18 January 2017

A bail out, a bail out ... #nlpoli

Conversation about the province's financial state in the past couple of weeks have turned to talk of bailouts and threats to the province's sovereignty.  A Carlton University economist  told CBC in early January that the provincial government would need a bailout to keep the province from collapsing under the weight of electricity rates once Muskrat Falls arrives. Energy analyst Tom Adams talked about Muskrat Falls with Pete Soucy and Paddy Daly.

The talk about bail-out is related, in one sense, to a refrain some people have been singing for a while now that somehow the provincial government is hard-done-by because it doesn't get Equalization despite having this huge financial mess.  People who say those sorts of things don't understand a thing about Equalization.

Let's take a quick look at the province's finances and the idea of a bail out.  In another post, we'll look at sovereignty.

The Problem

The provincial government's financial problem consists of two inter-connected parts.  One element is Muskrat Falls, which will cost something on the order of $15 billion.  The other element is the chronic overspending by government that will produce public debt of something between $15 and $20 billion if the government is able to balance the books by the early 2020s, as currently hoped.

Economist Ian Lee argues that the federal government will have to bail out Muskrat Falls.  He believes that doubling electricity rates to pay off the project will be too much for ratepayers to bear and will undermine the competitiveness of the provincial economy. He's right on both impacts. That's why the provincial government has been trying to come up with some way of paying for the project without having to double the rates, which was the plan when Danny Williams announced his pet project in 2010.

Most people who are familiar with Muskrat Falls know that much.  What they might not have thought about is the debt problem the government has.  There is the debt itself. That consumes more and more of the annual budget and sucks money out of important services like health and education.  The debt comes from the fact the government spends more than it takes in and the politicians won't do anything to change the situation.

If we keep going on the current path, the public debt - without Muskrat Falls - will be at least $15 billion within five to 10 years. We may see a temporary break if oil prices jump up again, but in all likelihood,  we will continue to add more and more and more debt as we spend beyond our means.

The circumstances of a bail out

The federal government bailed out four provinces during the Great Depression to avoid default on debt. The Government of Canada also participated in a joint bail-out with Britain for Newfoundland in 1932. One could consider that the Government of Canada also bailed out Newfoundland in 1949 when, as part of the Terms of Union, Canada assumed took on the entire Newfoundland debt of around $100 million in 1949. That could well count as the sixth bailout.

It's important to note that these bail-outs took place at a time of extreme financial crisis globally. For the four Canadian provinces,  the bailouts came in part because of a problem within the constitution. The 1867 compact had given the provinces the liability for delivering services, including relief to the unemployed but given the ability to raise the most revenue to the federal government.  In the aftermath of the Depression, the federal and provincial governments evolved a system of financial transfers to remedy the defect.

A federal bail out would not come, in other words, because citizens have to pay taxes they don't like or because electricity prices are higher than they might be or even because the provincial government has had to cut services.  If the past is any guide, a bailout would come because:

  1.  a province like Newfoundland and Labrador could not meet pay its debts, and 
  2. such a default would adversely affect other provinces and the federal government.

While Newfoundland and Labrador is not in that situation yet,  the government would have to be already in a crisis or on the verge of being in a crisis in order to trigger talk of a bailout. There are at least three specific situations that would create such a crisis or incipient crisis:

Default.  The provincial government could run up so much debt at the same time that it had insufficient cash that it could not afford to pay the interest on its debts when the payments came due or could not pay off bonds when they matured.  This is essentially what happened during the Depression.

No money available.   The government of Newfoundland and Labrador is current spending about $2.0 billion more than it collects in taxes and other revenue.  There are not a lot of lenders interested in giving Newfoundland and Labrador money in any event and it may happen that, as in 2015,  the pool of available money just dries up.  This might mean the government would miss a debt payment or it could equally not be able to make payroll for the tens of thousands of public servants in the province.

Bad credit. The provincial government already has the worst credit rating of any provincial government in Canada.  The bond rating agencies have already given the provincial government the triggers for further downgrades of the province's credit rating.  Any further changes in the rating would increase the cost of servicing future debt and would  further limit the pool of cash available to cover any future borrowing.

Any of those situations - individually or in combination  - would bring about the sort of financial crisis that would likely produce a federal bail out.  We are not talking about Equalization here.  That's one of the measures created after the Depression to ensure provincial governments don't get into financial trouble in the first place.

Bottom line:  a bail out is a ways off yet.  There's plenty of time to fix the government's financial problem and there are plenty of ways.  Folks who are focused on the federal government as the solution to the provincial government's problem just want to avoid making the responsible decisions we need to make in order to fix the problem we have.