Chafee reveals RI’s confusion about the 38 Studios bonds

My friend Josh Barro of Bloomberg View, who spends a happily inordinate amount of time writing about Rhode Island, interviewed Governor Chafee this week during the governor’s media roadshow in Connecticut and New York City. Josh pressed the governor on why he’s flatly ruled out defaulting on the 38 Studios bonds yet signed a law that reneged on promises made to state retirees – and Chafee’s reply was not convincing:

That raises a question that many state residents – especially retired employees – would like to see answered: If Rhode Island can’t afford to keep its promises to retirees, how can it afford to keep its promise to the 38 Studios bondholders? Chafee isn’t prepared to answer. …

And when it came to 38 Studios, Chafee couldn’t even answer a simple question: Is it ever appropriate for the state to issue moral obligation bonds?

“I’m not an expert on that issue,” he responded. After a year of dealing with the fallout from 38 Studios’ collapse, you would think he would be.

As the interview ended, Chafee remarked, “I’ll have to think a little more about Josh’s question” — the one about why you can freeze COLAs but can’t default on 38 Studios.

Local officials are fearful that the bond market won’t differentiate between a default on the moral-obligation bonds issued for 38 Studios and the general-obligation bonds backed by the state’s full faith and credit, particularly since Rhode Island is a municipal minnow compared with, say, California. A top policymaker once asked me to imagine a Wall Street Journal headline the day after: “Rhode Island defaults on bonds.”

While that’s certainly possible, it’s worth scrutinizing.

First of all, if any state officials in the country should be able to go to Wall Street and soothingly explain why the 38 Studios case is a unique one and the default won’t set a precedent, wouldn’t they be Gina Raimondo – a former venture capitalist beloved by financiers who crafted a landmark law slashing pension liabilities – and Rosemary Booth Gallogly – a veteran policymaker who’s overseen the successful restructuring of municipal budgets in Central Falls and elsewhere, all while explicitly protecting bondholders?

Maybe, maybe not. (And maybe Raimondo and Gallogly aren’t interested in trying.) But if that’s the case, a moral-obligation bond is effectively a general-obligation bond in all but name, with full repayment by Rhode Island taxpayers promised no matter what. If so, shouldn’t voters have to approve moral-obligation bonds at the ballot box as they already do with general-obligation bonds – and shouldn’t Rhode Island be paying the lower interest rate investors get on a lower-risk general-obligation bond?

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