Legislature mulls big bet for big debt

Posted: Friday, April 04, 2008

Is it possible to borrow your way out of debt?

While that sounds like a pitch made on late-night infomercials, some of the top finance experts in the Alaska Legislature think it's not as crazy as it sounds.

The process is called arbitrage, borrowing money at a low cost and investing it where it makes more money. The difference can be worth hundreds of millions of dollars a year.

"From an arbitrage standpoint, there's a tremendous opportunity," said Brian Andrews, deputy commissioner of the Department of Revenue.

The state is now set to bet as much as $5 billion that Andrews is right.

Andrews has been on a multi-year mission to get Alaska to issue what are known as pension obligation bonds, to help pay for its growing retirement obligations.

The Department of Revenue thinks that process can help pay for an estimated $8.6 billion in pension program unfunded liability. That's the difference between how much the state expects to have available over the next 20 years and how much it will need to pay benefits for teachers and state and local government employees.

"Our unfunded liability exists because we have less money in pension trusts than estimated expenses," said Rep. Mike Hawker, R-Anchorage. Hawker is chairman of the House Ways and Means Committee, and Andrews' most prominent advocate in the Legislature.

Few legislators other than Hawker claim to know much about pension obligation bonds, but the House and Senate have both unanimously passed legislation authorizing borrowing as much as $5 billion, and investing it with hopes that the strong market returns of the Alaska Retirement Management Board will continue and exceed the cost of borrowing.

The risk is that the state's investments may instead lose money.

"You can have negative earnings. We don't want to suggest that that isn't a possibility," said Gary Bader, chief investment officer for the Department of Revenue.

Legislation passed this year authorizes borrowing as much as $5 billion, but at least initially only $2 billion is likely to be done, said revenue officials and legislators.

Sen. Bert Stedman, R-Sitka, and co-chairman of the Senate Finance Committee, was a reluctant convert to pension obligation bonds, but now agrees with Andrews that they can be a useful tool for the state.

The key to making pension obligation bonds work, said Stedman, is to borrow money cheaply. That minimizes the risk of losses.

Stedman said declining interest rates mean this is a good time to issue bonds.

"We are in a very favorable interest rate environment today," Andrews said.

Stedman said the other part of the plan is to not go "whole hog," but stagger their bond sales and investments as a way of minimizing risk.

"We want this to be a slow and methodical process so we can work our way out of this problem, while ensuring it doesn't get worse," he said.

One change made in the Senate was to allow only the state, not local governments, to issue the bonds. The state assumed responsibility for pension liabilities this year, and there is no need for local governments to take that risk themselves.

"This is not a tool for small and unsophisticated organizations," Hawker said.

The House now has to concur with the Senate changes, but legislators said they expect that to happen easily.

Rep. Paul Seaton, R-Homer, said he's more comfortable knowing that only the state Department of Revenue, which has far more resources than any city, will be dealing with Wall Street and handling sophisticated investments.

"That's their whole job, to manage those kinds of moneys," he said.

How successful pension bonds are for Alaska will likely depend on what markets do after the state makes its investments. A New Jersey pension obligation bond issuance of $2.7 billion came right before the stock market took a dive, while a $2.9 billion Oregon offering caught the market upswing and has been very profitable, according to Pension & Investments magazine.

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