Seth Klarman '79 at a dedication ceremony for Klarman Hall in May of 2016.

Courtesy of Jason Koski / University Photography

Seth Klarman '79 at a dedication ceremony for Klarman Hall in May of 2016.

October 25, 2017

Klarman ’79 Says Puerto Rico Should Repay Its Debts, Johnson Prof Agrees

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Billionaire Seth Klarman ’79 — who manages a hedge fund that owns nearly $1 billion in Puerto Rican bonds — fought back against demands to wipe out its debt holdings on the island in a letter to his clients last week, saying its residents will be better off in the long run if financial obligations were honored.

Canceling debts “may be well intentioned,” Klarman wrote in his letter, The Wall Street Journal reported, but would be “impractical” as it would undermine the obligation of bond issuers to repay their obligations that support Puerto Rico’s credit markets.

Klarman’s comments came in response to intensifying calls to expunge the U.S. territory’s debt to free up funds to help resolve its issues following Hurricane Maria, a storm that left large parts of the island in destruction. Activist groups requested Klarman’s hedge fund, the Baupost Group, which owns $911 million in bonds backed by Puerto Rico sales taxes, to forgive its portion of Puerto Rico’s bonds, according to his letter.

Prof. Andrew Karolyi, finance, corroborated Klarman’s message, saying that forgiving Puerto Rican debt may make investors more shy about investing in the island and impede its ability to successfully raise funds in the future.

“If Baupost cancelled its bonds, investors would logically extrapolate that the possibility of debt forgiveness might come again, pushing up future financing costs and worsening the budget deficit further,” he told The Sun, pointing to the need to address the depth of Puerto Rico’s long-standing troubles. “What we really need is for the federal government to take the lead to help Puerto Rico resolve its structural budget problems.”

The island has also been in a painful recession since 2006, which worsened as past governments have brought it deeper into debt by borrowing to pay for its operating expenses.

As a U.S. territory, Puerto Rico’s political status has precluded it from filing for bankruptcy, until Congress enacted an unprecedented law in 2016 that allowed bankruptcy-like proceedings, which faced backlash by some creditors, The New York Times reported in May.

Seth Klarman '79, pictured here at a dedication for Klarman Hall in 2016, owns a hedge fund that manages nearly $1 billion in Puerto Rican debt.

Brittney Chew / Sun File Photo

Seth Klarman ’79, pictured here at a dedication for Klarman Hall in 2016, owns a hedge fund that manages nearly $1 billion in Puerto Rican debt.

While it is widely accepted that Puerto Rico cannot sustain its existing levels of debt, some disagree on whether a reduction in its current obligations would affect its ability to borrow again and finance new projects, and Klarman and Karolyi’s comments reflect a tension in beliefs about Puerto Rico’s long-term restructuring strategy.

Namely, those who demand that Klarman’s hedge fund forgive its debt holdings have challenged the assumptions that underlie the financial perspective.

Chris Arcé ’19, co-president of the Puerto Rican Student Association, said that the idea that creditors would not invest in Puerto Rico if it cancelled its debts assumes Puerto Rico can pay back its debts now.

“It’s clear Puerto Rico can’t pay its debts back. There’s no reason for people to think the economy is going to get better with the current situation and policies,” he said.

Puerto Rico — with approximately $123 billion in debt and pension obligations — declared a form of bankruptcy in 2017, according to The New York Times report.

As fiscal and humanitarian problems escalate following the hurricane, reports of the Baupost Group’s bond holdings in Puerto Rico were followed by Cornell students’ calls to boycott or modify Klarman Hall, named after the billionaire, to physically acknowledge Puerto Rico’s connection to the building, The Sun previously reported.

As much of the island still has no electricity or running water, demands to forgive Puerto Rico’s outstanding obligations have continued to mount in recent weeks. Around 50 Boston residents gathered on Saturday outside the office of the Baupost Group which holds nearly $1 billion of Puerto Rican debt, Boston University’s student-led Daily Free Press reported.

Protesters chanted, “Money for recovery, not Seth’s salary,” “Cancel the debt, Puerto Rico must be free,” and “Hey Seth, cancel the debt, don’t you have enough money yet?” according to The Free Press.

While the debate on whether the Baupost Group should forgive Puerto Rican debt continues to be important for Arcé, he said that public awareness should be expanded to consider the broader humanitarian difficulties facing Puerto Ricans, including the constraints of its “colonial” status.

“Once Puerto Rico is treated equally under law, we’ll have a stronger economy when trying to manage the debt crisis,” he said, adding that restructuring efforts should focus on implementing better policies to improve its business environment, public schools and hospitals needed for a stronger economy that is equitable for the impoverished.

Meanwhile, it appears unlikely that Klarman will forgive its debt holdings; Klarman has largely avoided controversy over his career and is known among investing circles for his discipline and substantial returns, CNBC reported.