The Puerto Rico Municipal Bond Crisis

The recent decline in Puerto Rico municipal bond prices has led to a wave of litigation, especially with respect to closed-end municipal bond funds that utilized leverage. In this paper, we examine both open and closed-end municipal bond funds; Puerto Rico municipal bonds; the cause of the decline in the Puerto Rico economy; and the use of leverage at the fund and account levels. Our research reveals a story of accelerating decline. The Puerto Rico economy has been struggling with low growth, high unemployment, rising debt and a host of other macroeconomic problems for many years. Indeed, the economy has endured a devastating recession which began in 2006, initiated by a severe government shutdown. As a result of these macroeconomic factors, Puerto Rico municipal bonds are now rated one notch above junk, a rating likely to be cut as more drastic measures are required from the government.