Keep paying on 38 Studios bonds?

If Rhode Island taxpayers are repaying a debt secured under fraudulent representation, should they keep paying?

The recent disclosure that the Securities and Exchange Commission has filed charges against the state’s economic-development agency and its bond underwriter – alleging fraud in the issuance of bonds to support the now-failed 38 Studios LLC – has resulted in renewed calls to stop state payments to bondholders.

Among other things, the SEC accused the state and bond underwriter of issuing $75 million in moral-obligation bonds that were not adequately explained to investors. The company fell into bankruptcy, defaulting on its state-backed loan.

Soon after the SEC’s announcement, it was reported by multiple media outlets that Rep. Karen L. MacBeth, D-Cumberland, would reintroduce legislation to stop additional payments to investors.

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Her legislation, originally introduced in January 2014, was put on hold after a single hearing. MacBeth could not be immediately reached for comment last week.

Why continue paying? The state risks defaulting, and a subsequent downgrading of its credit rating and borrowing ability.

The state’s credit rating for general obligations, last updated by the major ratings services in July 2015, has a stable outlook. Both Standard & Poor’s and Fitch Ratings Inc. have rated Rhode Island bonds at AA, while Moody’s Investors Service has set a rating of Aa2, according to the state.

Gov. Gina M. Raimondo and other state leaders on March 11 acknowledged the frustration of Rhode Islanders in making yearly payments on bonds associated with the failed gaming company, but stated that repayment is the best option.

“Defaulting on this obligation would lower the state’s credit rating, harm our efforts to create jobs and grow Rhode Island’s economy, and ultimately hurt the taxpayers,” stated a release jointly issued by Raimondo, House Speaker Nicholas A. Mattiello, D-Cranston, Senate President M. Teresa Paiva Weed, D-Newport, and Treasurer Seth Magaziner.

Raimondo says the state’s reputation is at stake. The state has also sued to recoup the losses, and has been advised by attorneys that repaying the loans will strengthen its position.

“I don’t want to damage our bond rating, credit rating or reputation in the market as being a state that doesn’t pay back its bills,” she told Providence Business News.

In 2014, shortly before the state made its first payment on the bonds, a study by SJ Advisors found Rhode Island’s bond rating would likely sink to “junk bond” status if the state failed to repay, resulting in higher interest rates for future bonds and affecting the value of outstanding debt.

Raimondo said the state made a “terrible mistake” in 38 Studios. “Let’s pay it back, let’s get this lawsuit done, let’s get back every penny we can, but really, let’s move on,” she said. •

Staff writer Eli Sherman contributed to this report.

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