Anchor Rising’s Justin Katz and Carroll Andrew Morse have both raised some good points about Rhode Island’s indebtedness today and yesterday. Carroll wondered about the scope of the “moral obligation bonds” promised for 38 Studios, and Justin questioned whether my analysis of the state’s debt burden was too sanguine. I’m going to respond to Justin first, and hopefully follow up with a separate post about MOBs unless Hurricane Earl prevents me.

Justin’s concern is the state’s $5.2 billion in “conduit debt.” (That’s when some other entity – Brown University, Rhode Island Hospital, RISLA, Rhode Island Housing – goes through the state to borrow money at a reduced cost.) I said Rhode Island taxpayers “are not on the hook” for that money because it carries no promise that the state will repay it.

“Nesi should be a little more careful with his language,” Justin writes. “The taxpayer is ‘on the hook’ but is trusting the recipients of the borrowed money to pay it back – sort of like the federal government trusted mortgagees through Fannie Mae and Freddie Mac to pay for their houses.”

That’s a fair point. As Justin points out, bondholders assumed taxpayers would make them whole if Fannie and Freddie ran into trouble, despite years of official statements to the contrary. And sure enough, when push came to shove the bondholders were right, and the Fannie-Freddie bailout could cost us nearly $400 billion.

Still, I think there are distinctions to be made here. Take a look at this chart from last year’s annual report of the R.I. Public Finance Management Board, which is tasked with keeping an eye on the state’s borrowing:

There you can see the four types of state debt. Basically, the higher on the chart you go, the more on the hook we are.

The first category is Tax Supported Debt. That’s just what it sounds like – the state promises to raise enough taxes to pay back its creditors. It’s the most basic kind of state bond.

The second category is State Supported Revenue Debt, which includes moral obligation bonds. In that case, the state makes a somewhat more wishy-washy promise – if the designated source of revenue (such as sales taxes at Providence Place) doesn’t produce enough cash, the governor will ask the General Assembly to appropriate money to cover the shortfall. Unlike tax supported debt, the state hasn’t made a legal promise to pay the bondholders off; but in practice, lawmakers almost certainly would.

Then we come to Agency Revenue Debt. In this case, the state doesn’t even promise that the governor will ask lawmakers for the money to cover a shortfall. But since the state is unlikely to let its creditors take the assets that secure the loans, like buildings at URI or the Pell bridge, lawmakers would probably vote to pay them here, too.

Then we come to the last category, Conduit Debt. “Investors would not expect any assistance by the state in the event the borrower experienced financial difficulties or if the debt were to default,” the finance board’s report says, and it’s not secured by state assets like bridges or public colleges (although residents probably wouldn’t want the water agencies to give away their reservoirs or sewage plants).

You can see that in fiscal 2008, more than 40 percent of the conduit debt was with the R.I. Health and Educational Building Corporation, a quasi-state agency set up back in 1966 to help local school districts and private nonprofits like Brown and the hospitals borrow money to pay for construction.

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.

(Still with me? I’m impressed.)

Lastly, I was struck by a point Justin made toward the end of his post, noting “the state’s interest in the health of its sub-borrowers,” like Central Falls and other cities and towns. That is a good point – as we’ve seen in Central Falls’ case, state officials are not about to let a municipality default or otherwise scare the bond markets.i

According to the same report I mentioned before, local government debt in Rhode Island totaled $1.7 billion in fiscal 2008. That’s slightly more than all the state government’s tax supported debt (the first of the four types described above), and could pose a problem in some cases, as we saw – once again – in Central Falls.