Orange County became the largest municipality in U.S. history Tuesday to file for federal bankruptcy protection, after an all-day standoff with Wall Street investors who insisted the county repay $1.2 billion in loans to its troubled investment pool.
The stunning news that one of the nation’s largest, wealthiest and most politically conservative counties was seeking protection from its creditors capped a day of turmoil that shook not just Orange County but the country’s financial markets.
Somber county officials insisted that the filing--made at 5:01 p.m. Tuesday, an hour after the Santa Ana federal bankruptcy court’s normal closing time--would have no effect on the county’s ability to maintain police protection, the county payroll and other basic services.
But the move raised questions about the funding of dozens of major projects in the county, from toll roads to a Disneyland expansion to a possible new stadium for the Los Angeles Rams and California Angels.
And it could cost the county its stellar bond rating, meaning it could become more expensive to borrow for public needs--if the county and other local government agencies are allowed to issue debt at all. One rating agency said it would drop Orange County’s rating today from double-A to triple-C--meaning its bonds are viewed as in danger of default.
“We took this action on behalf of the county and other investors so that the current financial situation can be resolved in an orderly fashion,” said Board of Supervisors Chairman Thomas F. Riley, adding that the move will help the county restructure its debts and ward off claims.
The bankruptcy means that the county’s investment pool--which includes the savings of 185 cities, school districts and other agencies--is frozen and restricted from withdrawals. It is unclear which debts the county will pay.
State Sen. Marian Bergeson (R-Newport Beach) called the bankruptcy a “difficult pill to swallow.”
“It’s a shocking occurrence,” said Bergeson, who will join the board in January. “We’re going to have to look to Sacramento, to Washington, and obviously we’re going to have to look to ourselves.”
Supervisors were roused from their beds at 3 a.m. with news of an impending financial catastrophe. They spent virtually all day behind closed doors meeting with their money advisers and attorneys to sort through the dilemma, made more drastic by investors’ demands that the county come up with $1.2 billion in cash or securities that had come due Tuesday.
On Monday, county officials, through a private firm, had tried to liquidate the beleaguered investment pool’s huge holding of derivatives--complex financial instruments that magnified the fund’s exposure to rising interest rates.
A senior executive at one of the four biggest Wall Street firms, who declined to be identified, said the bankruptcy was made inevitable after Orange County began approaching various firms, but all turned the county down.
The firms rejected taking on such a monumental task, the source said, partly because they found that the fund’s losses on the derivatives were much larger than the $1.5 billion that has been publicly reported.
The source declined to give a specific figure, but said his firm concluded that it’s “hundreds of millions” more than that, although not double the amount.
“They approached a number of people on the Street, including us, to liquidate the portfolio for them,” the executive said. “But no one wanted to trade with them. The people who looked at it (the portfolio) were frightened by it.”
By Tuesday, county supervisors and administrators were more nervous, placing calls to state and federal officials in search of financial help, such as low-interest loans to help resolve its cash crisis.
No assistance came, but one supervisor said the county has received an outpouring of genuine concern.
“We talked to a whole lot of people today . . . congressmen and senators and the governor . . . everybody else we could get ahold of, to ensure--absolutely ensure--that every avenue of legal relief was available to us,” Riley said.
It was clear by late Tuesday that the county had to file for bankruptcy, despite the embarrassment it would bring, officials said.
“There was no alternative given to us,” said Supervisor Harriett M. Wieder. “We were concerned with the fact that we are here to protect the public and to protect the investors.”
But investment bankers still wanted repayment of their loans and the county had no other choice. The county defaulted on 10 to 12 loans Tuesday.
“Everybody walked,” Wieder said. “The bond dealers--they walked.”
Supervisor William G. Steiner expressed some bitterness over the demands of the investment bankers--the same people that former Treasurer-Tax Collector Robert L. Citron has done business with for so long. Citron resigned Monday after 24 years on the job.
“We’ve had a steady parade of hot shots in blue suits representing the investment bankers pitching these sophisticated investment strategies and the treasurer obviously went down that path,” Steiner said.
The supervisor said he had two conversations with Gov. Pete Wilson to ask for help, including advancing state funds due the county early to provide liquidity to the county fund.
“I’m used to dealing with dysfunction,” said Steiner, the former director of the Orangewood Home for abused and neglected children. “But never anything of this magnitude.”
Filing under Chapter 9 of the federal bankruptcy code is a desperate last step for any public entity, because the stigma attached to such a move can lead to a bad credit rating and make it difficult, if not impossible, to borrow for public projects, legal and financial experts said.
“It’s rare, it’s quite rare . . . for any government to take that step--and unprecedented for a county of that size,” said Bennett Murphy, a bankruptcy expert and partner in the law firm of Latham & Watkins. “It’s seldom used, and I’d say that it’s quite unusual.”
Murphy said Chapter 9 functions much like Chapter 11 of the bankruptcy code for businesses--it provides a government with protection from its creditors while it attempts to work out a plan for rehabilitating its finances.
“Drastic financial distress--it’s there for that purpose,” Murphy said.
Faced with criticism from federal regulators that state officials have failed to step in swiftly to help, Gov. Wilson issued a terse, one-sentence statement through his press office.
“We will assist Orange County in analyzing the situation to identify the alternatives necessary so that Orange County can bring its finances back into solvency,” Wilson said.
Meanwhile, a spokesman for the state Department of Finance said officials there were gathering information in hopes of developing a strategy to help the county find a way out of the calamity.
“Job One is to get a complete picture of what the situation is,” said spokesman H.D. Palmer. “What we’ll do depends on what we find out. I wouldn’t want to prejudge any of that.”
The rumors of a bankruptcy filing spread from Wall Street to Washington to California through the day.
Rep. Christopher Cox (R-Newport Beach) had been the first to appear on television hinting at a bankruptcy filing. Cox, a former securities lawyer, said he had been in contact with county officials as the financial crisis exploded and will hold hearings to sort out what happened and find ways to prevent such catastrophes in the future.
The bankruptcy filing apparently was triggered when CS First Boston Corp., one of several large brokerages that has lent the county money to purchase securities, demanded additional collateral for its loans on Tuesday after the county failed to make a payment.
When the county was unable to put up the cash demanded, CS First Boston seized $2 billion of the county’s securities that had been held as collateral for the loans, according to Wall Street traders familiar with the situation.
The brokerage firm then placed those securities, mostly U.S. government agency bonds, on the bond market near the close of trading Tuesday, a move that stunned traders, dealers said.
CS First Boston officials would not comment on their relationship with the county or on any actions the brokerage might have taken on Tuesday.
Meanwhile, the brokerage with the closest relationship to the county--Merrill Lynch & Co.--said it had not asked for additional collateral and had no plans to cut off credit to the county.
Richard G. Paget, managing director and head of the municipal bond department at Baltimore-based Alex. Brown & Sons, said rumors of a bankruptcy by the county had been circulating all day. He said bond holders had been trying to sell off their positions, but couldn’t because there were no buyers. He said the situation “reminded me of the run on banks in the 1930s,” when everyone tried to get their money out at the same time.
“The situation was simple,” Paget said. “People wanted their money out and couldn’t get it.”
Paget said Alex. Brown received a report Tuesday morning from financial advisers that up to 180 of the bond issuers with investments in the Orange County fund were having financial problems and might be in danger of default.
As a result of the rumors and reports, municipal bond desks across the country were having extreme difficulty assigning prices to bonds. “It was pretty much confusion and pandemonium as far as credit analysis is concerned,” Paget said.
Paget said the bankruptcy declaration was analogous to the federal bank holiday declared by President Franklin D. Roosevelt during the Depression, which halted the run on banks. “What this does is buy the county time to sort this out.”
Peer Swan, chairman of the Irvine Ranch Water District--which had threatened to pull its remaining $300-million investment out of the pool--learned of the county’s worsening troubles early Tuesday.
“This is high-stakes poker,” Swan said. “I can understand from an investment firm’s perspective that this is a bad situation and they have shareholders who are very concerned. However, investment firms also have to realize that if they pull the plug, that’s it. And that’s a hard pill to swallow.”
The state attorney general’s office had lawyers “looking all day at the situation,” a spokesman said.
Spokesman Dave Puglia said the federal Securities and Exchange Commission, which is investigating the Orange County financial crisis, “has made contact with us,” adding, “we’re working with them in any way that can be helpful.”
But Puglia also said the office was rebuffed by the SEC earlier Tuesday after state attorneys requested access to all information on the ongoing crisis. The two sides agreed to discuss the dispute further on Wednesday.
Puglia said the attorney general’s office has been in contact with Orange County, “but we have not been made privy to the discussions or decisions of the board.”
Sources said that neither the SEC nor the Commodity Futures Trading Commission plans to take any major action in the near future, except to continue their very active investigations.
The SEC had considered seeking a court injunction that would have placed the Orange County fund into receivership. But federal regulators ruled that out, concluding such a step might cause more, rather than less, disruption to the securities markets, sources said.
One worry was that a receiver might forbid securities firms from selling any of the collateral they hold, which could cause serious disruption in the market.
Some of the same ill effects, however, might happen amid bankruptcy proceedings, in which a bankruptcy judge may issue orders about the handling of securities and collateral.
In addition, federal regulators were said to be concerned that there might be a political backlash if Washington stepped in to seize control of the Orange County fund.
Federal regulators, however, were concerned and surprised that no one on the state level had moved to take control of the situation. Some regulators said privately that anxiety on Wall Street and among investors in municipal bonds might have been assuaged if Wilson or state Atty. Gen. Dan Lungren had found a way to take charge and begin issuing directives to sort out the tangled mess.
Mary Shapiro, chairwoman of the CFTC, and William R. McLucas, director of the SEC’s enforcement division, declined to comment on the situation.
Two of the largest investors in the fund said the bankruptcy could have a serious effect on them.
Stan Oftelie, chief executive of the Orange County Transportation Authority, said his agency would be stuck financially if its $1 billion in the county’s fund was frozen for a long period of time.
“We’ve taken steps today to make sure we’re OK until the end of the year,” Oftelie said. “But after that I don’t know how long we could last.” He said the agency is counting on that money next to meet payroll demands.
Anaheim City Manager James D. Ruth, referring to the Disney and stadium projects, said: “We will be looking at all major projects in the city, including all capital improvement projects, to see if we’re going to freeze them,” putting them on hold until the crisis passes.
Across Orange County, the bankruptcy drew mixed reaction from the cities and other agencies that relied on the county to invest its money over the years.
“We’re encouraged by (the bankruptcy filing.) We think that means the county is taking control and protecting its assets,” said Tim O’Donnell, Brea’s assistant city manager.
“I think (the filing) was a wise move on the county’s part,” said Seal Beach Mayor George Brown. “A lot of towns were ready to draw their money out.”
Others were angry and wondered why the Board of Supervisors weren’t keeping a closer watch on the county’s money.
‘I think some of our supervisors really should think about resigning, except for the ones who were just elected,” Santa Ana City Councilman Ted R. Moreno said. “They should all be fired. Citron might be an elected official and treasurer but it was their responsibility as county supervisors to keep an eye on what was happening to the money.”
“This is one of the most shattering experiences that any of us in local government will ever face,” said Anaheim Mayor Tom Daly.
More Coverage of O.C. Bond Crisis
* LOSSES LOOM--Five school districts that borrowed millions of dollars for investments in county pool have greatest exposure. A22
* Q&A--Answers; to questions on the ramifications of county’s Chapter 9 bankruptcy filing. A24
* BOND MARKET--County’s bankruptcy action could set off panic selling, threaten its bond market activity. A24
* OFFICIAL RESPONSE--How city leaders are reacting to Orange County’s bankruptcy protection action. A25
* MARKET FEARS--County’s action may prompt problems for other teetering investors, financial analysts say. A25
* JAMES FLANIGAN--Behind it all lies newfangled graft and voters seeking government services on the cheap. D1
* THE FALLOUT--Wall Street fears that owners of government and muni bonds now will try to dump them. D1
County Seeks Protection
In a move that could have severe repercussions, the county Tuesday sought protection under Chapter 9 of the U.S. Bankruptcy Code. The step, which is expected to result in a lower credit rating for the county, may lead to a host of cost-cutting measures.
WHAT IS CHAPTER 9?
Only a municipality, such as Orange County, may file for this type of bankruptcy. Chapter 9 buys time for cities, school districts or other governmental agencies to work out ways to pay their debts.
WHY ORANGE COUNTY FILED
“There was no alternative given to us. We were concerned with the fact that we are here to protect the public and to protect the investors. And, of course, the county itself is 37% of this fund. Then, everybody walked. The bond dealers--they walked.”
--Harriett M. Wieder, county supervisor
WHAT IT MEANS
The filing could affect about 185 municipalities, school districts and other governmental entities that have invested billions of dollars in the county investment fund. All of them use their investments to raise money to meet their obligations, such as new construction, day-to-day services or loan payments. They also might not be able to borrow more money.
County Fund Investors
About 185 government agencies--schools, cities and special districts--have money in the Orange County investment fund. Money designated as being in the “bond pool” is kept separate because it is governed by specific rules regarding a trading practice known as arbitrage, an effort to profit by borrowing at one interest rate and investing at a higher one. Here is a partial list of investments as of Nov. 30. It does not include about $550 million borrowed by school districts and some individual investors:
Agency Commingled Pool County of Orange $2,555,620,144.87 Transportation Corridor Agencies 45,469,591.93 O.C. Employee Retirement System 133,368,133.21 O.C. Transportation Authority 533,214,927.34 O.C. Sanitation District $391,675,528.69 SCHOOL DISTRICTS Anaheim Elementary 8,195,095.54 Buena Park Elementary 4,372,602.99 Centralia Elementary 8,761,430.85 Cypress Elementary 6,781,785.21 Fountain Valley Elementary 5,652,274.37 Fullerton Elementary 5,135,978.87 Huntington Beach Elementary 6,964,640.68 La Habra Elementary 13,198,570.42 Lowell Joint Elementary 224,115.13 Magnolia Elementary 5,709,823.30 Ocean View Elementary 9,026,919.38 Savanna Elementary 3,502,369.38 Westminster Elementary 13,545,625.38 Anaheim Union High 19,393,555.70 Fullerton High 26,080,903.91 Huntington Beach High 22,576,957.13 Brea-Olinda 7,490,680.57 Capistrano Unified 74,977,478.92 Garden Grove Unified 55,533,788.92 Irvine Unified 105,816,239.05 Laguna Beach Unified 7,186,107.00 Los Alamitos Unified 12,526,409.33 Newport-Mesa Unified 82,402,832.16 Orange Unified 18,067,197.12 Placentia Unified 32,404,654.52 Saddleback Valley Unified 62,626,980.07 Santa Ana Unified 47,507,181.16 Tustin Unified 12,804,265.51 Coast Community College 21,706,393.84 North O. C. Community College 98,940,262.45 Rancho Santiago 16,762,391.36 Saddleback Community College 23,532,257.26 O. C. Department of Education 47,725,879.97 San Joaquin Elementary 1,548.82 Yorba Linda Elementary 47,480.34 Shandon Unified 178,411.17 Foundation Trust Fund 1,321,071.41 Community Facilities District 8 7,112,407.27 County School Service 21,461,375.56 Codesp Joint Powers Authority 262,157.50 Property and liability 196,395.81 Debt service 2,040,681.16 Special reserve 3,929,450.34 Public employees retirement 3,189.06 O. C. workers’ comp. insurance 6,900,645.06 Greater Anaheim Sp Ed GE 1,734,873.35 Schools Community Revolve 1,911,586.09 Teachers retirement annuity 7,722,207.34 Unapportioned school monies 1,366,588.68 S.A. Ins Compre Liab. 4,331,209.90 Capistrano Laguna Reg Off Prog 325,934.34 Payroll Revolve-Warr 145,921.06 Payroll Revolve-Chec 29,764,468.93 West Orange County Self Fund Work 8,949,311.84 South O. C. Prop/LIA Joint Powers 2,998,753.41 Orange County School District 1,127,253.43 Orange County fringe benefits 4,959,561.58 Schools excess 47,718,984.82 Area-wide school tax 67,192.25 School building aid 30.62 Schools total $1,043,512,338.57 CITIES Anaheim $169,568,734.31 Atascadero 5,082,641.04 Brea 10,880,402.71 Buena Park 28,953,542.12 Capistrano Beach 1,759,441.70 Claremont 5,377,923.54 Costa Mesa 7,149,035.00 Cypress 5,847,611.30 Dana Point 15,859,985.01 Fountain Valley 30,880,845.90 Fullerton 22,795,580.63 Garden Grove 5,451,587.24 Huntington Beach 48,605,050.26 Irvine 198,098,007.88 La Habra 8,170,628.52 La Palma 5,518,776.22 Laguna Beach 13,851,675.87 Laguna Niguel 18,089,331.91 Laguna Hills 916,934.35 Lake Forest 9,585,291.82 Los Alamitos 2,378,613.73 Milpitas 5,000,000.00 Mission Viejo 21,857,039.12 Montebello 47,106,000.00 Mountain View 39,783,094.99 Newport Beach 6,095,463.02 Orange 28,194,017.90 Placentia 20,685,505.00 San Clemente 35,834,956.04 Santa Ana 56,547,256.87 Santa Barbara 27,733,246.39 Seal Beach 2,060,644.82 Stanton 3,000,000.00 Tustin 183,570.98 Villa Park 1,282,297.02 Westminster 99,858.90 Yorba Linda 7,017,099.66 Cities total $916,903,671.77 WATER DISTRICTS Irvine Ranch $300,905,317.40 Orange County 118,418,944.24 Moulton Niguel 22,158,565.26 Santa Margarita 13,487,866.78 Aliso Water Management 13,150,774.79 Tri Cities 2,428,952.41 Capistrano Beach 2,307,829.65 Yorba Linda 2,645,124.75 South County 8,833,778.94 Municipal 4,531,304.24 Southern California Coastal 941,874.01 Water Research Coastal Municipal 1,232,734.65 Water districts total $491,043,067.12 OTHER DISTRICTS Bank of CA-PARS $16,253,042.77 Rossmoor Community Services District 711,361.40 Treasurer Community Facilities 729,592.82 District 90-1 729,592.82 Optima of Orange County 1,000,000.00 Cuyama Community Services District 1,186,153.65 Madera County Supt. Invest. 5,496,289.08 S.E. Reg. Reclamation Authority 7,312,198.52 SDIA Investments 1,132,412.88 Midway City Sanitary 3,977,189.61 Sunset Beach Sanitary 805,935.10 South Laguna Sanitary 11,471.34 Dana Point Sanitary 31.17 Volunteer Center of O. C. West 36,745.05 Capistrano Bay Community Services 30,370.76 Other districts total $38,682,794.15 TOTAL $6,149,490,197.65
Agency Bond Pool County of Orange $204,859,991.48 Transportation Corridor Agencies 296,294,198.03 O.C. Employee Retirement System O.C. Transportation Authority 559,733,372.30 O.C. Sanitation District $49,311,044.51 SCHOOL DISTRICTS Anaheim Elementary Buena Park Elementary Centralia Elementary Cypress Elementary Fountain Valley Elementary Fullerton Elementary Huntington Beach Elementary La Habra Elementary Lowell Joint Elementary Magnolia Elementary Ocean View Elementary Savanna Elementary Westminster Elementary Anaheim Union High Fullerton High Huntington Beach High Brea-Olinda Capistrano Unified Garden Grove Unified Irvine Unified 1,961,245.96 Laguna Beach Unified Los Alamitos Unified Newport-Mesa Unified Orange Unified Placentia Unified Saddleback Valley Unified Santa Ana Unified Tustin Unified Coast Community College 2,555,730.02 North O. C. Community College Rancho Santiago Saddleback Community College O. C. Department of Education San Joaquin Elementary Yorba Linda Elementary Shandon Unified Foundation Trust Fund Community Facilities District 8 County School Service Codesp Joint Powers Authority Property and liability Debt service Special reserve Public employees retirement O. C. workers’ comp. insurance Greater Anaheim Sp Ed GE Schools Community Revolve Teachers retirement annuity Unapportioned school monies S.A. Ins Compre Liab. Capistrano Laguna Reg Off Prog Payroll Revolve-Warr Payroll Revolve-Chec West Orange County Self Fund Work South O. C. Prop/LIA Joint Powers Orange County School District Orange County fringe benefits Schools excess Area-wide school tax School building aid Schools total $4,516,975.98 CITIES Anaheim Atascadero Brea Buena Park Capistrano Beach Claremont Costa Mesa Cypress Dana Point Fountain Valley Fullerton Garden Grove Huntington Beach Irvine La Habra La Palma Laguna Beach Laguna Niguel Laguna Hills Lake Forest Los Alamitos Milpitas Mission Viejo Montebello Mountain View Newport Beach $13,631,537.16 Orange Placentia San Clemente Santa Ana 94,211,999.52 Santa Barbara 11,780,015.49 Seal Beach Stanton Tustin Villa Park Westminster Yorba Linda 6,487,112.83 Cities total $126,110,665.00 WATER DISTRICTS Irvine Ranch Orange County Moulton Niguel $25,017,352.35 Santa Margarita 184,898.62 Aliso Water Management Tri Cities Capistrano Beach Yorba Linda South County Municipal Southern California Coastal Water Research Coastal Municipal Water districts total $25,202,250.97 OTHER DISTRICTS Bank of CA-PARS Rossmoor Community Services District Treasurer Community Facilities District 90-1 Optima of Orange County Cuyama Community Services District Madera County Supt. Invest. S.E. Reg. Reclamation Authority SDIA Investments Midway City Sanitary $2,057,712.34 Sunset Beach Sanitary South Laguna Sanitary Dana Point Sanitary Volunteer Center of O. C. West Capistrano Bay Community Services Other districts total $2,057,712.34 TOTAL $1,267,886,210.61
Source: County of Orange
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