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Puerto Rico poised for new battle with bondholders

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Bondholders are preparing to go back in to battle with Puerto Rico over a $35bn debt restructuring, gearing up for a fight even as the island’s economy remains under extreme stress from the fallout of the coronavirus pandemic.

Puerto Rico reached a deal in February with Autonomy Capital, Aurelius Capital Management, GoldenTree Asset Management and other investors to slash $24bn from its debt burden. News of the agreement sent the value of $3.5bn worth of debt borrowed in 2014 surging to nearly 75 cents on the dollar, its highest level since 2015.

But since then, coronavirus has hit the island’s finances further, exacerbating the economic strains left by Hurricane Maria in 2017. Puerto Rico has asked bondholders to accept a further $3.3bn cut in payouts — a prospect they are so far refusing to accept, sending that bond back down to 58 cents.

Creditors from four separate groups this week jointly filed a motion in a US court in a bid to speed up the bankruptcy-like process. They are debating their legal options if they cannot come to a new deal, according to people briefed on the matter.

The dispute highlights the added complications for Puerto Rico in dealing with its unsustainable debt burdens and its continued economic decline — a challenge that dates back more than a decade. As a US territory, not a state, it has had no recourse to the bankruptcy process used by municipalities like Detroit to cut their debts. It has instead relied on a restructuring process established by Congress in 2016 that also put in place a control board to oversee its budget.

“We have negotiated in good faith and we’re trying to find a way through bankruptcy for Puerto Rico, but it has to be sustainable,” said David Skeel, who was this week elevated to chair the island’s oversight board. “We haven’t reached a deal that everybody is happy with at this point. Hopefully people are of the view it is time to complete the restructuring and move on.”

US elections in November could prove a turning point for Puerto Rico and the 3m Americans who live there. A Democratic sweep of the White House and Congress could open the door to greater funding and change how Puerto Rico goes about restructuring its debts. The election could also affect whether the territory pursues US statehood, an idea floated in Democratic circles.

Puerto Rico's debt saga continues

Additional financial assistance would be welcome, given the severity of the coronavirus shock. The number of residents collecting unemployment insurance remains five times above the average recorded in January and February, before the virus hit, according to the Department of Labor. The official unemployment rate has not been reported since February, but the oversight board estimated that in July it could have reached 40 per cent, almost four times the national average.

“The pandemic has thrown everything upside down,” said Sergio Marxuach, the policy director of the Center for a New Economy think-tank. “The situation is extremely complex and the economy is in really bad shape.”

The latest proposal from the oversight board made public last week would increase an initial cash payout for the general obligation bondholders by $2.2bn. However, it would cut the overall debt issued to those creditors as part of the restructuring by $5.4bn, weighing on their total recovery.

The creditors, who are pushing for a new restructuring plan by November 30, have limited options. They are not able to sue the island or the board, but could request the judge overseeing the restructuring to lift the provision preventing litigation.

“Creditors believe that the deal that was announced in February was affordable and remains affordable. Creditors are also willing to restructure that deal to make it more flexible to deal with the pandemic,” said one bondholder involved in the negotiations, noting that the territory has $9.5bn to hand. “What creditors are not willing to do is to allow them to just take advantage of what we view as a temporary dynamic with the pandemic for their political benefit.”

Analysts noted that the timeline creditors had sought in their motion with the court may be untenable, given local and national elections could significantly affect the Puerto Rican economy and its ability to pay off its debts.

Joe Biden, the Democratic nominee for the presidency, has proposed forgiving disaster relief loans to Puerto Rican municipalities, reversing fiscal austerity measures and accelerating reconstruction efforts. He has also said the island is in need of further debt relief.

The oversight board itself could drastically change in the weeks ahead. Three of the seven members on the board have stepped down this year. Mr Marxuach added that the terms for the remaining members had expired and they too could be replaced.

President Donald Trump moved this week to add one person to the board, announcing he planned to appoint a partner of a lobbying firm that has worked for the island’s creditors.

“There is a risk of Puerto Rico trying to get to a solution quickly despite the serial disasters,” said Matt Fabian, who leads credit research at Municipal Market Analytics. “If you layer on a bunch of debt, that may mean they can’t afford it in the long term. It raises the risk that Puerto Rico will need to file for bankruptcy again 10 years from now.”



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Financial bubbles also lead to golden ages of productive growth

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Sir Alastair Morton had a volcanic temper. I know this because a story I wrote in the early 1990s questioning whether Eurotunnel’s shares were worth anything triggered an eruption from the company’s then boss. Calls were made, voices raised, resignations demanded. 

Thankfully, I kept my job. Eurotunnel’s equity was also soon crushed under a mountain of debt. Nevertheless, the company was refinanced and the project completed. I raised a glass to Morton’s ferocious determination on a Eurostar train to Paris a decade later.

With hindsight, Eurotunnel was a classic example of a productive bubble in miniature. Amid great euphoria about the wonders of sub-Channel travel, capital was sucked into financing a great enterprise of unknown worth.

Sadly, Eurotunnel’s earliest backers were not among its financial beneficiaries. But the infrastructure was built and, pandemics aside, it provides a wonderful service and makes a return. It was a lesson on how markets habitually guess the right direction of travel, even if they misjudge the speed and scale of value creation.

That is worth thinking about as we worry whether our overinflated markets are about to burst. Will something productive emerge from this bubble? Or will it just be a question of apportioning losses? “All productive bubbles generate a lot of waste. The question is what they leave behind,” says Bill Janeway, the veteran investor.

Fuelled by cheap money and fevered imaginations, funds have been pouring into exotic investments typical of a late-stage bull market. Many commentators have drawn comparisons between the tech bubble of 2000 and the environmental, social and governance frenzy of today. Some $347bn flowed into ESG investment funds last year and a record $490bn of ESG bonds were issued. 

Last month, Nicolai Tangen, the head of Norway’s $1.3tn sovereign wealth fund, said that investors had been right to back tech companies in the late 1990s — even if valuations went too high — just as they were right to back ESG stocks today. “What is happening in the green shift is extremely important and real,” Tangen said. “But to what extent stock prices reflect it correctly is another question.”

If the past is any guide to the future, we can hope that this proves to be a productive bubble, whatever short-term financial carnage may ensue.

In her book Technological Revolutions and Financial Capital, the economist Carlota Perez argues that financial excesses and productivity explosions are “interrelated and interdependent”. In fact, past market bubbles were often the mechanisms by which unproven technologies were funded and diffused — even if “brilliant successes and innovations” shared the stage with “great manias and outrageous swindles”.

In Perez’s reckoning, this cycle has occurred five times in the past 250 years: during the Industrial Revolution beginning in the 1770s, the steam and railway revolution in the 1820s, the electricity revolution in the 1870s, the oil, car and mass production revolution in the 1900s and the information technology revolution in the 1970s. 

Each of these revolutions was accompanied by bursts of wild financial speculation and followed by a golden age of productivity increases: the Victorian boom in Britain, the Roaring Twenties in the US, les trente glorieuses in postwar France, for example.

When I spoke with Perez, she guessed we were about halfway through our latest technological revolution, moving from a phase of narrow installation of new technologies such as artificial intelligence, electric vehicles, 3D printing and vertical farms to one of mass deployment.

Whether we will subsequently enter a golden age of productivity, however, will depend on creating new institutions to manage this technological transformation and green transition, and pursuing the right economic policies.

To achieve “smart, green, fair and global” economic growth, Perez argues the top priority should be to transform our taxation system, cutting the burden on labour and long-term investment returns, and further shifting it on to materials, transport and dirty energy.

“We need economic growth but we need to change the nature of economic growth,” she says. “We have to radically change relative cost structures to make it more expensive to do the wrong thing and cheaper to do the right thing.”

Albeit with excessive enthusiasm, financial markets have bet on a greener future and begun funding the technologies needed to bring it to life. But, just as in previous technological revolutions, politicians must now play their part in shaping a productive result.

john.thornhill@ft.com



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US tech stocks fall as government bond sell-off resumes

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A sell-off in US government bonds intensified on Wednesday, sending technology stocks sharply lower for a second straight day.

The yield on the 10-year US Treasury bond, which acts as a benchmark for global borrowing costs, climbed to nearly 1.5 per cent at one point. It later settled around 1.47 per cent, up nearly 0.08 percentage points on the day.

Treasury trading has been particularly volatile for a week now — 10-year yields briefly eclipsed 1.6 per cent last Thursday — but the rise in yields has been picking up pace since the start of the year and the moves have begun weighing heavily on US stocks.

This has been especially true for high-growth technology companies whose valuations have been underpinned by low rates. The tech-focused Nasdaq Composite index was down 2.7 per cent on Wednesday, on top of a 1.7 per cent drop the day before.

The broader S&P 500 fell by 1.3 per cent.

The US Senate has begun considering President Joe Biden’s $1.9tn stimulus package, with analysts predicting that the enormous amount of fiscal spending will boost not only economic growth but also consumer prices. The five-year break-even rate — a measure of investors’ medium-term inflation expectations — hit 2.5 per cent on Wednesday for the first time since 2008.

Inflation makes bonds less attractive by eroding the value of their income payments.

“I would expect US Treasuries to continue selling off,” said Didier Borowski, head of global views at fund manager Amundi. “There is clearly a big stimulus package coming and I expect a further US infrastructure plan to pass Congress by the end of the year.”

Mark Holman, chief executive of TwentyFour Asset Management, said he could see 10-year yields eventually trading around 1.75 per cent as the economic recovery gains traction later this year.

“It will be a very strong second half,” he said.

Line chart of Five-year break-even rate (%) showing US medium-term inflation expectations hit 13-year high

Elsewhere, the yield on 10-year UK gilts rose more than 0.09 percentage points to 0.78 per cent, propelled by expectations of a rise in government borrowing and spending following the UK Budget.

Sovereign bonds also sold off across the eurozone, with the yield on Germany’s equivalent benchmark note rising more than 0.06 percentage points to minus 0.29 per cent. This was an example of “contagion” that was not justified “by the economic fundamentals of the eurozone”, Borowski said, where the rollout of coronavirus vaccines in the eurozone has been slower than in the US and UK.

The tumult in global government bond markets partly reflects bets by some traders that the US Federal Reserve will be pushed into tightening monetary policy sooner than expected, influencing the costs of doing business for companies worldwide, although the world’s most powerful central bank has been vocal that it has no immediate plans to do so.

Lael Brainard, a Fed governor, said on Tuesday evening that the ructions in US government bond markets had “caught my eye”. In comments reported by Bloomberg she said it would take “some time” for the central bank to wind down the $120bn-plus of monthly asset purchases it has carried out since last March.

After a series of record highs for global equities as recently as last month, stocks were “priced for perfection” and “very sensitive” to interest rate expectations that determine how investors value companies’ future cash flows, said Tancredi Cordero, chief executive of investment strategy boutique Kuros Associates.

Europe’s Stoxx 600 equity index closed down 0.1 per cent, after early gains evaporated. The UK’s FTSE 100 rose 0.9 per cent, boosted by economic support measures in the Budget speech.

The mid-cap FTSE 250 index, which is more skewed towards the UK economy than the internationally focused FTSE 100, ended the session 1.2 per cent higher.

Brent crude oil prices gained 2 per cent at $64.04 a barrel.



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UK listings/Spacs: the crown duals

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City-boosting proposals are not enough to offset lack of EU financial services trade deal



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