by Wolf Richter, Wolf Street:

“We’re going to protect our people.” Hedge funds reel.

Puerto Rico’s Governor Ricardo Rosselló took the momentous step on Wednesday to trigger the largest municipal bankruptcy-type process in the US, four times larger than the prior record, Detroit’s bankruptcy.

Puerto Rico’s population has declined by about 10% since 2004 to 3.4 million. Its economy has declined by as much since 2005. Unemployment is at 14%. Public deficits have ballooned. Puerto Rico and over a dozen agencies, after years of reckless spending amid an aiding and abetting bond market, piled up about $73 billion in debt. That this was a mega problem became official two years ago; bonds crashed, and bond insurers got clobbered.

As multiple defaults have rippled through Puerto Rico’s debt since then, hedge funds jumped into the fray and snapped up the beaten-down bonds. They figured since US states cannot file for bankruptcy the US territory couldn’t either, and that much of the debt would have to be repaid, no matter what the cost to Puerto Rico and its people.

This calculus took a serious hit today.

“We’re going to protect our people,” Gov. Rosselló announced at the press conference in San Juan, after holders of defaulted bonds had filed a slew of lawsuits. He said one of the lawsuits claimed that bondholders should get all revenues generated by Puerto Rico’s Treasury Department. “I’m not going to allow that to happen,” he said.

The emailed statement by the Office of the Governor puts it this way:

In order to ensure the essential services to the public, the payment of the government payroll and the suppliers, Governor Ricardo Rosselló notified yesterday to the Fiscal Oversight Board (FOB) that the Government of Puerto Rico wishes to seek protection under Title III of the PROMESA Act.

After extensive discussions in good faith and the opening of the financial books of the Government of Puerto Rico to the creditors, there has not been sufficient progress in the negotiations, so that Title III of the PROMESA Act allows for a special court to restructure the public debt of Puerto Rico.

This is the bankruptcy-type process created last year by US law to help Puerto Rico restructure its debt under the supervision of a federal district court and emerge from its terrible debt crisis.

“The board has agreed to submit Title III protection immediately and they will submit it,” the governor said.

Thus the commonwealth is entering into the a bankruptcy-like process. A federal district court judge will preside over figuring out how to restructure a certain part of Puerto Rico’s debt, how big the haircuts will be, and how long payments will be stretched out.

“We remain committed to maintaining negotiations in good faith to reach agreements with creditors,” Rosselló said. “The best example that shows we can have dialogue is the Restructuring Support Agreement recently established with the creditors of the Puerto Rico Electric Power Authority. However, given the deficit that we have inherited, it is my responsibility to guarantee the best interests of the Puerto Rican people.”

Rosselló, who has been governor since January 2017, pointed out that during the transition hearings in December, it was revealed that the government deficit was actually $7.6 billion and not $3.2 billion, as the previous Administration had reported. He added:

“We are here to address the problems of Puerto Rico, not to look at the past, and I am convinced that our Island will be able to resume the path of economic development with the correct steps by the Government and the determination of each of its residents.”

“It is my hope that the Government’s Title III proceedings will accelerate the negotiation process, leading to as much creditor consensus where possible and achieving where necessary a prompt and efficient judicial resolution of any issues or disputes.”

Bondholders have 120 days to challenge the move.

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