JUNEAU -- Borrowing your way out of debt may seem counterintuitive, but some investment professionals are increasingly looking at borrowing as a way to boost underfunded retirement plans.
Now Gov. Bill Walker is wondering if pension borrowing may be useful in Alaska.
Under consideration are what are known as "pension obligation bonds," borrowing money on Wall Street using the state's strong credit rating, and then investing the proceeds along with the state's retirement trust funds.
If the state can borrow money at 5 percent interest, and earn an expected 8 percent on the invested money, the difference could bolster state retirement savings.
Borrowing money at a low rate and investing it to earn a higher rate is known as arbitrage, but it comes with risks, Michael O'Leary, a retired state investment adviser, has told the Alaska Retirement Management Board, which oversees the trust funds as it was reviewing such investments.
"There are no free lunches," O'Leary told the board.
The downside to the arbitrage process, he warned them, comes from risk of losses. If markets take a downturn after the state's investments are made, Alaska may not even be able to recover its losses, let alone make profits.
Further, if Alaska or any other government entity uses pension obligation bonds to make annual payments that would have otherwise been made from general funds, it can simply dig itself into a deeper financial hole than it would otherwise have.
While Walker has the authority on his own to issue up to $5 billion of such bonds, Revenue Commissioner Randy Hoffbeck said he would not do so without approval of the Alaska Legislature. He did not say what form that approval might take.
Bond payments would take financial appropriations by legislators, and many current legislators were not in office when the Legislature in 2008 authorized the Department of Revenue to use pension obligation bonds.
Hoffbeck declined to say what role the bonds might play in the state budget until Walker reveals his fiscal plan, which may happen this week.
But the Legislative Finance Division said in a briefing paper it provided for legislators that Hoffbeck's department is looking at pension obligation bonds "as a means of the state to reduce annual expenditures of general funds."
It is not clear how much the state's annual payment for retirement debt will be next year.
Legislators have already changed laws setting out how much they have to pay toward old pension debt, dropping annual payments that had ranged as high as $700 million to $1 billion, a reduction and delay that shifts costs to future generations and from the state to local communities.
But this year's extra pension payment is still expected to be either $216 million or $261 million, depending on which calculation method the Legislature chooses. The pension bonds may be used to make that payment, making it easier to balance the state's budget.
But Fitch Ratings, one of the major bond rating firms, has recently warned of the growing use of pension obligation bonds nationally and the impact on state bond ratings.
"Issuing POBs always exposes the issuer to timing and investment risks to which it otherwise would not be exposed," Fitch said in August.
When the Alaska Legislature first approved issuance of pension obligation bonds in 2008, the market was high, but soon took a major dive. Had then-Revenue Commissioner Pat Galvin made a major pension obligation bond sale and invested at the wrong time, the state could have lost billions.
But Rep. Mike Hawker, R-Anchorage, who sponsored the pension bond legislation, sees it differently. He said that if the department used pension obligation bonds to invest in 2009 when the stock market hit its low, it could have made billions.
"Had we done a substantial pension obligation transaction we would have largely resolved the underfunded status of the pensions today," he said.
Fitch said use of pension bonds has been growing, with bond issuances in the first half of 2015 already doubling all of 2014.
While many governments have found the use of pension bonds valuable, they've been problematic as well.
Pew Charitable Trust's Stateline publication reported that the 2012 bankruptcy of Stockton, California, can be traced to its sale of $125 million in pension obligation bonds in 2007.
"Counting on the bonds to close a gap in retirement funds for city workers, the city was unable to meet its financial obligations when investment returns failed to manifest during the recession," Stateline said.
Because it is not possible to know until years later whether the use of pension obligation bonds provide benefits that exceeds their cost, Fitch said it views the use of them at best neutral.
"Factoring in all considerations, Fitch views the credit impact of POBs to range from neutral to negative," the agency said in August.
The Legislative Finance Division, headed by David Teal, said it was unsure how bond ratings agencies might view a pension obligation bond sale, and it could be viewed anywhere from a "prudent reaction to our financial crisis" to an "act of desperation."
Alaska Dispatch Publishing