OP-ED | Six Reasons To Repeal The ‘Doomsday Bond Covenant’
Connecticut is facing a serious governmental crisis caused not by the absence of a budget but rather by the enactment in 2017 of an unprecedented and undemocratic promise made to purchasers of Connecticut’s general obligation bonds that will take effect this year unless the General Assembly puts on the brakes and re-examines the Doomsday Bond Covenant.
The 2017 state budget in Section 706 includes, for the first time in state history, a requirement that the state treasurer must include a covenant or pledge to bondholders in bonds sold after May 15, 2018. The pledge must promise that the state will not enact any laws taking effect between May 15, 2018 and June 30, 2028 that change the state’s obligation to comply with laws governing the Budget Reserve Fund, the cap on General Fund and Special Transportation Fund (STF) expenditures, the Volatility Cap, the statutory spending cap, and the caps on general obligation and credit bond authorizations until the newly sold bonds are fully paid off.
It’s understandable that legislators concerned about Connecticut’s budget crisis were searching for new devices to solve its many problems. Some of the principals in that debate are my good friends and former colleagues.
But by enacting Section 706, the General Assembly simply went much too far—even beyond its constitutional constraints—and needs both to re-examine and to repeal the Doomsday Bond Covenant.
Public financing often includes bond covenants inserted by the seller to protect the bondholder’s investment as a financial device to reduce the seller’s bond interest rate. Covenants include, for example, dedicating gas tax revenues and driver’s license fees to pay off STF bonds or dedicating tenant rental payments to finance affordable housing construction bonds or guaranteeing that the state’s share of payments into the Teachers Retirement Fund (TRF) shall not be reduced during the 25-year life of the bonds. In each of these cases, there is a specific and narrow nexus between the bond’s purpose and the covenant.
But in the case of the bond pledge required by Section 706, the covenant covers not just the dedication of a specific revenue stream (such as gas taxes or rents) nor the promise of a particular government practice (such as the maintenance of state pension contributions) but rather applies to all of the policies and practices found in the Budget Reserve Fund, the cap on General Fund and STF expenditures, the Volatility Cap, the statutory spending cap and the caps on General Obligation and credit bond authorizations. In short, the Section 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.
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.
That’s why I call Section 706 the Doomsday Bond Covenant—because it commits the state’s finances to an automatic irreversible course of self-destruction with no realistic built-in escape mechanism or effective emergency delay provision if the state over the next 10 years were to attempt to better manage its finances by changing any of these restrictive budget laws and “caps.”
What does this mean going forward?
First, the Doomsday Bond Covenant denies the state the ability to take advantage of smart budget reforms in responding to budget problems.
Consider the recent example of how a “bond lock” prevented the state from saving millions of dollars in its pension payments. When the governor and the General Assembly sought to renegotiate the terms of the SEBAC pension and medical benefits agreement with state employees last year, it was able to negotiate billions of dollars of savings in the budget and many billions over the lifetime of the agreement.
There was a legitimate debate in the General Assembly over whether the savings were sufficient and the new term too long, but no one contested the fact that the negotiated agreement had been legally renegotiated.
But when budget drafters considered whether they could reopen the payment schedule for the TRF to smooth out the upcoming finance peak and to achieve similar types of long-term savings in the underfunded TRF, it was blocked by the bond covenants arising from the state’s bond sale in 2008 to raise $2 billion to pay part of its share of a $5.1 billion shortfall.
The bonds could not be renegotiated to “smooth” or reduce the state’s financial contribution because the covenant that was inserted in the original sale included a state pledge not to reduce the state contribution into the fund over the 25-year life of the bonds.
Unlike the SEBAC collective bargaining agreement renegotiation, this bond pledge could not be broken or amended without significant financial penalty. The state was “locked in” without flexibility or any realistic escape.
Second, the Doomsday Bond Covenant strips away the state’s flexibility to adapt its financial program to fit changing economic circumstances.
By freezing the pledged budget laws to the May 2018 text, the Covenant handcuffs legislators for the next 10 years, preventing them from reacting to new conditions, new crises and new opportunities.
Here is a partial list of major new financial and budget occurrences, some actual and some hypothetical, that probably were not envisioned when the bond pledge was adopted. Yet they would undoubtedly require a significant new fiscal response that would not be possible if the Doomsday Bond Pledge were in force:
o Adjusting to the federal tax S.A.L.T. restriction
o Winning the Amazon HQ2 interstate competition
o Responding to a Hartford bankruptcy
o Funding a “Plaintiffs’ verdict” in the school funding case
o Solving an insolvency of the STF
o Juan F. Court orders the hiring of 120 social workers
o The Fiscal Stability Commission issues “Big Reform” proposals requiring amendments to all the Fiscal Caps
These are just some of the recent significant yet unpredictable contingencies that were not accounted for in the Bond Lock.
Third, the “escape clause” in Section 706 is an unwieldy and ineffectual remedy in case the Doomsday Covenant backfires.
The “escape clause” is not an effective antidote to the potential dire consequences of the Doomsday Covenant. It is difficult to construct an escape clause, other than refunding, that is both workable and also assures bondholders that it will not be easily invoked.
The escape mechanism is clumsy to say the least: the governor must declare an emergency, reduce expenditures for the current fiscal year by a significant percentage and then obtain three-fifths supermajorities in each chamber to approve his actions.
After observing the unprecedented disputes last year between the governor and majorities of both parties on the breakdown of joint budget negotiations in general or, in particular, over how to reduce appropriated spending to municipalities or the disputes over hospital litigation or Medicare Assistance, can we really take comfort that the escape mechanism could be quickly utilized?
And since the fiscal exigencies that might justify such extraordinary joint action are unlikely to be cured in just one year, can the “escape clause” process be invoked in successive or several fiscal years? It is not clear.
The only pragmatic part of the “escape clause” is the authority to sell “refunding bonds” issued to pay off the original bonds. But refunding authority is a commonplace practice—usually invoked to take advantage of lower market interest rates at the time of the refunding—and no such authority would need to be created by statute if the Doomsday Covenant had not been enacted in the first place.
The biggest problem, however, with invoking almost any escape provision to a bond covenant is that the ultimate penalty will be paid by taxpayers when the treasurer tries to sell the next series of bonds. Surely Connecticut will have to pay an interest rate premium after rating agencies determine that the ironclad guarantees against the state fiscal cap changes bondholders thought they were purchasing are in fact subject to future government discretion. The genuine financial risk we face from exercising the “escape clause,” even if it were deemed workable, is that bond purchasers will regard our state’s bonds in the future as the financial equivalent of Mark Twain’s cat reluctant to jump on a “cold stove.”
Fourth, the Doomsday Bond Covenant erodes majority rule as a guiding principle of Connecticut elections and of legislative enactments on fiscal issues by empowering a minority of legislators to control the ability of an elected super majority to act.
The “escape clause” in Section 706 requires that at least three-fifths of the members of each house of the General Assembly approve for a limited one-year period changing the terms of the covenant.
By requiring a “super majority” of three-fifths to act, Section 706 holds out the familiar promise of other “automatic” legislative tax-and- expenditure limitation devices that the requirement of a “super majority” guarantees a significant majoritarian consensus before an action can be taken. That may be valid in a general sense.
But Connecticut’s recent history in the General Assembly with these devices often produces the opposite result: the “super majority” requirement ends up empowering the legislative minority to impose its will as its price for forming a super majority coalition.
The state’s Constitutional Spending Cap as adopted in 1992 requires a similar three-fifths super majority to amend its statutory definitions and other terms. In our recent era of divided government, when Govs. John G. Rowland or M. Jodi Rell sought policy changes that majority Democrats in the legislature did not support, the majority had to acquiesce in order to get the minority Republican votes needed to invoke exceptions to the Spending Cap.
A similar dynamic took place with the enactment of the 2017 budget and Section 706 as well.
This is not to conclude that super majorities are not desirable to enact legislation or that bipartisan majorities should not be favored. My concern generally is with placing a super majority requirement for exemption into the Doomsday Bond Covenant and thereby granting enormous leverage to the 41 percent of legislators at the expense of majority rule for the 59 percent.
Fifth, the Doomsday Bond Covenant undermines democratic government in Connecticut by preventing legislators elected in the future and future General Assembly majorities over the next 10 years from changing the Budget Caps and Budget Laws.
It is a standard rule of parliamentary procedure that a legislative body in office during one election cycle cannot bind a successor legislative body elected in a later cycle. The reason is obvious: most fixed-term legislative bodies expire at the end of their final sessions and therefore successor legislators have powers equal to prior legislators to amend any existing law. The customary device is to use this simple introductory phrase in a new bill: “Notwithstanding any other provision of law…”
But the Doomsday Bond Covenant denies legislators and General Assembly majorities elected after May 2018 (at least until 2028) any authority to amend the Budget Caps and Budget Laws because that power has been delegated by the Covenant to the bondholders. The Bond Covenant promises to the bondholders that no other “provision of law” (notwithstanding the ineffectual “escape clause,” as I explain below) can override the pledge that the 2018 terms of the Budget Caps and Laws will not be changed.
Supporters of the Doomsday Bond Covenant often explain that they want to “tie the hands” of legislators to constrain spending. I understand their budget concerns. Let them “tie their own hands” if they wish, but they should not have any right to tie the hands of legislators elected in 2020 or 2022 or 2024 and force them by the enactment of the Doomsday Covenant in 2018 to lack the authority to make fiscal cap changes if that’s what voters want accomplished.
The Doomsday Covenant is undemocratic not just because it “ties the hands” of elected legislators but, even worse, because it “ties the hands” of Connecticut voters.
Sixth, the Doomsday Bond Covenant arguably raises a serious question of law over whether it constitutes an unconstitutional delegation of state legislative power to bond holders in derogation of the General Assembly’s legislative powers.
The Connecticut Constitution in Article Third, Section 1, establishes that “The legislative power of the state shall be vested in … the General Assembly.” But the Doomsday Bond Covenant strips the power to change, amend or repeal the Budget Caps and Budget Laws specified in Section 706 from the General Assembly and hands it over to the bondholders who purchased state bonds after May 15, 2018.
Consider this hypothetical possibility: Since the creation of new judgeships is an expensive personnel item, could the General Assembly in its wish to “tie the hands” of future legislators for budget discipline require the treasurer to include a covenant in future GO bonds that no additional judgeships shall be created and no additional judges shall be confirmed by the General Assembly between 2018 and 2028?
Here is another of the possible endless examples: the General Assembly enacted in 2017 a new Education Cost Sharing formula for grants to municipalities. In order to “tie the hands” of future legislators and prevent budget increases, could the General Assembly require the treasurer to include in bond covenants a pledge that the state shall not increase education cost sharing to any town by more than 1 percent between 2018 and 2028?
Of course not! But is there really any genuine difference in principle between these bogus pledges that unconstitutionally detract from the General Assembly’s legislative powers over judicial appointments and education spending and the Doomsday Covenant required by Section 706?
Out of respect for the State Constitution and our traditional democratic practices, the Doomsday Bond Covenant should not be allowed to remain on the statute books.
The Doomsday Bond Covenant in Section 706 is possibly the most unconstitutional and anti-democratic law enacted in Connecticut since the state’s constitutional convention in 1965. On its face, it could cause the nearly complete halt of the government and it unconstitutionally transfers critical portions of the state’s lawmaking and budget-making powers over the next 10 years from lawmakers and voters to bond purchasers.
Now that the unusual politically-divisive pressures of enacting a long-delayed budget in 2017 are over—and even acknowledging the legitimate fiscal concerns which led to its enactment last year—I urge the General Assembly in the coming session to scrutinize and to repeal the Doomsday Bond Covenant as it was enacted in Section 706 or, at the very least, to delay its effective date until its ramifications can be more clearly understood and its horrendous defects can be corrected.
Knopp is a former mayor and state legislator from Norwalk. He is a visiting clinical lecturer at Yale Law School.
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