MuniLand

The Rhode Island General Assembly’s House Finance Committee heard testimony last Thursday from Matt Fabian of Municipal Market Advisors – an independent research service with about 300 subscribers – about the cost and implications of the state defaulting on the 38 Studios moral obligation bonds. Committee Chair Helio Melo’s main line of inquiry was “Does it cost us more money in the long run” if the state were to default on those bonds?

At 29 minutes into the hearing Fabian says that it is unlikely that the state’s general obligation rating would be lowered below investment grade, but it could be knocked down one, two or three notches. He says “It could go down to a BBB, the lowest investment grade rating …  it is a scenario but not most likely.” This is the closest Fabian gets to predicting the cost.

Most members of the House Finance Committee wanted hard numbers to make a decision. Understandably, it seemed difficult for them to convert Fabian’s commentary into decisions for the state. WPRI.com reported:

The committee members listened to Fabian’s comments closely, but more than one expressed skepticism about the lack of hard data about the impact of a default.

“I say we get out of this now, have these insurance companies pay this bill, and then we negotiate with the insurance companies if they want to ‘morally’ come after us,” said Rep. Ray Hull, D-Providence.

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.

Although the national media has always been a fan of Rhode Island State Treasurer Gina Raimondo, I’ve personally been lukewarm on her performance. She built a case for draconian changes in pension benefits for current workers by inflating the portion of the state pension plan that was unfunded. This led the State Assembly to adjust pension benefits in a way that seemed to go against the law. Unions sued the state and State Superior Court Associate Justice Sarah Taft-Carter has just ordered the case to undergo federal mediation. But I’ve always thought the bigger issue for Rhode Island was that its pension fund had horrible investment returns; some of the lowest in the country. And Treasurer Raimondo has only taken steps this week to change the fund’s management.

Pension funds derive 60% of their revenues from investment returns on a national basis. The other 40% of revenue comes from employee and government contributions. Rhode Island pension funds have had sub-par investment returns for years. The first thing that I would have done was change the pension fund manager before making legislative changes. One year ago I wrote this:

[…]The problems Raimondo addressed were not the biggest that the state faced. The main problem with Rhode Island’s pension system is that it has very poor investment returns on its $6.5 billion portfolio of assets. Over the past ten years the state’s investments returned 2.47 percent compared with the national median of 3.4 percent (page 6). These returns are in the lowest tier of state pension plans, and this chronic underperformance is causing a substantial shortage of assets to pay retirees.

In his New York Times column yesterday, Joe Nocera laid the blame for the fiscal catastrophe in Woonsocket, Rhode Island on Jon Brien, a state legislator who blocked a bill that would have plugged a massive hole in the town’s budget by raising property taxes on its residents by 13.8 percent. Nocera argued that Brien took these actions to shrink the local government because he’s a conservative ideologue, further highlighted by the fact that Brien is also on the national board of ALEC, an advocacy group that pushes for smaller government.

Maybe it’s true that Brien was primarily motivated by ideology, but if Nocera had taken even a cursory glance at the financial statement for Woonsocket, he would see Brien’s position has some merit. Spending on retiree benefits and municipal debt are drowning Woonsocket. The city is in a death spiral.

Let’s start with what Nocera got right: Municipal pensions, the traditional whipping boys for conservative critics of out-of-control government spending, are not Woonsocket’s big problem. The town’s pensions are actually 60 percent-to-90 percent funded, pretty good by Rhode Island standards (page 77). Maintenance of the pension funds required a contribution of only 2.2 percent of the 2011 budget.

This morning’s jobs report revealed that 79,000 net new jobs were created in the country in May, nearly 50 percent below the consensus forecast of 150,000. Almost immediately following the release, there were loud and insistent calls for another round of monetary and fiscal stimulus. “Job growth stumbles again, raising pressure on Fed,” the Reuters headline ran. My fellow Reuters blogger Felix Salmon called for immediate federal stimulus funded by more debt issuance. Felix’s rationale, like many others’, is that with U.S. borrowing costs so low, stimulating current economic activity is a higher priority than worrying about paying down the debt in the future. Or to put it differently, a little more debt is preferable to enduring the economic pain of the economy rightsizing itself.

However, economic weakness is concentrated in just a few regions, and the solutions that many are pushing for – additional fiscal stimulus from Congress or further monetary easing from the Fed – are too diffuse to make much of a difference or require a national constituency that is unlikely to materialize. Unemployment fell in 37 states in April, but in California, Rhode Island and Nevada, there are still massive employment problems. The National Conference of State Legislatures reports (emphasis mine):

Unemployment rates were down in 37 states, the District of Columbia, and Puerto Rico in April 2012. Only five states saw unemployment rise and eight states had no change for the month, according to figures released by the Bureau of Labor Statistics on May 18, 2012.

Municipalities across the country are looking to local non-profits to pay for their share of community services. These payments, known as PILOTs, or “payments in lieu of taxes,” are voluntarily contributed by private schools, hospitals and other non-profits as an alternative to paying property taxes. As cities come under more fiscal stress, this will be a growing trend.

The mayor of Providence, Rhode Island, Angel Taveras, is in a wrestling match with Brown University over increasing the school’s annual payments to the city. Taveras is angling to get a bigger sum from Brown, but if he is unsuccessful, then his only option to balance his city’s budget would be to get public unions to agree to concessions. Others, including Robert Flanders, the receiver of nearby Central Falls, believe that Providence’s only option is bankruptcy:

“I don’t see how [Providence] can get out of it without going there,” said Flanders, a former state Supreme Court justice and a partner at Hinckley, Allen & Snyder LLP in Providence. He put Central Falls into bankruptcy in August and has since torn up contracts with city workers and cut pension benefits.

Chart source: Bonddesk

State politicians in Alabama, Pennsylvania and Rhode Island have lambasted municipalities within their borders that have either declared, or attempted to declare, bankruptcy. The politicians gripe that when a municipality in their state goes into Chapter 9 bankruptcy, it affects the cost of borrowing for the state and other issuers located there. But this rests on the false assumption that markets do not discriminate between different borrowers. Municipal bond issuers, like public companies, are looked at individually because every entity has its own story. After all, when American Airlines went bankrupt, it was not as if all airlines suffered.

Alabama Governor Robert Bentley explicitly used the increased cost of borrowing for other Alabama towns as a bludgeon against Jefferson County officials who declared bankruptcy last November. The Birmingham News wrote:

He [Governor Robert Bentley] said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. Bankruptcy is not right.”

It’s getting a little tiresome to hear all the adulation that’s being heaped on Gina Raimondo, the Rhode Island General Treasurer. She’s been praised in the Wall Street Journal, Time, and now CNBC as some sort of fiscal Joan of Arc who rescued the state’s public pension system from insolvency. I’ll give Raimondo credit for leading the charge to reduce benefits to Rhode Island public workers and increasing their retirement age, but she’s far from a pioneer in making tweaks to state pension plans – 17 other states have also made changes recently.

More importantly, the problems Raimondo addressed were not the biggest that the state faced. The main problem with Rhode Island’s pension system is that it has very poor investment returns on its $6.5 billion portfolio of assets. Over the past ten years the state’s investments returned 2.47 percent compared with the national median of 3.4 percent (page 6). These returns are in the lowest tier of state pension plans, and this chronic underperformance is causing a substantial shortage of assets to pay retirees.

A national clearinghouse for public pension fund data, the Public Fund Survey, wrote in its report for FY2010:

In her 2,500 word feature on the pension reform process in Rhode Island, New York Times reporter Mary Williams Walsh seems to have found more color than facts. The piece reads more like a campaign profile of Treasurer Gina Raimondo than an assessment of the gritty fight over public pensions in the nation’s sixth smallest state:

Ms. Raimondo also learned early on about economic forces at work in her state. When she was in sixth grade, the Bulova watch factory, where her father worked, shut its doors. He was forced to retire early, on a sharply reduced pension; he then juggled part-time jobs.

“You can’t let people think that something’s going to be there if it’s not,” Ms. Raimondo said in an interview in her office in the pillared Statehouse, atop a hill in Providence. No one should be blindsided, she said. If pensions are in trouble, it’s better to deliver the news and give people time to make other plans.

@tednesi Ted Nesi  The Dow is down 4% as I write this. But I’m sure the market will turn around once Central Falls releases its Ch9 plan at 3.

Central Falls, Rhode Island is a down on the heel community that has become the epicenter of the battle to preference municipal bondholders  over retired municipal workers in bankruptcy proceedings. This is a tale of the state of Rhode Island turning federal bankruptcy law and pension law upside down.

When an entity becomes insolvent and seeks the protection of a bankruptcy court it throws itself within the processes and rules of the federal bankruptcy court. Cities are not liquidated in a Chapter 9 bankruptcy but outstanding claims against a community are reduced so that the community can pay them all. Traditionally in bankruptcy proceedings pensions are treated similarly to bondholders and other secured creditors.