Riley: California Municipal Bondholder Law Follows Rhode Island

Riley: California Municipal Bondholder Law Follows Rhode Island

In 2011 a Rhode Island law was passed giving municipal Bondholders first lien on Tax Revenue in the event of Municipal Bankruptcy. This law preceded the bankruptcy in Central Falls and as a result Bond-holders lost nothing, Municipal workers and retirees were cut to 55% of their expected benefits. Later RI State Taxpayers were twice assessed by the General Assembly $2.6 million and $4.5 million to improve Central Falls workers compensation to 75% of pre-Bankruptcy expectation. The concern at the time was not about Central falls but rather the “inner circle secret” that Providence and 6 other cities were essentially bankrupt. The law was passed in order to persuade ratings agencies like Moody’s that contagion would not occur in Rhode Island were several municipalities were staring at huge pension and OPEB obligations. Now as a result of the law, those unfunded liabilities would be either  paid by local taxpayers, or retiree cutbacks and/or  State Taxpayers ,sparing the bondholders.  With bondholders guaranteed first liens, all legacy costs would be borne by local and state taxpayers, the law also saved the State of Rhode Island from a reduced credit rating.

Now California follows

Apparently California likes this solution as well because after a series of municipal bankruptcies in California, Governor Jerry Brown has signed a new law, known as SB222. Like the Rhode Island law, SB222 is designed to preserve Bondholders rights to the detriment of retirees and taxpayers. The law creates a “statutory lien” as opposed to consensual liens.  Prior to this California was silent on whether General Obligation Bonds were “secured “creditors in the event of Municipal Bankruptcy. According to a Bond Buyer report “This new law removes that ambiguity”.  

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How does this help and what are the unintended consequences?

It is very likely that this legal maneuver, by Rhode Island, prevented a junk rating from Moody’s .The rating downgrades would have spread to several towns. In California the same effect is expected as It may also temporarily lift or stabilize ratings in towns like San Bernardino.  However, there are always unintended consequences, and the unintended consequence of these laws is that a cushion of indemnified bondholders reduces oversight pressure from ratings agencies and muddies any sharp analysis from outsiders. It leads to a relaxed financial discipline in the locality.  Bondholders simply don’t care if Mayor Taveras lied about the financial condition, because they are guaranteed first lien. Just like our infamous 38 Studios bondholders couldn’t care less about the fundamentals because their return was insured AND guaranteed.  So, if the bondholders don’t care and the ratings agencies don’t care or even look, who should make sure Providence isn’t stealing or lying? According to Attorney General Peter Kilmartin it’s not his jurisdiction.  Auditor General Hoyle literally has zero power and works for Speaker Mattiello. He looks real bad so far, having missed the fraudulent accounting for years but so what? Shouldn’t RI pension plan beneficiaries who had $62 million stolen from the pension plan last June 30th care? Shouldn’t they sue? Why aren’t they concerned that Providence not only will write off $62 million forever, they also won’t pay last year’s pension contribution until October and there is no plan to pay on time in the next 10 years? Shouldn’t Moody’s care? Shouldn’t the Treasure? Governor?

A Consequence that is not so unintended

So Providence now has a “free roll” with the law in place. They know they won’t be rated junk even if they lie and default and steal. Thus Liabilities soar and cash flow is diverted without consequence despite already being the worst funded plan in the country. Why? The State and Providence are planning to get out of this fix is when, not if, but when bankruptcy/ receivership  happens in Providence they are well aware that it is the  State Taxpayers that will be stuck with the bill. 

Here’s how it works. Providence owes around $3 billion, maybe more, to actives and retirees. Upon bankruptcy bond holders get first lien and are fine, municipal workers are harmed but in bankruptcy are guaranteed by the State for 75% of pre-bankruptcy benefits. So $2.25 billion, which is 75% of the $3 billion owed, will be picked up by State Taxpayers. Effectively South Kingstown and Tiverton residents will be paying for the retirement benefits of Providence police and fire. This scenario is not far-fetched and I believe this is exactly how Mayor Taveras planned and Elorza is planning to get rid of their liabilities by sticking the State Taxpayers. The three billion plus in liabilities that now exists in Providence were of Providence‘s own making and it’s their problem alone. Non-Providence residents who don’t want to get stuck with the bill, should speak to their representatives and urge them to enact legislation that prevents or severely limits a State taxpayer bailout of Providence.

Could Providence soon be in receivership?

It’s not clear that the State of Rhode Island State taxpayers understand how close they are to actually having to bail out Providence. First there is the problem that neither the City nor the State has revealed the true financial condition of the State capital for about 20 years. But more recently Providence defaulted on a $62 million dollar payment, this “loan” is listed as a liability “due to retirement plan” due June 30, 2015. The payment was not made and neither the Mayor nor the Governor will either verify or deny this. It’s obvious they don’t want to discuss it. A big and very relevant question is whether the behavior of Providence Officials, The Governor and the State Treasurer is materially misleading municipal bondholders and taxpayers and does it violate Federal Securities law? I say yes and further I believe it goes beyond misleading and toward fraud. Presumably the States bond offering of approximately $170 million dollars announced last week by the State would have disclosed to potential investors and Ratings agencies Providence’s  recent default and its possible effect. However the 332 page Bond Offering Document that can be found at various sites including Bond Buyer and Munios, lacks disclosure. There is no reference to misstated or overstate assets, defaulted loans, or possibly illegal borrowing from the Providence pension fund mentioned in the document. Regarding the default in Providence on June 30, 2015 there is also no discussion of the possible impact on the financial condition of the State of Rhode Island.

I‘ve made this case clearly and submitted a report

Providence and the State seem to be unconcerned about default and so does the fire and police union. This has lead members of the media  to say that “because officials are nonchalant about the money” maybe there is nothing wrong. Nothing could be further from the truth. Federal laws have been violated and at some point, maybe soon, City and State officials are going to be in real trouble.

Why aren’t Unions crying foul?

The hard truth is that Providence is flat broke. They don’t have $2 million much less $62 million and at least one union believes their union will be better off by not suing, because workers could be severely impaired if the lawsuit triggers a bankruptcy. So that leaves me the only one telling the truth and asking for an investigation. In the end I hope those that are misleading bondholders, stealing pension money and covering up for crimes are taken to task. That long list  includes every accountant in Providence City Hall  and those professional Auditors and actuaries hired by Providence over the last 15 years, both Auditor Generals, the Municipal Crisis Pension Commission and Rosemary Booth Gallogly, Mayor Cicilline, Mayor Taveras, Mayor Elorza , all the city  treasurers in Providence 2004-2015, all members of the Council’s Finance committee 2004-2015,Governor Raimondo ,and treasurer Seth Magaziner. There are many many more who covered up these misdeeds and crimes and I write this article as part of a series, to preserve the record for posterity.  I don’t expect anyone to refute these charges because the truth damns all of them. Your elected and appointed leaders just want the story to go away. I want it investigated by the SEC and other law enforcement. So it’s up to you, the taxpayer, to maintain focus and protect yourselves on this issue and not worry about the many distractions. 

Michael G. Riley is vice chair at Rhode Island Center for Freedom and Prosperity, and is managing member and founder of Coastal Management Group, LLC. Riley has 35 years of experience in the financial industry, having managed divisions of PaineWebber, LETCO, and TD Securities (TD Bank). He has been quoted in Barron’s, Wall Street Transcript, NY Post, and various other print media and also appeared on NBC News, Yahoo TV, and CNBC.