$72 billion in now-toxic Puerto Rico bonds are stashed away in supposedly conservative bond funds and retirement accounts. Moody’s says the probability of default is now 100%. Some of the bonds have no legal protection and their recovery rate might be 33 cents on a dollar. Bonds with better protection will still get clobbered. Recovery on those will be 65-85%.
That’s not the worst of it. UBS (and probably lots of other banks too) underwrote some of the bonds and put them in their own closed-end funds. These funds are not traded. UBS sets the price. Some investors bought these bond funds with money borrowed from UBS and may have used them as collateral for more “investing.” However, UBS just decreed the collateral value on their very own Puerto Rico closed-end funds is now zero. That’s right zero. UBS is saying their own bonds are worthless. Expect a festive number of lawsuits.
Clients were warned that they can no longer use these funds as collateral for loans, even those loans they used to buy these funds with in the first place.
Thus, they will have to come up with new collateral very quickly or UBS may sell the bonds and come after them for the balance. Let’s be clear. Some of them are retirement accounts. All of them will take big hits.
Of course, banks made lots of money by underwriting slop everyone knew was risky then foisting it off on customers and clients. It’s all just terribly tragic. There will be investigations. UBS will promise to sin no more. The government will levy a stiff fine (or is this a protection racket.) No one will go to prison. Lots of people’s retirement accounts will drop in value. None of the banks care what happens to Puerto Rico.