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June 4, 2018 EDITOR'S TAKE

Bond covenants good step despite risks

Greg Bordonaro Editor
By Greg Bordonaro

Government finance is a mundane topic, but the state is experimenting with new fiscal restraints that have raised red flags among diverse constituencies, including business leaders.

If that line made you do a double take you're not alone. Yes, some business leaders are concerned about efforts lawmakers have taken to rein in spending and borrowing.

The issue will come to a head June 4, when the state conducts a $500 million bond issuance that will bear fiscal covenants mandated by state lawmakers last fall.

A so-called “bond lock” provision requires that all state debt issued from May 15, 2018 to July 1, 2020, bear certain covenants including restrictions on how much state lawmakers can borrow and spend over the next five years.

For example, the new covenants prevent annual growth in state spending from exceeding the average rate of personal income growth in Connecticut or inflation, whichever is greater.

And a bond cap prohibits the state from issuing more than $1.9 billion in bonding per year, a limit that will adjust annually to reflect the federal Consumer Price Index's inflation rate.

There is also a volatility cap that requires lawmakers to save income tax revenues from quarterly filings that exceed a certain amount.

Personally, I think these covenants are a step in the right direction in terms of reining in irresponsible budgeting and borrowing that has defined state government for far too long. Even Wall Street, which has knocked Connecticut countless times in recent years, applauded the move, with Fitch Ratings grading the debt issue an “A+.”

But I'll admit, there could be unintended consequences from enacting the new covenants, and they've raised enough concerns that even the CEO-led Commission on Fiscal Stability and Economic Growth urged lawmakers to delay the financial restraints by at least a year so that further analysis could be made on the long-term impact. (The Connecticut Business & Industry Association has supported the new restrictions.)

One of the chief concerns is that it provides the state little to no financial flexibility to respond to a crisis, like another deep recession or a natural disaster, which could require the state to spend more money.

If Connecticut is restricted as to how much it can borrow or spend during a crisis, it could adversely affect the future credit rating of the state and its municipalities. Those were concerns echoed by Bill Cibes, the former budget director under Gov. Lowell P. Weicker Jr., who has essentially called the new covenants a potential financial calamity.

Worst yet, Cibes and others have said, is that the covenants will hand over power to control public policy to bondholders instead of taxpayers and elected officials.

That is a legitimate concern because bond covenants, unlike many of the promises state lawmakers make, can't be easily broken, leaving Connecticut, which faces billion-dollar deficits in the years ahead, little financial wiggle room.

However, there are safeguards in place that make the risks worthwhile. Lawmakers, for example, agreed this spring to reduce the bond-lock pledge to five years instead of 10 years. There is also an emergency provision that allows lawmakers to alter the caps or debt limit if the governor declares a fiscal emergency and three-fifths of the House and Senate approve the change.

What this debate demonstrates is that there are no easy answers to Connecticut's fiscal woes. Between short-term, billion-dollar deficits and long-term unfunded liabilities, Connecticut faces tough financial times ahead and we'll have to make sacrifices one way or another in order to one day achieve fiscal stability.

The problem is lawmakers have been unwilling (or lack the capacity) to make many of the difficult decisions that would bring true fiscal reforms to the state. That's why they agreed to have bondholders hold us hostage in the first place, because when left to their own devices, spending and borrowing is in the DNA of many state legislators.

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