Trump's Puerto Rico Bombshell Just Adds to the Mess

(Bloomberg Gadfly) -- President Donald Trump has a gift for off-the-cuff utterances that ignore policy implications and roil markets and the culture alike. (There's a minor school of thought that there's a political mastermind at work, but that's another debate for another time.)

The latest bombshell is Puerto Rico, or more specifically, its debt. While visiting the island on Tuesday to inspect relief efforts after the devastation of Hurricane Maria, Trump referred to Puerto Rico's debt, telling Geraldo Rivera on Fox News , “We are going to work something out. We have to look at their whole debt structure.”

And then he threw out this bombshell: “You know they owe a lot of money to your friends on Wall Street. We're gonna have to wipe that out. That's gonna have to be -- you know, 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.” 

And just like that, markets were off to the races, leaving the island's creditors, which range from hedge funds to mom-and-pop investors, wondering what just happened. Prices on Puerto Rico's general obligation bonds maturing in 2035 plunged to the lowest since they were sold.

As Trump often does, he doesn't appear to have carefully thought through the issue, which is complicated, involves many different parties and has significant implications for bond contracts going forward, and not just in Puerto Rico. (He does have up-close experience with bankruptcy, so there's that.)

He was right about one thing. Puerto Rico has way too much debt. It's not exactly a secret. The island's $74 billion pile of bonds has been a slow-moving train wreck for years, pocked with threats, negotiations, promises and now, finally, what is essentially bankruptcy court.

After Hurricane Maria ruined the island's infrastructure, the discussion moved squarely to rescuing people who were struggling to get clean water and food. Still, its debt has always been just below the surface, with creditors eagerly hanging out on the wings, wondering when they can get involved again

Yet it's unclear how much power Trump has to "wipe out" the island's debt because the proceedings are already in court and guided by contracts that would have to be broken. Also, Congress has shown almost no inclination to get involved with these contentious debt talks, so it's unclear how much muscle Trump has behind him. On Wednesday, the president's budget chief, Mick Mulvaney, began walking his boss's comments back.

Just for argument's sake, if the U.S. government were able to unilaterally reduce Puerto Rico's debt load at the expense of hedge funds and mutual funds, that would set a dangerous precedent for the $3.8 trillion U.S. municipal bond market, not to mention many other markets. While it might sound convenient to simply wipe Puerto Rico's slate clean, the U.S. relies on contracts and legal documents as the entire foundation of its financial system.

Puerto Rico would certainly welcome an aid package that relied on creditors to accept a specific write-down of their holdings. But there's no guarantee that bondholders would be on board, and then there's that pesky bankruptcy court. And that's just the surface.

Trump says so many inflammatory things that it's easy to dismiss his dramatic rhetoric as tools to generate headlines. But his words carry weight. Grand pronouncements about huge policy shifts and breathtaking financial rescues make for great TV soundbites, but they evaporate just as quickly. More important, they're not helping the suffering residents of Puerto Rico or the negotiations over its debt, which don't appear to be resolving themselves any time soon. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

To contact the author of this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net.