September 1, 2010

What is a "Moral Obligation Bond"?

Carroll Andrew Morse

If you see the words "moral obligation" being repeated in statements and news reports related to the Rhode Island Economic Development Corporation's loan guarantee program with 38 Studios (like this one from Jim Baron of the Pawtucket Times, or this one from Ted Nesi of WPRI-TV (CBS 12)), there is a specific reason why: there actually are financial instruments called "moral obligation bonds" that are distinct from "general obligation bonds" and, according to a statement from RI General Treasurer Frank Caprio, that are being used to finance the 38 Studios deal.

The difference between moral obligation bonds and general obligation bonds is that moral obligation bonds do not involve a full-faith-and-credit promise by the government to use its sovereign powers (e.g. its taxation powers) to raise the revenue needed to pay off the bondholders. The basic concept is explained in The Financial History of the United States, written by Jerry W. Markham...

Moral obligation bonds were introduced by Governor Nelson Rockefeller of New York in the 1960s...[The] idea was that public corporations could be created that would issue housing or other bonds backed by income from the projects being financed, rather than from the state's taxes or other revenues. This avoided the necessity of obtaining voter approval of the bonds.
In fact, with moral obligation bonds, the government doesn't really promise to pay off the bondholders at all; that's why it's called a moral obligation (I'll throw it over to the ethicists, to decide if moral obligation should be considered more or less binding than legal obligation). There are, however, some rules that are supposed to be followed, regarding reserve funds to be used to pay off a moral obligation bond. Here is a brief description from the website of the Council of Development Finance Agencies...
Moral obligation bonds do not carry the full faith and credit pledge of the obligor (i.e. state or locality). Rather, the moral obligation requires the issuer to maintain a debt service reserve fund at a specified reserve requirement, typically maximum annual debt service, and report any deficiencies that arise to an appropriate official of state or local government. The official then is required to request an appropriation from the legislative body to make up any shortfall. Since there is no legal requirement to make the appropriation, timely payment depends on the obligor’s willingness to support the debt.
This newfound knowledge (at least to me) of "moral obligation bonds" leads me to ask if part of the initial wave of opposition to the 38 Studios deal, which came from many sources, was rooted in the fact that using instruments that are supposed to be paid for using future income seems an odd choice for guaranteeing a loan, where money will only be needed if the future income is not realized.

Or am I missing a step in how the chain of finance would work?

Comments, although monitored, are not necessarily representative of the views Anchor Rising's contributors or approved by them. We reserve the right to delete or modify comments for any reason.

Andrew, thank you very much for diving into this. I've been very puzzled all day about the seemingly new assertion that the state only has a "moral" obligation to repay these bonds.

Who knew that this is an actual type of bond?!

Posted by: Monique at September 1, 2010 5:47 PM

I am wondering if it is a tacit admission that the "Full faith and credit" of the state is in question. Would the rating agencies call them "junk bonds" if they were "general obligation"??

Posted by: Warrington Faust at September 1, 2010 8:05 PM


I think the more likely explanation is that moral obligation bonds can be issued, apparently, without having to get voter approval.

Posted by: Andrew at September 1, 2010 8:52 PM

i found your site googling 'moral obligation bonds'

its funny i just read 'confidence game' by christine s. richard (published in 2010). she has a small section describing moral obligation bonds... they were invented by john mitchell (later, from watergate fame) to issue bonds without voter approval. this is not the view of the critics, it is what mitchell actually said, almost ver-batim.

they were blamed in part for new york city nearly going bankrupt in the 70s. then they were banned. but i guess 'banned' could have different interpretations because there seem to be people still touting them (as far as i can tell in a google search).

i dont even know what 'studio 58' is but... just thought you might find it interesting.

Posted by: Anonymouus at October 11, 2010 5:05 PM
Post a comment

Remember personal info?

Important note: The text "http:" cannot appear anywhere in your comment.