Orange County’s investment fund went from $7 billion to $20 billion--then dropped. Where did the money go? Here is a review of the lending cycle that led to the current fiscal crisis, and a roundup of what the fallout may be.


Orange County figured that interest rates would continue to fall. They didn’t. Breaking down Orange County Treasurer-Tax Collector Robert L. Citron’s investment strategy to a basic level, here’s what happened:

1) Towns, schools districts and other agencies contribute to an investment fund, using proceeds from municipal bond offerings.


2) Citron invests the money in such things as government bonds. For $1 million, for example, he buys a bond that would pay the fund, say, 6% interest.

3) He then offers that $1 million bond as collateral to an investment banker such as Merrill Lynch, which gives him about $1 million more to invest.

4) Now, collecting interest on two bonds--purchased with his original $1 million and the borrowed $1 million--he has increased the payout of interest beyond the initial 6%. He assures the Orange County Board of Supervisors that the county is getting outstanding returns on investments.

5) Storm clouds form as bond interest rates charged by lenders begin to rise. Now every one to three months or so, Citron has to pay a higher rate on his loans.

6) Soon, the interest rate he is paying on his loans approaches what he is being paid on the bonds purchased earlier, thus slashing his investment return.

7) Meanwhile, the value of the bonds is dropping as interest rates jump. The bankers come to him and say those bonds, which he used as collateral to buy other bonds, are not enough to support the loans. They demand additional money to back them up, and that threatens to deplete the county’s cash balance.



County officials and a bankruptcy attorney sought to calm the fears of investors, employees and government agencies.

* A top county official said a tax increase is not being considered.

* Bankruptcy began having a practical effect. Cities halted projects and moved to limit spending.

* Legality of bankruptcy filing faced potential challenges from Wall Street and a home-grown taxpayer group.

* Municipal bond markets nationwide were shaken as investors feared troubles like those in Orange County could show up elsewhere.

* Federal Reserve Board governor said the central bank is closely tracking the Orange County crisis to weigh the chances of a breakdown in the financial system.

* Government officials around the country re-examined their own investment portfolios for similar problems.


* Orange County’s credit rating sank from top-notch to poor and a default risk.

* Commodity Futures Trading Commission chief said agency will step up policing of exotic investments, called derivatives, that were traded by Orange County.

* Federal Reserve Board Chairman Alan Greenspan testified that problems associated with derivatives are “a necessary price that we have to pay for a valuable addition to our financial system.”


Officials connected with various proposed and existing projects around the county acknowledge the possibility of major obstacles but for now they’re reserving judgment:

* Toll roads: Transportation Corridor Agencies, which is building three toll roads in Orange County, says projects appear to be safe in the short term but uncertainty and fear color the long-term picture.

* Westcot: Walt Disney Co. officials say it is too soon to comment on the future of their proposed Disneyland expansion but they remain optimistic.

* New baseball stadium: Anaheim officials say they will continue to negotiate with the California Angels on extending their lease and building a new stadium.


* New football stadium: Save The Rams organization claims new stadium for the Rams, whom they are trying to keep in Orange County, is still possible but would have to be largely dependent on private funds.

* Jails: Sheriff spokesman says too early to tell if future construction projects will be jeopardized.

* Orange County Transportation Authority: Officials say there are no plans to scale back bus service or halt any of the agency’s freeway construction projects, including the El Toro Y reconstruction. But problems would occur if money is frozen long-term in the county investment fund.



Officials said Wednesday they felt reassured that the bankruptcy filing would stabilize the county’s financial situation without jeopardizing their day-to-day operating funds, and that they expect their employees to be paid as normal. But at least one school district, Laguna Beach Unified, may consider joining the county in filing for bankruptcy protection. School officials have had little direct contact with the county treasurer’s office, and instead are being briefed by the county Department of Education, where they will meet this afternoon. Many individual districts are consulting bankruptcy and bond experts. California School Boards Assn. and the state Department of Education have also been asked to help.

County bondholders

Chapter 9 proceedings specifically protect the income promised to certain types of bondholders. Best off are holders of revenue bonds. Income pledged to pay interest and principal on these bonds must be paid directly to bondholders. The funds cannot be taken by the county to pay other bills. General obligation bond holders become general unsecured creditors--they get paid after county employees, some suppliers, bankruptcy attorneys and federal debts. There may be some delay and possible reduction in interest payments on some issues, but experts maintain that outright default would be a last resort.


Most officials say they have enough money to meet immediate payrolls, purchase supplies and honor obligations to vendors but worry about the future, especially if their money remains frozen for long in the investment pool. Anaheim on Wednesday halted planned capital improvement projects and initiated an immediate hiring freeze. Santa Ana’s day-to-day operations are not affected, but officials worry about the possible impact on such projects as a $100 million new city jail and police administration building, now under construction. And officials in several cities, including Huntington Beach, are concerned about whether they will continue to receive property tax disbursements scheduled for later this month. Other cities were more sanguine. Irvine City Manager Paul Brady says his city has enough liquidity to cover all operating expenses for three years.


County retirees

Payments to the county’s retired workers will be made on time, officials say. Bruce Bennett, the county’s bankruptcy attorney, said definitively that all day-to-day operations, including retirement payments will continue. “The checks that are out there now are going to clear,” Bennett said. “ . . . The retirees are going to be paid, and their checks are going to be clear.”


County officials say there will be no interruption in services or tax increase. Bankruptcy filing will enable officials to find sensible solutions for the county’s investment problems, while maintaining all day-to-day services, they say. “The filing is strictly related to the financial issue at hand, the bonds,” said Sandy Sternberg, county spokeswoman. “We have other revenue. . . . Government as usual is the best way to describe it.” Taxpayers still must pay their property taxes, which must be postmarked by 5 p.m. Dec. 12 to avoid a late penalty. That is an extension of two days because the normal deadline, Dec. 10, is a Saturday. County employees jobs are safe and they will be paid on time, say county officials. “People are going to be paid. You’ve got to get that out there,” Sternberg said. “The county’s got money. People are going to get paid. Services are going to continue. The average guy out there isn’t going to notice the difference.”

County vendors

County vendors who receive regular payments from the county will be paid on time, said Bennett.