For a man that has branded himself as the “king of debt,” President Donald Trump seems to have a very thin grasp on how the bond market works.
Trump, whose businesses have gone bankrupt no fewer than six times, said Puerto Rico’s debt would have to be “wiped out” by its Wall Street creditors. That statement sent the territory’s bonds tumbling.
Mick Mulvaney, the head of the White House Office of Management and Budget, immediately contradicted his boss, saying Trump should not be taken “word for word.”
“We are not going to be offering a bail out for Puerto Rico or its current bondholders,” Mulvaney said.
The Trump-Mulvaney contradictions make clear the administration has no long-term plan for dealing with the devastation in Puerto Rico, which continues to suffer from a lack of basic needs like electricity and clean drinking water some two weeks after being devastated by Hurricane Maria.
Business Insider asked Martin Guzman, an expert on sovereign debt restructuring at Columbia University, what should be done about Puerto Rico’s mountain of debt and recession-hit economy now that the island’s situation has been made so much worse by the storm.
This transcript has been lightly edited for clarity and length.
Pedro da Costa: What kind of debt restructuring would be appropriate for the island now?
Martin Guzman: My computations pre-Hurricane Maria show that Puerto Rico needed a reduction of the face value of its public debt in the order of 80%-90% to restore debt sustainability. The hurricane brings the need for an even deeper restructuring. Trump’s claim that the entire debt needs to be wiped out is sensible in this context. Otherwise, the country will enter into an even more severe, long-lasting depression.
da Costa: What do you make of Trump’s promise of “wiping out” the debt that Mulvaney immediately walked back?
Guzman: Trump’s “computation” was correct. Trump did not say American taxpayers would bail-out Puerto Rico’s bondholders. On the contrary, his words “you can say good-bye to that” mean to me that bondholders should face the loss. Mulvaney later said that there would be no bail out for bondholders, a statement that is consistent with Trump’s. But looking at the response of bond prices, markets are taking Mulvaney’s words as a (not too strong) signal that the debts will not be wiped out.
da Costa: What are the potential risks of a restructuring? Bond prices plunged after Trump’s impromptu promise.
Guzman: The two largest risks are generally the impossibility of achieving enough relief to restore debt sustainability, which would perpetuate the crisis, and the risks of holdout behaviour. As the Oversight Fiscal Board already filed for bankruptcy under the Title III of PROMESA, the latter risk should be contained. But the risk of not obtaining enough relief is large. Mulvaney’s words add uncertainty to the already high uncertainty that the debtor is facing.
da Costa: If you were in charge, what should we do to make sure the territory can thrive and prosper?
Guzman: To prosper, the country needs to address two fundamental problems. First, it needs to restructure debts to restore the sustainability of its public finances, in order to have the resources that the implementation of policies for escaping out the current depression require.
But the debt restructuring will not suffice. Puerto Rico also needs to transform its structure of production, transiting to one that is more dynamic and that provides more opportunities to its people. The country will need to find a right mix of productive policies, that develop sectors that boost productivity and create jobs, in a context in which it cannot run its own monetary policies. One thing is clear: if there is no restructuring that restores debt sustainability, there will be no resources for implementing any of the necessary productive policies.
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