Out with the Old
Last week I updated you on the bill to rewrite the PFD formula. Some of you got in touch to let me know I was a little murky about just what I think is wrong with the 40+ year-old way of calculating it. I apologize. Let me try again:
Most of you know Alaskans created the permanent fund by constitutional amendment in 1976. The constitution dedicates a sliver of our mineral royalties to the principal of the fund. It also prevents the legislature from spending that principal.
The money gets invested and the earnings go to the general fund. (First we hold those earnings in a reserve account at the Permanent Fund Corporation. But every nickel of that reserve is spendable with a simple majority vote of the legislature.)
In the early years, the legislature put strict limits on how the fund could be invested. Safety first was the rule: government bonds, and cash-like short-term investments only. But it quickly became clear Alaska could grow our savings a lot if we took a few calculated risks. In 1983 we decided to get into the stock market and buy commercial real estate. By 2005 the legislature had gradually replaced all restrictions with the “prudent investor rule.” That basically tells the fund to be as careful as other professional investors. Take smart risks, but don't go nuts.
So now along with stocks and bonds (both foreign and domestic,) real estate, and cash, there are investments in hedge funds, infrastructure, venture capital, private equity, and so forth. It worked great. By 1998, Alaska was making more from fund earnings than from oil. Today there's more than $76 billion in the fund.
What does that all have to do with the dividend? Lots. After an initial, unconstitutional attempt to tie the PFD to a person's length of residency, the legislature of the 1980s decided to send a piece of the fund's earnings out as checks. They wrote a formula based on the average "statutory net earnings" from the past five years and sent half of that to Alaskans.
When the formula was written, the fund owned bonds and certificates of deposit and money market-like investments. Figuring out the net income was easy. You combine the interest payments on bonds and cash, plus the earnings you realize if you sell a bond before its maturity date, and you're basically done.
There was a minor complication when we got into stocks. If the fund bought shares in a company for $30 each and they were worth $40 when we sold them, the extra $10 per share was "realized" as income when we sold, even though the value of the entire permanent fund included the whole value of the stock before we turned its increased value into cash. But it didn't make a difference to what we paid out. And besides, stock prices are posted daily, and the fund traded stocks all the time. It's not like any one company's shares made a huge difference.
Now that the fund is invested in stuff you don't trade every day, or even every year, it gets more complicated. Here's an example. After the 2008 crash, the permanent fund got together with some other very large investors and bought up a few thousand foreclosed houses. It made some money from rental income over the years. The rent checks count as realized earnings—easy so far. Over the years, the value of the houses grew a lot. We reported the fund being worth more as a result. But we still owned the houses, so the growth was 'unrealized' gains.
Then the fund decided to sell its stake in those homes. We got a lot of cash from that, but the total value of the Alaska Permanent Fund was the same the day before the sale as it was the day after. The difference? We 'realized' all our gains, so the net income of the fund went through the roof.
Under the old PFD formula, we would have plopped an unsustainably large chunk of those gains into the spendable part of the fund instead of reinvesting them. That's dangerous to the long-term value of the fund. If we send out mega checks (or use it as a windfall for other government spending) every time we rebalance our assets, we’re going to take more from the fund than it can bear. The real value of the fund would decrease over time.
Our state took a partial step away from that in 2017 when we limited how much can come out of the fund in any given year: 5% of the market value (averaged over several years.) We're living within that cap, which is good. We still need to change the PFD formula to match.
