Who Is Buying That Crap?

Dan and I follow municipal bonds, which is a bit more exciting than it sounds. The State of Illinois, the City of Chicago, Cook County, and many other entities in which I am a semi-unwitting participant will likely soon be on the front pages of newspapers as it sinks in that we can never repay these debts.

Back in late 2008, during the height of that financial crisis, the State of Illinois issued debt. In this post I basically asked the question “Who is buying this crap?” and the answer was JP Morgan, showing its solidarity (in a way) with the state of Illinois by buying the ENTIRE issue.

Puerto Rico is the new problem child of debt failure, and as Dan calls it, a “gapers block” over the entire municipal debt market. There were a lot of good reasons to buy Puerto Rico municipal bonds for many years – it was tax exempt, it had high yields, some of it was insured and / or tied to revenue streams like power or water, and historically there had been few or no failures of large-scale municipal bond issuers. It was great to own this debt and collect the high interest rates, as long as you watched it and got out before it collapsed. In a way this is “momentum investing” of sorts – get in and enjoy the ride up, but make sure you clear the exit before everyone else runs out of the movie theater screaming “fire”.

But the question in the back of my mind was always “Who is buying that crap”. Not sophisticated investors who knew how to ride the wave up and get out before it collapsed, but people who honestly believed that a set of statements by politicians and / or laws as they were currently constructed would magically allow a tiny and impoverished island to pay inordinate debts while their economy imploded around them.

A recent NY Times article titled “Pain of Puerto Rico’s Debt Crisis Is Weighing on the Little Guy, Too” provided a timely answer to my question.

To Lev Steinberg, it seemed like a good place to park his nest egg. Puerto Rico bonds offered high returns and tax-free income. And there was little chance, his broker assured him, that the government would default on its debt. So Mr. Steinberg went all in, investing more than 85 percent of his retirement savings in funds with large concentrations of Puerto Rico bonds.“They told me this was safe,” said Mr. Steinberg, a 64-year-old mathematics professor at the University of Puerto Rico, “that the legal protections to repay the bonds were strong.”

The NY Times article describes how local brokers and banks created products that leveraged up these bonds with borrowed money and then they were sold to Puerto Rico citizens (they were illegal on the mainland). The article said that 20% of Puerto Rican debt is owed to local citizens, and they bought many of the most “toxic” issuances (those with the least protections, like pension obligation bonds).

Thank you, NY Times, for helping to answer the timeless question “who is buying that crap”. The answer is gullible citizens, who believed in their government’s promises, and also thought that years and years of high returns could be manufactured endlessly out of thin air without corresponding risk.

Cross posted at LITGM

15 thoughts on “Who Is Buying That Crap?”

  1. I’m sure the NYT describes this as a moral failure of brokers. The government issuing the bonds, with no plan to ever pay them back, is blameless.

  2. I don’t think the brokers are free of responsibility just as the brokers who wrote junk mortgages and sold them as soon as the first payment was made on the mortgage were free of some blame. Of course, they are all responding to incentives that came from politicians.

  3. What’s the responsibility of stupid people who put EIGHTY-FIVE PERCENT of their retirement savings into ANY single instrument?

  4. Gene stole my thunder. Reminds me of when Enron blew up and we heard stories of employees with a large portion of their retirement money in that one stock. I didn’t feel sorry for them, and I don’t feel sorry for this math professor, who should have known better. I pay people to fix my car because I don’t know wtf I am doing. Others should accept their limits and pay professionals to do things they have no clue about.

  5. “What’s the responsibility of stupid people”

    “Mr. Steinberg, a 64-year-old mathematics professor at the University of Puerto Rico”

    I am sure Mr. Steinberg is not stupid. Gullible? Yes. Improvident? Yes. Untutored in Investing? Yes. Stupid? No. From his University web page:


    He has a Ph.D.

    1988, Ph.D., Institute for Mathematics and Mechanics of Academy of Sciences, Alma, USSR

    They might not have taught him much about economics, it was the Soviet Union after all, but I am sure they taught him plenty of math.

    Here is one of his 6 article titles:

    Steinberg, Lev G. “Inverse spectral problems for inhomogeneous elastic cylinders.” J. Elasticity 38 (1995), no. 2, 133–151, 73D50 (34A55 34B24)

    I am sure that I couldn’t understand it. Could you?

    Here is the problem. Everybody is ignorant and everybody is stupid. It is just about different subjects.

  6. “Everybody is ignorant and everybody is stupid”

    A few years ago, the family of a retired Professor of Psychiatry at UC, Irvine went to court to get a conservator assigned after the professor had sent a million dollars to a Taiwan money scam. He had given away his retirement funds.

    I agree about retirement stupidity. Doctors are notorious for it.

  7. I stumbled onto your blog a few years ago and put it in my news feed.

    I like Mr Schwartz’s comment above. Good, decent people are always susceptible to theft. It is their very nature to trust people because they are truthful and trusting themselves. In that sense, they are sheep.

    I wrote about something very similar today- A Nation Full of Suckers. However, people are starting to wise up. I included links to a great piece in the NY Post and a link to the Chapwood Index- indexing real inflation, not those garbage numbers cooked up by the BLS.


  8. “The answer is gullible citizens, who believed in their government’s promises”

    Perhaps this is a reminder of that the punishment for government malfeasance needs to be severe, and the more grave the offense the more terrible the punishment.

  9. In a just world, the Chicago teacher’s pension and other municipal unions would be obligated to invest significantly in that debt. At least they’d have a direct interest in its sustainability

  10. “I agree about retirement stupidity. Doctors are notorious for it.” Doctors in the NHS have a wonderfully remunerative defined benefit pension scheme. The latest dodge is to retire, start the pension, and return to work 24 hours later.

  11. One casualty of the NHS was that it ended the sale of practices by GPs which had traditionally funded pensions for the doctor. Something had to found to replace that.

  12. I remember the liberal argument as to why the national debt was no big deal – “We owe it to ourselves!”

    Perhaps that was before China and Japan started to buy so much Treasuries – or before we started to sell more than US citizens could buy.

    In the bigger scheme, it looks like the too-big-to-fail banks are laundering money for the government. The Fed gives them new cash, the banks buy government securities, and the legitimate wealth creators and wealth preservers get inflation.

  13. When I first began practicing bankruptcy law in the 1980s, we had a category of cases arising out of what we called “doctor and dentist deals”–guys with lots of spare cash to invest and enough brains to think they must know what they were doing, but no financial sophistication at all. The deals usually involved limited partnerships that front-loaded a lot of tax benefits and hoped you wouldn’t think about the corresponding tax hits built into the back end.

    My father was a very, very bright man, someone who’d have had no difficulty understand (or even writing) that article about elastic cylinders. He at least had sense enough to check with me before investing in a perfectly hideous limited partnership in the movie business. Starting from nothing, he managed to build up a completely adequate retirement estate.

  14. “One casualty of the NHS was that it ended the sale of practices by GPs”: are you sure? Here is a link to advice on how to include the value of “goodwill” when selling a practice.


    I don’t know much about the topic but I do know that GP partners typically own the practice’s property, so that a new partner coming in will typically take out a loan so that she can buy her share of the property. (I say “her” because most new GPs are women, I understand.)

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