Christie plan to give lottery to pension fund just a distraction

The pension fund would get the same $1 billion from the lottery or state budget. But for accounting purposes, the money counts more if it is being produced by an asset of the pension fund. So – presto chango! – the state’s unfunded liability would drop by $13.5 billion, says the Treasury Department.

This would only matter if it prompted debt-rating agencies to upgrade New Jersey (after years of downgrades) and reduce its borrowing costs. The bond analysis firm Municipal Market Analytics told Observer New Jersey that is unlikely. Sen. Jennifer Beck, R-Monmouth, sensibly prefers to hear from Moody’s or S&P before voting on the lottery plan.

Retirees, minimize your costs when buying bonds

But small investors can incur hefty trading costs even in higher-quality, less-obscure bonds. Research firm Municipal Market Analytics offers this example: Looking at a California general-obligation bond maturing in 2037, there were two inter-dealer trades on the morning of March 17 at nearly the same price: $112.73 and $112.67. Three minutes later, a customer bought $50,000 worth of the bonds at $115.10—2.2% more. Less than an hour after that, a large investor buying $6.9 million worth of the bonds got something much closer to the inter-dealer price: $112.99.

Such price discrepancies can make the muni market "very difficult for an individual investor," says Thomas Doe, president of Municipal Market Analytics. The market actually resembles a "flea market," he says, "because you have this eclectic product, very inconsistent supply and demand, and you're just trying to match the product with a buyer."

Chicago Public Schools borrow $275 million at sky-high interest rate

Matt Fabian, a partner at Municipal Market Analytics, said the 6.39 percent interest rate is about 4.5 percentage points “more than a ‘regular’ issuer would pay, but CPS left ‘regular’ two years ago.

“CPS has no regular market access so the price they pay to borrow is always the product of negotiation,” he added.

Goldman Sells American Dream in Unrated Municipal-Bond Deal

Investors purchasing the American Dream bonds will need to weather the potential pitfalls: The 1,136-page offering statement includes 36 pages of risks, ranging from whether the project will be completed on time to the “difficulty, expense, unfamiliarity and time-consuming nature" of getting to the center.

American Dream is across the highway from MetLife Stadium, the home of the National Football League’s New York Giants and New York Jets. Events at the stadium could adversely affect attendance.

Lisa Washburn, a managing director at Municipal Market Analytics, was skeptical that tourists coming to New York, with all of its culture, entertainment and shopping, would get on a train or bus to the Meadowlands, “a difficult to-get to destination in a relatively unattractive part of New Jersey."

“Parking and transportation is really substandard in this area," said Washburn.

New Jersey pension lottery plan is gamble: MMA

New Jersey Gov. Chris Christie’s proposal to used dedicated state lottery revenues to boost its underfunded pension system is not a viable solution, according to Municipal Market Analytics.

Christie has pushed the lottery plan since his February budget address arguing that that it would lead to an immediate $13 billion improvement in the pension fund’s unfunded liability. However, MMA partner Matt Fabian noted in a report released Tuesday that the proposal

Christie betting that lottery can bail out troubled pensions

Analysts and advocates say the deal — an arrangement that would be unique to New Jersey — probably won’t hurt, but there’s not a consensus on how much it might help.

“Where it does provide tremendous relief is optically,” said Lisa Washburn, managing director at Municipal Market Analytics, a firm that analyzes government bonds. “The numbers look better on a whole lot of levels. Whether or not they’re truly better is questionable.”

Since Christie took office in 2010, the state has contributed more than $6 billion to retirement funds to which past governors have often skimped on payments — or skipped them entirely. Still, the gap between the money expected to be in the funds and that which is owed to retirees has only grown. By any measure, it’s among the biggest unfunded pension liabilities in the country.

Puerto Rico Bond Traders Still Find Buyers Despite Epic Collapse

Since that filing, the 50- and 200-day moving averages for daily trade volume have increased by 17 percent and 6 percent, respectively.

“It has become more clear that there isn’t much money,” said Matt Fabian, a partner with Municipal Market Analytics Inc. “Maybe Puerto Rico investors were too optimistic in what they thought the control board would do or what Puerto Rico could theoretically pay them.”

While the securities are easily sold, some are still hovering near record lows. 

From Tax Codes to Traffic, a Megamall’s Risks

Sixty-nine percent of American Dream's 2.9 million square feet of space has been leased to tenants like Saks, Lord & Taylor, and Primark. There will also be a Nickelodeon amusement park and a DreamWorks water park.

Still, says Lisa Washburn, a credit research analyst for Municipal Market Analytics, the project should give any investor pause.

“I still remain skeptical about the ability for success for the project generally and specifically very concerned about the risks to bondholders,” she said.

S&P Downgrade Brings Illinois Closer to Junk--Update

Illinois also would have to make millions of dollars in termination payments on existing interest-rate swap contracts, according to S&P. Those penalties would be about $10 million in the event of a downgrade to junk by one rating firm, would reach $19 million if two firms gave the state a junk rating and could reach $108 million in the event of further downgrades.

"By letting the state get downgraded, Illinois's government is only making its own budget problems worse," said Matt Fabian, a partner at Municipal Market Analytics

Analysts for all three ratings firms have said that Illinois has significant economic strengths and that its deteriorating credit is in large part a result of political gridlock.

Muni-Bond Vultures Rethink Risks Lurking in Market's Junk Yard

Distressed muni-debt traders usually buy when the credit rating of a bond is downgraded to junk status. That’s when institutions, such as mutual funds, are forced to sell or otherwise long-term retail investors get spooked.

“Next time around, you bet that they’re going to be asking for lower prices when mutual funds want to unload something like Illinois,” said Matt Fabian, a partner with Municipal Market Analytics Inc. in Concord, Massachusetts.

“How the country will deal with municipal default is likely in its infancy,” Hatch said. “Ideas are forming, from a legislative and judicial standpoint, as to how we’ll handle large insolvent municipal entities.”

The flouting of constitutional rules may cause distressed muni-bond investors to insist on discounts, but it won’t scare them away from the market, Fabian said.

Municipal Bonds Richest in a Year as Supply Dries Up in Summer

The rally in municipal debt comes as analysts expect supply to continue to shrink in the summer months at the same time that cash-rich investors will have a hoard to invest. Citigroup Inc. analysts predicted that the market will shrink by $39.5 billion between June and August, while investors will receive $44 billion in interest payments.

"Because of the lack of supply relative to demand, and because of the relative height of nominal yields, its going to be hard for munis to project weakness over the summer," said Matt Fabian, a partner with Municipal Market Analytics Inc., in a telephone interview. "Left to their own devices, munis will be prone to rally."

Local Governments' Hidden Reason to Oppose Tax Cuts: Bank Loans

Some local governments have a hidden reason to root against President Donald Trump’s tax-cutting agenda: It could make their bank loans more costly, according to Municipal Market Analytics.

Municipalities have borrowed billions from banks to skirt the expenses associated with public bond offerings. But banks often include provisions enabling them to raise the interest rates if legal or regulatory changes diminish their returns. A cut in the corporate tax rate, for example, would likely result in a lower after-tax yield on a tax-exempt loan, potentially triggering “yield maintenance" provisions, wrote analysts at MMA, a Concord, Massachusetts-based independent research firm. 

“Given the current administration’s focus on tax-reform and/or tax cuts, borrowers that have these yield maintenance provisions could see their debt service costs rise," MMA wrote. 

Direct lending by banks has proliferated in the $3.8 trillion municipal market because states, local governments and non-profits can borrow at rates comparable to those on bonds, without the fees or disclosure requirements associated with securities sales.

Because loans aren’t classified as securities, states and cities aren’t immediately required to disclose them, despite the risk they can pose to bondholders and taxpayers. For example, banks can demand accelerated principal and interest if a payment is skipped or a government’s cash falls below a specific target, which could push the borrower into a liquidity crisis if it can’t cover the bills. 

MMA estimates that some $180 billion of such loans have been made. But given the lack of disclosure, it’s impossible to know how many borrowers might be subject to rate increases if federal taxes are cut, MMA wrote.

Under fire, Emanuel defends ‘payday loan’ plan to borrow $389M for CPS

“Borrowing against uncertain and late categorical funding from the state … may allow the district to remain open through the end of the school year and make its statutory pension payment, but it will come at a heavy price, both in terms of a high borrowing cost and the reputation of CPS. Worst of all, it does not help with the Chicago Public Schools’ budget shortfall next year and will, indeed, make it worse,” Msall said.

Matt Fabian, a partner at Municipal Market Analytics, said CPS is already the “main risk to the city from a triage perspective” and, therefore, the city would have been better off “giving” the district the short-term money it needs.

He suggested the city either borrow the money for CPS or raid the tax-increment-financing (TIF) surplus yet again, just as Emanuel did to the tune of $87.5 million to stave off another teachers strike.

“That’s a better option than paying 8.5 percent interest and taking more risk. There’s no reason to assume that the state grants are gonna be provided anytime soon,” Fabian said.

“The problem for Chicago and CPS is that the state is simply not going to help or the state is unwilling to help. So, the city and the school district need to work out plans of their own. Because they continue to rely on the state, they keep winding up in this same situation.”

Fabian urged Emanuel to move quickly to identify a permanent, local source of revenue for the Chicago Public Schools.

“Speaking for Wall Street, the street is impatient to get to a full-funding scenario. Investors want the long-term solutions produced in the short-term. As far as figuring out what taxes to raise and what spending to cut, full speed ahead,” he said.

The Chicago Sun-Times has reported the mayor is considering taxing high net-worth individuals, downtown businesses or both to generate the $400 million-to-$600 million needed to put CPS on more solid financial ground.

“That is one of the easiest things for Chicago to tax because they have had strong growth downtown. That would seem one of the more resilient areas of the economy to tax. It’s not unreasonable to look there first,” Fabian said.

“There isn’t much tax capacity in the neighborhoods and, from a national perspective, Chicago’s economy is very healthy. So, it could handle a higher tax burden, especially downtown.”

Fresh Off Another Downgrade, Connecticut Has a Plan to Lower Borrowing Costs

Nappier wants the state to start offering investors revenue bonds that are paid back directly from the state’s income tax revenues. Called tax-secured revenue bonds, these new bonds would be offered in place of general obligation bonds, which are backed by the state’s general revenue collections. Nappier’s office believes the dedicated income stream would mean the bonds would fetch ratings as high as AAA, resulting in a better interest rate and lower debt service costs.

The idea has received mixed reviews.While some observers call it a product that will offer comfort to bondholders wary of Connecticut’s troubles, others say it’s a “financial engineering gamble” designed to game the market. “To create something out of nothing -- they’re not being more fiscally responsible by doing it this way,” says Municipal Market Analytics’ Lisa Washburn.

Belle Haven Investments’ Tamara Lowin says Nappier’s proposal is simply another way to assure investors they’ll get their money back with interest. “This market loves the transparency of being able to see a direct revenue stream,” she says. “It’s a way to offer a credit designed with the ratings agencies in mind.”

But Washburn isn’t so sure that potential investors will be reassured by the new bonds and be willing to take a lower interest rate on the debt. “The likelihood that Connecticut will ever default and be in a situation where you have to test the structural provisions is really, really low,” she says. “But would I want to give it a pricing benefit as an investor? It’s definitely questionable.”

Muni Bond Ripple Effects Of The Puerto Rico Bankruptcy

There are major ripple effects as a result of this bankruptcy, and they affect large mutual funds, tax-free bond strategies for many retired investors, and scattered individual bond issues. The holistic concern is that risk is now being added to a sector where traditionally risk was considered to be extremely low.

That's because the Puerto Rico default is not only the largest in American history, but it comes on the heels of Detroit, Stockton, and numerous other municipal defaults. This Moody's report provides information on the largest defaults up through 2014, and this one for 2015. In his report on 2016 defaults, including Puerto Rico, Matt Fabian of Municipal Market Analytics says, "This is a dramatic reshaping of the industry's overall risk profile and will doubtless drive at least somewhat more conservative investor behavior in the future, in particular as regards large distressed governments like IL, NJ, CT, KY, and Chicagoland credits."

Puerto Rico Debt Donnybrook Kicks Off With Default Squabble (1)

Emma Orr, Steven Church and Michelle KaskeMay 11, 2017 9:31 am ET

(Bloomberg) -- Dealing with Puerto Rico’s crushing debt has started to resemble a circular firing squad.

Simply put, the bankrupt island can’t pay everything it owes, so creditors are taking aim at each other as they squabble over who will get what’s left. But the debt’s size and the tangled process invented to rescue Puerto Rico mean there’s no established rule book to shape what comes next.

Holders of general-obligation debt have declared their right to be paid first, owners of sales-tax bonds are squabbling with one another over who deserves priority, and they’re all up against the commonwealth’s leaders, who want the cash for essential services. Amid this melee, Puerto Rico’s federal overseers will have to choose between paying U.S. hedge funds everything they’re owed or keeping schools, water and electricity running.

“There just isn’t enough money,” said Matt Fabian, a partner with Municipal Market Analytics Inc. in Concord, Massachusetts, who foresees a chaotic brew of lawsuits, federal interventions and politics. “Nobody has any idea what’s going to happen.”

All told, Puerto Rico has about $74 billion in debt and $49 billion in pension liabilities. Hedge funds holding $1.4 billion of general-obligation bonds, including Aurelius Capital Management and Monarch Alternative Capital, have already sued to get overdue principal and interest. On the other side, owners of $17 billion in sales-tax bonds, including Tilden Park Capital Management and GoldenTree Asset Management, have entered the fray. They’ll meet for the first time in court on May 17 in San Juan.

Default Notice

The dispute over the sales-tax bonds, named Cofinas after the agency that issued them, began in earnest May 4. That’s when the trustee, Bank of New York Mellon Corp., sent a notice of default to the authority that sold the bonds. The object was to keep the government from diverting the sales-tax revenue to other purposes before it pays what it owes to investors.

The New York-based bank acted after weeks of pressure from senior bond owners who urged the trustee to safeguard their claims. In the process, junior bondholders were irked because the default notice could mean no payments for them until the senior bondholders are paid in full. The notice sets a 30-day deadline for a response from Puerto Rico, which is supposed to pay about $256 million of principal and interest on Aug. 1, according to data compiled by Bloomberg. 

Puerto Rico’s status as a commonwealth means it’s not subject to traditional bankruptcy laws. Instead, the island filed for the next best thing to deflect claims, called Title III. It’s an in-court restructuring based on the U.S. bankruptcy code that was created under Puerto Rico’s Promesa law last year. But it’s never been used before, which means any cuts imposed by U.S. District Court Judge Laura Taylor Swain will be more likely to face years of appeals than a typical case.

Delayed Filing

Puerto Rico’s initial Title III filing on May 3 didn’t include Cofina. If it had, BNY Mellon may have been prohibited from sending its May 4 default notice. But the oversight and management board didn’t file its separate Title III action for Cofina until May 5, giving the bank a window to declare the default.

The delay means it’s unclear whether the Title III filing voids BNY Mellon’s default notice, as well as a separate default notice sent by Ambac Assurance Corp. on May 1. Regardless, BNY Mellon and senior creditors are prepared contest a court’s decision if it’s not in their favor, according to a person familiar with the matter, who asked not to be identified discussing private information. The government hasn’t said how it will respond.

“As a public policy, legal defense strategies are not discussed until they are presented in judicial forums,” Yennifer Alvarez, a spokeswoman for Governor Ricardo Rossello, wrote in an emailed comment.

The senior bondholder group, which controls about one-third of the senior Cofina bonds, is led by hedge funds Whitebox Advisors, Tilden Park Capital Management, GoldenTree Asset Management and Merced Capital, according to Susheel Kirpalani, a lawyer at Quinn Emanuel Urquhart & Sullivan who represents the group.

Debt Due

For investors, there’s a lot at stake. Cofina holders are owed more than $8 billion in debt service through 2026, with $704 million in payments due in the next fiscal year, which starts in July, according to the commonwealth’s fiscal plan.

The territory owes all bondholders $33.4 billion in debt payments between now and 2026, according to the plan, but it proposes to pay only about $8 billion. The government hasn’t said how bondholders should divide those payments, or which group is first in line.

“This is a government restructuring, not a court one, so the government will be in the driver’s seat,” Fabian said. “Creditors will not be heard to the extent they’re saying, ‘let’s do it a different way.’ Those arguments won’t have any standing in a court.”

Owners of junior Cofinas could be left vulnerable. BNY Mellon holds a trustee reserve fund of sales-tax revenue with about $400 million, more than enough to handle the upcoming August payment, according to people familiar with the matter.

But because of the default notice, junior bondholders are unlikely to be paid, in order to safeguard claims of the senior Cofinas, said the people, who asked not to be identified discussing private transactions. Given the limited funds available for debt repayment, there’s a chance the subordinated holders could get little or no recovery. A representative for BNY Mellon declined to comment.

What’s more, general-obligation bondholders claim that the entire Cofina structure violates the island’s constitution, and all the sales-tax revenue is owed to them. If the general-obligation claims are supported in court, all of the Cofina debt could be ruled invalid and investors could receive nothing at all.

(Updates with BNY Mellon location in seventh paragraph.)

--With assistance from Rebecca Spalding

©2017 Bloomberg L.P.

Chicago Public Schools May Fall Short on Upcoming Pension Payment

by Tribune News Service | May 10, 2017

By Juan Perez Jr. and Hal Dardick

Chicago Public Schools has enough cash to complete the school year but the system is still short hundreds of millions of dollars needed to make a pension payment due at the end of June, Mayor Rahm Emanuel's top finance official said Tuesday.

CPS and city officials say that's because the state still owes CPS about $467 million in aid that has been held up by Illinois' budget impasse.

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While still trying to come up with a plan to keep the district from running out of cash, CPS and Chicago Chief Financial Officer Carole Brown used the state aid shortfall as the latest salvo in an ongoing battle with Republican Gov. Bruce Rauner's administration over funding.

"We're in this horrible, horrible position because the state's not doing its job," Brown said. "And the thing we hope people will do is encourage and push the state to pass a budget and pass a budget that has adequate funding for schools."

The state disputes the amount owed the district and blames the issue on a failure by Democratic state Comptroller Susana Mendoza, an Emanuel ally and Rauner critic, to make payments.

Officials say that without short-term borrowing or some other rapid infusion of money, the district will fall far short of making a $700 million-plus contribution to the Chicago Teachers' Pension Fund. Making a late or incomplete pension payment could violate state law and prompt a negative response from bankers the district needs to stay afloat.

"This is clearly a bad option," pension fund Executive Director Chuck Burbridge said Tuesday.

"I don't think the rating agencies would respond well to them missing the pension payment," Burbridge said. "Everybody knows where that gets you."

Brown on Tuesday acknowledged officials have discussed withholding the pension payment as they test ideas with bond rating agencies to see which would do the least additional harm to the district and the city's already low bond ratings.

"It's an option that we've talked about, but it's not an option that anybody's concluded is something that's viable, or an option that anyone's concluded is the preferred course of action," she told the Tribune.

Brown's comments reflect an ongoing debate within city government over how Emanuel can craft a CPS financial rescue that would likely also have to address another looming budget mess next school year.

Brown said CPS funding options include short-term borrowing, a loan from the city's tax increment finance districts and delaying payments to vendors that provide services to the district.

She declined to rule out reinstating a so-called head tax on jobs at large firms that Emanuel eliminated with much fanfare in his first term but which some aldermen and the Chicago Teachers Union have proposed resurrecting.

"I don't have the luxury of telling you we definitely aren't doing anything," Brown said.

The district began this budget year counting on $215 million from the state to help pay for teacher pensions. But Rauner vetoed the funding measure because he said legislators didn't tie it to broader pension reform.

CPS proceeded to cut school budgets and filed a lawsuit challenging state education funding. District CEO Forrest Claypool warned that Rauner's veto would force schools to close almost three weeks early. But after a Cook County judge rejected the district's lawsuit in April, Emanuel quickly staged a news conference to say the school year would go on as scheduled.

The district said it reduced its budget gap after Rauner's veto to $129 million, but it has regularly declined to acknowledge whether it had enough cash to pay the bills.

The $467 million in state funds that CPS says it is owed are separate from the $215 million in pension assistance from the state that the district had counted on. The money represents education grants that are part of regularly scheduled aid payments distributed to school districts across the state.

State government distributes general aid to school districts as well as grants that finance specific programs but are ultimately swallowed up and used for expenses in the district's multibillion-dollar operating budget. The budget impasse has delayed the distribution of more than $1 billion of that grant aid to schools across the state, a Wall Street ratings agency concluded last month.

Illinois State Board of Education records indicate CPS is owed roughly $324 million in grants that have yet to be processed by Mendoza's office. The district maintains that doesn't cover the full total owed by the state.

Rauner's office said Mendoza's office can send the money awaiting processing to Chicago at any time. Mendoza's office says there's no money to cut those checks without a state budget.

As of Tuesday, the teachers pension fund said CPS owed it about $716 million. The fund said it expects CPS to pay about $470 million of that tab by June 30, with the rest payable after a quarter-billion dollars in revenue arrives later in the summer from a new property tax devoted to teacher pensions.

Burbridge said the pension fund's outlook changes if the city falls short on its payments for less predictable reasons, such as a lack of state aid.

"The critical thing for us is being able to plan so we can structure our investments appropriately to both make the pension payments that are certain and take advantage of markets and the compounding impact of interest and dividends," he said.

Emanuel's administration told aldermen this week the issue is "extremely complex" while delaying an update on district finances. The solution will hold consequences not only for students, parents and teachers, but for the district's reputation with financial markets.

"The district doesn't have any good choices," said Matt Fabian, a partner at Concord, Mass.-based Municipal Market Analytics.

"Arguably, their biggest problem this year was relying on the state to help them in any way," Fabian said. "Their fundamental problem is they spend too much money they don't have, but really in fiscal year 2017, it's been relying on the state to fill that gap."

___

(c)2017 the Chicago Tribune

Puerto Rico's Bankruptcy a 'Dramatic Reshaping' of Muni Risk

The muni market hasn't posted much reaction to Puerto Rico's mammoth bankruptcy filing this week. The iShares S&P National AMT-Free Municipal Bond Fund  (MUB) stayed right around $109, roughly where it has been for the past three months.

But that doesn't mean muni investors should be shrugging off the largest bankruptcy filing in U.S. history.

Municipal Market Analytics' Matt Fabian puts it in pretty start terms in his Default Trends report Friday. Here's his summary of his report:

Assuming all remaining Puerto Rico bonds end up in payment default, as now appears likely, the municipal market's total for bonds in default will have roughly doubled to $74B, with Puerto Rico issuers accounting for 85% of that total. This would also roughly double the municipal market's current default rate from 1.02% to 1.93% (versus 0.30% excluding Puerto Rico bonds). This is a dramatic reshaping of the industry's overall risk profile and will doubtless drive at least somewhat more conservative investor behavior in the future, in particular as regards large distressed governments like IL, NJ, CT, KY, and Chicagoland credits.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Puerto Rico Declares “Bankruptcy” Due to $123 Billion in Debts

The island owes $74 billion in bond debts and $49 billion in pension payments.

Earlier this week, Puerto Rico, an American territory, sought “bankruptcy” protection after years of economic downfalls and facing $123 billion in bond and pension debts. So why did it take over two years for the island to address these problems?

First off, it’s not exactly bankruptcy since Puerto Rico is only a territory and the island cannot receive the same Chapter 9 protections like the states. Second, it was not until last year that Congress passed the Puerto Rico Debt Relief Bill:

The legislation would create a federal oversight board, appointed by Washington, with power to restructure Puerto Rico’s unmanageable debt load.

The bill provides for a stay, or halt, to any litigation brought against the Puerto Rican government and its debt issuing agencies that is retroactive to December. This provides breathing room for the board to start the process of restructuring and oversee a sustainable budget process.

The Puerto Rico Financial Oversight and Management Board

This committee invoked that law passed by D.C. in June of last year. This means that the island’s “standoff with creditors” will now go “before a federal judge in San Juan in a restructuring process known as Title III.” Supreme Court Justice John Roberts will select a judge to hear the case. He may choose any federal judge he wishes.

The Wall Street Journal explained how this will work out:

Chapter 9, which the city of Detroit used to obtain $7 billion in debt relief, relies on elected officials to negotiate with creditors and design repayment schemes. Under Title III, the federal board overseeing Puerto Rico’s finances is responsible for restructuring negotiations. The board, comprised of appointed technocrats, was designed to take local politics out of the equation. “Unlike chapter 9, a Title III case is not led by elected officials,” said Susheel Kirpalani, a lawyer for sales-tax bondholders. “That is a critical point to depoliticize the government’s restructuring and hopefully will lead to fairer outcomes for creditors.”

—

Settlement talks haven’t produced an agreement so far, but the board said it still wants to strike deals. If it can’t find takers, however, it can ask a judge to approve a plan over the objections of creditors, as in chapter 9. The board is required to “respect” creditor liens and priorities, but no one knows if that gives creditors real ammunition to resist forcible write-downs.

The court filing listed these problems. From NPR:

Puerto Rico’s labor participation rate is only about two-thirds that of the U.S. mainland.

The territory’s population has dropped by 10 percent since 2007.

Nearly half of Puerto Rico’s residents live below the federal poverty level.

How Did Puerto Rico Get In This Mess?

This did not happen overnight. In fact, it started decades ago. As of right now, Puerto Rico has “$74 billion in bond debt and $49 billion in unfunded pension obligations.”

The island has struggled to create jobs since Congress ended the federal tax credits it enjoyed. The local leaders tried to “cut spending and boost tax collections,” but they decided to take the borrowing route:

For over a decade, Puerto Rico’s government and its municipal corporations borrowed more to buy time to stave off deeper economic overhauls. With government payrolls down over the past decade, pension funds have fewer workers contributing and the plans are now underfunded by an estimated $45 billion.

The investors decided to ignore the financial problems:

For years, investors overlooked these fiscal and demographic problems because Puerto Rico’s bonds offered high yields and because they believed the island’s economy would eventually recover. Puerto Rico can issue debt exempt from federal, state and local taxes, unlike U.S. states, which made these bonds attractive to many mutual-fund investors and more recently, hedge funds.

But Puerto Rico began to lose access to the credit markets three years ago, when its ratings were downgraded. The door closed for good in 2015 when the island’s governor declared the debts unpayable.

Investors

Reality? The investors will probably not receive as much money as they want. USA Today points out that if the investors “hold secured bonds, they might get paid in full.” Without secured bonds, they “could suffer significant cuts, depending on which types of debt the judge determines to be vulnerable.” The main fight comes from two bondholders: Confina bonds and GO bondholders. From NASDAQ:

The Cofina camp argues that its claims on tax revenue are protected by the bond indentures and should not be used to pay holders of the island’s general obligation bonds.

The GO bondholders meanwhile have seen Puerto Rico default on their payments while staying current on the Cofina debt, because the taxes have already been remitted to the trustee.

Before Puerto Rico declared bankruptcy, these bondholders tried to work out “a deal with the government that would have valued their debt at 70 cents on the dollar.” But now the bonds have started to trade “around 66 cents on the dollar.”

Honestly, no one knows for sure what will happen next because this has never happened before. But these bondholders believe their should receive money first.

Pensions

The creditors believe they deserve money first, but what about those who have retired and need to receive pensions? The law Congress passed last year demanded that Puerto Rico “provide adequate funding for public pension systems.”

When Detroit sought protection, the retirees accepted “cuts after a judge ruled that their pensions could be cut in municipal bankruptcy.” Yet, under bankruptcy, the protections given to pensioners could collapse.

However, as Municipal Market Analytics analyst Matt Fabian said, the pensioners could “still fare better than investors” since they “are more politically empathetic than Wall Street creditors and bond insurers.”

Message of Puerto Rico debt crisis: Easy bets sometimes lose

When some of Wall Street's savviest hedge funds piled into Puerto Rico's debt in 2014, it seemed like an easy bet: Buy up the island's bonds at a discount, pocket the high interest and persuade politicians to make decisions that would raise the value of their investments.

Even if Puerto Rico's economy collapsed and its government unraveled, the investment funds figured they had an ace in hand. Puerto Rico was a United States commonwealth, and thus — like the 50 states — legally barred from declaring bankruptcy as a way to shed its debts.

But that safeguard was all but wiped out this week. On Wednesday, Puerto Rico essentially filed for bankruptcy in federal court, under a law Congress passed last summer to help the island cut its debt and escape financial calamity.

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In taking this drastic step, Puerto Rico asserted that it had no way to pay the $123 billion in bonds and pension debt it owes.

The unprecedented legal filing came only a few days after hedge funds and other holders of Puerto Rico's general obligation debt thought they had cut a deal with the government to avoid bankruptcy.

The move represented one of the lowest points in Wall Street's long, torturous history of investing in Puerto Rico's bonds. The hedge funds have been battling to protect their investments through the administrations of two Puerto Rico governors and across Capitol Hill, keeping an army of lawyers, consultants and operatives gainfully employed.

"I don't think anyone bargained for this," said David D. Tawil, a co-founder of Maglan Capital, a New York hedge fund that had at one point invested in Puerto Rico's debt. "I think most funds expected there would have been a consensual agreement by now."

It does not take long to see why a solution to Puerto Rico's debt problem has eluded the hedge funds and other investment firms that own the island's bonds: Many of the creditors think they are, or should be, first in line for the money. But the island also has to keep paying its police officers and its teachers while it struggles to raise revenue.

Two bondholder groups in particular — owners of general-obligation bonds and owners of Cofina bonds, which are backed by sales tax revenue — are at odds. Each of those types of bonds, their investors argue, carries protections that put those bondholders at the top of the pecking order after a default.

Puerto Rico's general-obligation bonds are backed by a provision in the island's constitution that promises that if there is not enough money in the general fund for all planned expenditures, general-obligation bonds will be paid off before anything else.

That sounds good, but investors in the Cofinas say they have an even better claim because they have a dedicated repayment stream in sales tax revenue.

The money goes straight from the merchants to a trust — not to Puerto Rico's treasury — so the government cannot lay claim to it and use it for anything else, such as paying the general-obligation bondholders.

With both the general obligation bondholders and the Cofina bondholders claiming dibs, it will very likely take a judge to force a resolution.

A law passed last summer under the Obama administration, called Promesa, was designed specifically to address Puerto Rico's predicament. It created a bankruptcy-like process that the island and other United States territories could use to restructure their debts.

Bondholders fought vigorously on Capitol Hill to derail the legislation but lost. They did win a few concessions in the makeup of the fiscal oversight board that would oversee the government's attempts to cut expenses. For instance, it would have to include three members from a list of people picked by Democrats and four picked by Republicans. That way, some bondholders figured, they could expect a more creditor-friendly approach.

But the bill that was finally enacted had many elements that could harm bondholders, including a "cramdown" provision, which gives a bankrupt government the power to force a deal on an unwilling creditor.

To investors — who bought the bonds assuming their legal protections were ironclad — it seems as though the governments in San Juan and Washington are constantly moving the goal posts.

Hector Negroni, co-chief executive of FCO Advisors, which is invested in Puerto Rico bonds, said the oversight board had failed to honor constitutional protections for bondholders and to carry out its duty to force the government to tighten spending.

The board's actions, he said, are hurting not only bondholders, but also the people of Puerto Rico, because the island's access to the debt markets would be indefinitely frozen.

"We were promised Promesa wouldn't change the rules against creditors," Mr. Negroni said. "Here we find ourselves with a board that has attempted to force a solution on us that does the exact opposite."

Do not count the hedge funds out just yet. Puerto Rico may have veered from Wall Street's preferred playbook, but some of these hedge funds employ skilled dealmakers and relentless litigators.

Those firms include Aurelius Capital, which was among the firms that fought Argentina in court for years over its sovereign debt default and succeeded in pressuring the government there to pay back its debt. But the legal issues may prove even more vexing in Puerto Rico.

The hedge funds are not the only investors in Puerto Rico's $74 billion in bonds. Those bonds had been a staple of retirement funds across the United States, generating hefty yields for mom-and-pop investors at a time of low interest rates.

Those retirement funds had been assured that Puerto Rico had little choice but to honor its debts — even as the island's pension costs swelled and its tax revenue ebbed. Mutual fund managers like Oppenheimer and Franklin Templeton are now fighting for repayment alongside the hedge funds.

It is too early to say whether the hedge funds will end up losing money on their investments, as they bought many of them at a discount.

Before the bankruptcy filing, general obligation bondholders were close to a deal with the government that would have valued their debt at 70 cents on the dollar, according to people briefed on the matter.

On Thursday, many of those bonds were trading around 66 cents on the dollar, according to Municipal Market Analytics.

Mr. Tawil of Maglan Capital said many investors had made the mistake of comparing Puerto Rico to an insolvent nation. But nations are typically bailed out by the International Monetary Fund before they collapse totally.

No such bailout has come for Puerto Rico. As a commonwealth of the United States, Puerto Rico does not qualify for I.M.F. assistance, and there was little appetite in Congress for a wholesale federal rescue. For months, investors and residents have been in a "five-ring circus," as Mr. Tawil put it, where bondholders are fighting with the government, the control board and one another.

Even so, Mr. Tawil is considering investing in the debt again. "We are in this unknown territory," he said. "How this all ends is unclear."