After Central Falls collapsed into insolvency in 2010, state leaders scrambled to contain the fallout and ensure the tiny city’s struggles didn’t cause a domino effect that would raise borrowing costs for other cities. House Democratic leaders quickly pushed through a new law giving bondholders first dibs for repayment if a city or town files for bankruptcy – which is what happened in Central Falls’ Chapter 9 case.
The law has won praise from big investors, but has been somewhat controversial locally: Governor Chafee rejected a call for its repeal by the AFL-CIO. One of the big unanswered questions, though, has been whether there was really a risk of contagion in the bond market – or if Central Falls wouldn’t impact other cities.
Stephen Eide, a senior fellow at the Manhattan Institute’s Center for State and Local Leadership, thinks the situation in Michigan since Detroit filed for bankruptcy may be vindicating Rhode Island leaders’ concerns. In a new post for Public Sector Inc, Eide writes:
[Rhode Island's] law was way more Wall Street-friendly than paying back the 38 Studios debt and incomparably harsher towards retirees, who took brunt of the bankruptcy cuts, than Gina Raimondo’s pension reform.
From a policy perspective, the deepest problem with the great Rhode Island bondholder bailout of 2011 is that many hold out hope that, someday, bondholders might play a more constructive role in holding state and local governments accountable for their fiscal misdeeds. But there’s little chance a bondholder will become a bond vigilante if he can be confident that, no matter how bad things get, his interests will never be harmed.
Anyway, the point is that events in Michigan have provided defenders of Rhode Island’s actions during the Central Falls meltdown (and also, for that matter, the 38 Studios affair) with strong evidence for their view that it’s never in the interest of a state government – who has a responsibility to all its governments and taxpayers – to let a locality jilt Wall Street. …
Whether one prefers Michigan’s approach or Rhode Island’s, fiscal distress is a state issue, and there are difficult choices to be made which must take into consideration the interests of all state taxpayers and local governments.
• Related: Q&A: Penn Law’s Skeel on RI pensions, bankruptcy and bonds (March 2, 2012)