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March 26, 2018

KENTUCKY WIRED -- GET OUT, AND GET OUT NOW

OP-ED 

KentuckyWired I WayKentuckyWired I Way

By George Ford

There are few ideas worse than governments getting into the Internet business.  Doing so is a certain path to financial disaster, as cities like Burlington-Vermont, Provo-Utah, Bristol-Virginia, Monticello-Minnesota, among many others, have learned the hard way.  The State of Kentucky now appears next to be added to an already long list of spectacular financial failures with its ill-conceived “Kentucky Wired” program.

Kentucky Wired was conceived by former Governor Steve Beshear in 2015.  Like other government-owned gambles into the Internet business, the state proposed to build and operate a state-wide all fiber-optic network to spur economic development.  Construction of the network is woefully behind and the revenues from the project are insufficient to cover the payments on about $286 million in revenue bonds.

Unlike the General Obligation bonds of the state, revenue bonds are not secured by tax revenue.  Instead, they are secured by the revenues and assets of the specific project to which they are assigned.  Revenue bonds are more prone to default.  Investors know these revenue bonds are riskier than the general obligation bonds and thus require higher interest rates to compensate for the higher risk.

Yet, with default looming, there are growing calls for a taxpayer bailout.  To its credit, rather than shift the burden of this debt to the state’s General Fund, the Senate has decided enough is enough and is refusing to pump more money into the failed venture.  Still, current Governor Matt Bevin worries that a default on the revenue bonds might spillover to the state’s bond rating on its General Obligation bonds, which are secured by the tax revenues of the state.  The state should allow the revenue bonds to default—and do so now, not later.

To illustrate the point, we need look no farther than the failed Internet endeavor in Monticello-Minnesota.  As in Kentucky, investors in the Minnesota government network knew that the telecommunications debt would be paid (or not) from the revenues of the telecommunications system, not the General Fund.  Unwisely, the city of Monticello supported the failing telecommunications system with payments from its General Fund, which put stress on the city’s finances.  As a result, Moody’s downgraded the city’s general obligation debt from a rating of Aa3 two spots to A2 (still a “Prime” rating), seemingly in support of Governor Bevins’ concerns.

However, Moody’s was clear that the downgrade was the consequence of the city’s General Fund support of the failing telecommunications network.  Moody’s stated plainly, “The city did not pledge its general obligation or annual appropriation backing to secure the debt, nor did the city pledge any other of its general revenues to support the debt.  However, the city elected to provide financial support to the utility, which has diminished the city’s financial position to some degree.”  Thus, the downgrade was a result of the financial stress of unnecessarily supporting the failing Internet venture.

The guidance seems clear enough.  In contrast to the Governor’s fears, any spillover to the state’s credit rating from a default on Kentucky Wired’s revenue bonds hinges on state support of the failed system from its General Fund, not a lack of it.  Governor Bevin should make clear that the Kentucky Wired’s debt is on Kentucky Wired, not the state.  Kentucky should get out—and get out now.

Of course, the bigger lesson is that governments should stay out of the Internet business altogether.

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Dr. George S. Ford is the Chief Economist of the Phoenix Center for Advanced Legal & Economic Public Policy Studies (www.phoenix-center.org), a non-profit 501(c)(3) research organization that studies broad public-policy issues related to governance, social and economic conditions, with a particular emphasis on the law and economics of the digital age.  He is a nationally-recognized expert in municipal Internet networks.

 

Comments  

0 #1 KYBondGal 2018-03-27 12:44
This rationale and comparison to Monticello, Minnesota is flawed. The bond offering for the KY Wired bonds clearly states that the debt is appropriation supported and to be supported by the General Assembly should project revenues and the primary source of security (the availability payments) fall short. The security offering is most similar to Kentucky's flagship issuer, the State Property and Buildings Commission, in that it is a "special and limited" obligation of the Commonwealth. So far the legislature has provided for the availability payments through debt service lapse in HB 303 from the 2016 budget session, so if your rationale is that they shouldn't pay with funds not pledged in the offering (which isn't accurate), you should note they already have. Fitch has clearly communicated that ratings will suffer should the KYWired bonds default.
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