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Billions of Puerto Rico's debt might be invalid, federal oversight board says

“This really is a milestone... It is perhaps the board’s best move in its two years of existence," said a Puerto Rican economist.
Image: The Capitol in San Juan, Puerto Rico, on July 1, 2015.
The Capitol in San Juan, Puerto Rico, on July 1, 2015.Joe Raedle / Getty Images file

SAN JUAN, Puerto Rico — The federal control board (FOMBPR) that oversees Puerto Rico’s finances is asking a court to invalidate more than $6 billion worth of debt issued by the U.S. territory, a move that would hit bondholders.

The board said late Monday the debt includes all general obligation bonds that were issued in 2012 and 2014 in “clear violation” of debt limits established by Puerto Rico’s Constitution. Instead of adhering to a balanced budget requirement, they were used to finance deficit spending.

If a federal judge agrees with the allegations, bondholders would lose their investments.

“This really is a milestone,” Puerto Rico economist José Caraballo told The Associated Press on Tuesday. “It is perhaps the board’s best move in its two years of existence."

It is unclear when a judge would rule on the board’s motion, but Caraballo said it gives the government bargaining power, noting that Detroit made a similar move during its bankruptcy.

Caraballo said those who bought general obligation bonds during that time might accept a big cut instead of risking a total loss, according to him, most of them are hedge funds and not individual investors.

“It was a very speculative emission,” he said. “They ran the risk of lending to a government they knew was in trouble and ignored the margin established in the Constitution.”

The board’s findings come after the board called for an independent investigation that began in September 2017 of all debt issued by Puerto Rico and its connection to the island’s current fiscal crisis.

According to the report released in Aug. 2018 by the firm who helped the board conducts its investigation, as of May 3, 2017, Puerto Rico had about $74 billion of bond debt and $49 billion of unfunded pension liabilities.

"For an economy of Puerto Rico’s size, the burden of this debt has been catastrophic—it has been a financial, and ultimately a humanitarian, catastrophe. The toll it has taken on the people of Puerto Rico begs a pressing question: How did it happen?" the report stated.

Advocacy groups like Hedge Clippers have been very vocal about the need to answer such a question.

“The Fiscal Control Board finally acknowledges what we have been saying for years, that the debt is illegal and shouldn’t be paid," said the group in a press release regarding the board's latest move. "The Board has the power to stop this abuse by allowing a citizen and democratic audit of all the debt, and then return to the Courts to demand the cancellation of all illegal debt."

No government officials have been accused of issuing debt above the limits established in Puerto Rico’s Constitution.The island’s now-defunct Government Development Bank, which issued loans and oversaw debt transactions, ceased operations in March amid a 12-year recession.

The bonds were issued in 2012 during the pro-statehood administration of Gov. Luis Fortuño as well as under the pro-commonwealth administration of Gov. Alejandro García Padilla.

Puerto Rico is trying to restructure a portion of its more than $70 billion in public debt and a federal judge is scheduled to hold a two-day hearing within days on a major debt restructuring case involving bonds backed by a sales-and-use tax.

Puerto Rico’s government announced in June 2015 that it was unable to repay its debts and declared a form of bankruptcy in May 2017.