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Bond expert: Defaulting on 38 Studios debt risky

June 7, 2013

PROVIDENCE, R.I. (AP) — The state could see its credit rating decline and the costs of future borrowing increase if it defaults on the money it owes for its failed investment in former Boston Red Sox pitcher Curt Schilling’s video game company, a municipal bond expert told lawmakers on Thursday.

The full impact of going back on the state’s obligations is difficult to predict with certainty, bond analyst Matt Fabian told the House Finance Committee, because no state has defaulted in a similar fashion in recent times.

“We haven’t seen a state walk away from bonds for 100 years,” said Fabian, managing director of Concord, Mass.-based Municipal Market Advisors, a research firm that provides analysis on the municipal bond market. ”... You need to go back to Confederate states.”

Fabian addressed lawmakers in response to a rising call to default on the money Rhode Island owes on its failed investment in the company, 38 Studios. The push to default on the bonds highlights the continuing anger over the $75 million guarantee given to the untested video game company. The state’s Economic Development Corp. approved the guarantee with the hopes of bringing high-paying jobs to the economically battered state. When the company filed for bankruptcy last year, the state was left on the hook for $112 million.

The budget proposal before lawmakers calls for an initial $2.5 million payment in the next fiscal year followed by annual payments of $12.5 million.

A vote on a default could come within weeks as lawmakers work to end their 2013 session. Top lawmakers said they are exploring all options.

“There are people who are very angry and upset about this whole thing, and I share that feeling,” said House Finance Chairman Helio Melo, D-East Providence. ”... We need to weigh some options. If we choose not to do this, does it cost Rhode Island more in the long-run? Would we be better off if we did it?”

Supporters of default insist that the insurance on the bonds will pay the bondholders and that the state is unlikely to see any longstanding damage to its bond rating or its financial reputation. Supporters — who include Senate Republicans, former state Treasurer Frank Caprio and the group Occupy Providence — say the people of Rhode Island shouldn’t pay for the mistakes of the state’s former economic development officials.

Rep. Karen MacBeth, a Cumberland Democrat who was among the first to suggest a default, noted that the General Assembly reneged on its promises to state workers when it cut public pension benefits in 2011. That was done in the interests of saving the state’s finances, she said, even though it meant breaking a promise to workers and retirees.

“I get emails every day about cuts to mental health, cuts to foster care,” she said. “We didn’t have the money for pensions, but we have the money for this?”

Democratic Gov. Lincoln Chafee, the current leaders at the EDC and Treasurer Gina Raimondo oppose the idea. Chafee’s Director of Administration Richard Licht predicted that the bond insurer would sue the state to recoup its losses if the state defaults. He noted that the state is suing Schilling, 38 Studios executives and even former EDC officials and could recover some of its losses.

“Doesn’t it say something that no one has ever done this?” Licht said. “There is no one that we’ve talked to (who) has said, ‘take this risk,’” Licht said. “The governor is not going to risk us being the test case.”

Attorneys for Schilling and others at the defunct company have said they disclosed everything about its finances to the EDC and lawsuit should be dropped.

Fabian presented a grim outcome if the state defaults. He said interest rates for the state could go up and its bond ratings go down. He said the state could earn a “stigma” as a potentially unsafe investment. It’s said the state could likely pay much more in the long run if it defaults than if it just pays the debt. He said bond experts still talk about how Arkansas was forced to default on bonds during the Great Depression.

With more and more lawmakers favoring default, the debate has complicated negotiations over the next state budget and worried the Chafee administration that a default could undermine efforts to improve the state’s reputation with investors.

One legislative supporter of default, Sen. Dawson Hodgson, R-North Kingstown, said he thinks the damage to the state’s financial reputation was done when the risky investment in 38 Studios failed. He said he believes investors understand that the investment was foolhardy and will forgive the state if it defaults.

Asked Thursday if he had been contacted by constituents on the matter and what their instructions were, Hodgson didn’t hesitate: “Yes. Don’t pay.”

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