Legislature(2009 - 2010)HOUSE FINANCE 519
01/23/2009 01:30 PM House FINANCE
| Audio | Topic |
|---|---|
| Start | |
| the Principles of the Permanent Fund Principal | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
January 23, 2009
1:35 p.m.
CALL TO ORDER
Co-Chair Hawker called the House Finance Committee meeting
to order at 1:35:54 PM.
MEMBERS PRESENT
Representative Mike Hawker, Co-Chair
Representative Bill Stoltze, Co-Chair
Representative Bill Thomas Jr., Vice-Chair
Representative Allan Austerman
Representative Harry Crawford
Representative Anna Fairclough
Representative Richard Foster
Representative Les Gara
Representative Reggie Joule
Representative Mike Kelly
Representative Woodie Salmon
MEMBERS ABSENT
None
ALSO PRESENT
Representative Mike Doogan; Senator Con Bunde; Senator Joe
Paskvan; Gregg Erickson, Economic Consultant, Erickson &
Associates; Pat Galvin, Commissioner, Department of
Revenue; Jerry Burnett, Director, Division of
Administrative Services, Department of Revenue; Mike Burns,
Executive Director, Permanent Fund Corporation, Department
of Revenue; Michael Barnhill, Assistant Attorney General,
Department of Law.
PRESENT VIA TELECONFERENCE
NONE
SUMMARY
^The Principles of the Permanent Fund Principal
Overview: The Principles of the Permanent Fund Principal
1:38:17 PM
CO-CHAIR HAWKER queried the process that results in the
Revenue Sourcebook numbers that the state uses to project
revenue for the coming year. The Revenue Sourcebook applies
to the remainder of the current fiscal year ending June 30,
2009, and to the fiscal year of July 1, 2009 through June
30, 2010. He questioned whether the recent dramatic change
in the world economy was cause for review of current
projections for FY09 and FY10.
PAT GALVIN, COMMISSIONER, DEPARTMENT OF REVENUE responded
that an FY09 interim revenue forecast associated with the
supplemental budget would be provided in a week. He
confirmed that the price of oil is currently lower than the
price used for projections in the fall. The number used for
forward price projection would be in the low $50s, which
was expected to create a shortfall of over a billion
dollars. He assured the committee that he would provide
more information as the exact dollars were known.
1:41:25 PM
Commissioner Galvin expressed concern about spending more
than was coming in. He reiterated that the FY09 numbers
used to project the FY10 numbers have dropped
significantly. He elaborated on the fluctuation in oil
prices over the last few months.
1:43:05 PM
Commissioner Galvin thought that the numbers would be lower
for the fall forecast.
Co-Chair Hawker explained that a significant budget surplus
or budget deficit would affect budget decisions.
Commissioner Galvin stated that he would provide as much
information, in a timely manner, as he could.
Representative Kelly advised using the lower numbers.
1:45:44 PM
Commissioner Galvin voiced that the Office of Management
and Budget (OMB) was working with DOR and were aware of the
drop in the revenue forecast. Co-Chair Hawker explained
that OMB director Karen Rehfeld would come before the
committee soon to answer further questions.
Representative Gara asked for clarification as to why the
FY09 budget has a potential $1 billion deficit but $5
billion in savings. He questioned Commissioner Galvin's
definition of the word "deficit".
Commissioner Galvin noted that there was a revenue
shortfall of over $1 billion dollars, not a deficit. He
mentioned other funds that could be considered savings
accounts. The budget can be rolled together from year to
year. It can be confusing understanding what funds are
located where.
1:48:31 PM
Co-Chair Hawker summarized that "shortfall" means that the
state simply has not saved as much as it planned. The state
will have saved $4 billion instead of $5 billion.
Commissioner Galvin concurred. He elaborated that a revenue
estimate is given in order to create a budget and that the
numbers are subject to change. The FY09 budget had
designated $1 billion for the constitutional budget reserve
(CBR), automatically resulting in $1 billion less income
for the state.
1:50:35 PM
Commissioner Galvin admitted that using the word "deficit"
may confuse the public when the state may be putting money
into savings at the end of the year.
Representative Gara asked that the administration not use
the word deficit when presenting to the public if there was
no real deficit as the public understands the definition of
the word. He expressed that it affects the public's mood to
hear the word. Co-Chair Hawker agreed that clarification
between "deficit" and "shortfall" should be made for public
understanding.
1:52:31 PM
GREGG ERICKSON, ECONOMIC CONSULTANT, ERICKSON & ASSOCIATES,
and founder of the Alaska Budget Report introduced a
PowerPoint presentation, "How the Permanent Fund Dividend
(PFD) Came to be at Risk" (Copy on File).
1:56:18 PM
Mr. Erickson went over Slide 2, "1976 Amendment to Alaska's
Constitution":
At least twenty-five percent of all mineral lease
rentals, royalties, royalty sale proceeds, federal
mineral revenue sharing payments and bonuses received
by the state shall be placed in a permanent fund, the
principal of which shall be used only for those
income-producing investments specifically designated
by law as eligible for permanent fund investments.
(Article IX, Section 15 (Effective February 21,
1977).)
Mr. Erickson cautioned misinterpretation of the 1976
amendment. At the time the amendment was made he believed
that the Permanent Fund was meant to be income producing
and permanent.
Mr. Erickson continued with "Orange County Debacle" (Slide
3):
The new rule arises in part out of the losses incurred
in 1993 by the government of Orange County. Managers
of county investments were able to avoid showing the
declining market value of bad investments because they
were not required to show the loss on the county-owned
fund's income statement. Accounting experts believe
that requiring unrealized gains and losses to be
reported will help provide early warning of such
investment problems.
("Alaska Permanent Fund Corporation (APFC) asks
for legal opinion on status of income,
principal," Alaska Budget Report, February 17,
1999)
Mr. Erickson pointed out that the Alaska Supplemental
Benefits System had placed money in Orange County's
Guaranteed Investment/Insurance Contracts. The contracts
were not guaranteed. The value of the contracts was
declining, yet dividends continued to be paid out. Orange
County and subsequently the state of Alaska lost a lot of
money. The Corporation therefore instigated the new rule.
Mr. Erickson continued with "Government Accounting
Standards Board (GASB)31" (Slide 4):
Governmental entities, including governmental external
investment pools, should report investments at fair
value in the balance sheet.
Fair value is the amount at which a financial
instrument could be exchanged in a current transaction
between willing parties, other than in a forced or
liquidation sale.
("Summary of Statement No. 31, Accounting and
Financial Reporting for Certain Investments and
for External Investment Pools," Government
Accounting Standards Board, March 1997)
Mr. Erickson recounted that GASB 31 presented a problem for
the Alaska Permanent Fund because its accounting practices
in determining dividends were comparable to Orange County.
This was not an issue when the fund was heavily invested in
bonds, but into the 1990s the Fund was invested mainly in
equities. Equities are less stable. The fear was that
Alaska might find itself in a position like Orange County
because the value of the assets was in danger of becoming
less than the value of the principal. The value of the
principal is determined by adding up all the money the
legislature by appropriation or constitutional dedication
had put into the fund since its conception in 1977. He
disclosed that the current principal is $29 billion.
2:02:29 PM
Mr. Erickson took his definition of principal from the
"1999 Request for Legal Opinion" (Slide 5):
The Alaska Permanent Fund Corporation (APFC) has asked
the national law firm of Morrison and Forrester to
prepare a legal opinion on whether the governor's
proposal in House Bill 90 to remove $4 billion from the
permanent fund would invade the principal of the fund.
…Communications Director Jim Kelly told the Senate State
Affairs Committee that a legal opinion had been
requested. The issue arose in the context of…testimony
on…a bill by Sens. Jerry Ward and Rick Halford to
transfer…the fund's earnings reserve to the principal.
("APFC asks for legal opinion on status of income
principal," Alaska Budget Report, February 17,
1999.)
Mr. Erickson recalled that in 1999 the PFD had a huge
budget reserve. The Knowles administration wanted to
transfer the reserves to the CBR. The Knowles
administration and the Department of Law contracted
Morrison & Foerster LLP to determine the legality of the
Knowles plan. Morrison & Foerster found in favor of the
plan but discovered that the dividend formula had to be
changed in order to avoid a conflict with the Constitution
of Alaska (see "1999 letter Morrison and Foester," Copy on
File).
Mr. Erickson turned to "1999 Legal Opinion" (slide 6):
Attorneys from Morrison and Foster say Gov. Tony Knowles'
proposal to take $4 billion from the permanent fund won't
violate the Alaska Constitution. But a formula in state
law that is used to calculate income available for
dividends (or other purposes) should be changed to avoid
a possible conflict-of-laws situation that could occur
under new accounting interpretations, the lawyers said in
a March 3 opinion.
("Lawyers OK $4 billion transfer from earnings
reserve to CBR," Alaska Budget Report, March 10,
1999.)
2:06:30 PM
Mr. Erickson continued with "The 2002 Crisis, Part 1"
(Slide 7):
For a few days in July a falling stock market shaved
$399.9 million off the principal of the permanent
fund. The erosion of principal, the first such event in
the fund's 25-year history, reached its deepest point on
July 23, culminating a slide that took the fund's
reserves from a comfortable $8.6 billion in the spring
of 2000 to a negative value in July.
("Fund recovers after market slide eats $400
million hole in principal." Alaska Budget Report,
September 17, 2002.)
Mr. Erickson explained that this was the first time the
value of the fund had fallen below its principal. Because
of the fallen numbers there was concern within the APFC
that dividends would be paid out by invading the principal.
Mr. Erickson continued with "The 2002 Crisis, Part 2"
(slide 8):
Later in July rising market values erased the deficit,
but the issues raised by the episode remain,
including;
1. worries that the fund's constitutional structure
is more vulnerable to meltdown that officials had
ever realized,
2. unsettling legal questions about APFC's authority
to transfer money to the state government when
reserve drops into the red, and
3. increased doubt over whether the fund will be
able to meet its dividend and inflation-proofing
obligations in 2003.
("Fund recovers after market slide eats $400
million hole in principal." Alaska Budget Report,
September 17, 2002.)
Mr. Erickson shared that due to this situation, APFC and
the Murkowski administration agreed it would be best to
abandon the concept of principal and embrace the idea of
Percent of Market Value (POMV) to eliminate ambiguity.
2:10:39 PM
Representative Gara queried the difference between the
earnings reserve and the Permanent Fund Principal. He
wondered if money is taken from the earnings reserve to
keep the principal intact when there is more in the
earnings reserve than in the principal. Mr. Erickson
responded that before 2003 the money came out of the
reserves. He discussed the difference between realized and
unrealized reserves.
Representative Gara asked if the monies were separately
invested. Mr. Erickson answered that investments were
pooled. Presently the practice of the fund is to allocate
unrealized gains and losses to the principal.
2:13:49 PM
Mr. Erickson explained that the Murkowski administration
inquired of Attorney General Renkes an opinion concerning
the idea of a POMV payout from the fund.
Mr. Erickson cited "Renkes Opinion and POMV (Percent of
Market Value)" Slide 9:
Only through a constitutional amendment, like that
currently proposed by the corporation trustees
establishing a payout limit of 5 percent of the total
fund value, can the rate of dedication be increased and
the deposit of income available for distribution be
limited. Absent such an amendment, the full amount of
income, made up of the realized gains and losses, is
available for expenditure.
(Renkes 2003 opinion AG file 663-03-0153.)
2:14:54 PM
Mr. Erickson interpreted from the Renkes Legal Opinion that
the notion of the principal does not limit the ability to
spend as long as realized earnings are in hand.
Mr. Erickson continued with "Renkes' Legal Opinion, Part 2"
(slide 10):
There is no basis for expanding the concept of
principal by creating a notational number that serves
as a limitation on the deposit of income for
distribution purposes.
(Renkes 2003 opinion AG file 663-03-0153.)
Rep. Eric Croft of Anchorage says he is still
pondering a lawsuit to challenge Attorney General
Gregg Renkes' opinion that unrealized gains shouldn't
be considered 'available for appropriation'.
("What do Democrats really want," Alaska Budget
Report, December 23, 2003.)
Mr. Erickson declared that the concept of POMV was less
antiquated than the idea of principal. He furthered that
the Renkes Opinion would not have been a problem had the
POMV been approved. He explained that POMV cannot be
reached without revisiting how the PFD is calculated. The
POMV annual payout compromise set forth by Hollis French in
2003 was resisted by the Murkowski administration. Mr.
Erickson felt that was the reason the POMV plan eventually
failed in the Senate.
2:18:19 PM
Mr. Erickson discussed "Investment losses of 2008-2009"
(Slide 11). He revealed that on Friday, October 10, 2008
the PFD dropped below principal for a second time.
Mr. Erickson "APFC's October 23 letter to OMB" (slide 12):
Erosion of the supposedly permanent principal has
stimulated Alaska Permanent Fund Corporation (APFC)
officials to seek guidance from the Palin
administration on the appropriateness of continuing to
draw money from the fund to pay their own salaries and
other corporation expenses. …'In times of extreme
market volatility with downward trends, as in the
current case, questions arise regarding the Permanent
Fund's ability to make cash payments for items such as
its operating budget,' wrote APFC executive director
Mike Burns…in an October 23 memorandum to OMB Director
Karen Rehfeld.
("Fund recovers after market slide eats $400
million hole in principal," Alaska Budget Report,
September 17, 2002.)
Mr. Erickson pointed out that the Permanent Fund is $1.1
billion below the principal. He stressed that if the fund
remains below principal there will not be enough in the
reserves to pay the dividend without further erosion of the
principal.
2:23:04 PM
Mr. Erickson highlighted "OMB's reply to Mr. Burns" (Slide
13):
A consultation with the Department of Law regarding
the corporation's current circumstances affirms
APFC's interpretation that the APFC operating budget
should be paid from the positive cash flow in order to
meet the FY09 appropriated budget.
(OMB Director Karen Rehfeld, Memorandum to APFC
Executive Director Mike Burns, November 5, 2008.)
2:24:47 PM
Mr. Erickson "Current Status" (Slide 14):
· Principal exceeds market value: fund is 1.6 billion
underwater.
· $1.1 billion needed on June 30 to pay PFD
· $3.9 billion in realize earnings "reserve" account,
but…fund investments must grow by about $2.7 billion
(1.6 billion + $1.1 billion) to avoid threat of court
intervention.
Mr. Erickson concluded his presentation with "Options"
(Slide 15):
1. Take no action
ƒHope markets rise as in 2002.
ƒHope nobody sues.
ƒIf dividends are blocked, deal with economic
consequences separately.
ƒTry to find consensus on a POMV amendment that can win
voter approval in 2010.
2. Adopt backstop plan.
ƒPay PFD (all or part) out of CBR, Alaska Housing and
Finance Corporation (AHFC) equity, or other sources.
ƒHope markets rise before June 30, 2010.
ƒTry to find consensus on a POMV amendment that can win
voter approval in 2010.
2:27:33 PM
Co-Chair Hawker asked about protection of the principle
under the Alaska Constitution. He asked how a dividend can
legally be paid if principal of the fund can be used only
for investments as stated in the constitution, and the
current value of the principal is less than the amount of
money deposited into it. Mr. Erickson answered that the
question should be answered by the Department of Law (LAW).
Representative Crawford understood that this year there was
a possibility that there would not be money available for
the PFD. He wanted to know what happens to the money in the
fund if dividends are not paid out. Mr. Erickson responded
that if the court blocked the transfer of money from the
permanent fund to the dividend fund, or put conditions on
transfer that had the same effect, the money would stay in
the permanent fund.
Representative Gara did not understand how the fund could
have principle that is worth more than the market value.
Mr. Erickson answered that the definition of principal as
Representative Gara understood it in this situation differs
from that of Attorney General Renkes as laid out in his
2003 legal opinion.
Representative Gara asked if there was a definition of the
word principal in the constitution. Mr. Gregg asserted the
word was used but not defined. Representative Gara asked if
there was another definition of the word other than
Attorney General Renkes' opinion. Mr. Erickson answered
that it was interpreted in the 1999 Morrison & Foerster
opinion and that opinion held the opposite view of Renkes'
opinion.
MICHAEL BARNHILL, ASSISTANT ATTORNEY GENERAL, DEPARTMENT OF
LAW, pointed out that there is valid appropriation in place
to pay out the 2009 dividend. He stressed the 2009 dividend
must be paid out by law. Co-Chair Hawker added that
although the value of the fund is less than the money that
has been deposited into it, money can still be taken out in
order to pay dividends.
Mr. Barnhill responded that Mr. Erickson's presentation was
premised upon a definition of principal without basis in
the state constitution or statutes. If there is no
definition of principal in the constitution, it is
necessary to turn to the statutes. The applicable statutes
are AS.37.13.140 and AS.37.13.145, which stipulate that
income is to be deposited into the earnings reserve when it
is received. He referred to Article 9, Section 15 of the
Alaska constitution, which requires that income from the
permanent fund be deposited into the general fund unless
otherwise provided by law. In order for the income to be
income it has to be realized and cannot be unrealized.
Language in the statutes also says that net income of the
fund shall be calculated under general accounting
principles excluding unrealized gains and losses. Principle
must be everything that income is not and can rise and
fall.
Co-Chair Hawker stated that the original concept of the
permanent fund was make investments that would produce
income. A netting requirement was necessary if losses were
being produced and only income could be moved.
2:38:08 PM
Mr. Barnhill divulged that when the fund was established
there were three viewpoints on how it should be used:
1. social welfare programs
2. economic development
3. savings
Mr. Barnhill added that income producing investments by
definition leave out social welfare programs. He pointed
out that investments are never guaranteed. The income
producing investments in the fund have lost value.
Representative Crawford asked if the principle is
permanent.
Mr. Barnhill replied that money could not be appropriated
from the principal but could be appropriated from the
earnings reserve. The value of the principal could go to
zero but that that would be a result of the market going
down.
Co-Chair Hawker opined that if the market value was going
down dividends should not be paid in order to protect the
principal. Representative Crawford added that it would seem
that this made the permanent fund not so permanent.
Mr. Barnhill reiterated that the state constitution
protects the principal from appropriation.
2:42:43 PM
Co-Chair Hawker asked could the question be remedied if
income going into the permanent fund earnings reserve,
which is managed by the principal, had been left going into
the general fund, which can be appropriated from. Mr.
Erickson qualified that would solve some legal issues but
would not be consistent with his understanding if the 1976
constitutional amendment.
Mr.Barnhill thought that had all of the income from the
permanent fund been deposited into the general fund the
value of the fund would currently be $12 or $13 billion. He
surmised the notional value that Mr. Erickson spoke of is a
product of inflation-proofing. That means taking some
permanent fund income that is in the earnings reserve and
dedicating it back to the principal. Co-Chair Hawker
communicated that the notional value had been a judgmental
decision made by the legislative body to make deposits to
the permanent fund principal as well as the 25 percent that
is constitutionally mandated.
SENATOR CON BUNDE asked if the legislature should
appropriate from the earning reserve back into the corpus
of the fund to make it whole. Mr. Erickson replied that it
would be an option.
MIKE BURNS, EXECUTIVE DIRECTOR, PERMANENT FUND CORPORATION,
DEPARTMENT OF REVENUE, addressed an earlier question
regarding whether the fund could disappear through
continually accessing the earnings reserve. He warned that
there was less than $4 billion in the earnings reserve, and
if the country's financial situation continued to
deteriorate, the earnings reserve would dissolve itself
long before the fund.
2:47:18 PM
Mr. Burns stated that APFC accounting has operated under
the Renkes Opinion for six years and in the interim period
their auditors have approved of APFC financial statements
using the opinion. He added that the auditors give
deference, not reverence, in the legal opinion handed down
by Renkes. Co-Chair Hawker communicated that it is an
example statutory accounting versus General Accepted
Accounting Principles (GAAP). He parlayed that statutory
accounting principles, however different from GAAP, comply
with the legal authority.
2:49:12 PM
Mr. Burns deferred to Co-Chair Hawker's interpretation but
wanted to add that if issue had been taken with the opinion
it would have been noted in a footnote or management
letter.
REPRESENTATIVE MIKE DOOGAN commented on Mr. Barnhill's
statement about the use of the PFD as an economic
development and savings vehicle and not to pay for social
programs. Mr. Barnhill retorted that was correct and had
been in the 2003 opinion. Representative Doogan disagreed.
He informed the committee that he was the aide to the House
permanent fund committee that wrote the permanent fund
bill. After three years of debate the question of using the
permanent fund as an economic vehicle was answered in the
negative. He felt that it would behoove Mr. Barnhill to
review the history of the fund.
Co-Chair Hawker concurred with Representative Doogan. He
reminded the committee that the PFD was designed to be an
ongoing source of revenue.
2:53:32 PM
AT EASE
2:54:04 PM
RECONVENED
Co-Chair Hawker stated that the question of the definition
of principal and how it determines the pay out of the
dividend needed to be resolved sooner rather than later. He
pointed out that although LAW has currently determined that
there is no danger to the legal authority to have a PFD for
2009, there are still serious intellectual questions to
interpret.
2:56:02 PM
ADJOURNMENT
The meeting was adjourned at 2:56 PM.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 1999 TransferOfSecurities MorrisonFoerster.pdf |
HFIN 1/23/2009 1:30:00 PM |
|
| 2003_0618_ClarifyingAcctgProcedures_Renkes.pdf |
HFIN 1/23/2009 1:30:00 PM |
|
| Erickson column 11-2008.pdf |
HFIN 1/23/2009 1:30:00 PM |
|
| Rehfeld to Burns 11-5-2008.pdf |
HFIN 1/23/2009 1:30:00 PM |
|
| Alaska Constitution and Statute.doc |
HFIN 1/23/2009 1:30:00 PM |
|
| APFC200811.pdf |
HFIN 1/23/2009 1:30:00 PM |
|
| Rehfeld to Burns 11-5-2008.pdf |
HFIN 1/23/2009 1:30:00 PM |
|
| How the PFD came to be at risk.pdf |
HFIN 1/23/2009 1:30:00 PM |