Long before Puerto Rico's debt crisis – and probably before the living memory of any Bond Buyer reader –Arkansas ran into a similar emergency in the 1930s. Like Puerto Rico, Arkansas faced bond debt disproportionate to its size, a worldwide economic downturn that crimped revenues, and resistance in the courts to its debt restructuring efforts.
Arkansas defaulted on its bonds from 1932 to 1935 and took more than a decade to definitively resolve its problems.
This three-part series examines Arkansas' road to default, details the state's efforts to resolve the crisis, and explores the similarities and differences with Puerto Rico today. Part two: "How Arkansas Solved Its 1930s Debt Crisis." Part three: "Is Puerto Rico on a Similar Path to 1930s Arkansas?"
Part I: Arkansas' Road to Default
Arkansas' 1874 constitution specified that county governments rather than the state government would have primary responsibility for road construction and maintenance. However, the constitution also barred counties from borrowing for this work.
With the growing popularity of bicycles and automobiles in the early 20th century, Arkansas residents became increasingly concerned about the state's roads' poor conditions. In 1907 Arkansas government passed a law allowing the formation of local road improvement districts that could borrow to pay for road construction and maintenance. The districts sold significant-sized bonds but didn't always efficiently use the funds. "If roads in the different districts connected, it was largely accidental," B.U. Ratchford wrote in his book "American State Debts," published in 1941.
A state highway commission created in 1913 by the legislature had little authority and funding. But in 1923 the state passed the Harrelson road law authorizing increased taxes for roads and a state highway system.
The state government's road debt leaped higher in 1927 when, in act 11, it committed to paying off the local improvement districts' debts, though without formally assuming the bonds. The act also authorized a new bond for more road construction. Lieutenant Gov. Harvey Parnell had an important role in the passage of this act. "Crisscrossing the state with a modern highway system fit squarely into Parnell's avowed mission to change the image of a benighted Arkansas," according to "The Governors of Arkansas," a 1981 book edited by Timothy Donovan, Willard Gatewood Jr., and Jeannie Wayne.
In 1927 the legislature also approved a substantial bond to fund Confederate pensions and benefits for their dependents.
Adding to the financial burden, the flood of 1927 washed out 511 bridges and damaged many highways, according to Lee Reaves, "Highway Bond Refunding in Arkansas," Arkansas Historical Quarterly, December 1943. Replacing and repairing the damage increased the state's debt.
In March 1928 Gov. John Martineau resigned to become a federal judge, leading Parnell to become the governor. That year Gov. Parnell authorized a substantial amount of new bonds for road and bridge construction.
That year the legislature authorized further highway and bridge bonds, envisioning the state's debt would reach about $177 million, according to Ratchford. As things turned out, state debt in the 1930s would peak around $168 million. By 1929 Arkansas ranked 46th out of 48 states in per capita wealth but was first in per capita indebtedness, according to Reaves.
Then the Depression hit. By 1932 only 62.7% of the state's labor force was employed, according to "The Governors of Arkansas".
However, the seriousness of Arkansas' debt problem wasn't immediately apparent or important to voters. In August 1930 they voted for Parnell for the governorship in the Democratic primary over a challenger who had said further highway bonds would bankrupt the state. "Arkansans did not seem concerned about bonded indebtedness; they were interested in roads and gave Parnell a decided majority over [his opponent] in the primary," according to "The Governors of Arkansas."
In 1931 state government authorized an additional $14 million in indebtedness, according to Ratchford. Instead of $14 million, it ended up incurring $10 million more before its credit collapsed. While these sums may seem small to the modern reader, the state's total debt was $120.5 million in June 30, 1930. Also, its domestic product was much smaller than it is today, both on an absolute basis and because each dollar had much more purchasing power.
As the Depression started to hit Arkansas, state government revenues sank. They fell from $22.5 million in 1929-1930 to $20.4 million in 1930-1931 to $17.5 million in 1931-1932, according to Ratchford.
Most of the state's debt depended on highway fund revenues, which declined from a peak of $10.9 million in 1930 to just $7.4 million in 1932, as the gasoline tax and auto license tax revenues feeding the fund shrank.
Debt service due on highway bonds, local district bonds, and toll bridge bonds in 1932 was $8.5 million. The state had a problem that it soon resolved through nonpayment.
Starting in August 1932 Arkansas stopped paying certain district bonds, according to Ratchford.
"In an effort to relieve the strain caused by the heavy maturities of the district bonds, the legislature in 1932 authorized the refunding of the district bonds into revenue bonds," Ratchford wrote. The revenue bonds would have maturity dates 10 years after the district bonds for which they were exchanged. The new bonds would generally carry slightly less interest but would have a slightly better lien on highway revenues.
"The old bonds were not to be canceled," Ratchford wrote, "but were to be held as collateral for the revenue bonds and, in case of default on the latter, might be reclaimed."
As of February 1933 only $15 million out of $47 million of the district bonds had been exchanged.
Soon the state was in default on all its highway debt. On March 1, 1933, Arkansas defaulted on state debt proper by not paying $770,500 in interest on highway bonds. The state made no further interest payments until 1935.
The default on the highway, bridge, and road district bonds was significant because it accounted for 90.3% of the state's debt. In addition to the default, the legislature in 1933 rubbed salt into the bondholders' wounds by using the highway fund to increase the pay of the highway commission chairman and violating pledges to the holders of highway bonds. The violations were reducing the license tax on cars and light trucks by 50%, putting $1 million in highway maintenance ahead of paying highway bonds, and allowing the counties to retain a one cent gasoline tax that was supposed to go the bondholders.