Earlier this month, Rhode Island’s state treasurer made an interesting “suggestion” to that state’s legislature. Seth Magaziner urged the legislature to cap the amount of money the City of Providence can borrow at one time. He also wants to cap interest rates on bond debt. Magaziner suggests that the legislature forbid the city from making interest payments that exceed 4.5%.
Magaziner’s “suggestion” stems from a request by the City of Providence to borrow $515M to make the city’s pension fund whole. That staggering amount reflects the pension deficit Providence has accumulated over the years. The City of Providence and the State of Rhode Island maintain separate pension funds for their employees and retirees. The City offers more generous pension benefits, but also instituted a cost-of-living-allowance (COLA) freeze ten years ago.
Magaziner’s rationale for capping interest rates at 4.5% is that the rate increases the likelihood that the city’s investments will outearn the interest rate on the debt. Looked at another way, it could limit the damage a 4.5% interest loan could do to the city’s budget if the investment income tanks. (The legislature currently self-imposes a 5% cap on borrowing by the State.)
Limiting the amount the city can borrow may also have some benefits. Magaziner suggests that borrowing such a large sum at one time could subject the city to an unfavorable interest rate on a large sum of money. Restricting the amount of any particular bond issue could allow the city to take advantage of favorable changes in interest rates while still achieving its ultimate goal of re-funding the pension system. Currently, he suggests capping the amount of any bond issue at $150M in any six-month period. Additionally, Magaziner suggests limiting the bond issue to no more than 25 years.
A policy to cap interest rates would prevent expensive loans
Recently, a California municipality acquired a pension obligation bond at 4.2% interest. Currently, the cap is reasonable, but it could leave open the possibility of not being able to issue bonds. During a bond issue, if no one is willing to issue bonds at or below that interest rate, it would not be possible to borrow at that time. However, if the interest rate is that high, forgoing a bond issue might be in order.
It would be nice if the WCC Trustees adopted a policy to cap interest rates payable on bond issues. (Especially if they intend to borrow against WCC’s general fund ad nauseam.) When interest rates exceed the cap, the College administration cannot borrow funds for any purpose. While it sounds inflexible, it also sounds fiscally responsible.
Photo Credit: Chris Butterworth, via Flickr