For many politicians, limits on their power to incur debt are an obstacle to be evaded rather than a concept to be honored. This is why some Rhode Island politicians want Rhode Island taxpayers to honor and pay a moral obligation bond for 38 Studios. Presently, there is a debate about whether Rhode Island should pay the moral obligation bond issued by the R.I. Economic Development Corporation (EDC) for 38 Studios. Over the next eight years, Rhode Island would pay at least $90 million if it honors this moral obligation bond. However, Rhode Island is under no legal obligation to pay this bond. Rhode Island is only legally required to pay general obligation bonds, which have been approved by the voters in a referendum consistent with the state constitution. Under Rhode Island law, the General Assembly may reject any request to appropriate funds toward a moral obligation bond issued by EDC. Also, it is unlikely that refusing to pay the 38 Studios moral obligation bond will cost taxpayers more in the long run than paying it. For example, if Rhode Island's credit rating was reduced from AA to A, and its borrowing costs increased by 10 basis points, this would only mean an increase of a few hundred thousand dollars per year on a 20-year bond of approximately $209 million, the amount of bonds approved by Rhode Island voters in 2012. This is much less than $12.5 million a year for seven years to satisfy the 38 Studios moral obligation bond. If Rhode Island's bond rating was dramatically downgraded, which is unlikely, and its borrowing costs increased by 100 basis points, this would still only mean an increase of a couple of million dollars per year on a 20-year bond of approximately $209 million. This is still less than paying $12.5 million a year for seven years to satisfy the 38 Studios moral obligation bond. Regardless, Rhode Island taxpayers should oppose making any payment on the 38 Studios moral obligation bond out of principle. Moral obligation bonds are merely a scheme used by politicians to avoid voter approval. Rhode Island taxpayers should stand up for the fundamental principle that the public should not pay for debt they have never approved.
Moral obligation bonds began in New York in 1960. New York Governor Nelson Rockefeller, a liberal Republican, had grandiose ambitions for government expansion. But the New York electorate resisted approving additional debt. Unwilling to limit his desires, Rockefeller turned to John Mitchell, a prominent municipal bond lawyer. To avoid the requirement of obtaining voter approval before incurring debt, Mitchell created the concept of the moral obligation bond. With moral obligation bonds, Rockefeller could incur debt for a housing authority and numerous other programs without obtaining voter approval through a bond referendum. Years later, after Mitchell was released from prison for his crimes associated with Watergate, he was questioned as to whether moral obligation bonds were simply a means of bypassing the rights of voters to approve debt in a referendum, and Mitchell admitted that this was "exactly the purpose" of moral obligation bonds.
Likewise, moral obligation bonds came to Rhode Island due to a crafty bond lawyer and an ambitious governor frustrated with an electorate's refusal to approve more debt. After the adoption of a state investment income tax in 1969 and the adoption of a state income tax in 1971, Rhode Island voters became wary of approving bond referendums. In each of three elections between 1969 and 1972, Rhode Islanders rejected bond referendums for a low-income housing authority and bond referendums for economic development purposes. In 1973, James Skeffington, a lawyer eager for bond work, drafted legislation that created the R.I. Housing and Mortgage Finance Corporation (RIHMFC). This legislation avoided the need for a referendum by giving RIHMFC the authority to issue moral obligation bonds. Governor Philip Noel pushed the legislation through the General Assembly. A year later, in 1974, Skeffington helped to draft legislation creating the Rhode Island Port Authority and Economic Development Corporation, which was given the power to issue moral obligation bonds. Again, Noel pressed the legislation through the General Assembly.
Rhode Island's first moral obligation bond to promote economic development was issued in 1974 for Fairmount Foundry, which sought to a buy the ITT Grinnell Foundry in Cranston. One of the two owners of the Fairmount Foundry was a "friend" of Governor Noel. In 1976, the foundry floundered and closed. Rhode Island taxpayers paid over $4 million for the cost of a moral obligation bond they had never approved. Twenty years later, in 1993, under Governor Bruce Sundlun, a moral obligation bond was issued for a biotechnology company called Alpha-Beta Technology. In 1999, Alpha-Beta Technology closed, and Rhode Island taxpayers paid nearly $30 million for the cost of a moral obligation bond they had never approved.
If Rhode Island becomes the first state to default on a moral obligation bond, it would set an example for other states. This would not be the first time. Back in 1843, Rhode Island was the first state to put a restriction in its constitution requiring that voters approve the incurring of state debt. This was to protect Rhode Island taxpayers from the costly economic development ventures that had bankrupted other states in the 1840s. Due, in part, to this restriction, Rhode Island became debt free by 1894. A few years later, however, voters approved the issuance of debt to construct a domed marble palace for its politicians called the State House. Unfortunately, since the State House opened in 1901, it seems that some politicians who work there have never ceased to concoct plans to increase the debt burden on the people of Rhode Island. Repudiating the moral obligation bond for 38 Studios would put an end to one of those schemes politicians devised to increase the debt burden on voters.
From the opinion page of The Providence Journal on August 27. 2015
When politicians idiotically staked tens of millions of taxpayer dollars on a highly speculative videogame company called 38 Studios, Rhode Island suffered more than financial losses. The disastrous venture - and the failure of the political establishment to fully review its conduct and hold anyone accountable - has further poisoned public trust here, to the point that any ideas to help the state come under knee-jerk attack by a deeply cynical and negative populace. The level of negativity has become so toxic that it is very difficult now to move Rhode Island forward and capitalize on its many advantages.
Citizens groups themselves have become tainted by the reflexive negativity. But they had a point last week when they argued at a press conference that Gov. Gina Raimondo and House Speaker Nicholas Mattiello owe it to the public to authorize "unfettered ... investigations" into what went wrong. Such action would help restore the public's trust - and build support for the good work that Ms. Raimondo, Mr. Mattiello and Senate President Teresa Paiva Weed are now doing, in shifting the focus of government in Rhode Island toward generating jobs and fixing problems.
Recently, it emerged that former House Speaker Gordon Fox, now residing in federal prison, met secretly with 38 Studios officials before Gov. Donald Carcieri got into the act. Then the deal was sprung upon the public as a fait accompli. Clearly, such a public investment should have been fully vetted, permitting those with expertise in business investments to raise red flags. Unfortunately, Speaker Mattiello - who cultivated political relationships with Mr. Fox and former Speaker William Murphy - has already dismissed the call for unfettered hearings.
"Former Speaker[Gordon] Fox has admitted to serious criminal offenses and is currently serving time in federal prison," Mr. Mattiello said in a statement prior to the press conference. "The newest allegation about his involvement in the 38 Studios deal does not change the fact that the General Assembly is not an investigative body. If the State Police, the Attorney General's office or the FBI feel that an investigation is warranted after learning of this new information, then I would encourage them as the appropriate agencies to do so."
We would beg to differ with his contention that the legislature is not an investigative body. While the attorney general and U.S. attorney bring charges and represent the public in prosecuting crimes in the courtroom, the General Assembly has a well-established and constitutionally essential role of providing oversight of government, particularly of the executive branch. As our sometime columnist and part-time Rhode Island historian Steven Frias has pointed out (see "R.I. needs 38 Studios probe," Commentary, July 22 [posted below]), the Assembly in the past has done useful work on behalf of the public in looking into very similar scandals.
He cited the 1974 case of Rhode Island's using a moral obligation bond to help a company buy and keep open a foundry in Cranston. When it went bankrupt, costing taxpayers $4 million, then-Speaker Edward Manning oversaw five months of hearings into the fiasco by a committee chaired by Rep. Raymond Gallogly. "The more we talk about it, the better off we'll be," Mr. Gallogly said.
Through the hearings, Mr. Frias recounted, the public learned that the state's "Economic Development Corporation lacked the technical expertise to properly analyze the business ventures it financed." Also, the committee discovered that "public officials ignored warning signs in order to make a risky decision amidst a crisis atmosphere." We have many lessons to learn about the much costlier 38 Studios fiasco. Unless we fully expose how Rhode Island government failed the public, we will be unable to learn from those mistakes - and a festering culture of cynicism and negativity will continue to drag down the state.
July 22. 2015 2:01AM
With little debate, the General Assembly last month adopted a budget that included another multimillion-dollar payment toward the moral obligation bonds of 38 Studios. While taxpayers are paying millions every year because of the failure of 38 Studios, years pass without a full and public investigation into the 38 Studios debacle.
Last year, the House Oversight Committee, under Chairwoman Karen MacBeth, began gathering information and exposing the roles played by certain insiders. But when MacBeth requested that subpoenas be issued to key players in the 38 Studios failure, House Speaker Nicholas Mattiello refused and asserted that the General Assembly is a "legislative body, not an investigative body." Years ago, however, the General Assembly investigated a fiasco comparable to 38 Studios. As a result, for a number of years, Rhode Island avoided making the same mistakes again.
In 1974, Rhode Island's first moral obligation bond to promote economic development was issued by the Rhode Island Port Authority. This bond helped provide financing to Fairmount Foundry to purchase and keep open the ITT Grinnell Foundry in Cranston. In 1976, the foundry went bankrupt. State Rep. Aram Garabedian demanded an investigation. Some feared an investigation could interfere with negotiations over the sale of the foundry. However, after the General Assembly paid off the moral obligation bond, at a cost of approximately $4 million, Speaker Edward Manning created a new committee, the House Committee on Government Operations, chaired by Rep. Raymond Gallogly, to investigate the Fairmount Foundry fiasco.
Over the course of five months in 1977, this committee conducted about 10 public meetings and heard testimony from various individuals, including public officials and the owners of Fairmount Foundry. Some were displeased that there was any investigation. At one hearing, a banker involved in the fiasco complained that focusing on Fairmount Foundry would hamper the state government in fostering economic development. Rep. James Mahoney defended the investigation by stating the General Assembly doesn't want the state "to be a proving ground for someone who wants to make a million bucks" while Representative Gallogly responded by stating: "The more we talk about it, the better off we'll be." At another hearing, former Gov. Philip Noel, a friend of one of the foundry owners, staunchly defended moral obligation bonds as necessary for Rhode Island "to get an edge on competing states," and dismissed the millions paid by taxpayers by saying: "That's peanuts. We give more than that away in food stamps."
From these hearings, the public learned that the Economic Development Corporation lacked the technical expertise to properly analyze the business ventures it financed. Also, the committee discovered how the loan requirements for the Fairmount Foundry owners were reduced, and that public officials ignored warning signs in order to make a risky decision amidst a crisis atmosphere. In addition, taxpayers discerned how managerial mistakes eventually led to the demise of the foundry.
After the hearings concluded, Gordon Bryd, the acting director of the Port Authority, stated: "I don't think there will ever be another moral obligation bond issued by the Port Authority." For about 15 years, Mr. Bryd was correct, because Rhode Island wisely avoided issuing another moral obligation bond for an economic development project. There are many reasons to investigate the 38 Studios debacle. Possibly, the most important reason is that Rhode Island should once again learn the valuable lesson that it is inherently dangerous for Rhode Island public officials to be given the power to act like venture capitalists with taxpayer money.
When the government tries to finance specific enterprises, there is an inescapable risk that public officials will agree to flawed financing schemes to help a few favored businesses for questionable reasons. To grow the economy, government should instead focus on improving the business climate by lowering the overall cost of doing business. The 38 Studios debacle clearly showed that Rhode Island had forgotten the lesson it learned from the Fairmount Foundry fiasco. Perhaps a public investigation into 38 Studios will give Rhode Island another chance to learn from its failures.
Steven Frias, a twice-monthly contributor, is a regulatory lawyer, Rhode Island's Republican National Committeeman and the author of "Cranston and Its Mayors: A History."