net worth individuals to buy property to shield their income from federal income taxes (shady but legal, apparently). A number of the big resorts were on building sprees, adding big homes to their properties to try to entice buyers. The entire thing struck me as a con/shell game.

Their teacher's pension system is, in the words of the Times, a "ponzi scheme":

https://www.nytimes.com/2017/03/08/busi ... sions.html
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inbox788
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Re: Puerto Rico Bonds Bankrupcy

Post by inbox788 »

informal guide wrote:Of this exposure, only Vanguard High-Yield Tax-Exempt Fund holds uninsured Puerto Rico bonds. All other fund holdings are insured by firms able to make timely payments on claims if the situation warrants.3 Insured Puerto Rico bonds are held in Vanguard Intermediate-Term Tax-Exempt Fund, Vanguard Long-Term Tax-Exempt Fund, Vanguard New Jersey Long-Term Tax-Exempt Fund, and Vanguard New York Long-Term Tax-Exempt Fund."

I own a small P.R bond insured by one of those less solvent bond insurers. When P.R. defaulted, I got paid less than 25% of the interest due on the bond over the last three semi-annual interest payments. It is currently trading at around 60% of par, with a 5.5% coupon and a 2019 maturity.
Thanks everyone for a great discussion on a complex situation that has many aspects. As expected, there is little risk in the event, and the event itself seems to be a minor and limited one, though moving one small step further down the bankruptcy path.

This differentiation of insured vs uninsured makes me question the cost and value of insurance on these types of bonds. With bond returns so low, what is the cost to insure? Too low and you wonder how the companies will pay out and too high and who's going to buy it? And this example of partial (quite small IMO) compensation for loss makes me wonder if the cost of insurance is just not worth it to the investor. It might be to the fund that sells an "insured" product. And there's probably different insurance for interest vs return of investment.
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Re: Puerto Rico Bonds Bankrupcy

Post by psteinx »

Muni bond insurance is a whole 'nuther topic.

Briefly, up until about 10 years ago, a large chunk of new issuance was insured. Issuers paid something for the insurance, to presumably get a better rating and lower yield. Investors didn't (so far as I know - there may be rare exceptions), pay directly for insurance, but presumably exhibited some preference for insured bonds, otherwise issuers wouldn't bother.

Then the insurers ran into problems. I think those problems were mainly caused by fallout from the housing/mortgage crisis (where insurers were also active), but anyways, it exposed the fragility of the insurers. So insured muni bonds largely stopped being a "thing". Yes, there are older bonds out there, issued a while back, that carry that insurance, for whatever that's worth. And I think there's still a small amount of of insurance going on for new issues, but not anywhere near what it was 15-20 years ago.

For a typical small-time investor like most of those on this forum, muni bond insurance just doesn't matter much, assuming you're not going to play in dangerous waters like Puerto Rico or the like.
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Phineas J. Whoopee
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Re: Puerto Rico Bonds Bankrupcy

Post by Phineas J. Whoopee »

Dirghatamas wrote:...
No no you misunderstood what I said. Obviously we all know that Munis are not taxed by the federal Govt. This is true for all states so fine PR also somehow made it by some act of congress. That is not the curious part.
...
Why do I know this? It randomly showed up as an article in my news feed a few years ago. I am always looking for tax optimization so the Google bot recommended it and I read it. I have no idea how this was made legal (you pay no federal taxes) but to me it implied a higher level of sovereignty than ordinary states.
1) You are right that I misunderstood your post. Thanks for the clarification.

2) You are wrong that there is any implication about sovereignty. Puerto Rico-derived personal income is exempt from federal income taxation because the US Congress, in which Puerto Rico has no full voting representation, created law that says it is. Congress can change that law, too, anytime it likes. There is no underlying US Constitutional nor international law reason, related to sovereignty or otherwise, why it must be that way.

PJW
Dirghatamas
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Re: Puerto Rico Bonds Bankrupcy

Post by Dirghatamas »

PJW
Just out of curiosity, I found the Google feed article again (it is from 2015) and re read it now. In hindsight, it seems obvious that one should stay away from shady things.

The gist of the article (from 2015) is that ordinary (or investment) income earned in PR is free from federal taxes making it the only state/territory in US where US citizens can be free of US federal taxes. That apparently had been in existence for a long time and is obviously a very big deal.

The new spin was that the Governor of PR at the time had created a constitutionally binding (I don't know what that means), executive order which allowed US citizens of NON PR heritage to settle in PR and pay no PR taxes. Apparently, this would be guaranteed for at least 20 years.

The punchline from the article was that for high net worth US citizens, moving to PR was the most tax efficient long term location one could have. Apparently (according to the article) this was creating excitement in Wall Street types with billionaires like John Paulson heavily investing in PR and considering moving there.

Of course for me this was non-actionable, just a mildly interesting article but it did leave me wondering how this could be legal and how this could be sustained (how will a state/territory survive with no taxes).

As it turns out the answer is obvious. When something looks shady and too good to be true, it probably is. With an economy nose diving rapidly, the then Governor was looking for quick money from any source and trying to guarantee all sorts of things.

As for sovereignty, thinking more, I agree with you. It (the tax stuff) doesn't imply a higher level but just a random, messed up situation where laws inconsistent with any other state could be put up.
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inbox788
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Re: Puerto Rico Bonds Bankrupcy

Post by inbox788 »

PFInterest wrote:Also why would you use corporates as a substitute? They are not the same.
Good question. I was looking at the options for low risk, one or two steps away from the no risk FDIC insured savings and CDs. Not sure if T-bills and iBonds fit the no risk category, but are very low risk. Next I found were the short term corporate, government and municipal bonds. Am I overlooking something else that might increase risk a little for a little extra return (to no more than a total bond fund)?

I'm still learning about their interest rate risk and sensitivity, tax benefits, after tax returns, etc. The amount was so small, I figured, I'd rather pay the tax on a higher yield, with possible lower after tax return, than deal with the tax reporting matters at this time. http://finance.zacks.com/report-tax-mun ... -4402.html As the difference grows, I'd take the more optimal after tax risk/return route, but events like this give me pause. Is the return higher because risk is higher?
Theoretical wrote:The default risk in municipals looks to be getting picked up by the market.

Highest yield 20 year AAA munis on Fidelity are barely lower yielding than AAA 20 year corporate bonds and barely higher than GSE bonds despite being tax-advantaged. Even at median yields, long munis are very close to GSE yields nominally.
Is there any way to measure or asses this default risk or compare the risk between muni, GSE and coprorate?
Theoretical
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Re: Puerto Rico Bonds Bankrupcy

Post by Theoretical »

Historically, municipal bonds have been dramatically safer than corporates, and even more so for GO or essential service revenue (like water/sewer, education, or transportation):

http://www.municipalbonds.com/education ... pal-bonds/.

As far as GSE bonds go, we already know Fannie and Freddie got saved, and they took on outrageous risks. The TVA is a unique utility that has internal sources of revenue, a debt cap, and is required to charge utility rates sufficient to service that debt. There's occasional talk of privatizing it, but it too is likely to get bailed out if necessary.

With munis, there is always the slight to moderate risk of tax reform changes removing their tax-exempt status, so that risk is priced in. However, for them to be yielding at near parity to equal maturity AAA corporates is troubling, because the yield spread for the corporates/Agency bonds is far lower than even a dramatic tax reform (say making bond interest taxable as qualified dividends) would suggest.

The black swan event with these would be a much higher bond default in investment grade municipals than the historical average.
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Phineas J. Whoopee
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Re: Puerto Rico Bonds Bankrupcy

Post by Phineas J. Whoopee »

Re-reading the thread, it seems there may be some misunderstanding on the part of some readers between the technical and colloquial meanings of the term bankruptcy.

Simple failure to repay a loan as agreed is default. Any debtor can do that all on their own, although it may have consequences.

Bankruptcy is much more complex. A power higher than the debtor relieves them of their obligation to pay. Once granted protection the debtor no longer is in default, because they no longer owe the money, within the confines of the bankruptcy court's order.

There is no power higher than a sovereign, so nobody has the legal authority to remove its obligations, unless its creditors forgive the debt, including by agreeing to accept less than originally contracted, which sometimes colorfully is called take a haircut.

Contrary to popular usage, one does not declare bankruptcy. One voluntarily petitions a bankruptcy court for protection. Current US practice is for the court to issue a temporary order upon receiving the properly filled out paperwork. Later proceedings determine whether the debtor is granted permanent protection. Such protection normally comes with a plan to make the creditors as whole as the court finds legal and reasonably possible.

The creditors too can petition a bankruptcy court, following a default, which may force the debtor into bankruptcy against its will.

The court can conclude no debt restructuring or relief is called for, which goes to the heart of the difference between declaring bankruptcy and petitioning for protection.

There exist political factions which disagree with certain high-profile orders from the last few years. Let's not argue about them. I'm trying to stick to facts about the processes and definitions. If I have those wrong then by all means, argue away, and as usual I'll accept any correction if I'm mistaken, and publicly thank the poster(s) who pointed it out.

Maybe my post will help someone navigate the admittedly confusing concepts and word usages.

PJW
Tier1Capital
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Re: Puerto Rico Bonds Bankrupcy

Post by Tier1Capital »

Phineas J. Whoopee wrote:The creditors too can petition a bankruptcy court, following a default, which may force the debtor into bankruptcy against its will.
This doesn't apply to municipal bankruptcies -- the Chapter 9 of the Bankruptcy Code.
NibbanaBanana
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Re: Puerto Rico Bonds Bankrupcy

Post by NibbanaBanana »

Wasn't the tipping point of the great financial crisis when the tiny island nation of Iceland went bankrupt?
TIAX
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Re: Puerto Rico Bonds Bankrupcy

Post by TIAX »

NibbanaBanana wrote:Wasn't the tipping point of the great financial crisis when the tiny island nation of Iceland went bankrupt?
Iceland isn't tiny and it didn't go bankrupt (whatever that means).
Northern Flicker
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Re: Puerto Rico Bonds Bankrupcy

Post by Northern Flicker »

There is no power higher than a sovereign, so nobody has the legal authority to remove its obligations, unless its creditors forgive the debt, including by agreeing to accept less than originally contracted, which sometimes colorfully is called take a haircut.
Puerto Rico is an exception, however, under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act. This was passed essentially to try to ensure an orderly default.

The event that made the news recently was Puerto Rico filing for Title III bankruptcy.
Risk is not a guarantor of return.
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Phineas J. Whoopee
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Re: Puerto Rico Bonds Bankrupcy

Post by Phineas J. Whoopee »

jalbert wrote:
There is no power higher than a sovereign, so nobody has the legal authority to remove its obligations, unless its creditors forgive the debt, including by agreeing to accept less than originally contracted, which sometimes colorfully is called take a haircut.
Puerto Rico is an exception, however, under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act. This was passed essentially to try to ensure an orderly default.

The event that made the news recently was Puerto Rico filing for Title III bankruptcy.
The point is Puerto Rico clearly is not sovereign, which gets to the heart of the posts I was responding to. If someone other than your creditor can relieve you of your debt, you can't possibly be a sovereign. Puerto Rico's debt can be reduced by action of a Federal court per legislation by the US Congress to which, even if there had been no other evidence (and it's plentiful - it needed Congress's permission and specific approval of the text to adopt a constitution, and as evidenced by PROMESA Congress can override it), Puerto Rico agreed by petitioning for relief. I had hoped I made the sovereignty aspect clear in the parts of my post you silently elided, in combination with my earlier posts in this thread. Evidently not.

PJW
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in_reality
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Re: Puerto Rico Bonds Bankrupcy

Post by in_reality »

Phineas J. Whoopee wrote:
jalbert wrote:
There is no power higher than a sovereign, so nobody has the legal authority to remove its obligations, unless its creditors forgive the debt, including by agreeing to accept less than originally contracted, which sometimes colorfully is called take a haircut.
Puerto Rico is an exception, however, under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act. This was passed essentially to try to ensure an orderly default.

The event that made the news recently was Puerto Rico filing for Title III bankruptcy.
The point is Puerto Rico clearly is not sovereign, which gets to the heart of the posts I was responding to. If someone other than your creditor can relieve you of your debt, you can't possibly be a sovereign. Puerto Rico's debt can be reduced by action of a Federal court per legislation by the US Congress to which, even if there had been no other evidence (and it's plentiful - it needed Congress's permission and specific approval of the text to adopt a constitution, and as evidenced by PROMESA Congress can override it), Puerto Rico agreed by petitioning for relief. I had hoped I made the sovereignty aspect clear in the parts of my post you silently elided, in combination with my earlier posts in this thread. Evidently not.

PJW
This is surely a point of contention for the upcoming litigation. To what degree the obligation was constitutionally guaranteed and what that means.

A bigger issue to me, one seemingly more relevant to non-PR bond holders, are very long term zero coupon type bonds issued through Goldman. These sold at huge discounts +90% because obviously payment is remote but were included in pension funds at their full value.

What an easy, tricky and deceptive way to boost your funding level.
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Phineas J. Whoopee
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Re: Puerto Rico Bonds Bankrupcy

Post by Phineas J. Whoopee »

This thread is about Goldman Sachs and pension funds' use of GAAP now?
PJW
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in_reality
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Re: Puerto Rico Bonds Bankrupcy

Post by in_reality »

Phineas J. Whoopee wrote:This thread is about Goldman Sachs and GAAP now?
PJW
Um maybe more about deceptive practices and pension liabilities which are a worry in general for munis.
Valuethinker
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Re: Puerto Rico Bonds Bankrupcy

Post by Valuethinker »

TIAX wrote:
NibbanaBanana wrote:Wasn't the tipping point of the great financial crisis when the tiny island nation of Iceland went bankrupt?
Iceland isn't tiny and it didn't go bankrupt (whatever that means).
Iceland has a population of about 300k people.

GDP estimated here at $12.3bn

https://en.wikipedia.org/wiki/Economy_of_Iceland

Both of these numbers would be less than 2 London boroughs put together.

What do you you consider tiny?

Iceland did not "go bankrupt" but it rescheduled its debts. The mistake the Irish made was to assume the debts of their vast (relative to GDP) banking system. The Icelanders refused to, and negotiated with countries like the UK and Netherlands forced to bail out their own citizens who were depositors of those banks.

Countries don't "go bankrupt" but they do default-- or reschedule if an event of default can be avoided.
informal guide
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Re: Puerto Rico Bonds Bankrupcy

Post by informal guide »

TIAX wrote:
informal guide wrote: I own a small P.R bond insured by one of those smaller, less solvent bond insurers. When P.R. defaulted, I got paid less than 25% of the interest due on the bond over the last three semi-annual interest payments. It is currently trading at around 60% of par, with a 5.5% coupon and a 2019 maturity.
Sorry to hear that. Can you link us to the EMMA (or some other) page where it shows these reduced payments? Did the insurer provide an explanation as to whether they plan to make full payments in the future?

Is it possible to see what payments an insurer is making on EMMA?
Thanks for your sympathies, TIAX. My sympathies go to the small muni bond holders who live in PR and who did not diversify their muni bond holdings beyond the various P.R. bonds. Here is the EMMApage on the bond I own - -I take full responsibility for taking the risk and being subject to the default.

https://emma.msrb.org/SecurityView/Secu ... =745220FJ7

The bond insurer of my bonds, FGIC, itself went into rehabilitation under NY State laws (in my view, bankruptcy for insurance companies) and emerged in 2013. Since then, they have been paying only a percentage of the claims submitted. - - now up to 25%. Other bond insurers are in much better situations. my payments from P.R. defaulted on this bond beginning January 2016, a little over 2 years after I bought it at just over 80 Cents on the dollar, face value. Your can Google FGIC and get a good picture of its mess.

This 2016 Fidelity Investments document is a good overview of the various Puerto Rico borrowers

https://www.fidelity.com/bin-public/060 ... -guide.pdf

Here is a good summary of today's bond insurers:

https://www.janney.com/File%20Library/F ... -final.pdf

I knowingly took risk on this bond -unlike other risky muni bonds I bought, this one will not do well over its term. It is now selling at around $60 per $100 par amount. It is doubtful I will even recover my nominal investment over the next 10 years, ignoring the time value of money. Fortunately it is a small portion of my muni portfolio.
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