Can we cut to the chase on the question of paying off the 38 Studios bonds?  Even without the question of corruption, when government turns to debt to fund its programs, officials have incentive to make it sound as risk-free as possible.  Hence the attraction of language such as Rep. Mike Chippendale cited in Andrew’s post, earlier:

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.

It’s very strange that, in all of the talk about whether to repay the bonds, I haven’t heard anybody note that the existence of that language is what allows the state to issue the debt without going to the voters.  If state government is going to make decisions based on the belief that such language is mere “boilerplate” without any actual meaning, then no moral obligation bonds should ever be issued again, and the people of Rhode Island should sue state government for a species of fraud.  Here’s Article VI, Section 16 of the state constitution:

The general assembly shall have no powers, without the express consent of the people, to incur state debts to an amount exceeding fifty thousand dollars, except in time of war, or in case of insurrection or invasion; nor shall it in any case, without such consent, pledge the faith of the state for the payment of the obligations of others.

By treating moral obligation bonds as identical to general obligation bonds, the General Assembly would in effect be admitting that it pledged the faith of the state without the express consent of the people.

There’s another participant in the systemic fraud, however.  Investors — and therefore the ratings agencies whom they use for pricing of their investments — have an incentive to maximize their returns and minimize their risks.  As I’ve been saying for years, now, the fact that the 38 Studios bonds were of the moral obligation sort meant that investors were promised more money in return.

To pair the legal language above with its counterpart in the investment framework, here’s text from the assessment that Moody’s issued in September 2010:

The A2 rating assigned to the bonds reflects the strength of the state’s moral obligation to appropriate funds, the state’s Aa2 general obligation rating, the likelihood of appropriation, and the specifics of timing notification and payment mechanics related to the moral obligation. The rating also incorporates the strength of the loan payments from 38 Studios, which provide the primary source of payment on the bonds, relative to other types of revenue pledges. Another consideration is the essentiality of the project being financed, a new video gaming company to create jobs in Rhode Island. Given the development stage nature of the company, loan payments from 38 Studios have inherently more risk than other revenue streams that have established track records and predictability. These factors are reflected in the three-notch distinction between the state’s general obligation bond rating of Aa2 and the rating on these bonds of A2.

The statement gives more detail on these rationales subsequently, but there are two key points that the above paragraph is adequate to reveal:

1. Moody’s explicitly draws a distinction between the two types of bonds.  On the basis of that distinction, the State of Rhode Island accepted a higher cost for the debt.  If Moody’s were now to say that there is no distinction, then it’s guilty of a species of fraud, as well.
2. There is a significant level of detail related to these specific bonds, right down to “the strength of the loan payments from 38 Studios.”  The assessment even notes that a “company bankruptcy” could change the rating for these bonds downward.  Whatever fright show government officials and the ratings agencies may put on to goad Rhode Islanders into making good on a debt for which they did not duly offer their “express consent,” Moody’s job is ultimately to tell investors how risky the bonds are.  If a future general obligation bond becomes available with none of the risk — if it’s backed by the full faith and credit of the state, based on the specific consent of the people of Rhode Island — the agency has an obligation to treat it as less of a risk than a moral obligation bond.  Furthermore, if Rhode Island’s representatives are explicit that they are “defaulting” on the moral obligation because they take the language of the law seriously, investors should have plenty of evidence to disregard any downgrades that Moody’s makes as punishment for the 38 Studios bonds.  (Frankly, I wonder if it would even be legal for them to do so.)

The bottom line applies not just to finances, but to government and society almost across the board: Americans should stop allowing insiders to treat them like a mass of unsophisticated fools who can’t possibly understand the nuances of transactions.  Instead, we should begin forcing government agents and private financial agencies to live up to the contracts that they have with us.

Personally, I’d be proud if my state were to prove to be a leader in calling bull on the whole charade.