Tuesday, May 1st, 2018
In the years before Hurricane Maria devastated Puerto Rico, a debt crisis crippled the island's finances, wiping out billions in Puerto Rican investments and leaving the island's infrastructure dangerously vulnerable.
Now, a former UBS insider is speaking out publicly about the bond frenzy that pushed the island into default, and then landing it in bankruptcy just four months before the storm.
The bank official, Carlos Capacete, says he watched as banks like UBS helped fuel the crisis, encouraging the local government to take on billions in debt. As that debt grew, the Puerto Rican government failed to maintain the island's basic needs, like its aging power grid. When the bond market collapsed, it took with it the savings of thousands of Puerto Ricans.
While the Puerto Rican government is not blame-free, Wall Street’s role in pushing the risky debt has been overlooked, Capacete said.
“In the sub-prime mortgage crisis, people were talking about Wall Street. 'Look at what they did to Main Street,'” Capacete said. “In Puerto Rico, the crisis is, 'Look at what the Puerto Ricans did.' Nobody talks about Wall Street … The bonds that were sold that created the huge $74 billion bond debt in Puerto Rico was sold using all the investment bankers in Wall Street. It’s not just the Puerto Ricans. If the banks would have been responsible, if they had said, ‘Hey, listen, you can’t borrow this amount so we’re just going to limit this to that,' we wouldn’t be in this place right now.”
Capacete spoke publicly for the first time as part of a joint investigation by FRONTLINE and NPR into the response to Hurricane Maria, "Blackout in Puerto Rico."
Before leaving the bank in 2014, Capacete worked for more than 25 years for UBS Puerto Rico, an offshoot of the Swiss finance giant and the largest wealth manager on the island. He rose through the ranks of the bank, becoming the head of the largest branch on the island, in Hato Rey, the central banking district in San Juan. At his peak, he managed a $3 billion portfolio. But his world would come crashing down, along with the Puerto Rican economy, after he raised a red flag about practices at the bank that put Puerto Rican investors at risk.
Before the market crash, Puerto Rican bonds were big business for banks. Borrowing took off in 2006. That’s when, to stave off a government shutdown, Puerto Rico increasingly began borrowing to cover annual government expenses, rather than for major infrastructure projects like most cities and states. In a matter of 14 years, the island added $48 billion dollars to its debt.
For UBS Puerto Rico and other banks, the government’s borrowing binge provided new opportunities, Capacete said. The banks played a central role as underwriters for the government’s bond offerings, seeking out buyers for Puerto Rican debt and earning millions of dollars in fees.
“All the major banks in New York would come to Puerto Rico on a regular basis to pitch deals,” Capacete said. “‘Listen, we can do an additional $200 million, an additional $500 million.' That’s how the deficit, the structural deficit, was financed.”
Capacete said that even as research reports started coming out in 2012 raising questions about the sustainability of Puerto Rico’s debt, managers continued to tout the bonds to customers.
Banks like UBS focused not just in underwriting bond deals for the government of Puerto Rico, which were sold to investors across the United States. They also found a lucrative niche by creating specialized Puerto Rican bond funds sold only to clients on the island – funds that Capacete helped oversee. These bond funds were riskier than what's allowed on the mainland because Puerto Rico, as a U.S. territory, is exempt from key investor protections provided under the Investment Companies Act of 1940.
At first, Capacete said, the funds created steady earnings for Puerto Rican clients. But over time, he said, there weren’t enough new investors to sell to, so the bank had to find ways to sell more to its existing clients.
By 2011, sales were slowing and brokers were raising concerns. That May, a group of UBS Puerto Rico brokers compiled a list of 22 problems with the funds, including excessive supply and price instability. In response, bank managers convened a meeting with all the brokers on the island.
“So you all know, our gross production is down some 40 percent,” then UBS-PR Chairman Miguel Ferrer said in a recording of the meeting later made public. “When I ask, or when the brokers are asked why they are not producing, almost all of them answer the same thing: because there is no product. Bullshit, bullshit.”
By the end of the meeting the message was clear: Sell the funds or find a new job.
That sales push, Capacete said, wasn’t just for the bond funds. He says the bank was also pushing financial advisers to sell Puerto Rican clients more loans, using their bond investments as collateral. That’s when Capacete grew suspicious.
“There were other of my peers that were being very successful. So successful in fact that I found it very strange,” Capacete said. “Because you have an economy that’s contracting … it didn’t make any sense to me that these people were doing so much business doing loans.”
He began looking into it. “And then one day, this client comes up to me and tells me, ‘Hey, you know what? Are you aware of what they’re doing in this other branch?’ And I said, ‘Tell me.’ And he told me the scheme. They were taking out the loan. The adviser was telling them to take the money to a local bank, keep it there for one or two weeks, bring back a similar amount and use it to buy more Puerto Rico funds.”
Capacete believed it was against banking rules to use these kinds of loans to buy securities like the Puerto Rican bond funds. He worried clients did not understand that by using loans to buy more bonds, their losses would be magnified if the market failed. Alarmed, he alerted compliance officials at the bank in May 2012, but said he heard nothing until the following February, when he got a visit from two compliance officers from UBS’ U.S. headquarters.
"One of them speaks and says, ‘We understand that you’re concerned whether there are financial advisers doing non-purpose loans for purpose’ which means misusing the loan program," Capacete said, recounting the meeting. "And I said, ‘Yes I am.’ And she said, ‘Well, we’d like you to know that we’ve completed an investigation and that we have found no such instances.’"
Capacete said he jumped from his seat in disbelief.
“It was contrary to company policy and you were putting the clients in a really high-risk situation,” he said. He believes the bank didn’t pay enough attention to his concerns “because they were making money." The loans were profitable, he said, "and I was the one that was … spoiling their party.”
The party ended in August 2013 after a major financial publication raised concerns about Puerto Rico’s ability to repay its debt, sending bond prices into free fall. Soon, investors big and small saw their portfolios drop. Puerto Ricans, who’d been heavily concentrated in the island’s bond funds, were hit especially hard, with losses in the billions.
Capacete’s concerns would eventually get the attention of the Securities and Exchange Commission, which in 2015 settled with UBS for $15 million over allegations that one broker had engaged in the loan scheme. The settlement said UBS’s failure to catch the broker was “due to a clerical error” yet was still a “significant lapse.” UBS did not admit guilt by settling.
UBS declined to be interviewed, but in response to questions, called Capacete a disgruntled former employee who has sued the bank on multiple occasions. The bank said the terms of its loans are fully disclosed to clients and that the bank performed an internal investigation that found only one broker had misused its loan program.
"After a thorough investigation confirmed the allegations, the broker in question was terminated,” the statement said. UBS also pointed to a separate SEC finding that found it had not misled its clients.
The bank continues to face fallout over its Puerto Rican bond funds. In all, UBS Puerto Rico has paid over $65 million in regulatory fines, and to date, more than 1,900 UBS customers in Puerto Rico have filed claims against the bank. More than half of those cases have settled with damages estimated at more than $350 million, according to the Securities Litigation Consulting Group, which has provided expert witnesses in cases against UBS.
“The problem is the risk that the clients were being put into, that they didn’t understand,” Capacete said. “Whenever you recommend a strategy to a client, you better make sure that it’s suitable for them because if not, you’re responsible.”
Emma Schwartz and NPR's Laura Sullivan contributed to this story.