Donald Trump's Complicated Understanding Of Debt Only The Latest Tragedy To Befall Puerto Rico

How is it even possible that this guy doesn't know how bankruptcy works?

You might have missed it between images of Trump chucking paper towels at Puerto Rican hurricane survivors or reacting maturely to reports that Rex Tillerson called him a moron, but on Tuesday night the president blurted out a sentence that shook the foundations of a critical $4 trillion market. Speaking about Puerto Rico’s fiscal crisis with Geraldo Rivera on Hannity, the president explained:

“We have to look at their whole debt structure. You know, they owe a lot of money to your friends on Wall Street, and we’re going to have to wipe that out. You can say goodbye to that. I don’t know if it’s Goldman Sachs, but whoever it is, you can wave goodbye to that.”

It might be the first time something uttered on Hannity ever moved markets. Many Puerto Rico bondholders did indeed wave goodbye after Trump’s comments. The territory’s debt fell 8 cents below Tuesday’s levels to 36 cents on the dollar. Here’s the mood on Wall Street:

A prominent bond broker says his clients who are holding Puerto Rican debt are just about “suicidal” after President Trump threatened to wipe them out.

The obvious question here is whether Trump knows what he’s talking about. For White House budget chief Mick Mulvaney, however, the question is whether you know what Trump’s talking about:

“I think what you heard the president say is that Puerto Rico is going to have to figure out a way to solve its debt problem,” Mick Mulvaney, director of the White House budget office, said in an interview Wednesday.

That is decidedly not what we heard the president say, but everyone is entitled to their own facts. Mulvaney’s message may contradict what Trump plainly told Geraldo, but it jibes with comments Trump made earlier in the week – namely, that by making the mistake of being hit directly by a category 4 hurricane, Puerto Rico had “thrown our budget a little bit out of whack.” It’s easy to read the “wipe-out” threat as just another bit of noise in the signal.

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But we live in an actual world where bond traders have no choice but to actually trade every day, and to do so while incorporating all available information. So when the president of the United States indicates an intention to cancel the debts you hold – no matter how faint the odds of that happening are – you have to countenance it.

But what exactly is going on inside the head of the self-professed King of Debt? The hedge funds, banks and individuals who hold Puerto Rican debt would certainly like to know, as would the people of Puerto Rico.

To Trump, an old hand at Chapter 11, debt is not a contractual obligation that unites disparate stakeholders under a common legal framework. Instead, it’s a useful business expedient that, if and when it becomes a problem, goes away, providing you throw enough lawyers at it. One can imagine Trump looking at the Puerto Rican fiscal crisis, seeing that he has at his disposal the federal government – i.e., the greatest arsenal of lawyers in existence – and thinking hey, there’s no municipal statute or section of the constitution that can stop me now.

But who are we kidding? There was nothing pre-meditated about this. You couldn’t even say Trump spoke before he thought, because thought clearly never entered the picture. Trump was as always just saying stuff, letting his gut lead him toward the message he thinks his base wants to hear. It was an emotional rather than intellectual response.

But if we’re going to entertain the possibility that the White House might make an effort to reduce Puerto Rico’s debt burden beyond current efforts (which already disadvantage current bondholders), what would it look like?

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There are a few options. Not included in these options is an executive order. The president can’t extinguish debts by fiat, if only because the Ffth Amendment prohibits the loss of property – in this case, bonds – without due process. And even if Trump could decree the debt away, doing so would fundamentally undermine the municipal debt market, where such interventions are unheard-of.

What the government could do is issue new low-interest rate bonds that are senior to the old ones. He could also try to influence the current bankruptcy-like proceedings, which aim to subject existing bondholders to a haircut in order to get the island above water.

Obviously we’re wasting our time with these hypotheticals. But this mental exercise is exactly what’s going on at every municipal bond desk in the country right now. They have it rough. Not as rough as Puerto Rico, though.