Warning Came Too Late for Precarious Fund : Crisis: Citron aide saw danger and threatened to quit. Bankruptcy move followed county’s frantic bailout search.

It was a defining moment in what would become the county’s worst financial crisis. In early November, Orange County Assistant Treasurer Matthew Raabe met with his since-departed boss, Robert L. Citron, and threatened to resign.

County officials said Wednesday that Raabe was worried about Citron’s management of the gigantic bond portfolio that contained billions of dollars invested by more than 185 municipalities and government agencies. Raabe feared a cash flow crisis, and he thought the pool was in serious jeopardy.

Just a few days before, the Irvine Ranch Water District had sent the county treasurer a letter expressing similar concerns about the bond portfolio. Citron did not flinch. It was as if he was in denial, official sources said.

The unraveling had clearly begun. On Tuesday, county government--its options apparently exhausted and its financial SOS to the state and the Clinton Administration unanswered--filed for the largest municipal bankruptcy in United States history.

The fateful decision to seek protection under Chapter 9 of the U.S. Bankruptcy Code was reached after a long and frustrating attempt by county leaders, attorneys and major investors to salvage the bond portfolio.

“We were just trying to hang in there and make a bad situation better and get some control of it,” Steven E. Lewis, the county’s auditor-controller, said of the effort to cope with financial crisis. “We went everywhere looking for help. In the end, I don’t think we had much choice.”

Raabe’s threat to resign was a watershed event for county officials, who shortly thereafter began to take seriously the prospect that Citron’s aggressive investment strategy had placed investors and local governments squarely in harm’s way.

Citron and Raabe, sources said, met with County Administrative Officer Ernie Schneider to discuss the pool’s problems. Schneider formed a management team of county officials to review the status of the $20-billion portfolio. Then, during the first few weeks of November, Schneider individually briefed members of the county Board of Supervisors and revealed that the fund had liquidity problems.

Neither Citron, Schneider nor Raabe could be reached for comment Wednesday night.

In interviews this week, county supervisors all said they had no idea how severe the bond portfolio’s troubles were until the weekend before the bankruptcy petition was filed.

“The speed with which these events have transpired is of shocking proportions,” said County Supervisor Gaddi Vasquez. “It’s a difficult challenge that we now face. My reaction was of tremendous shock.”

Citron’s investment strategy relied heavily on using the investment pool’s U.S. Treasury bills, notes and bonds as collateral to borrow short-term at low interest rates, and investing the borrowed funds in mid-term corporate bonds and securities that pay a higher rate of return.

The strategy could yield large returns while interest rates remained low and stable. But it could backfire when interest rates rise, as they have since the first of the year. When interest rates go up, bonds and securities purchased when there were lower interest rates lose value.

Orange County’s problem is magnified because Citron leveraged the fund almost 3 to 1, by putting up $7.5 billion in bonds as collateral for loans that enabled him to buy $20 million worth of bonds.

Citron has admitted that he did not foresee, as other investors have, the rapid increase in interest rates this year by the Federal Reserve Board, which has been concerned about the prospect of inflation as the economy continues to expand.

But according to his next-door neighbor, Dan Miller, Citron still defends his actions as county treasurer. “I have nothing to be ashamed of,” Miller quoted Citron as saying. “I did nothing wrong. And I’m feeling pretty comfortable with myself.” Miller said Citron told him he could repeat the comments to the news media.

In mid-November, the outlook for the fund worsened when the Federal Reserve Board raised interest rates 0.75%. The move prompted one fund investor, Peer Swan, the president of the Irvine Ranch Water District, to ask Citron to pay out $100 million of the $400 million his agency had put into the pool.

This triggered further scrutiny of the fund’s cash position. The review discovered that the portfolio’s cash balance had dropped rapidly from $2.2 billion during the months before to $350 million by Nov. 30.

Dec. 1, rumors swept through Wall Street that the county’s investment pool was suffering from cash flow problems. The unfounded reports sent shock waves through the financial markets where municipal securities are traded.

Before day’s end, county officials disclosed that the investment pool containing $20 billion worth of bonds and securities had plunged in value at least $1.5 billion--more than 20% of the pool investors’ total stake. Raabe and Citron were adamant that the fund investors could ride out the downturn if they stuck together.

In the week since the staggering drop in value was revealed, Orange County officials, investors and financial advisers frantically worked to stave off the worsening financial situation.

Top county administrators and members of the Board of Supervisors held marathon meetings to unravel the situation and sort out their options. They have been awakened in the middle of the night by sheriff’s deputies to attend special closed-door sessions to figure out what to do as the financial crisis deepened.

Lewis said that during one stretch he worked 35 hours straight. Others have put in longer hours, like Raabe, who was appointed Citron’s temporary replacement after the treasurer resigned and who reportedly toiled four days with little rest. “We have been working day and night,” Lewis said. “It has been a killer as far as the amount of work.”

Over the weekend, investigators from the federal Securities and Exchange Commission pored over the portfolio’s books and contemplated appointing a receiver for the fund. Vasquez said the Securities and Exchange Commission consulted with former Gov. George Deukmejian about the possibility of being the county’s receiver.

On Sunday, the crisis had become too much for Citron to bear. He offered to resign. One county official said that Schneider personally drafted Citron’s resignation letter and drove to his house in Santa Ana to have him sign it.

According to the source, Citron “broke down.”

Bert Scott, head of the county’s General Services Agency and a close friend of Citron, visited Citron after his resignation. “He’s doing considerably well under the circumstances,” Scott said. He is “going through a healing process. That might take a little time.”

On Monday, Citron’s departure was made public. That same day, the SEC told the county it would not get involved in a receivership. At that point, the county made pleas to state and federal representatives to help them solve their liquidity problem.

“We went to the state and even the Clinton Administration,” Lewis said. “They didn’t do enough.”

Later that day, county officials worked behind the scenes trying to decide whether to sell the entire bond portfolio, albeit at a tremendous loss. The county shopped around for a number of Wall Street firms to do it.

“You can’t imagine the pressure we were under,” County Supervisor William G. Steiner said, referring to the proposed liquidation of the fund.

Steiner and Supervisor Roger R. Stanton were concerned about liquidating the fund without consulting with investors in the portfolio. While the county found a firm interested in liquidating the entire fund, officials were busy consulting with some of the larger investors.

“There was a whole big room full of people in New York City with computers ready to go and sell it in five minutes,” said Steiner. “It was a huge decision for us to make.”

The county decided not to sell when it could not determine how much the investment was worth. It appeared that the only option left was bankruptcy.

At 3 a.m. the next day, sheriff’s deputies and county officials rousted the Board of Supervisors from their sleep for an emergency briefing to deal with a growing default situation.

While board members met in closed session throughout the day, Orange County defaulted on 10 to 12 loans used to buy bonds in the fund. CS First Boston, a Wall Street investment bank, and other Wall Street firms then seized about $2 billion in bonds and put them on the market.

The Wall Street firms had made loans to the fund, which were secured by bonds and holders of the county’s municipal debt. Lenders can look to their collateral for repayment if defaults occur.

County Supervisor Thomas R. Riley said officials were left with no choice after a number of investment bankers declined to roll over or renew $1.2 billion of existing financial instruments called reverse repurchase agreements. The action resulted in a default of the agreements with the county.

“We didn’t know where we were going. We didn’t know whether we were going to be able to operate the county in a manner that would be acceptable to us.”