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Despite market turmoil, Alaska considers risky bond strategy

State considers borrowing money to buy stocks that it can use to pay retirement debts

Posted: Thursday, November 19, 2009

Alaska narrowly avoided losing hundreds of millions of dollars when it delayed making a big bet in the stock market just before the market's big fall last year.

Now that the market has rebounded somewhat, the Department of Revenue says it is again considering the investments as a way to help pay for its mounting pension deficit.

The money is needed to pay retirement costs for city and state public employees and teachers, but pensions are guaranteed, so the Legislature will have to find the money elsewhere if they don't save enough for expected costs.

Some legislators say Alaska should reconsider, though, and not take a chance on increasing the deficit.

"This is not a riskless strategy," said Sen. Bert Stedman, R-Sitka, co-chairman of the Senate Finance Committee.

What the state wants to do, and which was authorized by a law passed last year, was to raise $2 billion by issuing what are known as Pension Obligation Bonds. The state would invest the money, mostly in stocks, hoping to earn more than the cost to pay off the bonds.

If the strategy works, Alaska could earn an estimated $40 million a year in the difference between the expected investment return and the cost of the bonds, Department of Revenue officials said last year.

Alaska has about $16 billion set aside to pay future retirement costs, but expects those costs to total $23.5 billion, giving it an unfunded liability of $7.5 billion, as of its most recent annual accounting.

The Legislature authorized up to $5 billion in bonds, said Jerry Burnett, deputy revenue commissioner, but only $2 billion are likely to be issued, at least initially.

Burnett said plans to issue the bonds are on hold, waiting for interest rates to decline.

The state expects to earn about 8.25 percent return on its investments over time. The lower the interest rate, the more likely the deal is to work out for the state, Burnett said. Rates for the bonds are currently above 6 percent, and they'd have to be 5.5 percent or lower before the department would look at issuing the bonds, Burnett said.

"If there is a window, we may take advantage of it," he said.

Burnett said Alaska is not trying to time the stock market, which has fluctuated wildly in recent months, but instead is seeking the lowest possible rates for the bonds.

"All we can control is a decision about what the interest rates is when we sell them," Burnett said.

The best time to have sold the bonds and then bought stocks would have been last March, when the Dow Jones was at a multi-year low.

"They would have had huge returns, and everybody would have been patting themselves on the back," Stedman said.

Burnett agreed that would have been the ideal time. The stock market has rebounded 64 percent since then, he said.

On the other hand, had the state issued them immediately after approval by the Legislature, the state would have likely lost hundreds of millions if they'd bought large amounts of stock at the same time.

"It's a good thing we didn't do them immediately after we were authorized," Burnett said.

"We'd have been ready to jump out the window," Stedman said.

The Pension Obligation Bond bill had been introduced in 2007, by Rep. Mike Hawker, R-Anchorage, who is considered one of the Legislature's most financially knowledgeable members. It passed through the House of Representatives, but was held up in the Senate Finance Committee by a reluctant Stedman until late in the 2008 session.

With strong backing from the administration of former Gov. Sarah Palin, the bill passed the Legislature with no opposition.

Had it passed in 2007, Stedman said the state would likely now be faced with substantial losses.

Now, he said, the recent actions have raised questions about whether the state should have ever considered Pension Obligation Bonds.

"I think we need to go back and revisit that," he said.

Rep. Beth Kerttula, D-Juneau, and House Minority Leader, said she'd been reluctant to support them but had been persuaded by the Department of Revenue.

"We had a lot of good information, good testimony, that it was one method of helping out with the unfunded liability," she said.

Now, she too would like to see it reconsidered.

"It appears that it was a very good thing that we didn't use it," she said.

Hawker did not return phone calls, but told the Legislature that issuing Pension Obligation Bonds would mean Alaska was taking a "more innovative and contemporary view of the state's ability to use structured financing" to deal with the unfunded liability.

Burnett said that if interest rates fall to an acceptable level, it would likely take about 60 days to prepare for the bond sale.

• Contact reporter Pat Forgeyat 523-2250 or patrick.forgey@juneauempire.com.



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