'Alaska, Inc.' and the Rise of the State's Permanent Fund
By Dermot Cole
Oil taxes and royalties have been the source of about 90 percent of Alaska's unrestricted general revenues, but with oil prices flagging and production way down, they're not coming close to matching state spending. Alaska is staring down a $3.5 billion deficit and the state's long-term prospects are bleak.
One bright spot: Investment income from state savings has shown remarkable resiliency and has overtaken oil-production taxes in their value to the state. But the deficits will require the Legislature to spend down those savings accounts, eliminating any help they could provide. Only one giant savings account is protected by the state Constitution: the Alaska Permanent Fund.
Veteran Alaska Dispatch News reporter Dermot Cole has written extensively about state spending and the Permanent Fund from his base in Fairbanks. Now, in this three-part series, he examines how we got to this point and what we can do to move forward.
One of the most successful investments in the history of the Alaska Permanent Fund grew out of a chance conversation by two men waiting in line at Gate A18 in Boston's Logan Airport for a flight to Seattle. A friend introduced Dr. Larry Corey, the president of the Fred Hutchinson Cancer Research Center, to David Fallace, a portfolio manager for the Alaska Permanent Fund.
"He was a nice guy. We talked about children and life, and where you're from," Corey told a reporter for the website Xconomy about his March 2013 meeting with Fallace. "He said he was interested in cancer and cancer therapy."
They boarded the Alaska Airlines jet and became "so immersed in the conversation that at one point a flight attendant had to shoo them back to their seats to free a path to the plane's restrooms," a 2013 article on the Fred Hutchinson website recounted.
Flying cross-country, Corey told Fallace that researchers had high hopes for treating cancer patients with a technique in which genetically engineered white blood cells in the immune system can be made to identify malignant cancer cells and destroy them.
But frustration over the slow pace of research grants had prompted major cancer research centers to look at starting a commercial enterprise to fund research and clinical trials.
Sensing an opportunity for the fund, Fallace set up a meeting in Seattle at which Corey talked to Mike Burns, the executive director of the Permanent Fund, and Jay Willoughby, the chief financial officer of the fund.
The participation by Fred Hutchinson, Seattle Children's Memorial Hospital and the Memorial Sloan Kettering Cancer Center in New York made this a sensible investment for the fund, Burns said.
The company is a new venture, but so far, the $128.5 million Alaska investment in Juno Therapeutics is among the most successful in the history of the Permanent Fund.
The Friday before Christmas, the new biotech company held an initial public offering later described by a JP Morgan analyst as "maybe the most successful IPO in the history of this industry."
"The company has been founded on the promise that engineered T cells can revolutionize the way we treat cancer and maybe, by the way, some diseases beyond that," Juno Therapeutics President Hans Bishop said during a January conference call.
The Permanent Fund, with 25.5 million shares, has seen its $128.5 million investment climb to more than $1.2 billion, though the stock price remains volatile.
At the February meeting of the Permanent Fund board of directors, Greg Allen, an analyst from Callan Associates, a company that advises the fund, said the performance of Juno Therapeutics fits "the definition of a home run."
The long-range goals of Juno Therapeutics are nothing short of curing cancer, a vision laden with risk and the hope that some day the company will earn a profit for investors. The long-range goals of the $53 billion Permanent Fund, while not quite so ambitious, are also not so well defined.
The rise of the Permanent Fund
The 1976 Alaska Constitution amendment that created the fund required only that the deposits be placed in "income-producing investments" and that the Legislature would have the power to decide what to do with the earnings.
There was general agreement that the fund would be a savings account with many competing ideas about how and when the savings would be used. For more than three decades, about half the income has been used for Permanent Fund dividends and about half has gone back into the fund.
Nearly $20 billion has been paid out in dividends since 1982 and one of the surest ways to prolong a political career in Alaska has been to pledge allegiance to protect the dividend against all foes.
Periodically, when oil prices have crashed, Alaska leaders have opened discussions about a broader range of options for fund income, only to see the discussion end when better times returned.
In 1999, most Alaska leaders supported a "yes" answer for an advisory vote that asked, "After paying annual dividends to residents and inflation-proofing the Permanent Fund, should a portion of Permanent Fund earnings be used to help balance the state budget?"
The voters responded with an overwhelming "no," by an 83 percent to 17 percent spread. Rising oil prices allowed the state to put off difficult decisions about future revenues.
Today, with the state's oil income collapsing by billions, and bigger deficits on the horizon, it seems inevitable that Alaskans will once again be asked to consider how the Permanent Fund fits into the state's financial future.
The fund earned about $2.2 billion in the first two months of 2015, which is more than the state expects to collect this fiscal year in unrestricted petroleum revenue. These are mostly hypothetical profits that won't be cashed in. They can vanish just as quickly as they appeared.
Multibillion-dollar swings in value can work both ways. In 2008, when the world economy was in free-fall, the fund lost $9 billion in about 10 weeks.
Where once the Permanent Fund was exclusively in bonds, with lower risk and lower profit potential, it is now diversified across a range of worldwide investments, from shopping malls and office buildings to fixed-income instruments, fledgling companies, rental homes and 776,870 shares of Apple Inc.
"There's a lot of good news, not a lot of bad things to talk about right now. The fund is in very good shape," Steve Center, a vice president of Callan Associates, said at a Juneau meeting late last month.
The fund has grown to more than $50 billion because Alaska oil revenues have been large enough that legislators and governors have always found other ways to finance state operations.
Inception of the Permanent Fund
The fund began with a dream of creating a measure of financial stability from a nonrenewable resource, an idea that took shape soon after the events of Sept. 10, 1969, in the Sydney Laurence Auditorium in Anchorage.
On that day, the world's biggest oil companies bid more than $900 million to look for oil on North Slope land that was not already under lease. The stakes had skyrocketed because the largest oil field ever found in North America had been discovered at Prudhoe Bay in 1968.
Almost immediately, some Alaska political leaders announced their intentions to save it for the future. But the attempt to sock it away ran headlong into public demands to improve education and upgrade other public services in a state that had scrimped by during the first decade of statehood.
Most of the oil windfall was spent in the years that followed on new schools, expensive loan subsidies and programs like the so-called "longevity bonus" that went to longtime residents.
The impermanence of the $900 million helped secure the easy passage of the 1976 constitutional amendment to save at least some oil money in a Permanent Fund once the trans-Alaska pipeline began pumping oil.
At a 20-year reunion that year of delegates to the Alaska Constitutional Convention, delegate Katherine Nordale said she asked one of the convention's key advisers, John Bebout, what he thought of the permanent fund plan. She said she was shocked to hear him say, "You are establishing a fourth branch of government."
She wrote attorney Clark Gruening, then a legislator helping write the rules for the new fund, to warn against allowing the fund to exercise too much control over the state.
"Unless it is managed very carefully and vigilant scrutiny is exercised every step of the way, the people of Alaska may reap little benefit, but millionaires may be created to the detriment of the general welfare of Alaska," she wrote in 1977.
Gruening wrote back that legislators worried about that potential as well, though they would draft safeguards and provisions for oversight along with investment standards to seek the highest returns.
One of the pivotal decisions came when the Legislature rejected efforts to shape the Permanent Fund into a development bank to bankroll Alaska projects. Instead, the Legislature decided to build a savings account for the future.
In a recent phone interview from Juneau, Gruening said that meant that most of the money would be invested Outside in paying propositions.
"That was the right decision," he said. "Otherwise, we would have probably put a lot of it into soft loan programs and megaprojects, which would have not returned much, if anything."
Over time the rules evolved about the relative balance of risk, reward and safety -- with legislators signing off on an approach that allowed for diversified investments to spread the risk and achieve some measure of safety while also allowing for growth.
The fund became the repository of at least one-quarter of the oil royalties collected by the state since the trans-Alaska pipeline went into operation. The first deposit of $734,000 took place on Feb. 28, 1977.
Since then the principal has grown to about $38 billion, while about $15 billion is split between realized and unrealized earnings. Realized earnings are available for appropriation by the Legislature.
A small part of the principal consists of several thousand dollars donated by Robert Bacon, an Anchorage attorney who had his dividend checks deposited in the principal of the Alaska Permanent Fund annually during the 1980s.
"I look forward to the day when we have what we should have been having all along, which is a stream of infinitely renewable income for the general fund out of the extraction of our nonrenewable resources," he told the trustees of the Alaska Permanent Fund Corp. in 1989.
Now retired in Oakland, California, Bacon has long since been among those former residents who do not collect a dividend, but he said he believes there is a future for the fund as something other than a dividend machine.
Gov. Hammond's 'Alaska Inc.'
There was discussion early on that some of the fund's earnings be used for cash payments to residents, but most of that came later, largely because Gov. Jay Hammond never tired of talking about what he first called "Alaska Inc."
As shareholders in the mythical company, Alaskans ought to collect dividends and their common interest in future dividends would make them a force to keep government growth in check, Hammond theorized.
He was right that Alaskans became vigilant defenders of the dividend, but they did not do much to hold down government spending, most of which was financed with oil taxes.
In 1980, Fairbanks insurance man and legislator Dick Randolph led the charge to get rid of the state income tax. He still believes it was one of the highlights of his career in Alaska, a policy change that has saved Alaskans billions.
At the time, Hammond went along with killing the income tax, but he later said his greatest regret was not vetoing the measure. Ending the tax severed one of the biggest restraints on government growth, he said.
Within a few years, the dividend became the most popular part of state government, creating political alliances for preventing the balance of the earnings being used to pay for government services, though that has always been within the purview of the Legislature.
The Permanent Fund has 38 employees, a number limited by the Legislature, though the corporation has argued for years it needs more staff and resources to manage the account. The corporation, which spends about $100 million a year on external management fees, has a budget for internal operations of about $11 million.
In 2012, Jay Willoughby, the new CFO of the fund, said the advantages included the size of the fund, its long-term horizon and a "strong culture of risk."
The disadvantages included its physical location in Juneau -- making business travel difficult and time-consuming, along with a small staff and salaries that had not kept pace with the financial industry.
In 2014, he told the board that no progress had been made on meeting these challenges.
Last spring, Revenue Commissioner Angela Rodell said legislators don't understand the level of investment required to manage a $50 billion fund, according to minutes of a meeting last May.
The fund has been nurtured by an environment in which it was allowed to grow since 1977 because the state had enough money coming in from oil taxes and royalties to pay for state government elsewhere.
But even if oil prices rebound, the gap between what it takes to pay for state government and public education, which is mainly paid for by the state, will continue to widen.
If a rebalancing of spending and revenue is overdue, the menu is full of tough choices.
It could come down to steep cuts in education and Medicaid or use of the Permanent Fund earnings reserve and new taxes, all proposals that will be hard to sell to the public.
Delay could mean trouble for incumbents in 2016 and 2018, even with greater public involvement and awareness.
In a recent news conference, Gov. Bill Walker talked about taking a measured approach to the new economic reality.
"It's going to be one of those things that you don't hit a light switch and all of a sudden you have a balanced budget or a sustainable budget. It's going to be a process."
That a day of reckoning would come has long been inherent in an economy dependent on a nonrenewable resource. The exact timing was unknown, dependent on world events not controlled by anyone in Alaska.
"Some suggest elected officials will wait until the state falls over the cliff into the 'fiscal gap' because only then will enough elected officials believe they have constituent support to access previously unused revenue sources such as the Permanent Fund earnings or to reinstate a personal income tax," Commonwealth North said in a 2007 report, reflecting a sentiment shared by any number of Alaskans over the years.
Delaying difficult discussions puts the state at increased risk, the report said, a message that seems more urgent today.
"We believe Alaskans can come together, and through thoughtful and informed discussions throughout the state, urge elected and appointed officials to take prudent action -- before the economy is in peril."
(c)2015 the Alaska Dispatch News