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Control by Covenant

MAR 17, 2010 7:14pm ET
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While much has been made of a deficit-borrowing proposal in New York, less attention has been paid to how those bonds would force fiscal discipline through bond covenants.

“The reason I proposed borrowing, some borrowing, was that if they don’t limit it, there’s a good chance the Legislature will want to do a hell of a lot more,” Lieut. Gov. Richard Ravitch said in an interview. “Second of all, I am suggesting that the best credit the state has — which is the [personal income tax] bonds — be used and we have to do a borrowing to get this covenant in place.”

Ravitch’s proposal, released last week, called for a series of budget reforms intended to return the state to structural balance in five years. Key to the plan is the migration to Generally Accepted Accounting Principles budgeting from the current cash method.

The plan’s teeth lie in a ­financial review board that could effectively shut down the state’s capital program if the budget gets out of balance. Unlike the state imposing a control board on a municipality, such a board can’t be imposed on the state because power can’t constitutionally be taken away from the Legislature and governor.

Ravitch’s plan would accomplish similar control by requiring the placement of bond covenants in all future state-backed bond documents, which would trigger an event of default if the review board found the budget out of balance, and neither the Legislature nor the governor took steps to return it to balance. The plan would give the governor extraordinary powers to cut spending if the Legislature did not act.

“Politicians, whether they’re from the left or the right, know that they can’t lose access to the market,” Ravitch said. “You’ll never get to the default, I don’t think, unless you have a crazy person that’s governor.”

New York’s capital plan over the next five fiscal years calls for $48.8 billion of spending, of which $29.1 billion would be bond financed.

Asked whether the capital program could grind to a halt if the state couldn’t access the debt market because it had defaulted under the new bond covenants, Ravitch said: “Yes, sir.”

Such a board actually exercising that power to force lawmakers to take action on the budget is unlikely, said Dall Forsythe, former state budget director.

“There are two possibilities — one is the state would get its budget in balance, the other is that the board will never say that it is not because of fear they would throw the state into default,” Forsythe said. “It would be a catastrophic event. It’s hard to imagine who on the review board would vote for that.”

The plan to finance up to $2 billion in deficit spending annually for three years during the transition to GAAP financing has been criticized, but Ravitch said it is necessary because the state faces a $9.5 billion deficit in fiscal 2011 and a cumulative deficit of $60 billion over the next five years.

“It is not easy to cut $10 billion in one year, and that’s another reason why some borrowing has to be part of the scheme,” he said. “You can’t get to true structural balance — that is, having recurring expenditures and recurring revenues match each other — you can’t get that status immediately.”

Using the PIT credit to borrow right now is better than some of the ideas Ravitch has been pitched by investment banks, including a tobacco bond deal, he said.

“If you’re going to borrow, better borrow with your best credit to get the lowest interest rate rather than the cockamamie schemes the banks are proposing,” he said.

At least one idea in Ravitch’s plan — changing the start of the fiscal year to July 1 from April 1 —is unlikely to happen this year.

“It is impossible, mechanically, to go to a June 30 year this year,” he said. “What is important, since I don’t believe there will be a budget by April 1, is that everybody get down to business and figure out what to do.”

Sen. Carl Kruger, D-Brooklyn, chairman of the Senate Finance Committee, said that fully analyzing the political and fiscal implications of Ravitch’s proposal, let alone drafting legislation, “couldn’t happen in this budget cycle.”

Kruger was cool to the concept of a financial review board.

“I don’t know of any governmental body, any legislative body, that would gleefully accept an outside group usurping their authority,” he said.

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