Other peoples’ money funds mistakes

David MoonBlog

by David Moon

Puerto Rico is broke and in default on $58 billion in debt. Its solution is to make payment on the loans in default with a sales tax revenue stream that is already committed as collateral for $15 billion of still performing loans.

Lawsuits are flying, as Puerto Rican officials describe the dire consequences that will occur if it isn’t doesn’t breech existing bond covenants.

Puerto Rico’s attempt to unilaterally divert collateral from one loan to another is the equivalent of trying to get multiple mortgages on your home and promising each lender a first lien. People go to jail for that.

There are legal processes in place for default and they ought to be followed. Absolving people of the consequences of their own decisions by forcing amended terms onto third parties is malfeasance when financed by the most easily and commonly misused type of money: Other People’s Money (OPM.)

In June 2011, then-University of Tennessee Athletics Director Mike Hamilton was three weeks away from the expiration of his contract. Had the University chosen not to renew Hamilton’s contract, it would have owed him practically nothing, much like when regular people get fired out in the real world.

The University, however, using OPM, gave Hamilton a $1.3 million severance to which he was not contractually entitled. It may have been humane and it may have been the practice everywhere else. But it was a non-obligated, malfeasant misuse of public funds, regardless of the source.

When a third-party is aggrieved in order to fund the non-performance of existing contracts between two other parties, it is called expropriation. The enforcement of contracts—that is, the protection of property rights—is a basic function of government. Yet governments are among the most egregious and casual mis-appropriators of OPM, choosing winners and losers in a system designed for people to both benefit and suffer the consequences of their actions.

Financial contracts are based on property rights and the foundation of law—people are willing to invest because there is a capital structure enforced by contract.

The 2008 financial crisis provides examples of unequal use of OPM. The federal government forced a negotiated bankruptcy onto General Motors, treating UAW bond holders more favorably than other bond holders with identical contractual rights.

The federal government bailed out AIG, but allowed Lehman Brothers to fail.

The bail out of Fannie Mae and Freddie Mac was so poorly structured that private shareholders of the government sponsored entities are now entitled to billions in annual profits. Rather than follow the original plan to release the entities, Congress unilaterally simply refuses to release Fannie and Freddie from government conservatorship, instead diverting those profits to the Treasury.

Every time someone is allowed to buy their way out of problems using OPM, free markets die a little more.

David Moon is president of Moon Capital Management. This article originally appeared in the USA TODAY NETWORK.