The New York Times reported in June that hedge funds invested heavily in Puerto Rico, feeling sure that the Puerto Rican government could turn the economic crisis around.

Now that the debt crisis has worsened, hedge funds are advising the government of Puerto Rico to save money by closing some schools, laying off teachers, and cutting university budgets. Most people think of education as the seed corn of future growth, but not the hedge funds. They want their debts repaid. Maybe they will propose bringing the African model of cheap, for-profit schools to Puerto Rico, which will cut costs considerably while opening new investment opportunities. (See here.)

According to the Times:

Hedge funds like Appaloosa Management, Paulson & Company and Blue Mountain Capital gathered in a conference room at the Barclays offices in Midtown Manhattan last September to talk about what was then the hottest trade: Puerto Rico.

An hour into the conversation, however, it became clear that if things started going bad, not everyone in the room was going to get along. Some had wagered on real estate, while others had bought up the debts of the central government and its troubled electric utility.

Those divisions intensify an increasingly contentious battle the hedge funds are beginning to wage to salvage an investment that, less than a year ago, looked like a sure thing.

This week’s announcement by Gov. Alejandro García Padilla of Puerto Rico that the commonwealth may seek to delay debt payments has thrown the hedge funds’ investment strategies into turmoil.

The governor said that at the rate the debt is developing, every person in Puerto Rico would owe creditors $40,000 by 2025.The Bonds That Broke Puerto RicoJUNE 30, 2015
Puerto Rico is struggling with more than $70 billion in debt and a sluggish economy.Puerto Rico Debt Crisis Splits Congress on Party Lines and Draws Muted Response From White HouseJUNE 29, 2015
Gov. Alejandro García Padilla plans to discuss the island’s fiscal crisis on a televised broadcast on Monday night.Puerto Rico’s Governor Says Island’s Debts Are ‘Not Payable’JUNE 28, 2015
Even debts that appeared to be secure now seem in jeopardy, sending hedge funds and other investors scrambling to re-examine their legal rights and potential remedies should the government push for a restructuring.

The Commonwealth’s biggest cheerleader on Wall Street has been John Paulson:

For the hedge funds, the idea was to lend the money at high interest rates, then flip the bonds to traditional municipal bond investors, like mutual funds, once the fiscal crisis on the island had passed. As part of that strategy, some of the hedge funds circulated research last summer arguing that Puerto Rico’s problems were overstated.

But Governor García Padilla is now contending exactly the opposite, releasing a report by former officials at the International Monetary Fund and the World Bank that says that Puerto Rico’s deficit is worse than it appears and that the commonwealth cannot solve its problems without restructuring its debts, possibly even its general obligation bonds.

Still, Puerto Rico’s relationship with the hedge fund industry is complicated. At the same time the government is gearing up for a series of restructurings with hedge funds and other creditors, officials are courting investments in the broader economy.

Hedge funds have been among the few investors willing to take a chance that Puerto Rico can turn things around.

Puerto Rico’s biggest hedge fund cheerleader in New York has been the billionaire John A. Paulson. Mr. Paulson told investors at an investment conference in San Juan last year that Puerto Rico’s economy was turning a corner. He went as far as to predict it would be the Singapore of the Caribbean, referring to the Southeast Asian city-state that is considered the region’s biggest economic success story.

Mr. Paulson bought up some of the island’s most exclusive luxury hotels, including the St. Regis Bahia Beach Resort, the Condado Vanderbilt Hotel and the La Concha Renaissance hotel and tower.

And he has acted as a de facto liaison between the commonwealth and Wall Street.