Advocates of paying off 38 Studios debt go silent

Nearly a year of reassurances from Rhode Island’s top political leaders that the state will pay off its 38 Studios LLC debt hasn’t quieted advocates of a tactical default.
A group of lawmakers is pushing bills to cut all 38 Studios bond payments from the upcoming fiscal 2014 budget, while supporters of paying off the $75 million loan guarantee to Curt Schilling’s defunct video game company have become nearly silent.
Despite pledging support for paying the bonds to Moody’s Investors Service in a report from the ratings agency last May, House Speaker Gordon D. Fox is now publicly uncommitted on the issue.
“No position has been finalized,” said Fox spokesman Larry Berman about the 38 Studios bonds. “The Speaker will continue to study the issue.”
General Treasurer Gina M. Raimondo through a spokeswoman said the state’s debt consultants had advised against a default so her office has not analyzed the option.
And although Gov. Lincoln D. Chafee stands by his longstanding position to pay the debt for moral reasons, he did not send anyone from the R.I. Economic Development Corporation, which issued the 38 Studios bonds, to a recent legislative hearing on a series of default bills.
With little coming from the strongest supporters of paying the bonds, advocates of default have grown louder.
“It couldn’t be clearer that the bond holders were accepting the risk,” said Rep. Spencer E. Dickinson, D-South Kingstown. “The third issuance of bonds was at an interest rate of 7.75 percent. That tells you anyone buying them was walking into a casino.”
Dickinson is a co-sponsor of a bill filed by Rep. Karen MacBeth, D-Cumberland, which would bar the state from paying back the bondholders.
On whether the bill has a chance, Dickinson said he believed it has the support of a majority of House members, but that they might back down if asked to do so by Fox, who has been closely aligned with Raimondo.
The 38 Studios loan was financed through state “moral obligation” bonds issued by the quasi-public R.I. Economic Development Corporation under $125 million in borrowing authority granted by the legislature.
Unlike general-obligation bonds, which state government is contractually obligated to pay, moral-obligation bonds are backed by a more nebulous pledge that the legislature will make appropriations to back them. Also unlike general-obligation bonds, which are used for the bulk of state borrowing and such purposes as infrastructure, clean water and affordable housing projects, moral-obligation bonds do not require approval by voter referendum.
Critics of moral-obligation bonds describe them as “gray-market financial instruments” that don’t provide clear lines of responsibility.
Both supporters and opponents of paying the 38 Studios bonds believe that default would eliminate moral-obligation bonds as a financing option for a significant period of time.
But they differ on whether or not that is a bad thing.
“We ought to be issuing general-obligation bonds with the full faith and credit of the state or we ought to be issuing revenue bonds backed up by a revenue stream,” said Gary Sasse, director of Bryant University’s Institute for Public Leadership and a former director of administration under Gov. Donald L. Carcieri. “Moral-obligation bonds result in bonding for projects where there is a lot of gray area.”
As further reason for avoiding moral-obligation bonds, Sasse mentioned Alpha-Beta Technologies, a pharmaceutical company lured to Smithfield with $30 million in state-backed financing.
Alpha-Beta folded after the drug it was working on fizzled out and the state paid the bond, but was able to recoup $25 million by selling the company’s former plant.
According to state Budget Officer Thomas Mullaney, Rhode Island currently has $6.5 million of non-38 Studios outstanding moral-obligation debt out of $1.9 billion in total tax-supported debt.
Perhaps the best example of the potential negative consequences state leaders are worried about is in the transfer of the former the Interstate 195 lands, which the state is using moral-obligation bonds to facilitate. (The proceeds will go to the R.I. Department of Transportation, the current land-owner, and then be paid back through either sales to developers or, if no development, state appropriations.)
Mullaney said a default on 38 Studios bonds could make such a transfer more difficult or expensive. An even larger and more frequently asked question is how a 38 Studios default would impact the state’s general-obligation borrowing costs.
After its report last May citing anti-default assurances from Fox, Chafee, Raimondo and Senate President M. Teresa Paiva Weed as reasons not to downgrade the 38 Studios bonds, Moody’s has given no guidance on what would happen to the state’s credit rating if it didn’t pay.
Calls to Moody’s and fellow credit-rating agency Standard & Poors were not returned. No representatives for the agencies appeared in the recent legislative hearings on default bills.
Neither Chafee, Raimondo, Fox nor Paiva Weed were able to provide any estimates of how much a default may cost the state, according to their spokespeople, who didn’t provide any firm plans to develop any.
Speculation about what might happen to state borrowing costs has included a half-point to full-point increase in the interest rates the state sees for general-obligation debt.
Sasse said a recent default in Washington State had resulted in a single-grade lowering of the state’s credit rating that was upgraded four years later.
While he hasn’t said Rhode Island should default, Sasse said state leaders should at least find out specifics and provide evidence for whatever decision they make.
Counting interest payments and reserve funds held back from the bond sale, Rhode Island is estimated to owe $89.2 million on the 38 Studios loan.
Chafee has put $2.5 million in next year’s budget to cover the first 38 Studios payment and plans to include $12.5 million annually for the next seven years after that.
Dickinson said even if investors do punish Rhode Island for defaulting on the bonds, it is unlikely the state will borrow enough in the near future to offset the cost of repayment.
“My impression is the financial industry doesn’t walk away from anything for that long and in six-to-eight years, they will be back,” Dickinson said. “They are not punishing themselves. Personally, it might be a good idea to take a break for 10 years from some of these EDC programs. Personally, I don’t see a downside.” •

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