Chafee's Confusion About Moral Obligation

Has Rhode Island's governor put bondholders above state workers? 

I had an odd conversation with Rhode Island Governor Lincoln Chafee this week.

Chafee has been in the job since 2011. During that time, Rhode Island has endured some of the most intense fiscal stresses of any state. Several decades of economic underperformance have led to severely underfunded state and local public employee pension systems. The economic crisis of the last few years, which hit Rhode Island exceptionally hard, exacerbated those pressures.

Under Chafee, Rhode Island has drawn national attention for two major fiscal events. First, the state legislature passed (and Chafee signed) the country's most sweeping public employee pension reform. The measure included a provision discharging about $1 billion in existing pension liabilities by freezing retirees' cost of living adjustments (COLAs) for 15 years. This wasn't a small cut; by the time the freeze is over, many retirees' payments will be one-third smaller than initially promised.

Second was the implosion of 38 Studios, former Red Sox pitcher Curt Schilling's video game enterprise. Rhode Island offered the company a loan guarantee to relocate from Massachusetts. Now, the venture is bankrupt, and the state is on the hook to bondholders for $112 million.

The 38 Studios guarantee took the form of a "moral obligation" on a bond issuance, meaning the state doesn't have an actual legal obligation to make bondholders whole. Bondholders were paid a higher interest rate to compensate them for a risk of nonpayment that exceeded the typical risk of a general obligation bond. But Chafee and other political leaders in Rhode Island have been resolute: the state will pay.

That raises a question that many state residents -- especially retired employees -- would like to see answered: If Rhode Island can't afford to keep its promises to retirees, how can it afford to keep its promise to the 38 Studios bondholders? Chafee isn't prepared to answer.

In an interview at Bloomberg News's New York bureau on Monday, the governor dismissed out of hand the idea that defaulting on the 38 Studios bonds might be in the state's best interest. To him, this is a simple moral issue.

"Even if the cost-benefit showed that, to the penny, we were better off defaulting, I'd consider it not honorable and damaging to our reputation," he said. "I don't know if you can factor that in as dollars and cents."

Later, he added "The words moral obligation speak for themselves."

But aren't the pensions a moral obligation, too? After all, people spent their careers working for state and local governments in exchange for specific pension benefits. I asked Chafee, why it was acceptable to freeze the COLAs and unacceptable to break the moral obligation on the bonds.

He responded: "Good question. A lot of discussion about that and, in fact, we're in court on that issue with the unions." But he never got around to explaining why his position is right and the unions' is wrong.

Instead, he sought to disclaim ownership of the COLA freeze, which was part of the 2011 pension reform law and the key issue the unions are suing over.

"I knew that the path we were taking was going to get us into litigation, and I had the decision whether to sign it once it passed," he said. "There were other areas of pension reform that I disagreed with, but in the end I did sign it."

Asked why he signed, he responded that he had to weigh costs and benefits, and that a key concern was that a veto would have been overridden by the large legislative majority that had passed the bill.

This is disingenuous. Chafee urged the legislature to pass pension reform, and helped build the veto-proof majorities that got the bill to his desk. I witnessed this: In October 2011, I spoke on a panel after a joint presentation by Chafee and state Treasurer Gina Raimondo in which they advocated the pension reform plan that eventually became law. At the time, Chafee also called for additional reforms that would have drawn more litigation by cutting benefits in locally run pension plans that were left untouched by his joint reform with Raimondo.

Now, Chafee says he was the voice of caution: "We got a little too aggressive. The treasurer was very aggressive, I was more, 'we need buy-in, avoid litigation.'"

When I asked why he teamed up with the treasurer to promote the bill, he said "We had to have a united approach."

Chafee's lack of resoluteness on the pension issue, and his misplaced resoluteness on paying the 38 Studios bonds, is concerning. Rhode Island's biggest fiscal problem is that the state made more promises than it can keep. Yet Chafee is touting a mediation process that may lead to a partial unwinding of the pension reforms he championed, in exchange for an end to union litigation.

This would repeat a pattern that we've often seen in state level pension reforms -- a law that looks like it will produce big cost savings gets unwound years later for political or legal reasons. Just ask New York lawmakers, who have gone through five rounds of pension reform since the late 1970s.

And when it came to 38 Studios, Chafee couldn't even answer a simple question: Is it ever appropriate for the state to issue moral obligation bonds?

"I'm not an expert on that issue," he responded. After a year of dealing with the fallout from 38 Studios' collapse, you would think he would be.

As the interview ended, Chafee remarked, "I'll have to think a little more about Josh's question" -- the one about why you can freeze COLAs but can't default on 38 Studios. Taxpayers and public workers in Rhode Island should hope that he does.

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