Games and Liberty Part III: 38 Studios and State Spending

Photo credit: Conjurer8341

“The state is the great fiction through which everyone endeavours to live at the expense of everyone else.”
— Frédéric Bastiat, from “The State” in Journal des débats

Two of our most essential liberties are the right to our life, and our property. When a portion of what a citizen earns and produces in his life — his livelihood — is taken by government without consent, a portion of his life and property has been apprehended. No matter the portion, if part of his earnings — what he spends a majority of his life producing; his livelihood — are seized, part of him is not free. If a part of a citizen is not free, then none of him is free. He is a slave to the state.

Another immorality of taxation is it allows one citizen to obtain the money of another citizen, without his consent. If I believe a certain cause or project is worthy of funding, and would like you to contribute, the burden is on me to convince you. I must present my case logically, and passionately, but if you still refuse, then I have to accept that and move on. You have the right to choose what you spend on, and I do not have the right to take your money, no matter how “right” I am or how moral I believe my cause is.

No matter what my cause is, no matter how “good” or moral it is, no one would condone my actions if, say, after you refuse my petition for funding, I take out a gun, threaten you, and then forcibly take your money. Yet we condone the government forcibly taking our money all the time.

And today, if someone wants money from their neighbor, the most effective course of action is not to petition the neighbor, but the government. If I can get a law passed that says the government will spend X amount of dollars on me or my issue, then your money will be taken in the form of taxes and transferred to me, my group, and my cause regardless of your dissent. All I need is a majority vote in order to plunder the minority and that pitfall of democracy goes against the idea of liberty.

But instead of criticizing this notion in general, all around the world certain spending is criticized politically. Taxes eventually hurt everyone, but not equally. Certain groups only criticize certain spending because they have an agenda. Namely, to use to the government to spend in their favor. Instead, we should start with the understanding that taxation is almost always bad, and scrutinize all spending. In order to avoid taxation whenever possible, a government must be kept small, spending kept minor, and superfluous spending must be eliminated.

A government doesn’t have an automatic right to what you earn, or own. Neither does your neighbor. And the latter certainly doesn’t have the right to use the former to plunder you. That’s the premise we must start from.

But just like the lesson we learned about government regulation on gaming, even if for the sake of argument we allow government involvement, they tend to not know what they’re doing. In our example today we’ll see that a state governor bought into “experts” telling him a popular game “flopped”. The reason that kind of misunderstanding occurs is because government is often ignorant of the things it tries to meddle in.

Even if we excuse the immorality of what governments attempt (which we shouldn’t), their good intentions are too often hampered by ineptitude.

Over the next two weeks, I’ll examine how government spending can affect the video game industry, and through taxes, how it affects everyone, including gamers.

Today, I’ll touch on one topic of poor government spending. Next week: I’ll discuss a counter-intuitive matter of taxation, and finally a free-market alternative to government spending in gaming.

Kingdoms of Amalur and the finances of Rhode Island

In 2010 the Rhode Island Economic Development Corporation (a government agency that uses the “quasi-public agency” title for itself) granted a loan guarantee for $75 million in bonds to 38 Studios, founded by former Boston Redsox pitcher Curt Schilling. The studio was preparing to release Kingdoms of Amalur: Reckoning, an RPG originally started at Big Huge Games (acquired by 38 Studios in ‘09) with involvement from Ken Rolston, R.A. Salvatore, and Todd McFarlane.

Kingdoms of Amalur released in early 2012 to mostly positive reviews, and reportedly sold over 1.2 million copies in its first three months. But shortly after, on May 1st, 2012, 38 Studios failed to pay an “Annual Guaranty Fee” to the EDC in the amount of $1.125 million. Failing to pay that amount meant that 38 Studios had technically defaulted on the loan.

That fee was separate from the scheduled payments to the bondholders that were to take place twice a year. Reportedly, 38 Studios had taken $49.8 in cash from the $75 million in bonds, and put $23.4 million into a Capital Reserve Fund and a Capitalized Interest Account, essentially in reserve to make the payments to investors who bought the bonds until revenue from game sales started to come in, at which point the money from said sales would pay the bondholder payments.

While trying to use remaining funds from the loan to develop their MMO, Project Copernicus, things deteriorated quickly for 38 Studios. They ran out of money. They couldn’t pay their staff, failed to pay the EDC, and eventually laid off all 379 of their employees.

Schilling started his game company, originally called Green Monster Games, in September 2006. And between 2006 and July 2010 (when the EDC approved the backing of the $75 million loan), the company steadily grew in staff, but struggled to make progress on Project Copernicus. Then in less than two years 38 Studios spiked, spiraled, crashed, and burned. It left unemployment and debt in its wake.

The mismanagement of 38 Studios has been well chronicled. Schilling spent money liberally, interfered with hired managers, had unrealistic expectations of the game’s development timetable, and when faced with his own business and industry inexperience, ignored his hired executives.

38 Studios had difficulties stemming from Schilling’s relentless optimism well before their 2010 state-backed loan, but the relocation to Providence, Rhode Island (a stipulation of the deal with the state) and hiring spree that followed (in order to meet state requirements for the loan) served to further carry the illusion that everything was fine when it wasn’t.

38 Studios was running out of money, and hampered by poor management, before the loan. I don’t believe a sudden influx of funds alone can cause bad decisions, but it can facilitate actions that otherwise may have gestated longer, and more appropriately, in the absence of said influx of funds.

For six years, since founding the studio in 2006, Schilling and his executives tried to secure private financing. A combination of Schilling’s unwillingness to sacrifice equity in the company in exchange for funding, and the overly apparent air of hubris around the inexperienced company drove off funding for years. Schilling continued to pour in personal funds, and rarely cut back spending.

Todd Dagres, of Boston-based venture capital firm Spark Capital, speaking to Jason Schwartz of Boston magazine, said how nervous he was about Schilling having so much control, how overconfident he was, and how little MMO experience was around developing Project Copernicus.

Despite the usual confident posturing from Schilling, Dagres and Spark Capital, like many other VC firms, passed on investing in 38 Studios.

Even though it was clear the private sector had reservations about investing in 38 Studios, the government predictably assumed it knew better. A government guaranteed loan manipulates the market, creates confidence where none has been earned, expecting taxpayers to hold the bag if the debtor defaults, even though taxpayers don’t get to make the call about what investments to make.

With interest, the total of taxpayer responsibility for repayment of the bonds came to a projected $112.6 million, minus the $23.4 million that was kept by 38 Studios to make payments, and the residents of Rhode Island will be responsible for approximately $89.2 million.

Former Rhode Island Governor Donald Carcieri, EDC executive director Keith Stokes (who resigned after 38 Studios defaulted), and Rhode Island House Speaker Gordon Fox, who all pushed for the creation of the loan program and the loan to 38 Studios, would all argue that the investment was meant to create jobs. It created a brief spike of jobs, but netted a loss, as the employees who started with 38 Studios before the investment also lost their jobs, many of them after relocating.

Whatever their struggles, 38 Studios was creating jobs in Massachusetts before getting money from Rhode Island. The interference from Rhode Island’s EDC took potential jobs from people in Massachusetts, failed to prevent those already employed with 38 Studios from losing their jobs, and may have even expedited the downfall of a company already enamored with the notion of spending more money that it should have.

38 Studios didn’t need more money, it needed more sense.

Curt Schilling said of the politicians who pushed for and approved the loan for his company, that they had “pure motives”. But motives should not decide what is a good investment or not. Creditworthiness of the debtor and the creditor’s supply of capital, among other things, should decide the viability of a loan. It’s yet another example of government interfering in things best understood and practiced by free people in free markets.

Schilling claims that Rhode Island politicians were “working for the better of the people, of their constituents,” which is not true, because if it was they would have left taxpayer dollars out of backing a loan for 38 Studios, left those dollars in the hands of the people, and let private citizens and companies decide whether 38 Studios should have a loan or not, separate from government backing. WPRI 12 in Rhode Island conducted a poll that showed 54 percent of Rhode Island voters disapproved of the loan.

Schilling has been a vocal supporter of Republican candidates for office (supporting George W. Bush in 2004, and John McCain in 2008), and is a self described Republican. And yet like most of the neo-conservatives that occupy the Republican party in America, he misunderstands the basic principles of conservatism and small government.

Schilling added, while being interviewed by Sean Hannity of Fox News, that, “I’m not looking, never have been, for handouts.”

Whether Schilling was looking for a handout or not, he gladly accepted one.

John Robitaille, an aide for the former Governor Carcieri, said of the loan to 38 Studios that it was necessary because Rhode Island is “an unfriendly environment for business.” Yes, it is, and it will remain so as long as government tampers with private industry.

I’d like to point out some great work linked to in this piece by WPRI’s Ted Nesi and Boston magazine’s Jason Schwartz. Nesi’s reporting on the on the 38 Studios collapse was stellar. I had a solid understanding of the situation going in, but Ted’s reporting on things like the EDC “quasi-public agency” title and also on the “annual guaranty fee” gave me further insight I didn’t expect to have. Schwartz’s chronicling of the mismanagement by Schilling was riveting, and worth reading just for the clarity painted and details revealed.


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One response to “Games and Liberty Part III: 38 Studios and State Spending”

  1. […] couple of weeks ago, we looked at the demise of 38 Studios. The video game developer failed after receiving $75 million in bond loans backed by the state of […]

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