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Bond Covenant ‘Straight Jacket’ or ‘Doomsday’ Scenario?

by | Jan 31, 2018 6:29am () Comments | Commenting has expired | Share
Posted to: State Budget, Taxes, State Capitol

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HARTFORD, CT — It went unnoticed for months, but a single section of the state budget signed in October is receiving high praise from some and causing alarm for others.

Section 706 of the bipartisan budget created a new bond covenant that will require the General Assembly to guarantee payment of general obligation and credit revenue bonds over the next 10 years, while also adhering to restrictive bonding, spending, and volatility caps.

The provision will be attached to bonds issued after May 15, 2018. But it comes with an escape hatch that would require the governor to declare an emergency and 3/5ths of the House and Senate to change the bonding, spending or volatility cap definitions for the fiscal year in progress.

For better or worse, those three caps tie lawmakers hands when it comes to the state budget. It means they cannot spend or borrow beyond the caps defined in the most recent budget. Some described it as a necessary “straight jacket,” while others called it a “doomsday bond covenant” that potentially violates the state constitution by putting obligations to bondholders ahead of legislative authority.

“In short, the Sec. 706 covenant applies to the most comprehensive set of budget cap laws ever passed in our state encompassing nearly the entire budget of the State of Connecticut,” former Norwalk Mayor Alex Knopp wrote in his Jan. 24 testimony. “If the General Assembly were to take the unlikely step of violating this pledge by amending these budget caps and laws at any time over the next 10 years, the purchasers of the bonds would be able to enforce the covenant in court to demand immediate payment of their principal, interest and penalties, whether or not the state would be in a fiscal position to afford to fulfill its obligations.”

Sen. John Fonfara, D-Hartford, who advocated for the language, said he respects Knopp, a former state lawmaker, but the budget was adopted by an overwhelming number of lawmakers and signed by the governor.

He said the legislature has proven again and again that when there are budget surpluses they can’t help but spend the money. However, the money is often one-time revenue and has contributed to the current cycle of continued budget deficits.

“The covenant is intentional on my part to bring about discipline for future legislatures,” Fonfara said.

He said the legislature was budgeting revenue, like the volatile revenue from the estimates and finals portion of the income tax, as if it were permanent. As an example, Fonfara said that if you get a one-time bonus at work, you don’t go out and buy a car or a house that will require a continued monthly payment in the amount of the bonus. But that’s what the legislature was doing.

Fonfara said that if the volatility cap wasn’t in place earlier this month when Connecticut saw a $675 million windfall from residents making early personal income tax payments and from the repatriation of off-shore hedge fund income, then there would have been no stopping his colleagues in the legislature from spending some of that money.

But under the new volatility cap also included in the budget, the windfall revenue must be deposited into the Rainy Day Fund, which has been depleted over the past several years.

Christine Stuart / ctnewsjunkie State Comptroller Kevin Lembo, a proponent of the volatility cap, said he’s not a fan of the language the legislature ended up adopting, and he’s not in favor of adding additional controls over legislative spending into bond covenant language for future borrowing.

“The legislature has ceded it’s authority, I would argue without understanding, to a bank, to a bondholder, to a foreign government, to whoever is holding our bonds,” Lembo said Tuesday.

He said he knows the pushback is an argument about fiscal responsibility, but “we’re a government and governments have constitutional authority and responsibility.”

On Tuesday, Lembo told a group of advocates gathered at the state Capitol for the annual CT Voices for Children budget forum that he tried to come up with an analogy for the situation using a pizza restaurant.

“You’ve got one oven, you’ve got a couple of employees, and your pizza is pretty good,” Lembo said.

He said imagine if you went to the bank to try and get a loan for a second pizza oven and were told that’s not possible. Then you guaranteed the revenues from that oven to the bank and the bank still wanted your in-laws to co-sign for the loan. The bank finally gives you the loan and three weeks later your first oven fails. You can’t buy a new one because you can’t afford it and you can’t borrow money for another. Then your restaurant burns to the ground.

“You have all this money sitting in their bank, but they refuse to allow you to use it,” Lembo said. “That’s what Connecticut just did. Locked ourselves into a position that could be catastrophic for its balance sheet.”

Lembo said it sounds good on paper and makes a “wonderful political sound byte … Sound bytes are not going to solve our problems.”

But Fonfara said that’s an oversimplification of the problem.

Fonfara said there’s nothing wrong about being disciplined when it comes to state finances.

He said the provision brings predictability to the budget, which is what progressive groups like CT Voices for Children should support. It will also provide a more realistic fiscal picture for organizations funded by the discretionary part of the budget.

But groups whose support comes from that part of the budget worry they will get even less than they do now.

Literature from CT Voices for Children says the bond covenant and the spending cap will force the legislature to cut another $3.8 billion from the budget to pay its “nonfunctional” costs. The fixed portion of the state budget, including debt service and pension contributions, accounts for 53 percent of the total budget.

Senate Republican President Len Fasano, R-North Haven, said unlike the bond covenant for the Teachers Retirement System, there is flexibility in this one because the governor and 3/5ths of both chambers could agree to put the provision on hold for one fiscal year.

“People just want to keep spending money. There is not a will in this building to say ‘no’ and ‘we can’t afford it’,” Fasano added. “I get why. There’s good causes, but putting it in a bond covenant, we remove our inability to [stop ourselves from doing] things that otherwise are not fiscally prudent.”

He said the language ensures the promise to follow the bonding, spending, and volatility caps.

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