State Must Pay 38 Studios Bondholders

Any elected official in the state of Rhode Island who recommends that we walk away from our 38 Studios debt should have his head examined.  As painful as it is, the collapse of 38 Studios means we owe about $105 million to the bondholders who helped finance the ill-fated venture. As legislators deal with restructuring the RI EDC, they are also debating how to repay the loans coming due and, taking a walk on the wild side, questioning if the state should repay them at all.

Governor Chafee, who believes we need to pay the bondholders their money with interest attached, has placed a first payment in his budget for the next fiscal year, which starts July 1^st.  Chafee’s repayment plan calls for annual payments of $12.5 million for the next seven years, preceded by a first payment of $2.5 million.  That would bring our total debt repayment to over $112 million and take eight years to retire.  

We now know, thanks to intrepid reporting by WPRI’s Target 12 investigators, who those major bondholders are: major insurance and financial service companies like USAA, the military member insurance giant, and Transamerica, as well as Wells Fargo and First Southwest. USAA and Transamerica purchased almost two-thirds of the $75 million bond notes; USAA alone bought almost $36 million.

Walking away from repayment rests on a spineless and self-destructive legal argument that straddles the difference between a “moral obligation” as opposed to a “general obligation” to repay. As WPRI’s report stated, “The 38 Studios debt was legally classified as moral obligation bonds rather than general-obligation bonds. Governments promise investors they’ll repay general-obligation bonds, but only pledge to consider repaying moral-obligation bonds.” Of course, despite the legal distinction, states always repay moral obligation bonds. To not do so would label them as big time credit risks. As has been reported elsewhere, only one state has defaulted on a moral obligation bond: Arkansas and that was in the midst of the Great Depression.   

Those who say we should renege, like former Governor Carcieri who helped get us into this mess in the first place, argue that the bondholders accepted risk in buying the bonds and if we don’t pay they can go to their insurance companies for the make good. Rhode Island taxpayers, who aren’t at fault, shouldn’t be burdened by it.

Too bad the world doesn’t work that way. Should Rhode Island default on the obligation using a legal tactic, our reputation in the global financial community would be ruined, our credit rating would plummet, and costs would soar to get anyone to back our bond offerings. We would drive a stake into all efforts to get our state viewed more positively in national rankings and to spur outside investment and economic development.

One thing we can do is to attempt to renegotiate the terms of the repayment, as some are advocating. That should be looked into, although it probably means we would end up paying even more in the end for easier terms on the way through the repayment program. The bottom line is that we have to repay. There is no honest or proper way to get around it, so let’s get it going.

38 Studios’ financing was an inside political deal that violated the loan and legislative processes in the first place and then was badly managed. The process of properly vetting such a risk, which may have stopped the inside wheeling and dealing in its tracks, was strangled by an overwhelming desire to land a video game development company and use it to nurture an industry within our borders. That it was headed by Curt Schilling made it even more attractive for all the wrong reasons. Curt is back on sports radio these days discussing what he always knew best: baseball. The state’s taxpayers were again ill-used by their elected officials and that, unfortunately, is tough luck. We have a process to change that by not reelecting them, but that’s another headache inducing sad story. 

Should State Reexamine Pension Law?

Involved parties in Rhode Island state government may be getting a little more apprehensive over the fate of their defense arguments on behalf of the state pension reform law enacted late 2011, which is being challenged by labor and is now before Superior Court Judge Sarah Taft-Carter, melded into a previous court challenge relating to pension changes enacted during the Carcieri years. That’s because local communities like Providence and Cranston are forging ahead successfully with local pension plan overhauls with labor cooperation. Taft-Carter is obviously following these developments and, in fact, she oversaw and approved the new Providence deal.  

Just last week Mayor Allan Fung of Cranston and Mayor Angel Taveras of the capital city announced settlements with their public safety unions to help save the locally administered plans. Not only do the agreements save the plans from eventual insolvency, but they rescue the municipalities from potential bankruptcy. The agreements, which the involved unions and retirees accepted grudgingly in the face of each city’s financial realities, eliminate COLA payments over a ten-year period in Providence’ case and cap and reduce COLAs in Cranston’s case under a more specific agreement, also for a decade.

The Providence settlement follows the state pension reform law in that COLAs are frozen for a 10-year period while in Cranston 3 percent COLAs get frozen every other year for a decade with the city reducing the COLA rate down to 1.5 percent in years 11 and 12. Providence, which had already reached similar pension deals with its other unions that remain to be ratified, will save $18.5 million this fiscal year and Cranston will save 6.5 million in next year’s budget. The deal spares Cranston – and Mayor Fung – a property tax increase. Providence taxpayers may get hit with an increase just the same.

Both Taveras and Fung, along with Mayor Scott Avedsian of Warwick, pushed during the state pension negotiations in the General Assembly to get locally administered plans wrapped into the legislation. They were supported by Governor Chafee in that attempt but were ultimately unsuccessful, in no small part because legislators went with the recommendation of plan mastermind General Treasurer Gina Raimondo, who felt that adding local plans could jeopardize the legislation in court once it was challenged, which is exactly where it sits now.

Taft-Carter has asked that the state and the unions challenging the pension overhaul to  discuss their differences via non-binding arbitration, which the state opposes in principle but must now engage in. Under those imposed conditions, it’s not especially helpful to the state’s position to witness important local communities succeed at negotiations with their unions. If they can do that and gain concessions that both sides can live with, why can’t the state?

And if Providence and Cranston can do it, Warwick will too and so will other communities with belly up local plans. West Warwick is in desperate straits with its underfunded plans and its unions – and taxpayers – are going to have to come to agreements or face state intervention. East Providence came close – a special overseer was appointed – but the city across the river from the capital city has spared itself the prospect of becoming the next Central Falls by undertaking a series of tough measures.

The painful experience of Central Falls, where taxpayers who could ill afford them got hit with tax increases and retirees had their pensions cut by a whopping 50 percent, strikes fear in local governments across the state. Labor, in the end, will accept concessions because of a simple and inescapable calculation: refuse to deal and the municipality that pays the salaries and retirement benefits could go bankrupt and then no one gets much, if anything.

The fate of the state’s case rests on an interpretation of case law and the notion of an implied contract obligation inherent or not in successive contractual bargaining agreements. The state can resist negotiations now, lose the case and elect to fight on. But that costs more money and increases the liability if the state loses its appeals before higher courts. Or it can step back, elect to negotiate, and reach a new modified agreement with labor, eliminating the court challenge. Providence and now Cranston show that it can be done.  Should the state rethink its strategy?                

Tax Breaks for Some Companies?

Is it right and does it make good public policy to provide tax breaks to certain companies operating in Rhode Island in return for those companies hiring new workers? That’s one of the issues facing the General Assembly right now in its budget deliberations. The issue of tax breaks for new hires – the program is called the Jobs Development Act (JDA) and 11 in-state companies benefit from it - is controversial on its face and it has been hard for the state to track because it has to rely on the participating companies to report back on their staffing levels.

The issue has becomes even more sensitive with Governor Chafee’s stated desire, made in his budget proposal, to cut the state’s corporate tax rate down to 7-percent from its current 9-percent rate over a three-year period. As a businessman operating in the Ocean State, I applaud the Governor’s call to reduce the corporate tax rate; doing so will ease the tax burden on Rhode Island businesses, which they could certainly use, make Rhode island more competitive with our neighbors, and it also sends a pro-business message out to companies that might be looking at our state to do business in. It will also help keep companies here.

However, one can’t cut a tax revenue without making it up somewhere else. To replace the lost revenue the Governor wants to take an axe to the Jobs Development Act and cut it in half over two years. The JDA currently reduces the corporate tax rate from 9-percent down to 3-4-percent. Under Chafee’s plan the qualifying companies’ tax break would be reduced to 6-percent, one percentage point lower than the new corporate tax rate of 7-percent.

Halving the credit will cost some very big companies a lot of money, and no other company more so than CVS of Woonsocket. CVS, as has been reported, has saved millions each year under the Jobs Development Act. For example, last year the pharmacy giant (2011 net revenues of $107 billion) saved over $15 million on its tax bill to Rhode Island because of the JDA. And, naturally, it is fighting back against any thought of cuts to the JDA and holding up the prospect that it can grow its workforce outside Rhode Island if it so decides. It could even choose to relocate its corporate and other operations out of the Ocean State entirely, taking thousands of jobs with it. Just the thought of something like that that makes legislators nervous, as it should.

Regardless of the arguments pro and con when it comes to tax breaks for new hires and maintenance of employment levels, what has CVS done to deserve such breaks? The company is making a forceful argument on its behalf. To qualify for the JDA tax credits, companies have to add jobs starting at $40,000 a year with benefits; CVS says it has added and retained 2,100 job in-state since 1997, while also adding infrastructure and contributing more than $1.2 billion to the state’s GDP. GDP contributions are important because companies create a “multiplier effect” when they engage vendors and suppliers and their employees spend their earnings in the local economy. Plus, companies like CVS support many good causes – the CVS Caremark Charity Classic and their recently announced pharmacy program with the RI Free Clinic, to name just two. Undoubtedly, having CVS remain headquartered here in Rhode Island paying good wages and contributing to the community is vital to our economy.

But all companies face the same challenges, and all companies hire when they need to, so why should taxpayers subsidize certain companies for doing what most companies would do anyway? Even accepting the fact that life is unfair, the principle of tax fairness after all should not create a special class of favored employers, who share their tax savings with investors on the backs of taxpayers.

So both arguments have merit and the hard choice is which side to favor at this point to accomplish a larger purpose. Lowering the corporate tax rate will benefit all businesses, small and large, while allowing certain companies to take advantage of tax credits based on hiring and retention of good paying jobs helps those companies grow their workforce and pump more money into the local economy. Since the art of successful politics is compromise, we should expect our legislators to find a common middle ground that satisfies both sides of this debate.