Puerto Rico's economy and bond ratings are starting to resemble those of Detroit and Greece. Larry Summers, the former Treasury Secretary last week called Puerto Rico's bonds "the junkiest of the junk".
The question, burned UBS retail bond investors are asking is, how did this happen?
Look no further than the pockets of Wall Street for the answer. The Street's endless thirst for underwriting fees and brokerage commissions has brought the municipal bond market in Puerto Rico to the brink.
The Wall Street Journal recently reported that in 87 bond deals since 2006, Puerto Rico sold $61 billion of bonds which resulted in fees to Wall Street firms and their cohorts of $1.4 billion. The fees charged were higher than those assessed on other financially troubled US states and cities. In fact, according to Reuters, banks such as UBS, were paid gross spreads averaging 31% higher than spreads charged to Detroit.
UBS, one of the major underwriters of Puerto Rican debt, not only charged fees to underwrite Puerto Rican bonds, they then neatly packaged these bonds into their own "closed end mutual funds", charged retail investors a "front end load" of 4.75 % and annual fees of 1%.
Due to the increasing deterioration of the municipal bond market in Puerto Rico, investors have been forced to liquidate due to margin calls and vulture hedge funds, according to reports from the Wall Street Journal and Bloomberg this week, are jumping in to take advantage.
These hedge funds with enormous resources and great research capabilities, are buying Puerto Rican bonds for their portfolios at discounts of 30% to 50% of par value. According to the Wall Street Journal, an investor call hosted by the Puerto Rican Government Development Bank drew 1200 participants, "an unusually large number for a municipal - investor presentation".
"Hedge funds are making a large bet on municipal debt, bringing aggressive tactics to a $3.7 trillion market long known as humdrum," according to a report in today's Journal by Michael Corkery and Matt Wirz. "The strategies include demanding high interest rates in return for financing local governments, buying the debt of struggling municipalities on the cheap, and trying to profit on rising volatility as many mom-and-pop investors who have dominated the municipal-bond market for decades flee amid deepening fiscal problems in many U.S. cities and states."
"Hedge funds are a new phenomenon in our market," said Richard Larkin, director of credit analysis at brokerage firm H.J. Sims & Co., who has spent 38 years as a municipal-bond analyst. "And I don't think there is any good that can come of it."
To understand how Puerto Rico is in such dire straits, simply follow the money to Wall Street.
Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.