Not paying the moral obligation debt related to defunct video-game company 38 Studios could be more costly to Rhode Island in the long run, a municipal bond expert said Thursday night.

"Once you default, the state's credit rating might be lowered and you might have a more difficult time accessing the markets," Municipal Market Advisors managing director Matt Fabian told the House Finance Committee in Providence.

Debate simmers within the Ocean State about whether Rhode Island should honor the debt its Economic Development Corp. guaranteed for the failed 38 Studios, which collapsed in 2012.

In addition to risking more costly borrowing, Fabian said, the state's reputation could suffer for decades. "The state would be seen as having gotten away with something. People don't forget this," he said, citing Arkansas defaulting on bonds during the Great Depression.

Fabian also said Indiana paying off several moral obligation bonds in the late 1990s — including some for failed ventures — has helped it maintain its triple-A rating.

Moody's Investors Service rates Rhode Island's general obligation bonds Aa2, while Fitch Ratings and Standard & Poor's rate them AA.

Lawmakers are considering whether to pay debt related to a $75 million loan guarantee the Rhode Island Economic Development Corp. provided 38 Studios in 2010, backed by the state's moral obligation. Interest has pushed the tab beyond $100 million.

The company, owned by former Boston Red Sox pitcher Curt Schilling, moved from Maynard, Mass., to downtown Providence after receiving state incentives, but filed for Chapter 7 liquidation last year.

Fabian's Concord, Mass., firm lists Assured Guaranty Municipal Corp. — the bond insurer in the 38 Studios deal — as a client, prompting some legislators to question Fabian's neutrality, but Fabian said MMA has built a reputation for independence as a data and research provider. MMA's work, he added, has included advocacy for state and local issuers.

"I know there are people angry about this, but there is no interest here to protect bondholders in any way," said committee chairman Helio Melo, D-East Providence. "We're here to protect Rhode Island and we want to lay out some options."

Two bills are pending the legislature that would prohibit Rhode Island from paying the debt. Gov. Lincoln Chafee and other top state officials favor paying it, saying not to would risk backlash from the capital markets.

"It's a moral obligation debt, so we have a moral obligation to pay it," Chafee said Thursday. "I've been consistent. We should pay it."

Chafee's budget proposes an initial $2.5 million payment, followed by $12.5 million for seven years thereafter.

But former state Treasurer Frank Caprio and Moderate Party gubernatorial candidate Ken Block have spoken out in favor of defaulting. Others say they now are unsure, or recommend waiting to see if the state can recoup at least some of the money. The EDC has sued Schilling in Rhode Island Superior Court.

"When all this came out, I thought we should pay, but now half of me says we shouldn't," Rep. Doreen Costa, R-North Kingstown. "Our focus should be a full-blown investigation of why this happened. There's so much of this we don't know."

Bob Cusack, a portfolio manager at WhaleRock Point Partners LLC in Providence, said Rhode Island should carefully weigh the benefits and consequences of not paying. Benefits, he said, could include positive reaction from investors.

"Business people are attracted to jurisdictions where fiscal discipline is practiced. But is a default on a moral obligation an example of fiscal discipline? 38 Studios is an example of reckless public finance — venture capital equity investing masquerading as cash flowing debt," Cusack said earlier in the day during a discussion at the State House co-hosted by the libertarian-leaning Stephen Hopkins Center for Civil Rights and the left-leaning Occupy Providence.

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