We’re better off not bailing out 38 Studios

The following op-ed was submitted to the Providence Journal by Randall Rose, a member of Occupy Providence. Some links have been added. (You can also sign our “No bailout” petition.)

We’re better off not bailing out 38 Studios

The 38 Studios bailout is unpopular, but politicians and Wall Street are stepping up their efforts to spend large amounts of taxpayer money on it, even though the Wall Street lenders who will get our money are already fully covered by insurance. Although there are threats that Wall Street will retaliate if we don’t do a bailout, the threats are misleading, and we’re better off not paying. Here’s why.

Bailout advocates may make this issue sound more complicated than it is, but it’s actually pretty simple. The Rhode Island Constitution says that any significant “state debts” must be approved by voters. That’s why bonds are placed on the ballot. But the 38 Studios deal never went to voters, and voters were against it from the beginning. Polls showed over 50% saying No. To get around the constitution, politicians got a different company, the EDC, to borrow $75 million for the benefit of 38 Studios. Although the EDC is controlled by politicians’ appointees, it’s not part of the state government. The state government never agreed to take part in the EDC-38 Studios deal. When the deal happened, politicians hinted to Wall Street that they would consider a bailout if the deal went bad, but constitutionally they couldn’t promise anything.

Now politicians and Wall Street tell us that just because of this EDC deal, we have a “moral obligation” to spend $75 million plus interest. That’s exactly what the RI constitution rules out. It says that politicians can’t “pledge the faith of the state for the payment of the obligations of others” without voter approval. So RI’s faith wasn’t pledged, and we have no obligation. When financial people talk about “moral obligation”, all it means is a deal backed by a mere hint from politicians that there might possibly be a bailout if things go bad, even though the government isn’t committed to it. 38 Studios lenders may hope for a bailout, but the bond documents told them that the state is “not obligated” by this alleged “moral obligation”. If politicians hinted about bailouts, that can’t give us an obligation, because their power can’t go beyond the constitution. There’s a reason why the constitution requires voter approval for this — it prevents us from being on the hook for exactly the kind of shady, non-voter-approved, economically unsound deal we see in cases like 38 Studios. “Moral obligation” deals are nothing but an attempt to effectively take away that constitutional right, to let insiders make bad deals without asking us. We need not, and should not, reward the Wall Street lenders and insurers who seek profit by colluding with politicians in unethical deals that go around our rights.

As the bailout’s unpopularity shows that their moral argument is losing, advocates of a bailout have resorted to threats. Moody’s, a credit-rating firm which gets paid by people engaging in these kinds of deals, tells us that we should pay the bailout money just as if it was real voter-approved debt. If we don’t, they’ll lower our credit rating. These threats have happened before.

After our state pension fund stepped in to finance the American Express building in Providence, the EDC under Gov. Almond signed a commitment in 1999 to help protect retirees from losses on the deal. The building’s value went down, and politicians were asked in 2006 to support the EDC’s commitment by bailing out the pension fund’s loss using taxpayer money. George Carvalho, who was then a leading official in the RI Treasurer’s department, said “It’s a moral obligation – if they didn’t make good on it, it could impact the state’s bond rating.” But state politicians, including new governor Don Carcieri, refused to pay. The pension fund, already struggling financially, was left to absorb the losses, and in 2011 politicians announced that because of the pension fund’s financial troubles, the state would break its contractual obligation to retirees. Politicians are eager to pay a mere “moral obligation” to Wall Street, but retirees in Rhode Island are treated worse, with the state even willing to break its legally binding promise. There were no repercussions from Wall Street over how the pension fund was treated, and Moody’s says that it still favors the 2011 pension cuts.

The state of Washington in 1983 also got threatened, when it refused to bail out lenders to the Washington Public Power Supply System over a failed nuclear-power project. One firm’s study, touted by the state’s governor, backed up the threat by saying that the state would have to pay up to 2% more in interest on its voter-approved debt, and some on Wall Street were saying that the interest-rate penalty could be more than that. As former RIPEC head Gary Sasse accurately reported at a rare open debate June 6th at the State House, the actual impact on Washington was much less. The interest-rate hike amounted to only 0.5% at first, and declined after that, disappearing within 4 years. Wall Street’s bark was worse than its bite. A news story quoted the Shearson firm telling its clients to lend money to Washington since the opportunity was “highly undervalued”.

In fact, the debate that Sasse spoke at, organized by Occupy Providence and the Hopkins Center, was a rare chance to hear both sides debate the issue fairly. Bailout advocates from Gov. Chafee and Gina Raimondo to the EDC and Moody’s were invited to be in the debate, but said no. It’s noteworthy that they never risk a public conversation with leading bailout opponents.

Unlike Vadnais Heights or Spokane, which pulled out of deals they had officially approved, Rhode Islanders simply oppose a bailout for a deal that our state always avoided agreeing to. So it’s misleading to compare our state to those cities. All agree that even if Moody’s cuts our ratings, our voter-approved debt will remain investment-grade.

Our interest rate depends on the investors we find, and they look beyond credit ratings to do their own evaluation. That’s why states with the same credit rating can get strikingly different interest rates, as RI Administration Director Richard Licht (a bailout advocate) publicly admitted. Our small size helps us: our debt isn’t many billions, so we don’t need to find as many lenders as bigger states do. Even if many on Wall Street join Moody’s in trying to punish us for not bailing out the 38 Studios debt, there will be some smart lenders who recognize we remain committed to paying all the other debt, which is less shady than 38 Studios. There are enough smart lenders who just want profit and will find our voter-guaranteed debt attractive with a relatively small interest-rate hike. That’s what saved Washington from its huge threatened 2% interest-rate hike — a smart minority of investors lent to Washington and did well with only 0.5% extra interest. In RI’s case, even the harshest forecasts haven’t threatened the 2% interest-rate hike that Washington was falsely threatened with. Our pension cuts and the 2010 Fiscal Stability Act have made the voter-approved debt of our state and cities more attractive to many types of investors. We’ve made enough sacrifices to please Wall Street lenders. We don’t need this bailout.

Some say the insurance company, which has to pay the loan and interest if we don’t, may sue us. Let them sue. There certainly have been lawsuits against cities and states that refuse a bailout, and the legal precedent supports us. Prominent Oklahoma judge Steven Taylor dismissed one such “moral obligation” case against a city, saying that the city had “no obligation, indebtedness, or liability”. Lawsuits over “moral obligation” loans, where there’s no actual promise by the government to pay, are never victorious in court, and often are just dismissed.

We often see politicians who are too ready to satisfy the insurer and lenders, who they see as powerful. But the right decision isn’t just about seeing whether they can threaten us enough. We can do more, and actively defend ourselves. The state and cities should permanently ban new “moral obligation” deals. Those deals have repeatedly led to disaster in RI, since they evade our constitutional protection. Future loans and bonds should more often, or always, be voter-approved and official, which is cheaper than off-the-books debt. We also save if fewer taxable bonds are created for projects whose public purpose is questionable. Finally, North Dakota, with the nation’s lowest unemployment rate, has profited from having a professional state-owned bank, which can make loans in the public interest and helps protect the state from Wall Street pressure. All these things can help build a new and attractive kind of economic strength.

These measures would save so much money that any threat from Wall Street would be manageable, or better than manageable. We can also save the $75 million-plus on 38 Studios, and continue to pay all other state-related debt, which is more reputable. After years of bad insider deals in RI, the people’s gut feelings are accurate. Our state’s poor economic situation has been worsened by the culture of shady insider deals, and not bailing out this deal would improve our climate. The “No bailout” petition on OccupyProvidence.com already has over 1000 signatures.