Review & Outlook

Our take on the investing, financial, & economic themes of the day

Puerto Rican Debt Crisis Heats Up Again: Judgment Day for Greedy Bond Fund Managers?

After the market close the other day Moody’s downgraded Puerto Rico’s municipal debt by three notches, lowering its estimation of the island’s bonds to junk status.  I wrote about the Puerto Rican debt crisis last year in December.  Puerto Rico’s risky municipal debt contaminates a lot of bond mutual funds, since its income’s double tax exemption (from both federal and state taxes–every state in the Union, that is) and high yield has proved irresistible to many fund managers.  In particular, some state-specific bond mutual funds unconscionably loaded up on Puerto Rican bonds in order to juice yields and entice investors.  The result is that lots of mom and pop investors who thought they were investing their nest egg in relatively safe municipal bonds from their home state were actually buying a quasi-junk bond fund.  One of the biggest offenders was the Oppenheimer Rochester Virginia Municipal Fund (ORVAX), which at one point had over 30% of assets in Puerto Rico bonds.  A number of these bond mutual fund managers are now suing Puerto Rico, which looks to me like a preemptive defensive move to protect themselves from their own shareholders’ eventual lawsuits.

Puerto Rico has more than $70 billion of total debt outstanding.  By comparison, New York City has about $110 billion outstanding, but New York City’s population is about 8.4 million  and growing, while Puerto Rico’s is 3.6 million and shrinking.  (A wag in my office asks how much of Puerto Rico’s population is already resident in New York, if not going there.)  In short, it don’t look good.

The Puerto Rico situation is a nice case study in the continuing rationale for investing in individual bonds instead of bond funds: investors should know what they own and why they own it.