Posted on Monday, January 24, 2011
AS the states dream up budget plans for a new year, some find themselves staring at deficits in the billions of dollars, vanishing federal stimulus funds, mounting health care costs, their own struggling cities and a canyon of underfunded pension liabilities ahead.
That — meshed with images from the European debt crisis — has led some to begin fretting about the possibility, however remote, that a state, unable to pay its bills, might tumble into default. Some policymakers have begun quietly discussing whether states should be allowed to seek bankruptcy protection, a legal status granted to qualifying taxation districts, towns, cities and counties but not to entire states.
Yet plenty of experts on municipal bonds and government finance — who view as alarmist the notion that a state may default on its obligations — note that it has been decades since any state actually defaulted on its bonds, or, in their view, even came close.
As it happens, the most recent such collapse occurred during the Great Depression, when Arkansas found itself, in the words of one state historian, “plain, flat broke.” There are familiar threads then and now, not least of all the overlay of a national financial slump.
But in many ways, the situation in Arkansas was a unique set of decisions and woes, piled one on top of the next, and a case study, some contend, in why this will not happen to states today. As that thinking goes, times now for states are undeniably grim, but not as grim as they once were in Arkansas. But should a state find itself near default, there is also a lesson in Arkansas, where the fallout lingered for decades.
In the 1920s, Arkansas made a push to build roads for the nation’s fast-expanding automobile industry, hoping to pull the state into the modern age. Local road districts took on the task, borrowing money and building what they could, but the result was more a financially troubled mishmash than a statewide network, so the state eventually stepped in, said Ben Johnson, a history professor at Southern Arkansas University in Magnolia.
The state borrowed more money to expand roads as well as taking on the debts of the local road districts — a move some now compare to states’ offers of financial assistance to sinking cities (like Harrisburg, Pa., or Hamtramck, Mich.) and the imagined possibility that a state would ultimately be toppled by bailing out a rush of failing or bankrupt municipalities.
In 1927, the Mississippi River system flooded, covering a third of Arkansas and destroying infrastructure (including some of those precious roads) and miles of cotton fields, a key product in the state.
And so, by the early 1930s, after the crash of the stock market and another natural disaster — this time, a cotton-withering drought — Arkansas was looking at a catastrophic ratio of debt payments, said C. Fred Williams, a historian at he University of Arkansas at Little Rock. The total debt had grown to more than $160 million (a lot at that time), and the state’s annual payments grew unsustainable. By some historians’ estimates, the state owed half its annual revenue to debt payments, and others say the payments were even higher.
At one point, the state’s treasurer reported that Arkansas’s general revenue fund showed a balance of $4.62, Dr. Johnson said, and by 1933, Arkansas could not make its bond payments. Analysts tick off many reasons that such a crisis would not happen now, or at least not in exactly the same way — with a default on bonds. For one thing, states’ payments on bonds generally amount now to only 4 percent or 5 percent of their total budgets, according to the Center on Budget and Policy Priorities. Still, states have other obligations that some view as vulnerable, including to pension systems.
In most states, some bonds are considered the first priority for payment, or a very high priority, even before ordinary services. Certainly, any serious talk of allowing states to seek bankruptcy protection under Chapter 9 — which municipalities can currently pursue — could create doubts in an anxious municipal bond market.
Perhaps the largest protection against a repeat of Arkansas 1933 is the simplest: states have straightforward — if not always politically palatable — ways to pay their obligations if problems arise. They can raise taxes or cut spending. Arkansas had those options too, but its costs had grown monstrous (for a while, the state had among the highest per capita debt in the nation), and the prospect of new taxes seemed impossible at a moment when per capita income was among the lowest in the country and the state’s revenues were rapidly shriveling. “The problem is,” said James E. Spiotto, a municipal bankruptcy expert at Chapman & Cutler, a law firm in Chicago, “if you don’t address the problems, then the problems sometimes get larger.”
For the record, Arkansas 2011 is not facing the level of economic misery of some other places. State officials are predicting a slight rise in revenue. Some leaders are talking of cutting the sales tax rate on groceries. And the state owes 2.6 percent of its spending — among the lowest in the country — to debt interest.
After 1933, Arkansas officials eventually restructured their debt, under pressure from unhappy bondholders who had filed suit. But the fallout would leave its mark for years.
Whatever political wind had rolled in with so much excitement (and borrowing) in the 1920s turned the other way. New leaders promised to retrench. They adopted rules that required more approval for any borrowing. One state leader even briefly entertained a plan to end the state’s support of education after eighth grade as one more way to save, Dr. Johnson said.
In the eyes of John A. Dominick, a professor of banking and finance at the University of Arkansas, a series of financial struggles — including the experience of 1933 — has created an unwritten tenet that still ripples through the state’s culture: Never spend more than you have.
For years, infrastructure updates were all but forgotten. Roads were left as they were. Another highway bond issue was not approved until 1949. And the state’s financial and psychic image to the nation, already tenuous, was further set back. “1933 was a good lesson, one of those things that’s hard to learn about debt until it happens to you,” Dr. Williams said. “But it also held back ambitions.”
By MONICA DAVEY, THE NEW YORK TIMES