September 15, 2014
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Why did EDC take risk with 38 Studios?
Ken Block

A moral hazard is defined as a lack of incentive to guard against risk where one is protected from its consequences.

The 38 Studios implosion is a prime example of a moral hazard. The state of Rhode Island played venture capitalist (badly) and committed $75 million of taxpayer money to the deal. 38 Studios failed to find private equity to finance their operation – even after Rhode Island jumped in with both feet. Other state governments like Massachusetts took a pass on the 38 Studios deal.

Any experienced investor with an aversion to risk would have passed on personally investing in the 38 Studios deal. I suspect that none of the sitting members of the board of the Economic Development Corporation (EDC) at the time the investment was made would have put any of their personal fortunes on the line for this deal.

A key question to ask is why did Rhode Island take the risk? Why did the board members of the EDC commit to the deal? While I am sure that political pressures factored into the mix, the best answer I can come up with is because the dollars put at risk did not belong to anyone making the decisions – hence the moral hazard.

As information trickles out, it appears that very little oversight was exerted by Rhode Island over 38 Studios. Also, Rhode Island took no equity stake in the business, something that any private investor would have insisted on for financing such a large percentage of the operation. Moral hazard is the best explanation for why this was possible. It appears that no one on the governmental side felt the imperative to protect the invested dollars.

It is too easy to be careless with other people's money – particularly when the money involved comes from a great many people in the form of taxes. Examples abound of government spending programs fraught with waste and fraud. One of my favorite examples is the Lifeline program, run by the Federal Communications Commission, which provides cell phones to qualified low-income Americans. On Lifeline's website, http://www.lifeline.gov/lifeline_Consumers.html, the first line of the page states that Lifeline's goal is to "eliminate waste, fraud, and abuse, saving up to $2 billion over 3 years."

Governments tend to have little incentive to proactively monitor for wasteful spending programs. Most monitoring tends to occur after a scandal has occurred and vast sums of money have been stolen or frittered away. This seepage of money away from its intended purpose weakens the program in question and unnecessarily raises the cost of government.

While governments can't fully manage money like an individual (not much chance of stuffing a billion dollars into a mattress), wouldn't it be nice if those spending our tax dollars at least tried to ensure that taxpayer dollars are being used for their intended purpose and that the financed programs achieve their stated goals?

At all levels of government in our country – and especially throughout Rhode Island – we need our elected leaders to do a better job of protecting the taxpayers' dollars. Moral hazard is at play whether the problem is an amazingly poor public investment, a spending program rife with waste and/or fraud, unsustainable pension and retirement benefits for public employees or a ballooning federal deficit that imperils the economic well-being of future generations.

It should not be left to investigative reporters, whistleblowers and other outside parties to effectively oversee public spending programs by calling out the waste and/or fraud. Any significant public expenditure initiative should be required to contain financing for a well thought out monitoring and oversight program.

Accountability in government starts at the top. Voters should insist on it.

Ken Block started the Moderate Party and was its candidate for governor in 2010.


Comments
1 comment on this item

Ken Block nails it! Nothing will improve in terms of R.I. local and state government until we elect officials who have enough common sense, let alone education, experience and a commitment to those who elected them, to pass the "moral hazard" test. Allowing a Studio 38 fiasco to take place when the economic situation of the State is in such jeopardy is a betrayal of the taxpaying public. We deserve better, from the Governor right down to the local town council and all the commissions, administrative boards and committees in between. However, taxpayers will only get what they demand. If you elect unqualified, special interest owned candidates, don't expect them to pass the "moral hazard" test.

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