In the second semester of the 2017-18 academic year, Robert Chirinko, Professor of Finance, took sabbatical leave to further his research on the Puerto Rican debt crisis and other research projects. Between January and March, he was a visitor at the Booth School of Business, University of Chicago. He continued working on his research projects at the Einaudi Institute for Economics and Finance in Rome from March until June. The Puerto Rican research was a continuation of a paper he started to write at UIC, but now he’s had the opportunity to finish up in the Eternal City. His paper, entitled “What Went Wrong?: The Puerto Rican Debt Crisis and the ‘Treasury Put’” explores why investors continued to purchase bonds issued by Puerto Rico knowing the country’s tumultuous financial state.
“The fundamental question is, if Puerto Rico was in such bad shape financially, why were investors continuing to loan money to them?” Here’s some finance 101: bonds are debt securities that companies or governments issue when attempting to raise capital. An investor purchases the bond, and the issuer agrees to pay back the loaned amount, plus interest, over a designated period of time.
Puerto Rico, a United States territory, issued bonds to raise capital for governmental needs, despite its inability to pay back the value of the bond. Investors, knowing that the country was in financial disarray, still decided to purchase these bonds under the assumption that if Puerto Rico defaulted, the U.S. Government would ensure that the investors got their money back. The authors refer to this “implicit guarantee” as the ‘Treasury Put.’
So how does one uncover the reason why investors would make such a financial decision? This is where Shaina Henderson (B.S. in Finance, 2016) and Ryan Chiu (B.S. in Biology and Political Science, 2017) came in.
“This project needed a lot of work in terms of carefully reading and analyzing documents, so I placed an advertisement for a student to do an independent study,” Professor Chirinko recounts.
Through this ad, he was able to enlist the help of Shaina initially and later Ryan to collect data about bonds issued by Puerto Rico.
“It’s a lot of hard work, finding an initial set of information about the bonds and digging in and reading what is called the official statements.” Shaina and Ryan had to delve deep into the specifics of official statements defining the bonds issued by Puerto Rico to uncover the required data, then put these data in “machine-readable form” so that they could be analyzed with the aid of a computer.
What did their research uncover? As Professor Chirinko noted, investors seemed to assume that if Puerto Rico defaulted, they would expect the U.S. government to bail them out – the ‘Treasury Put.’ To test the validity of this assumption, they used a unique event, the city of Detroit’s bankruptcy, as a “treatment.”
Ultimately, the government decided not to bailout Detroit. “In July 2013, the city of Detroit went bankrupt. Detroit is not as big as Puerto Rico, but it’s big. They had about $20 billion in debt and other liabilities (such as pension obligations).” Many believed, given the government bailout of New York City in 1975 and many subsequent bailouts, that Detroit would be bailed out as well.
“The answer, which was a surprise to people, was no. The Obama Administration gave no bailout to the city of Detroit. Matter of fact, some senators introduced legislation in Congress specifically saying that they were not going to bailout cities and states – they wanted to say on the record that they were not in the bailout business.”
Shaina and Ryan collected data on bond prices after the bailout denial of Detroit, which showed that their hypothesis was correct: the implicit guarantee disappeared and the prices of bonds fell dramatically as a result.
Professor Chirinko was highly pleased by the level of research Shaina and Ryan conducted to produce the data necessary for this paper. Shaina was able to use this research for her Finance independent study and Ryan used it for his honors thesis. Working as a research assistant like Shaina and Ryan gives students the opportunity to do hands-on, collaborative research with their own professors, which is great to include on a resume or cover letter.
As is usual for an academic research paper, the preliminary work is presented to other scholars for comments. Revisions follow, and the new version of the paper presented again. In this case, the initial presentation was at a seminar in the UIC Business Finance Department, followed by presentations at the University of Chicago, the Einaudi Institute in Rome, and a conference with a group of French financial economists. The final version of the paper will be presented at the Brookings Institution in Washington in July, and then submitted for publication in an academic journal.
Professor Chirinko recently announced that he has extended his sabbatical through June. Luckily, it won’t be all work for him this summer. He was able to steal away for a few days to Western Sicily to experience the fabulous opera house in Palermo, the best Greek ruins in the world in Agrigento, and indescribably good pasta and gelato throughout the island!