Still on the Hook

Ted Nesi has responded to my post, yesterday, about state conduit debt. Giving some further details about the situation in Rhode Island, Nesi writes:

To return to Justin's critique, the reason it's easier and cheaper for these institutions to borrow through the state isn't because of an implicit Fannie-Freddie promise; it's because state bonds are tax-exempt, which tends to reduce how much interest they have to pay and the amount of time they get to pay it. The treasurer's office tells me there has been a surge of interest in RIHEBC bonds since credit markets started to seize up in 2007.

The tax exemption is likely part of it, but to my knowledge, bond ratings are still a factor, and when the the financial vehicle is issued by a public agency — created through legislation and staffed with board members appointed by elected government officials — the game is somewhat different than purely private ventures.

More important, though, is that there's got to be something in these deals for the state. For the most part, that something is an ability to borrow money without first acquiring direct voter approval. If, for example, the R.I. Health and Educational Building Corporation — which lends substantial money, let's remember, to government agencies like municipalities for education buildings — finds its borrowers defaulting in substantial amount, it will have a more difficult time finding investors, and its interest rates will have to go up to attract them.

That's where the Central Falls example comes into play: The reason given for state involvement in appointing a municipal dictator to repair the city's finances was that one municipal bankruptcy in the state would affect the borrowing opportunities for all municipalities in the state based on bond ratings. As I've said, if the borrowers utilizing the "conduit" cannot fulfill their obligations, the state will find a way to smooth the financial hit.

If defaults happen on a limited, atypical basis, then the arrangements will never be a problem, but remember that the reason that we're discussing the matter at all is that about half of the state's total debt is associated with the conduits. Therefore, even though we must certainly be aware of the different implications of the various forms of public bonds, it remains wise to keep an eye on them all, and it is hardly unreasonable to compare the figures on a state-by-state basis.

Rhode Island apparently leads the nation in conduit debt. We should be very suspicious about why that might be.