Municipal bonds used to be conservative investments sold to Mom-and-Pop, buy and hold retail investors to put under their mattresses for years or even decades. Muni bonds were sold as stable, long-term investments with the clear advantage of generating tax-free income.
That is no longer the case. The $3.5 billion Puerto Rico municipal bond issuance in March shows that the muni market has transformed into yet another playground for ultra-wealthy hedge fund investors looking to make a fast buck. In the process, hedge funds and other high-risk investors have undermined the stability of the municipal bond market - the very stability that small retail investors crave.
This is nothing new in the investment game. As noted in this blog's recent post about Michael Lewis' new book, "Flash Boys," institutional investors and hedge funds have been manipulating the financial system for as long as stocks and bonds have been sold and traded. What's worrisome is that the municipal bond market has now been infected.
The primary purchasers of this debt were "buy and flip" hedge funds, such as Paulson & Co., led by billionaire John Paulson; Brigade Capital Management and Och-Ziff Capital Management. Each bought over $100 million in the offering and flipped much of it within days for a tidy profit, according to a report last week in The Wall Street Journal.
This was a highly unusual offering of 21-year bonds by the Commonwealth of Puerto Rico, which have yields north of 8%. Rather than holding for the long term, many of these investors were speculators and at least half of the offering has since been sold, according to the WSJ's Matt Wirz, who authored the article linked above.
Wirz also reports that the flipping of recently issued debt is likely to raise borrowing costs for the Commonwealth.
Since the March 11 bond sale, "prices of Puerto Rico's bonds have fallen amid concerns it may restructure some of its debt, hurting some investors who purchased bonds at the offering price," or par, Wirz writes. "Some hedge funds are known for their short-term investment strategies. If the island's debt investors sell in and out of their bonds, it could push up Puerto Rico's borrowing costs."
Another, perhaps more ominous sign for Puerto Rico is an indicator that its bonds may face a "restructuring." That means that Puerto Rico officials will seek more favorable terms for current debt agreements in an effort to avoid a default.
Restructuring professionals are descending on the island, according to the Journal. Cleary Gottlieb, a restructuring law firm, together with consultants FTI Consulting and Milstein & Co., are busy figuring out how to restructure and give a major haircut to existing bondholders. A big group facing such a decline in the value of their bonds are the retail investors who were sold Puerto Rico bonds and closed end funds in their portfolios by their brokers at UBS.
Investors holding what they thought were safe and secure Puerto Rico bonds should be prepared for the next stage in this island's wild financial ride.
Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions. For more information about Zamansky LLC, please visit http://www.ubspuertoricofunds.com/.
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.