38 Studios bonds: Don’t default and don’t repay

In my last post I insisted that Rhode Island needed to keep its word and not default on the 38 Studios bonds. I know more now, and my conclusion has changed.

After much discussion with Randall Rose of Occupy Providence, who educated me quite a bit, and Sam Bell of RIPDA, I looked into the relevant documents in detail and rethought the 38 Studios bonds default/repayment issue. Most of what follows is derived from Randall’s research. I’m only going to cover the directly-relevant points of what convinced me to change my tune; I’ll leave the full story to Randall to write.

First, a little background on bonds. There are two basic types. General Obligation bonds are fully backed by the state, including use of its taxing authority to cover the bonds. In Rhode Island’s case the voters have to approve the bonds via a referendum.

Revenue bonds, the second type, are issued by non-state authorities who repay the bonds from income generated by the activity funded by the bonds in the first place. They are typically used to avoid getting the approval of the state’s voters for their issuance.

“Moral Obligation” bonds are Revenue bonds with perhaps a casual (or more rigorous) assurance by the state that it will repay the bonds if there is a default. HOWEVER: more often than not detailed or specific guarantees don’t appear in any document. Moral Obligation bonds are very fuzzy, seemingly used to make Revenue bonds be as safe as General Obligation bonds while providing a higher interest rate to the investors (bondholders).

The 38 Studios bonds are revenue bonds issued by the quasi-public RI Economic Development Corporation. BUT: are they moral obligation bonds? Is the situation just really a matter of keeping our word to cover them? No and no indeed.

The most important and telling documents in this case are the 38 Studios and EDC Loan and Trust Agreement and the RI law governing the rules of these specific loan guarantees. Let’s take a look….

In the Loan and Trust Agreement on page 9 is the text:

“This  Bond  is  issued pursuant  to  and  in  full  compliance  with the  Constitution  and  laws  of  the  State  of  Rhode  Island. This  Bond  is  a  special obligation  of  the  Corporation,  payable  solely out  of  the  revenues  or  other  receipts,  funds  or moneys  of  the  Corporation  pledged  under  the  Agreement  for  its  payment….

Neither the  State of  Rhode  Island nor  any  municipality  thereof shall be  obligated  to  pay  the  principal  of  the  Bonds, the  premium,  if  any,  the  Redemption  Price  or  the  interest thereon.  ….”

(Emphasis is mine.)

This seems pretty clear. In general, a moral obligation might influence the state to cover the bonds. However, no where in the document is the word “moral” much less the term “moral obligation.”

The law referred to above creates the “Job Creation Guaranty Program” for the EDC. This is the program that created the basis for the 38 Studios bonds and EDC guarantees. About halfway into the law is the text:

“During each January session of the general assembly, the governor shall submit to the general assembly, as part of the governor’s budget, the total of such sums, if any, required to pay any and all obligations of the corporation under such guarantees or bond obligations pursuant to the terms of this authorization. All sums appropriated by the general assembly for that purpose, and paid to the corporation, if any, shall be utilized by the corporation to make payments due on such guarantees or bond obligations.”
(The emphasis is mine.)

“Moral” does not appear anywhere in the law, and recall it’s not in the Loan and Trust Agreement. Nor could I find it in any of the other subsidiary documents on the EDC’s 38 Studios page.

The sum total of what all this means is that if the EDC doesn’t have the money to pay off the 38 Studios defaulted bonds, all that has to be done on the part of the state is:

1. The Governor must ask for the EDC-desired funds in his/her budget presented in January of every year.
2. The General Assembly is not required to honor that request; it can be removed from the final General Assembly-approved budget.

So, the law effectively states that RI doesn’t need to back up the EDC (for this program). Note that the state has NOT defaulted on any obligation; there is nothing to default on. Thus, the state does NOT need to repay the bonds.

There are, of course, other concerns, such as retaliation by the bond market against Rhode Island via lower bond ratings, etc. However, from other cases in the US, if there is an effect it will probably not be large nor last long.

My apologies for not knowing enough when I wrote my last post; “moral obligation bonds” are a cypher and intentionally vague and misleading. The more one learns the more one may need to modify his/her views. I still believe Rhode Island needs to stand behind its word; in this case it hadn’t given it.

What are your thoughts on the above? Please add any information in the comments you feel will help the discussion. Thank you.