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Even Before Hurricane Maria Hit, Puerto Rico Was In Financial Ruin


It was early morning last September 20 when Hurricane Maria struck Puerto Rico, leaving a trail of death and destruction. In the months that followed, we've heard a lot about how the storm crippled the island, leaving millions without power, food and water. Now, over the next two days, we're going to take a deeper look at where things went wrong before and after the storm. NPR and the PBS show "FRONTLINE" have spent the last seven months investigating, and today they reveal a disaster that began long before Maria, a decade of Wall Street dealing that made millions for banks while the island teetered on the edge of financial collapse.

Today NPR's Laura Sullivan reports on how a once-prosperous island ended up in financial ruin, unable to prepare for the storm that was to come.

LAURA SULLIVAN, BYLINE: Long before Maria you probably knew Puerto Rico was in financial trouble. The story went something like this - Puerto Rico borrowed way too much money over the years, overspent that money, and now it can't pay any of it back. And then there was this other story that tens of thousands of Puerto Ricans lost their savings. But what hasn't made much sense is what one thing had to do with the other.

If Iowa or California borrowed money and defaulted, you wouldn't expect people living in Iowa or California to lose their money, too. And what was more unusual, Puerto Rico imploded over municipal bonds. They're supposed to be the most boring, safe financial investments out there. You buy a Puerto Rican bond, Puerto Rico pays you back later with interest.

CATE LONG: It's bizarre, OK? It's really bizarre.

SULLIVAN: I asked a Wall Street analyst named Cate Long what she thought of this.

LONG: Governments don't collapse like that. And, yeah, there was hundreds of people looking at this, and nobody saw it. This is like - I mean, look at it from the outside. Yeah, this is a crazy story, man.

SULLIVAN: It did seem crazy. Could Puerto Rico really destroy its own financial interests all by itself, or were there other players who may have had their own interests? Down in San Juan, I stop by the nonprofit Center for a New Economy to get some of the backstory. The center's policy director studies the island's finances.

SERGIO MARXUACH: My name is Sergio Marxuach.

SULLIVAN: Say your last name again.

MARXUACH: Marx like Karl Marx...


MARXUACH: ...And swatch like the watch.

SULLIVAN: Marxuach said that for decades Puerto Rico was booming. It had the special tax break that lured pharmaceutical companies and manufacturers to the island. But then in 1996, Congress began phasing it out. Within a decade, the island spun into recession and to compensate borrowed money.

MARXUACH: The government was borrowing at an incredible clip. Some years the debt would increase by 15 percent year over year.

SULLIVAN: How much percent?

MARXUACH: Fifteen.

SULLIVAN: It's easy to fault Puerto Rican politicians for this. Why didn't they just cut spending, cut school budgets and police budgets and whatever else? But you could ask every voter the same question - who do you like better, the politician who takes away all your favorite programs and gives you nothing, or the one who tells you can have everything you want and someone else will pay for it 20 years from now? Puerto Ricans chose the latter. They turned to investment banks to come in and put the bond deals together.

MARXUACH: All they do is act as intermediaries. They find buyers.

SULLIVAN: Usually that's pension funds, your retirement account or their own clients.

MARXUACH: That's what they get their fees for essentially. And then they're off. They are not on the hook.

SULLIVAN: So it's not their money...


SULLIVAN: ...That's at stake here.

MARXUACH: Yeah. So they don't care.

SULLIVAN: Puerto Rico bonds had perks and in theory should have been safe. Governments rarely go broke. Yes, there was Detroit. But Puerto Rico has as many residents as almost half the states in the country. The last time a state defaulted was 1933 in Arkansas.

MARXUACH: Fund managers, they will not admit this now, but when Puerto Rico was selling debt like pancakes, they loved Puerto Rico debt. Since they had slightly higher interest rates and no taxes attached to them, you immediately look like a genius, right? You just bump up the entire return for the entire portfolio. So that's your bonus, right? That's your new Mercedes, your new yacht.

SULLIVAN: Has anybody come forward from inside these banks to talk about what was really going on?

MARXUACH: No. No. It's a very close-knit world in Wall Street. And the tendency is just to keep quiet and keep working.

SULLIVAN: I went in search of that close-knit world. I found more than a dozen bankers and brokers involved in Puerto Rican bonds. They described a fast pace of moneymaking and competition and Puerto Rican politicians eager for an influx of cash. And then one afternoon, I found someone deep on the inside, a former top manager for the largest broker-dealer on the island, UBS. Carlos Capacete said he got his start in Puerto Rico's Golden Mile in the 1980s.

CARLOS CAPACETE: All the major banks in New York would come to Puerto Rico on a regular basis to pitch deals. Listen; we can do an additional 200 million, additional 500 million. They make commissions. They make fees. This is kind of like a money-making machine. As long as there are transactions coming and going, they're making a ton of money.

SULLIVAN: Capacete said he said that was all great until about 2011, when he and other bankers started realizing what many bond investors hadn't yet figured out - Puerto Rico was in trouble. There was too much debt. And this is where you might expect UBS and other banks to stop with the bond deals, stop pitching Puerto Rico bonds and stop selling Puerto Rican bonds to their clients. But the opposite happened. Capacete said when it came to clients, UBS pushed brokers to sell.

CAPACETE: There were some hard-line tactics to sell the funds, you know, like go out and get them. Let's go. You got to sell these funds. They were just trying to push the bond funds to whoever had a heartbeat.


UNIDENTIFIED PERSON #1: (Speaking Spanish).

SULLIVAN: There's an audio tape secretly recorded at a UBS meeting in Puerto Rico that's now part of lawsuits. You can hear a top company manager telling brokers to sell the bonds or...


UNIDENTIFIED PERSON #1: Go home. Get a new job.

SULLIVAN: These bonds were specifically designed to sell to Puerto Ricans. They were part of special bond funds that were far riskier than what regulators allow on the mainland. Brokers sold tens of thousands of Puerto Ricans into these special funds. Hundreds of millions of dollars of the island's wealth was now highly concentrated at the worst possible time. And then Capacete heard a troubling story.

CAPACETE: One day this client tells me, are you aware of what they're doing in this other branch? And I said, tell me. And he told me the scheme.

SULLIVAN: Capacete said he says he learned some brokers were pushing Puerto Rican clients who had already put so much of their retirement or savings into the special funds to go borrow money and put it into the funds, too. It's like using poker chips to take out a loan for more poker chips and betting them all on the same hand.

CAPACETE: It's unethical. It's against the bank's regulations. And it puts the clients in a really, really tough risk situation.

SULLIVAN: Capacete sent emails warning UBS. Almost a year later, two officers from the bank's compliance office came and said they found no evidence of the practice.

CAPACETE: And I jumped up and I said, you're kidding, right? This is a joke. And I told her, look at the big accounts and follow the money. I left the room, and I don't think I ever spoke to them again.

SULLIVAN: Why do you think the bank would want to turn a blind eye to something like this?

CAPACETE: Because it was profitable. And I was the one that was - in Spanish we say (speaking Spanish). I was the one that was spoiling their party.

SULLIVAN: UBS declined NPR and "FRONTLINE's" requests for an interview but said its loan terms were fully disclosed, and that the program as a whole did not violate financial regulations. It pointed to a separate case where regulators found it didn't mislead clients and called Capacete a disgruntled former employee who has sued the bank, and said it fired the one employee who had been violating policies.

Eventually, federal regulators investigated and found the bank should have had a system in place to prevent the practice. They fined UBS $34 million for the loan scheme and other problems. They also fined UBS and four other banks for putting clients at risk in the special funds. Eighteen hundred UBS customers have now sued.

But in 2013, the party came to an end for investors. Bond prices tanked. All of those tens of thousands of Puerto Ricans tied up in the same risky funds were in serious trouble, and those that had taken out additional loans suddenly had to cover them. Within months, billions of dollars of Puerto Rican wealth was wiped out.

And surely by now the government and banks would want to be done with this Puerto Rican bond business. Rating agencies downgraded Puerto Rican bonds to junk. I asked Puerto Rico's current governor, Ricardo Rossello, what he thought of this period, and he put it this way.

RICARDO ROSSELLO: The governor of Puerto Rico was run as a big Ponzi scheme. What you had was essentially a black box of a government running that had no clarity as to what was being borrowed and what was being spent.

SULLIVAN: But in 2014, cable news was ablaze. The banks in Puerto Rico were going in for another bond deal.


UNIDENTIFIED REPORTER: Demand for Puerto Rico's debt was through the roof.

SULLIVAN: It was the largest municipal junk bond offering in U.S. history.


UNIDENTIFIED PERSON #2: This deal I believe is a $3 1/2 billion deal. So we're up...

SULLIVAN: Puerto Rican officials for their part told me they needed the cash to make payroll. But when I went back to the bankers I had met, several of whom had worked on the deal, they told me something else. They said this bond was more than just a bond deal. They said it was also an exit strategy for the banks. See; in the years before the bond, the banks had been loaning Puerto Rico money or making investments in other ways. Government documents show hundreds of millions of dollars were now at stake on an island in financial trouble.

And dig deep into the 2014 bond documents, and you'll see it, too. Almost a quarter of the entire bond goes to pay them back, almost $900 million that didn't go to Puerto Ricans or even to keep the government afloat but went to pay back loans, pay fees or eliminate other risk of banks directly involved in putting the deal together. Barclays, which led the bond deal, got almost half a billion dollars; Banco Santander, 100 million; JPMorgan, 74 million; Morgan Stanley, 24 million; and others.

Neither Barclays nor any of the other banks would agree to an interview. In statements, banks said they fully disclosed their financial stake in the deal and did not influence how Puerto Rico used the money. Morgan Stanley said they also extended Puerto Rico $250 million in credit after the bond. It was difficult to find bank insiders to talk on the record about this. And then I found one former broker who would.

AXEL RIVERA: I started back in 1983 in Wall Street.

SULLIVAN: I met Axel Rivera in a hotel lobby in San Juan. He was at Morgan Stanley when the record 2014 deal was done. As he flipped through the bond, he said when the island got closer to default, banks were getting nervous. They had too much debt on the island.

RIVERA: They wanted to try to get as much as they could of their exposure out of their books.

SULLIVAN: Your colleagues at Morgan Stanley...


SULLIVAN: ...Told you...


SULLIVAN: ...That they had exposure to risk at that time.

RIVERA: That they had much more than what they wanted, and they needed to unwind that.

SULLIVAN: And they needed the 2014 bond...

RIVERA: That's correct.

SULLIVAN: ...To get them out. Then who gets left paying the bill?

RIVERA: The bondholders, whomever they are. The banks get out, and everybody else gets - they get stuck with the bill.

SULLIVAN: Rivera said for banks like Morgan Stanley and others, the bond was the finale, capping years of profit with a way out.

RIVERA: Most of the general public didn't understand what was going on. The darkness of this bond deal made a lot of people in Wall Street happy, but it was immoral in many ways.

SULLIVAN: Fifteen months later, the then-governor announced the island couldn't pay any of its debt. It was broke. The bond funds crashed, savings, retirements, pensions gone. The government started closing hospitals. There was no money to shore up bridges or electrical grids. And then - well, you know what happened next. A Category 4 hurricane came barreling into Puerto Rico. If ever this island needed the federal government to come and bring its A-game, now was the time. What it got was anything but. Laura Sullivan, NPR News.


CORNISH: Laura Sullivan continues her reporting tomorrow with an examination of the government's flawed response to Hurricane Maria. You can see the "FRONTLINE" film "Blackout In Puerto Rico" tomorrow on your local PBS station.

(SOUNDBITE OF PAVANE'S "LA DANSE DE DAPHNIS") Transcript provided by NPR, Copyright NPR.

Laura Sullivan is an NPR News investigative correspondent whose work has cast a light on some of the country's most disadvantaged people.
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