More on Rhode Island’s 38 Studio bond repayments

May 10, 2013

Lots of ink has been spilled about the famous ex-Major League pitcher Curt Schilling, who convinced the state of Rhode Island’s Economic Development Corporation to issue $75 million of privately placed “special and limited obligations bonds” to fund a loan to his gaming company. After getting the loan Schilling and Company proceeded relatively quickly to go bankrupt and was unable to repay the loans to EDC, which funded the bonds.

Matt Bai, of the New York Times, wrote a lengthy story of the personalities involved but provided little detail about the financial underpinnings of the story.

Josh Barro, at Bloomberg, detailed how he badgered Rhode Island’s governor Lincoln Chaffee with questions about the 38 Studios bonds and then was offended when he didn’t get the answers he wanted. Barro unfairly blasted the governor for his pension reform, which is comparable to what 40 plus other states have done.

Then my fellow Reuters blogger Felix Salmon got immersed in the intricacies of public issuer obligations to bondholders in Rhode Island:

Rhode Island’s moral obligation bonds, then, are a bit like the bonds of a sovereign nation: they’re a measure of willingness to pay. And when it comes to public-sector borrowers, willingness to pay is all important. Yes, it would be legally possible for Rhode Island to default on its moral obligation bonds while staying current on its general obligation bonds.

Felix raises some interesting points but probably wasn’t aware of Rhode Island’s special place in muniland. The state passed legislation in 2011, unique in the nation, that gave owners of Rhode Island local bonds very powerful rights to full repayment. Nick Brown of Reuters wrote in August 2011:

The law adopted last month gives municipal bondholders a lien on taxes and general revenues collected by the cities and towns whose bonds they buy.

This means the bondholders would be repaid before other creditors such as workers, suppliers and pension fund beneficiaries if the municipalities went bankrupt.

State officials hope the law boosts confidence among investors in a state whose communities face growing financial strain. Even larger cities such as Providence and Pawtucket face the potential for higher borrowing costs as their credit ratings, still investment-grade, face downward pressure.

The law was adopted three weeks before the small Rhode Island city of Central Falls, population 19,000, made headlines by filing a rare municipal bankruptcy, one year after having been put under state control.

So Governor Chaffee and state legislators in 2011 enshrined in law that bondholders with local Rhode Island paper would not be haircut. In the case of 38 Studios it would be hard to see how the state would radically shift direction and choose to stiff these bondholders. These bonds have not defaulted and are current on principal and interest payments. In fact they are now rated AA-, which is the state’s rating and two steps higher than they were originally issued.

Everything in Rhode Island’s recent legislative history says that protecting bondholders is sacrosanct. The context for this discussion extends beyond Curt Schilling and his gaming endeavor. Governor Chaffee and others are trying to keep capital flowing into the state. In their minds paying off 38 Studios bonds seems to be a reasonable price to pay to accomplish this.

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