When “Bankruptcy” is on the Table, It’s Not a Normal Election

If the financial situation in Newfoundland and Labrador is dire—and governments don’t have actual solutions—what is likely to happen?

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Recent musings by Ches Crosbie that he would put “bankruptcy on the table” for dealing with the fact the province is going “belly up” and Ottawa cannot afford to have a “failed province” all sound pretty ominous. Maybe these are issues that we should talk about in this election.

Despite the crass opportunism of the timing—and a campaign that is being conducted around boutique issues and shrill defences from a surprisingly thin-skinned government—this is not a normal election.

I’m sorry, it just isn’t.

Elections rarely involve much serious policy debate anymore (if they ever did). But in this situation, the parties are unquestionably asking for a mandate to tackle the province’s very serious economic and financial problems. Indeed, the premier’s desperation to downplay Moya Greene’s task force during the first week of the campaign only highlighted that people KNOW there are very hard choices coming. They would kind of like to get some sense of what the plan is. Please.

So, how did we get “here”? What exactly is “here”? And why aren’t we talking more about how we are going to get out of “here”?

A Province in Receivership: or, the Year of Three Crises

Debt Crunch

First, in March 2020, the province discovered it couldn’t borrow money.

With the global Covid crisis unfolding, a collapse in oil prices (and corresponding revenues), and the already nightmarish state of its public finances, Newfoundland and Labrador was ultimately rescued by the Bank of Canada’s decision to intervene in financial markets and buy provincial bonds themselves. This was a powerful signal to the financial industry that provincial bonds were safe, further hammering home the belief that the federal government implicitly guarantees provincial debt and thereby allowing provinces to borrow money at low interest rates. Newfoundland and Labrador was saved! Metaphorically, the lights stayed on and payroll was met.

Of course, this wasn’t the first time we had run into this problem—it’s recurring.

It’s important to understand that intervening to allow Newfoundland and Labrador to borrow more money is a double-edged sword. It gets us through a crisis like this, but it also means we accumulate more debt—and we are having trouble affording the debt we have now. We will run into this problem again.

Support from the Bank of Canada and federal government have become key to the province’s financial sustainability. This is what I mean by saying that the province is in “receivership.” There is no term to describe our situation and this is the best I have got. We get to continue acting like a province—we’re even having an election—but a lot of big decisions now require the intervention of our “creditors” in Ottawa, and it is the federal government that matters here. (“Masters in our own house” indeed!)

But what Ottawa wants is for us to just keep borrowing money and make the problem go away until it’s someone else’s problem. In the interim, a province with a shrinking population and workforce goes deeper in debt.

In the Fall budget, senior government officials actually insisted that there was no reason to be concerned about the province’s ability to borrow, with or without Bank of Canada assistance. (Several of these officials have since been replaced.) Nonetheless, the province’s finances were clearly a mess. Debt servicing costs for this year are projected to be over $1.5 billion, surprisingly similar to the $1.8 billion deficit, despite historically low interest rates. A lot of voices weighing in on this issue will tell you the “province is living beyond its means” by spending too much on health care or some such thing, but the thing that most differentiates Newfoundland and Labrador from the other provinces is debt and debt servicing costs.

The province’s gross public debt is approaching 100% of Gross Domestic Product—and it is gross public debt that matters when you’re in the position we are in. (You have to come up with the cash to service all of the debt; accrual-based accounting doesn’t make that problem go away.) That’s a very big number for a subnational jurisdiction—almost unprecedented. Sure, there are national governments around the world that owe more. But they control their monetary system, and as a province, we only collect half the tax revenue from our citizens—Ottawa gets its taxes as well. Differences in accounting aside, the province originally budgeted to borrow another $3 billion this year.

Moya Greene’s task force has been asked to come up with plans to generate surplus budgets in three years. How is that going to be done, and how is it going to be done while paying billions in debt servicing? Concerned citizens would like to know.

Muskrat Falls

The second crisis unfolded in December. Buried by the government in the holiday news lull, the province decided (or discovered; we don’t know which) that they could not come up with the $850 million needed to cover payments on Nalcor’s Muskrat Falls-related debt. Essentially what happened is that Nalcor couldn’t pay its bills (please do NOT think about those executive Christmas bonuses right now), the province did not step in to make the payments, and so the federal government—which probably really regrets giving a loan guarantee to Muskrat Falls bonds—agreed that they would cover the payments and start negotiating a deal to rework the finances of the project. This is a process where the province seems to hope that the federal government will make missed payments to creditors in exchange for an ownership stake in Muskrat Falls.

It’s unfortunate there aren’t more details for the public on this. This is a major about-face by government. The whole point of Muskrat Falls was to make investments that would produce revenue into the future for the citizens of the province—the way Churchill Falls has done for the people of Quebec. Selling part of the project basically smashes former premier Danny Williams’ “no more giveaways” mantra that was used to push this project forward.

Don’t get me wrong. Federal equity in the project is probably a good idea: it may be the only way that the province can get a bailout from Ottawa without the other provinces noticing that we are getting a sweetheart deal (see below). It’s probably necessary, given the province’s debt and borrowing problems. Essentially, Nalcor’s ballooning financial problems cannot simply be added to the province’s woes without serious implications.

To put it bluntly, in the last five years, the province has given Nalcor over $3 billion as equity investment. When Muskrat Falls was conceived, the province argued that the project would not impact the provincial budget—but that, like so much else about Nalcor, was wishful thinking, or a fib. The point is that instead of receiving dividends from Nalcor (how owning a Crown corporation with a monopoly on power generation is supposed to work), we have been borrowing billions to give to Nalcor, and those billions have contributed to the ballooning debt servicing costs that are producing the province’s financial crisis.

It would be good to know what the government’s plans are for Muskrat Falls and Nalcor—or at the least, someone should be asking some questions about it. Even the Independent Auditors review of the province’s Public Accounts for last year recently highlighted the problems insofar as the Government is STILL committed to “rate mitigation” and keeping power rates among the lowest in North America. Doing that ensures that Nalcor can’t pay its bills and that the province will have to cover those costs itself. This is a significant unfunded promise that will drastically worsen the province’s financial position.

How much of Nalcor’s assets are going to be sold to the federal government? How is rate mitigation going to be paid for? How will all of this impact the billions that Newfoundland and Labradorians have already borrowed to pay for Muskrat Falls? These are all questions we need to know more about.

Declining Oil and Gas Industry

The third crisis has been occurring in oil and gas. In the weeks leading up to the election the government rolled out its actual economic recovery plan for the sector in a flurry of controversial spending announcements. There is no space to go into the details here.

It’s no secret the sector is in crisis. It’s really unfortunate for people in the affected industries. There is a possibility that projects under construction will never enter production (projects the provincial government via Nalcor has invested in) and projects already in production might cease operations. The government’s response has basically been to funnel public money (most of it federal—see above—the province has no money of its own) into ludicrously expensive job creation/job maintaining (?) programs for a largely white collar work force.

Far more ominous—no one seems to care about wasting federal money—is that the province has “agreed” to the idea of reducing royalty rates. In public. Which is a pretty weird way to negotiate with industry. We can now probably safely assume what their demands are going to be.

Anyways, yes. You are reading that right. The province is having trouble paying its own debts, it has no clear plan to pay Nalcor’s debts, and it plans to return to surplus budgets in three years—but it has millions for oil and gas. These are the type of decisions that have put us in the mess we are in.

We should know more about how the government plans to pay for these things.

Structural Adjustment in the Canadian Federation

So, if the situation is dire, and governments don’t have actual solutions, what is likely to happen?

There is no system in place for dealing with a provincial “bankruptcy” in Canada. Internationally, a state that can no longer manage its debt payments can seek financial assistance from the International Monetary Fund and its creditors. Normally that state has to accept conditions in exchange for debt relief—a structural adjustment program which places conditions on the debtor. These are the usual austerity-type measures: cuts in health care spending, the sale of publicly owned assets to private investors, and the like. This is all pretty normal stuff in international political economy, and pretty horrible for those who go through it. But there is no system in place within Canada to deal with this type of situation.

Not since the 1930s has a province defaulted on its loans. (Fun fact: it was Alberta in an early bout of the “let those eastern ____ freeze in the dark” spirit.) Canadian provinces now operate in a weird space where the federal government’s implicit guarantee of provincial finances (see above) allows them to continue borrowing despite serious questions about their financial health, without strings attached. And there is no formal system of imposing conditions if, say, a province accumulates too much debt or were to default. The feds could pay back the province’s creditors—and it’s likely they would, as Canada’s financial industry is pretty cozy with the federal government and there would be many risks if they didn’t.

But it’s not clear what the consequences would be for a province.

Politically, it’s hard to imagine federal politicians, who also want to win seats in the province, imposing an IMF-style structural adjustment program. Seamus O’Regan presumably prefers cutting ribbons on new hospitals and such things in the province, not closing them down. Also, the constitution requires the federal government to act to ensure similar levels of public services across provinces. The creditors in Ottawa also work for Newfoundland and Labrador; weird but true.

At the same time, bailing a province out is problematic because there are other provinces—many of them in financial distress as well. The 1990s Chrétien-era offloading of more responsibility to provinces to pay for things like health care has devastated provincial finances across the country. Canadian subnational debt is disproportionately large in general— Newfoundland and Labrador just happens to be the worst. A table on Gross Subnational Debt from Dr. Kyle Hanniman’s excellent research on this topic is instructive:

Gross subnational debt to revenue and GDP, 2019 (percentage). Source: S&P. Debt refers to entire subnational sector. (Hanniman, 2020.)

Unless the federal government wants to fix this structural problem—which seems unlikely—they certainly don’t want to start a process where giving special treatment to one province might result in demands from others. They have incentives to avoid a systematic response, such as some sort of formal debt relief for a province.

As a result, Canadian federalism has lurched into a place where federal governments have strong incentives to a) help a province continue borrowing, and b) avoid providing provinces with debt relief in a way that will be seen as debt relief. This situation is likely to be managed in a secretive way where the trade-offs being discussed between the provincial and federal governments are never made clear.

The lack of transparency, in turn, generates problems for managing the crisis. Everything we know about these situations suggests transparency and a broad sense of burden-sharing (“we are all going to share in the pain” etc.) are key to adjustment. It’s hard to generate that kind of public sense when the government is deliberately obscuring the situation and throwing money at the oil and gas industry.

The only example of a provincial debt crisis we have is from Saskatchewan. In the 1990s, the Romonov government was given a small, stealthy, unconditional bailout from the federal government as it went through a severe financial crisis. The national government provided some money, and the provincial government used that as a bridge while it unrolled a draconian austerity budget (involving across-the-board tax hikes and public sector cuts). The government sold that budget as being required by creditors, and under the circumstances they were clear and consistent in what they were doing. The austerity budget combined with rapid economic growth—Saskatchewan wasn’t in nearly the distress Newfoundland and Labrador is in now—saw the province come out of crisis without further assistance.

It was an approach in which everyone “won.” The federal government and political elites got to pretend that they hadn’t bailed out a province. The interests of Saskatchewan’s politically well-connected creditors were protected—Saskatchewan’s citizens paid their debts. And conservative voices in Saskatchewan that wanted cutbacks, hospital closures, and austerity got what they wanted.

Well, OK… so not everyone “won.” But the people that matter in Canadian public policy won, and that’s the important part.

What is to be Done?

As I’ve said, our province is in a kind of receivership. Provincial and federal officials are trying to figure out ways to keep provincial funding going without creating the appearance of large scale debt relief.

That was the basis of the changes to the Atlantic Accord in 2019 and the basis of the current deal over Muskrat Falls payments. What these arrangements mean for the province and what conditions might come with them need to be discussed.

Selling assets to the federal Government is not a nothing burger. Bringing down a budget for next year without a clearer plan is going to be a problem, and shoveling public money to executives at Husky is only going to make the problem worse.

The province has been racked by crises over the last 12 months—it is by no means an easy situation in which to govern. But this is not a normal election. Whoever wants to form a government to tackle the province’s problems should give us some basic idea of how they intend to do it.

Otherwise, we stay in receivership, beating a steady path to the prime minster’s office to see if he wants to buy even more of our megadam—and praying that interest rates never go up.

Photo by Jp Valery on Unsplash.

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