La Fortaleza, the governor's mansion in San Juan.

Third of a three-part series.
Part one: Arkansas' 1930s Default Foreshadowed Puerto Rico
Part two: How Arkansas Solved Its 1930s Debt Crisis

The parallels between Puerto Rico's debt crisis so far and Arkansas' Depression-era experience suggest the island territory faces a long and bumpy road to recovery.

Both governments rapidly increased their debt levels. In Arkansas' case, its local improvement districts first quickly incurred debt in the teens and '20s. In 1927 the state government promised to pay for this debt and continued to borrow heavily.

In Puerto Rico, total public sector debt rapidly increased from around 2001 to about 2014. According to an official statement for a 2006 bond sale, Puerto Rico's total public sector debt was $39.5 billion. This would grow to about $73 billion in mid-2014. The commonwealth government proper had net tax supported debt of about $50 billion.

In 1928 the legislature projected Arkansas's debt would reach about $177 million in the following year or so. This would have been about 34% of per capita income in 1928. As things turned out, state debt in the 1930s would peak around $168 million. In the 1930s per capita income declined substantially and in the Depression the state's ratio of per capita debt to per capita income was certainly higher than 34%.

By comparison Puerto Rico's per capita debt, excluding the debt of its public corporations and municipalities, in 2014 was about 55% of its per capita income. Residents of both Arkansas and Puerto Rico were poor relative to the citizenry of the rest of the nation as the crises hit.

Sharp economic downturns hit both governments hard. In the U.S. the Depression cut the real gross domestic product by 30%. Arkansas was a comparatively poor state and fully felt the downturn. In fact the state's economy began to decline in the early 1920's due to a fall of commodity prices according to Ben Johnson, interim provost at Southern Arkansas University.

By comparison, Puerto Rico's economic activity index is down about 19% from its peak in mid-2005.

In both cases efforts to restructure debt were met with a lack of cooperation from the courts. In Arkansas the federal court sided with bondholders in their suit against the state's Ellis Refunding Act. In Puerto Rico, courts have sided so far with bondholders in their suit against Puerto Rico's Debt Enforcement and Accountability act, which Puerto Rico had passed to provide a bankruptcy mechanism for its public corporations.

Puerto Rico has also been similar to Arkansas in so far as it is exploring defaulting on its bonds through exchanging bonds. Sometimes Arkansas' exchange failed (Ellis Refunding) and sometimes it succeeded (Act. No. 11 of 1934). It remains to be seen how Puerto Rico will do with the technique.

However, there are some important differences between the two governments.

In Puerto Rico the territory's own constitution provides a first lien on revenues for its own debt (as opposed to the debt of the public corporations and municipalities). The Puerto Rico constitution also provides a means for debt holders to seek redress if the debt is defaulted on. These things were absent in Arkansas in the 1930s.

Arkansas' state government debt problem became much worse when it decided to pay off the debt of the local road improvement districts. In past years Puerto Rico's government had financially supported some of its public corporations. But recently it has been trying to get its public corporations to pay off their debts without the central government financial support.

Arkansas' economic problems were part of a worldwide economic downturn. Puerto Rico's downturn was part of the Great Recession. However, whereas the U.S. economy has been growing since the second half of 2009, Puerto Rico's economy has generally been declining since mid-2005, with the exception of 2012.

Also, Arkansas' debt was focused overwhelmingly on financing road and bridge construction. Puerto Rico's debt has been used and sometimes misused for a wide variety of purposes.

Because of its triple tax exemption, Puerto Rico's debt is held widely throughout the United States. Arkansas' debt was probably primarily owned by Arkansans and Arkansas banks.

Finally, Puerto Rico's outstanding debt generally has higher interest rates than that of Arkansas. However, Puerto Rico has benefited by inflation, albeit at low levels. From 1929 to 1933 the average price level in the United States fell by 24%. Arkansas was supposed to pay back its debt with more valuable dollars while Puerto Rico will be able to pay it back with less valuable ones.

Municipal Market Analytics partner Matt Fabian said the differences outweigh the similarities. "Puerto Rico isn't a state and has been transparently headed for default for years," he said. "When Arkansas defaulted, it was on the heels of thousands of cities and special districts defaulting [in the Depression]."

Chapman Strategic Advisors managing director James Spiotto said both cases involve governments struggling with large upcoming debt service payments. In the case of Arkansas, it was facing large payments due in the 1940s, which led to the RFC refunding of 1943.

That refunding helped lower the Arkansas government's interest costs. With various proposals for Federal help just starting to move through U.S. Congress, Spiotto said it remains to be seen if Puerto Rico's solution will also depend on U.S. backing.

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