Surreal at the State House II: John Simmons Versus the Rule of Law

During testimony before the Rhode Island House of Representatives Oversight Committee last night advocating for full payment of the 38 Studios moral obligation bonds, John Simmons of the Rhode Island Public Expenditures Council repeatedly made the point that the bond market will not recognize any difference between non-payment of moral obligation versus non-payment of general obligation debt.  They will both be considered “default” by the state of Rhode Island.

Simmons stated that, based upon the bonding agreement, there was “fully an obligation of the state of Rhode Island to make the payments if the underlying transaction went under”. Representatives Spencer Dickinson and Mike Chippendale both challenged this.

Rep. Dickinson paraphrased an Economic Development Corporation bond prospectus, referring to a statement that “there’s no possible way that the state or any municipality is intended to obligate itself in the case of these bonds” (on page 35, according to the Rep). Mr. Simmons responded that he had seen similar language in other prospectuses “30, 40, 50 maybe a lot more times”.  Pressed by Dickinson as to why this did not establish a clear difference between moral and general obligation bonds, Mr. Simmons read from a ratings agency statement, and said that the agency “is saying to you that it doesn’t make a difference to them if it’s GO, moral obligation or appropriation debt. If you do not pay it is default on debt. They’re giving an equal weight, in the sense of how they approach it”.

Rep. Chippendale quoted from the law that authorized the bonds…

I’m just going to read it. “The 2010 bonds and the interest thereon do not constitute a debt, liability or obligation of the state or any political subdivision thereof, and neither the faith or credit nor the taking or taxing power of the state or any political subdivision thereof is pledged to the payment of the bonds, or the interest thereon. That’s a fairly clear statement. Of course, you did address that and you said that’s fairly boilerplate…

Mr. Simmons’ reply was that…

What you have in the language is fairly standard boilerplate language on this type of debt, constant debt, this is a fairly large amount.

But a blithe dismissal of some very clear language in the bond authorization is a blithe assertion that everyone — legislators, citizens and investors — should know that the rules that the financial industry makes up for itself (and for its own benefit, by the way) can automatically override the plain text of a law. Finance industry decrees are the real final law of the land; the law made by legislatures, on the other hand, is only real to the degree that it does not conflict with the limits that financiers lay down.

This kind of system, where the people are expected to accept that there are privileged classes who can ignore the plain meaning of actual laws made by the government chosen by the representatives of the people, cannot be reconciled with the rule of law. If the best argument that John Simmons can muster about there being no difference between moral obligation and general obligation bonds is that bondholder and ratings agency decrees can override what the law says, his opinion on this aspect of repayment deserves summary dismissal.

More to come on this topic…



  • http://rifuture.org SGH

    We don't live in a world where rational ratings agencies exist! We have the financial crisis to prove that. Yeah, it sucks that the State has to pay money because people are idiots (and there are a lot of idiots in the 38 Studios saga) but that's how it is. Stupid people with lots of money get paid when other stupid people are out there enforcing their stupidity on others.

  • _Andrew_

    I like your last sentence, because it basically reinforces the reason why there are precise rules for what counts as an obligation and what doesn't when it comes to government appropriations, i.e. a true obligation on the people isn't incurred, any time any idiot in government agrees to something.

  • Dan

    While I am fully in favor of not repaying the atrocity of central planning that was 38 Studios, I think this post conflates rule of law with the if-then practical considerations that go into policymaking. It doesn’t hand any real power to the ratings agencies – it only concedes and accounts for the power they already have. One way to reduce their power over the state would be to stop making such stupid loans.

    • _Andrew_

      Dan,

      Before this specific hearing, I wouldn't have necessarily thought of this as going all the way to a rule of law issue, but it was John Simmons who was willing to dismiss the actual text of the law as "boilerplate" that doesn't really mean anything. If Simmons is supposedly advocating on behalf of Rhode Islanders, he's the one that needs to stick to saying he's just being pragmatic, and make up a better reason why ratings agencies and, more importantly, bond buyers, shouldn't recognize a clear constitutional and statutory difference between "moral obligation" and "general obligation" bonds as meaningful.

      Consistent with what you suggest, I think it would be an entirely reasonable outcome for RI to have a very hard time getting "moral obligation" financing in the future and paying a slightly higher rate, for a while, for "general obligation" financing that goes through all of the proper constitutional steps for imposing a long-term obligation on the taxpayers.

  • observer

    One thing i have never heard explained by the proponents of paying the MO. If the insurer should not be liable for honoring the policy it wrote and was paid for in this instance, pray tell exactly when would it be OK to call on the insurer. One thing everyone agrees on, absent the insurance, this deal does not happen. Assured Guaranty may have been a little too casual in underwriting 38 Studios. Insurers suffer losses. I'm sorry about that. There weer enough red flags surrounding this. Caprio, who was the sitting General Treasurer and presumptive future Governor, asked the agencies not to rate the deal until after the election.. In and of itself, that should have warned Assured Guaranty off. Candidate Chafee tried to enter the EDC meeting and lodge a protest. Rosemary Booth Gallogly disfavored it. Who, exactly, was for it except the pols who were getting cut in in one form or another?

    • _Andrew_

      Spencer Dickinson asked a version of this last night. I'll go back through the video this weekend and get the answer (because I didn't really understand it, as I was listening to it live).

      The really strange thing to me is that Simmons was explicit that if RI does use the insurance, the state is still considered as going into default, even if the bondholders get a full payment on time.

  • Michael McCarthy

    I will not weigh in on the overall context of the post – but I would like to take a moment to say thank you for everyone who seem to be recognizing the very real difference between the investors-at-large and the "job creators."

    Investors certainly aren't evil, and I don't even propose vilifying the One Percent – they're human after all – however they are NOT the job creators. In my world, the job creators are the small businesses. I am incredibly concerned for them. Do I want a lower corporate tax rate? Not really, in fact, absolutely not – but do I want lower commercial property taxes and more-sane regulations on the small business that do the majority of the job creation in Rhode Island? Yes I do.

    Regarding the moral obligation bonds? The oligarchy rules. Dan rightly says that the letter of the law says one thing, and the reality speaks to another. Guess I can't disagree with that.. but the expanding distance between that law and the reality of its current application is very ugly and worthy of discussion.

  • mangeek

    The way I see it is that a ‘moral obligation’ bond is like a friend casually borrowing money from me. A ‘general obligation’ is a friend for.ally drawing up a loan with me.

    If my friend skips town on the GO, I can go to court to try and recoup it. If he skips town on the MO, then I can’t, but I reserve the right to call him an a** and never loan him money again, contract or not.

    It gets trickier when you’re talking about laws and governments, but the ratings agencies and insurers are presumably free to hold a very negative view of a borrower who decides not to pay something back that they could.

    If we were in great shape and didn’t depend on financing so much, we might be able to get away with skipping-out on an MO every few decades, but we’re not. If we had a great reputation fiscally but a few bad eggs managed to pen a corrupt deal, and we punished them for it, we might be able to get away with this, but most of the folks who signed-off on this are still in office.

    As for folks who say ‘I didn’t make this deal’, I think part of living in a representative democracy is taking responsibility for the actions of your government. When I see a botched roadwork job, I don’t say “the government screwing us again”, I ask “how did WE let this happen?”

  • justinkatz

    Mangeek,

    Your analogy is flawed generally, but in your specific use of it, you're not even getting to a comparable situation. This isn't your friend borrowing money as a favor to help him out. It's you lending it to him to make a profit. What's more, because you realized there was a chance he might skip town, you demanded that he promise you almost twice the profit, and you explicitly acknowledged that he had a right to skip town.

  • Warrington Faust

    Regardless of whether a bond is collateralized, or not, it is a promise to pay. That promise is being reneged upon, that is a "Default". As to the insurers, I think their obligation is to pay if the state cannot, it is not obligated to pay because the state refuses. If your car is insured for "collision" and you intentionally drive it into a bridge abutment, do you expect the insurance company to pay?

    • _Andrew_

      The people who made the promise lacked express legal, never mind legitimate, authority to do so, on behalf of the people who are providing the money (see the Constitutional Amendment in Justin's post above).

      Also, with regards to your second point, I don't think intentionality captures the problem here. This was more like writing Evel Knievel an accident insurance policy with very few restrictions knowing what he does for a living, then refusing to pay when he gets hurt trying to jump the Grand Canyon on a motorcycle.

    • observer

      Sorry Warrington, the obligation to pay lies with 38 Studios and EDC. The state of RI is not a party to this. That's the whole point of MO vs. GO

  • Patrick

    Actually the state is a party to this. The state agreed to possibly pay back the loan if 38 Studios did not. It's akin to co-signing on a loan. You're not first in line to pay it back but if #1 defaults, the debt falls to you. What you choose do do with the debt at that point is up to you. But RI is definitely a party to it.

  • observer

    Patrick, I don't think you understand the MO. The bondholders can't sue the state, in the event of a failure of them to receive either the principal or interest. They could sue 38 Studios or EDC. neither of those possible defendants is the state of RI. Assured Guaranty would actually be doing the suing, as it would have to honor its insurance to the bondholders or go out of business. The legal position of the state is nothing like a co-signor.