Berko: Puerto Rican bonds a bad buy

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Malcolm Berko addresses questions about stocks. Reach him at P.O. Box 8303, Largo, FL 33775 or mjberko@yahoo.com.

Dear Mr. Berko: In 2013, my stockbroker had me buy $60,000 worth of Puerto Rican Sales Tax Financing Corp.’s tax-free bonds. I bought these bonds for my individual retirement account. The coupon was 5.5 percent. I paid $770 per $1,000 bond ($46,200 total), and they were supposed to mature in 2022. I got a great 7 percent current return, and the bonds were guaranteed by the collection of sales taxes in Puerto Rico. But now the bottom has dropped out. The bonds pay nothing, and I’ve lost at least 50 percent of my investment. My broker says that the bonds were recommended by his firm and that he didn’t know they were risky. Three of my golfing buddies use the same broker and own the same bonds. What are our chances of getting out of this without getting scorched? Could you explain what happened?

— C.D., Springfield, Ill.

Dear C.D.: Puerto Rico was a foreseeable economic disaster. It was a result of such gross political stupidity that even members of Congress were stupefied.

For at least a decade, Puerto Rico (meaning “rich port” in Spanish) was a predictable disaster from which only a limited recovery was possible. Bondholders, mostly hedge funds and bottom feeders, purchased huge pieces of Puerto Rican debt because Congress encouraged them to believe that those bonds had the imprimatur of the U.S. Treasury. Wall Street’s hedgies and bottom feeders bought the island’s bonds at enormous discounts, pocketing 8 to 12 percent tax-free. Now they’re bleeding like stuck pigs.

For years, these funds paid dues to their congressmen, believing Washington would, if necessary, rescue and guarantee Puerto Rico’s bonds. But for unexplained reasons, when push came to shove, Congress refused to guarantee Puerto Rico’s debt.

Because Puerto Rico cannot declare bankruptcy, the Obama administration devised a plan called the Puerto Rico Oversight, Management and Economic Stability Act, or PROMESA (which means “promise” in Spanish). One of the elements of PROMESA is a “cram-down” provision giving the insolvent Puerto Rican government the power to force a bad deal on unwilling creditors. This gives Puerto Rico’s politicians (and certain members of Congress) nearly czar-like control over how much of and to whom Puerto Rico’s billions of dollars’ worth of debt is to be paid.

Be assured that the bottom feeders who made the requisite political contributions will be treated with favoritism. Selected Puerto Rican politicians will receive their expected vigorish, and some members of Congress will also participate. And it shouldn’t come as a surprise that swarming U.S. lawyers will usurp a handsome percentage of every claimant’s distribution. And you, dear reader, because you own this in your IRA, won’t even get a tax loss!

Next time you see Mitch McConnell, Harry Reid, Jack Lew, Chuck Schumer and Marco Rubio on TV, be mindful that they voted for and supported PROMESA. You’ll recognize them by their sincere smiles, their candid rhetoric and their tonsured hair. The financial press has gone overboard to be fair. But the media fail to recognize that many of the participants consider this an opportunity to butter their own nests. And that’s a low blow.

There’s more. There’s a very concerning provision in PROMESA stipulating that if board members are unable to agree on the amounts to be distributed and to whom, Congress can remove them and appoint preferential members to the board. It’s concerning because the consensus believes that influential members of Congress could propose guarantees to Puerto Rico like those made to the Tennessee Valley Authority, New York City in the 1970s, Fannie Mae, Freddie Mac and Detroit recently. There’s going to be millions of dollars waiting to pollute a politician.