Russell Moore: Don’t Pay 38 Studios Bonds

Monday, June 10, 2013

Russell J. Moore, GoLocalProv MINDSETTER™

 

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In the end, the question has nothing to do with morals.

All that matters is if it will cost Rhode Islanders more in the long term than the $112 million it will save ($75 million principal, $37 million in interest) by not paying off the bondholders who backed the failed video game company founded by former Red Sox star Curt Schilling.

This is a decision that should be made as cold and rationally by state leaders as it was by the bondholders who thought they could make a profit lending money to a highly speculative video game company.

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And the burden of proof is on the state leaders who believe it will end up costing more in the long term to demonstrate why that’s the case. Thus far, I've yet to see enough evidence to convince me that we’re not better off just leaving the Wall Street investors who received a good interest rate investing in a baseball player’s company holding the bag.

Merely telling me “Wall Street always wins” isn't going to cut it.

The argument made by finance expert Matt Fabian to the House Finance Committee last Thursday was that if the state fails to back this moral obligation, it will see higher borrowing costs over the long term because Rhode Island would be seen as a high-risk entity. Those spiked borrowing costs, he argued, would cost us more than $112 million over the long term.

Let’s not forget that Fabian is a managing director of Municipal Market Advisers whose clients include the insurance company for the bond as well as at least one bondholder. Call me cynical, but my experience tells me that people seldom like to bite the hands that feed them.

No legal obligation

Here’s the bottom line: we are not legally obligated to pay back these bonds. Keep that in mind whenever someone says not paying has something to do with “the good name of the state.”

To not pay what one doesn't legally have to pay is quite different from refusing to pay a bond that we’re legally obligated to back. Fabian seems to be conflating all types of bonds in order to convince us to pay the bonds that will benefit his clients.

The state has never failed to pay back a bond that it was legally obligated to pay.

That means something. The fact that we backed away from something we weren't legally obligated to pay in the first place is not the same as welching on a general obligation or revenue bond. I, for one, tend to think that investors would take that fact into account when deciding whether or not to loan Rhode Island money.

In a report on April 18, 2013 on GoLocalprov.com, Stephen Beale went right to the source and asked a Moody’s analyst what the impact of a default those bonds would look like. The answer: it’s too early to tell.

“Too early to tell what the impact would be on the GO rating—it would depend on the specific decision and circumstances,” Moody’s spokesman David Jacobson told Beale.

If it’s too early to know all the facts, than at the very least, it’s too early to pay.

Further complicating the issue is that the state is currently in litigation over the issue of how the bonds were sold and marketed. If the bond writers injured the state and bondholders, one would think that that would mean Rhode Islanders are not on the hook.

Also, the question of insurance is also relevant. The sophisticated investors who bought these bonds demanded that they be insured for exactly this type of scenario. The fact that the bond buyers demanded that the bonds be insured tells us that they knew they were conducting risky business. Without insurance, no money would’ve been lent in the first place.

It’s important to remember that hardly anybody outside of former Republican Governor Donald Carcieri and his cronies on the EDC board supported the idea of giving such a massive loan to a fledgling pre-revenue company run by a man with no experience in the business. Polling done at the time showed a plurality of Rhode Islanders opposed this deal, and only a small percentage actually supported it. That’s why the Rhode Island Economic Development Corporation, a quasi-public agency, decided to go the route of the moral obligation bonds.

Fair Warning

And the bond buyers cannot say they were not warned. Frank Caprio, who was General Treasurer at the time, intervened in the bond sale by warning potential bond buyers that this was a risky investment—a move made primarily to stall the deal so cooler heads would prevail and we wouldn't wind up where we are now.

With the exception of Carcieri, who as Governor chaired the EDC, no state elected leaders were involved in the process—not even the Speaker of the House, despite the fact that he has taken plenty of unfair criticism over this issue.

Unlike the way this process was handled, normally, the state asks voters to approve bonds by referendum question—think renovating Fort Adams in Newport, or funding matching federal grants for road and bridge improvements, for example. Or, the state will offer revenue backed bonds to fund projects. For instance, if TF Green wants to extend the runway, it can use its expected incoming revenue streams to fund the borrowing.

Neither method was going to get Governor Carcieri the Curt Schilling pictures and autographs he wanted.

Make no mistake about it: the process used to borrow this money was designed to avoid citizens from having any say through a general obligation bond. Asking those very citizens, who were circumvented in the first place, to make these bonds whole is ridiculous.

Cod liver oil?

Having spent years covering Rhode Island as a news reporter, I noticed a few things about Rhode Island government. We spend too much. We borrow too much. And we tax too much.

Even if it is true, and I argue that it’s not, that the state would see some type of a significant downgrade as a result of failing to pay these 38 Studios bonds, there’s a simple solution. Stop borrowing so much money.

It’s a novel concept, I admit, but it would force us to decrease our spending, which might very well then get us on a path to reduce our taxing. That may very well be the “cod liver oil”, as our Governor would say, that we need to create a better economic and business climate in the long term.

Or, we can just force senior citizens and struggling middle class families to bail out the speculative Wall Street big shots. I know which side I’m on.

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A native Rhode Islander, Russell J. Moore is a graduate of Providence College and St. Raphael Academy. He worked as a news reporter for 7 years (2004-2010), 5 of which with The Warwick Beacon, focusing on government. He continues to keep a close eye on the inner workings of Rhode Islands state and local governments.

 

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