moral obligation bonds

June 2, 2014June 2, 2014

Nick Mattiello cowers to corporate interests

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The article, House speaker outlines state’s economic priorities, in the Providence Journal started badly. Paul Grimaldi wrote,

“The newly elected speaker of the house told a roomful of business people Thursday that fixing the state’s fiscal problems is his priority.”

I didn’t vote for Mattiello for speaker, nor did you. He was “elected” by a bunch of frightened representatives after just a few days of discussion. There was no political campaign, no public discussion. Yet he’s the “elected speaker”?

And he’s talking to a group of “business people” at a Chamber of Commerce breakfast in the Kirkbrae Country Club. He’s reassuring them. Why? Because he’s counting on their contributions to his campaign and any political action groups he might be setting up in the wake of Gordon Fox’s resignation.

In the article, Mattiello says that 38 Studios was one of the biggest debacles in the country’s history.” Really? Did he miss the Real Estate Bubble? The Dot.Com implosion? Stock Market Crash of 1929? Teapot Dome? 38 Studios has been and remains a huge sucking chest wound in Rhode Island’s economy, but it’s not the worst thing that’s ever happened in the US, not even in the state. Remember the Credit Union crisis?

But, having recently returned from a visit to the Bond Rating Folk in New York, Mattiello claims that we have no choice but to repay our “Moral Obligation.”

Let me reframe that little trip as a school yard scene…

Roger the Rocket wants a new video game! He doesn’t have enough money to buy the game, and Wally the Banker won’t lend him the money. But Little Rhody, who wants to be Roger’s friend, and thinks he’ll be able to play the game too, promises to pay Wally the Banker back if Wally will lend Roger the Rocket the money.

Wally loans Roger the money. Roger loses it on his way to the store. Roger can’t pay, but Wally says that Little Rhody has to pay.

Little Rhody doesn’t know what to do. Rhody didn’t have the money either! So Rhody goes to Wally the Banker’s friend, Bondy, who gives out grades of A, B and Junk, and ask them for advice.

What do you think Bondy told Little Rhody to do?

Juvenile? Yes. Simplistic. Yes. Realistic? Startlingly so.

But the bad news is that the article keeps getting worse. Mattiello is telling these business people everything they want to hear. He’s going to lower corporate taxes. He’s going to raise the estate tax threshold.

One proposed bill, whose “nuances” he refused to discuss, would shift the way corporations taxes are assessed, from property, payroll and sales to just sales. In theory, this would increase revenue (presumably because they’d increase the taxes on corporate sales?), but in reality it looks like another big tax break for CVS. Think about it. What’s the biggest corporation in this state with the most employees and the most property?

Poor Little Rhody doesn’t know what to do. The rich kids all have so much money. Rhody wants to play in their playground. Maybe if Rhody will do whatever the rich kids say, then Rhody will be popular and have money too!

What do you think Rhody will do?

June 1, 2014

Almonte: Good at grandstand, but not negotiating

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The third candidate for Treasurer, Ernest Almonte, never replied back to me after repeated attempts of reaching out to him. I therefore can’t say what his position is about standing up to the ratings agencies and their deceptive ratings practices.

During his campaign, Almonte has been critical of exploring all options before making a decision on repaying the 38 Studios loans. Now, after House Speaker Mattiello put on a display of cowardice by pledging that taxpayers will be on the hook to Wall Street for the 38 Studios debacle, Almonte issued a press release urging elected officials to negotiate a settlement.

You can’t walk into a negotiation unless you have leverage. Promising Wall Street (who gamed the 38 Studios deal to begin with) that tax payers will be on the hook for the deal, gives up leverage. All along, Almonte has been giving up leverage by trumpeting the Wall Street talking points about repaying a bogus “moral obligation.” Almonte is doing nothing more than political grandstanding, which is a shame.

The elected leaders of Rhode Island have yet again been bamboozled by Wall Street. Wall Street sold a deal they knew was rotten and got our elected leaders to roll over and parrot the talking points of the 1%. It looks like any chance we had at negotiating a settlement is quickly going down the drain.

May 28, 2014May 28, 2014

Magaziner: Explore any legal avenue to limit cost to taxpayers

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Candidate for Treasurer Seth Magaziner says that he has a history of standing up to big Wall Street firms, highlighting his work as the author of a shareholder proposal to break up Citigroup. He has worked at Trillium Asset Management, a socially responsible investment firm, for the last four years.

Magaziner said in an email to me: “I believe that one of the biggest disappointments with the Dodd-Frank Financial reform was its failure to adequately deal with the ratings agencies, which absolutely shared a great deal of responsibility for the 2008 financial crisis. It is ludicrous that bond issuances are rated by for-profit companies which are paid by the issuers. The conflicts of interest are mind-boggling.”

He continued, “38 Studios was a terrible deal for taxpayers. I believe we should explore any legal avenue that might limit the cost to taxpayers, including the role played by the ratings agencies. As Treasurer I will also work to bring all parties to the 38 Studios deal to the negotiating table, to see if we can reach a settlement that will minimize cost to taxpayers while avoiding the potentially severe consequences of an outright default.”

Magaziner has criticized Frank Caprio’s initial support of the 38 Studios deal, but as I pointed out in a previous post, Caprio did eventually come out strong against the deal and did his best to prevent it from happening.

Despite his criticism of Caprio, the two candidates seem to agree more than they disagree. But it seems that Magaziner’s approach is too muted. I’d like to see him be more vocal about standing up to Wall Street and fighting for the people of Rhode Island.

May 27, 2014May 27, 2014

Caprio: Ratings agencies hands weren’t clean in 38 Studios deal

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Former Treasurer (and current candidate for Treasurer) Frank Caprio reached out to me concerning my stories about the deceptive ratings practices of the ratings agencies.

According to Caprio, the ratings agencies hands weren’t clean in the 38 Studios deal because they did in fact overrate the bonds. Furthermore, Caprio asserts that if he is re-elected as Treasurer, that he will dig into the ratings agencies.

As Ian Donnis reported in August 2010, Caprio visibly fought to prevent the 38 Studios deal from happening by going directly to the ratings agencies and investors. Unfortunately, his efforts were circumvented by the EDC, who had the discretionary power to issue the bonds. Some people have criticized Caprio for his initial support for 38 Studios and then changing his stance in opposition of the deal. In my opinion, it was courageous for Caprio to change his mind and he demonstrated leadership qualities by standing up for the taxpayers of Rhode Island.

To take action, Caprio said he would follow similar steps that he took in 2009 regarding the mismanagement scandal at the Central Landfill. Although he didn’t have an official oversight role as Treasurer, he pressured the State to take action. The result was that the right outside experts and attorneys were hired and without even having to file a lawsuit, his work led to a recovery against the Central Landfill board’s directors liability insurance of its policy limit of $5 million dollars.

Concerning the misdeeds by the ratings agencies, Caprio believes RI can look to the actions taken by the Obama administration and states such as CT and CA in seeing which law firms could be possible partners to work with RI against the ratings agencies.

Caprio also claims that the State can save substantial money by not voluntarily repaying the 38 Studios bonds. Instead, the State needs to call the bond insurer (Assured Guaranty) and the bond holders (large institutional investors) to the negotiating table to negotiate a settlement. He thinks that under the threat of non-payment by the State the insurer (who faces an $80 million dollar payout) and the bondholders would entertain the following:

Since the bondholders have received over $20 million in payments already and the fact they can agree to a waiver of default per the bonds, the state should get the waiver (holders of 50 percent of aggregate principal of bonds have to agree – which is USAA and Transamerica) and start a deliberate negotiation. Caprio says, “I believe the bondholders will see it in their interest to take a haircut on future payments. The institutional holders of these bonds don’t want the national attention on this minimal investment they have in their multi-billion dollar portfolios.”
The bond insurer should then be asked to be part of the solution with paying the new negotiated reduced amount to the bondholders and in return include them as leading the civil lawsuit currently being litigated against First Southwest, Wells Fargo, executives of EDC, etc. The bond insurer will then be in position to recover any payments it makes as part of this process.

All along this process the rating agencies will be briefed and updated by the State and it’s leaders. No default will happen since we will get time to negotiate per the waiver of default process allowed in the 38 Studio bonds (see page B-46: Waivers of Events of Default).

“I believe the State taxpayers will be relieved of having to make payments now for this failed deal. Remember that the RI taxpayers are not legally obligated to pay this bill per the bond nor by state law,” maintains Caprio.

Caprio has been outspoken on this issue for a while now. Last June, GoLocalProv reported:

Caprio says state, not Wall Street, has leverage

At a minimum, before making a decision on payment, Caprio said the state [needs to] convene a meeting of interested parties—including the bondholders and the insurer on the bonds—to attempt to negotiate a deal using the fact that it is not legally obligated to pay as leverage.

“I’m not going to lead the fight to defend multi-billion [dollar] insurance companies who are sophisticated investors to make sure they are made whole,” Caprio said, adding that the burden of paying back the bonds would fall on the average Rhode Island taxpayer. “If this money was coming out of every legislator’s personal pocket, would they be so quick to pay on debt which they have no legal obligation to pay?”

It seems to me that Caprio has a thorough understanding of the complexities of this issue and I commend him for that. I’ve been frustrated with a lot of other candidates and pundits who have simply been using Wall Street’s own talking points to bully Rhode Islander’s into thinking they have a bogus “moral obligation” to the 1%.

In my next feature, I’ll post candidate for Treasurer Seth Magaziner’s thoughts on how to deal with the ratings agencies.

May 19, 2014

Ratings agencies knew they were serving rotten sausage

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If the ratings agencies are wrong to consider lowering Rhode Island’s credit rating for not making payment on the 38 Studios bond, they were really wrong when they gave the 38 Studios bonds an investment grade rating in the first place.

38 Studios was always a risky investment, and the state never had a legal obligation to pay on the bonds. The ratings agencies are responsible for an artificially high rating, and are now trying to push around the people of RI into paying for a deal they knew was bad all along.

The bond prospectus clearly states that “no guarantee can be made that the Company will meet it’s Loan Payment obligations under the Agreement or that the Company will continue to be in business now or in the future.”

On page 29, it says:

Development Stage Business. The Company is a development stage video game and entertainment company with no revenues from product sales, except those projected by the Company over the next several years. The company is currently considered “pre-revenue” and no guarantee can be made that the Company will meet it’s Loan Payment obligations under the Agreement or that the Company will continue to be in business now or in the future.

And on page 26, it says there has been “substantial doubt” the company would succeed since the summer of 2010:

On July 6, 2010, the Company’s auditor, PricewaterhouseCoopers LLP issued a “going concern” opinion in connection with the Company’s most recent audited financial statements stating that the Company will require additional financing to fund future operations and raising substantial doubt about the Company’s ability to continue as a going concern.”

But a company’s success or failure isn’t the only factor for investors to consider. These bonds had an insurance policy, and because of the insurance policy backed by Assured Guaranty, the bonds would receive an investment-grade issue rating of AA+/Aa3. But there was also an underlying rating of A/A2 issued to the bonds. The underlying rating of A/A2 means that the ratings agencies felt that the 38 Studios bonds were investment-grade even without the backing of an insurer.

The NY Times’ Mary Williams Walsh reported in August, 2012 that municipal bond defaults are in fact much higher than most people are aware of: “Moody’s Investors Service has reported that from 1970 to 2011, there were only 71 municipal bond defaults. But the Fed report counted 2,521 defaults in that time.” Economists at the Federal Reserve Bank of NY found that municipal bond defaults are only reported for investment-grade rated bonds, not for unrated (junk) bonds. Furthermore, their research showed that: “…financing projects using new technologies or projects with no historical track record tend to make up a majority of unrated IDB defaults.”

So the main reason we can’t default is because these were investment-grade bonds. But why were these bonds investment grade?

Is there the potential for a lawsuit? Maybe. Giving artificially high ratings to bonds backed by specious economic activity in the real world caused the mortgage crisis too. An ongoing federal lawsuit filed by Eric Holder in 2013 claims that credit rating agency S&P defrauded investors and fueled the financial crisis. At the center of the suit are the favorable ratings issued by the credit ratings agencies on what they knew were toxic assets.

“Holder accused S&P of falsely claiming that its high ratings were independent and objective,” reported the USA Today in Feb 2013. In reality, Holder charged, the ratings were influenced by conflicts of interest and the firm’s drive to reap higher profits by pleasing bond issuers at the expense of investors.

In other words, imagine the following scenario as outlined by Acting Assistant Attorney General Tony West: “buying sausage from your favorite butcher and he assures you the sausage was made fresh that morning and is safe. What he doesn’t tell you is that it was made with meat he knows is rotten and plans to throw out later that night.”

Beginning in the 1970’s, bond issuers began paying credit ratings agencies to get higher ratings on their bonds. This is a type of conflict of interest that Eric Holder was talking about above. Despite all of the evidence pointing to the ratings agencies gaming the system, little has been done to change business as usual. The issuer pay model still exists and the “Big Three” ratings agencies have seen their profits soar largely as a result of their ratings business.

For years, the ratings agencies have been shielding themselves from lawsuits by claiming that they are essentially financial journalists – their ratings are merely opinions protected by the free speech clause in the First Amendment. Litigants would have to show that the ratings agencies had “actual malice” in order to have a case, which is extremely difficult to prove.

But a 2009 federal district court ruling rejected the free speech defense that credit ratings agencies had been using for years:

The suit alleges the two ratings services issued misleading ratings to a $5.86 billion investment vehicle that collapsed in 2007. Scheindlin acknowledged that ratings typically are “matters of public concern,” protected by the First Amendment from liability. However, the protection doesn’t apply, she wrote, “where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large,” as the plaintiffs in the case alleged.

Page 33 of the judge’s opinion states that because the ratings weren’t disseminated to the public at large, but instead to a select group of investors in connection with a private placement, that the free speech defense wasn’t viable. Court rulings in 2010 in California and 2011 in New Mexico yielded the same results.

These court cases are somewhat similar to 38 Studios, which was also a private placement. It therefore may be possible for a group of taxpayers (or the bondholders) to file a class action lawsuit against the ratings agencies for negligent/fraudulent ratings issued to the 38 Studios bonds.

A little more food for thought. The (sadly) slow implementation of the Dodd-Frank Act should hopefully make the big three ratings agencies less of an influential factor in the future. A recent SEC report showed that ratings practices by the ratings agencies still have some problems. Remember that the 38 Studios bonds were issued prior to Dodd-Frank being implemented at all, so we can probably assume that the ratings agencies had even more problems back then. In a 2013 Rolling Stone article I cited earlier, internal credit agency emails revealed:

Moody’s and S&P, have for many years been shameless tools for the banks, willing to give just about anything a high rating in exchange for cash.

In incriminating e-mail after incriminating e-mail, executives and analysts from these companies are caught admitting their entire business model is crooked.

“Lord help our fucking scam . . . this has to be the stupidest place I have worked at,” writes one Standard & Poor’s executive. “As you know, I had difficulties explaining ‘HOW’ we got to those numbers since there is no science behind it,” confesses a high-ranking S&P analyst.

It’s quite ironic that a few companies that fueled an enormous financial crises are now trying to bully the people of RI. Where has Wall Street’s moral obligation to Main Street been?

May 12, 2014May 13, 2014

38 Studios sucks, but we need to pay the bill

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Let me ad some very insightful commentary on the whole 38 Studios saga: it sucks.

It sucks that much of the legislature feels they were conned into providing the cash for the deal. It sucks that Don Carcieri would recruit Schilling to bring his company here. It sucks that anyone in the then-EDC would believe it was a worthwhile deal. It sucks that we’d invest so much money in a long-shot product. It sucks that 38 Studios collapsed, mainly due to sucky management. It sucks that there was little oversight from the state on 38 Studios, despite being a major investor. It sucks that we’re repaying the investors who were already insured in case of 38 Studios’ failure. It sucks that the state used a “moral obligation” bond rather than a “general obligation” bond to provide the money, and to circumvent voters. It sucks that all of Rhode Island’s credit is being threatened by ratings agencies if the General Assembly chooses to default on the repayment. It sucks that the ratings agencies are ignoring the law that’s very clear that we don’t have to repay.

But with all that out of the way, let me tell you that it doesn’t matter how much it sucks. What matters is that it’s happened. Commentators and politicians can cry and moan about the unreasonableness of this all; about how the ratings agencies are being unnecessarily punitive, about how the bond yields took into account the chance of default, about how the investors will get all their money back through insurance, etc., etc. All of that is crying over spilt milk. Now it’s up to us to act like adults and clean it up.

In the complaints against repayment, you can see a lot of how people wish things were. Unfortunately, Rhode Island doesn’t exist in a land of make believe. It exists in the here and now. At the end of the day S&P, Moody’s, and Fitch (the big three credit ratings agencies) don’t play by the rules Rhode Island sets. These are the same agencies that were vital in enabling the existence of toxic assets that fueled the Great Recession and got away scott free. These are agencies that determine the borrowing ability of sovereign nations. Rhode Island, which lacks many of the tools sovereign nations have to blunt the damage from traumatic downgrades of our bonds, cannot go up against them and win.

Were we perhaps the state of New York, and could make life miserable for the ratings agencies, I would be more bullish about our chances of taking them on. If RI was the United States of America, which is impervious to ratings agencies at the moment, I would say go ahead and ignore them.

But we’re not. The very same people calling for us to default are the same people who go around decrying our flaws. They’re the ones ignoring that the ratings agencies can make or break us. It’s awful that we have to kowtow to the whims of these idiots, and the idiot investors who put money into the 38 Studios bonds. But these are the idiots that set the rules for Rhode Island, not the other way around.

To those of you looking to right this injury, I say “forget it, Rhode Island. It’s Wall Street.” The best we can do is bow to circumstance, lick our wounds, and ensure that this can never, ever, happen again.

December 15, 2013

38 Studios: The gift that keeps on giving to the RIGOP?

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House Minority Leader Brian Newberry is suggesting that the need to pay $12.5 million each year for the next decade is going to be a political winner for the RI Republican Party. The thinking, as Newberry explained to me on Twitter, is that legislators who are held relatively blameless for spending the money in 2010 will be judged by their votes in 2013 and 2014; going into November 2014, General Assembly members who voted “Aye” twice are going to have spent $15 million of the state’s money to pay back bondholders who were already covered with insurance in the event of 38 Studios going bankrupt and the State refusing to pay.

The problem with default is that Moody’s has actually threatened Rhode Island that the rest of its bonds will suffer should it choose to utilize the insurance option. Given that we can’t find anyone (except Ted Siedle) to study the impact of default, I still think we should take Moody’s at their word. After all, we have Lehman Brothers as proof that they’re stupid enough to do it.

But I think Newberry is wrong when he says that 2014 will be the year that the Republicans ride 38 Studios to victory. First, it assumes that the General Assembly passes nothing that might buoy the incumbents’ popularity in 2014. Second, just because someone hates their current Democratic representation doesn’t necessarily mean they want a Republican instead.

We’ve had scandals in the past that brought down Democratic leadership; only to have it replaced by another set of Democratic leadership (scandal used to be the typical method of succession among Speakers of the House). The Republican caucuses in the GA are small enough that they skew rightwards, and if you only look at the population of the places they’re from (not their districts represented) they come from towns that make up less than a third of all Rhode Islanders, mostly more rural and suburban areas. When close to 6 out of 10 Rhode Islanders live in an urban area, I simply don’t see how Republicans are supposed to appeal to these voters with the flagship policies pushed by their current legislators.

But beyond that, Republicans are also to blame for not being great enough critics of the deal at the time. Going into the 2010 election, 38 Studios was an unpopular deal with voters, and had Republicans wanted, they could’ve assaulted the Democrats for it. Except that that would’ve entailed going after Gov. Donald Carcieri, who was the leading shepherd of the deal as well as ignore that its primary beneficiary was Republican Curt Schilling, baseball hero.

The problem is that 38 Studios is a bipartisan boondoggle. The money was appropriated by Democratic and Republican legislators to be given by a Republican governor to a Republican businessman (I use that last term loosely). There’s an old saying, “an ounce of prevention is worth a pound of cure.” That’s the situation legislators find themselves in. What gets people riled up is that the deal should not have happened. Now that 38 Studios has gone belly up and the bill has arrived on our doorstep the subsequent vote each year for funds isn’t going to be a referendum on whether you support the original deal. It’s whether you think Wall Street is bluffing or not, and whether Rhode Island can afford to take the risk to find out.

So 38 Studios isn’t a hammer for the Republicans to use against the Democrats. It’s a sickness in the state budget that politicians on both sides are going to have to figure out what the appropriate cure for it is.