County to Fight Sale of $9 Billion in Collateral

Orange County plotted a legal fight Thursday against Wall Street firms that have unloaded nearly $9 billion in bonds being held as collateral for loans to the county, as officials named a former state treasurer to advise the county on navigating its financial crisis.

News of the bond selloff touched off a new round of fears that the county’s financial situation was more dire than suspected, and that losses in its investment pool--which the county already has said was down $1.5 billion--may have deepened.

If the securities sales are upheld in federal court, the impact could be devastating to the more than 180 cities, school districts and other agencies that have invested about $7.5 billion in the pool.

“We are seeing a lot of hysteria on Wall Street,” said county Supervisor William G. Steiner. “We’re taking actions to address that.”

Indeed, after several days of seeming paralysis over the financial crisis that forced the county into Bankruptcy Court this week, local government leaders went on the offensive Thursday. The county:

* Authorized its counsel to file a federal lawsuit against several brokerage firms that this week sold securities they held as collateral for loans to the county--many of which were dumped on the financial markets Thursday. No suit was filed, however.

* Named former state Treasurer Thomas W. Hayes as the county’s financial adviser. Hayes served as Gov. Pete Wilson’s finance director for two years.

* Imposed a hiring and salary freeze on county workers and at least temporarily stopped paying county vendors. Many of those who are not being paid were furious over the latest developments. “If you are expecting a payment, checks are not being released today,” county workers recited to vendors from a prepared script.

* Set up a separate, low-risk fund for all the property tax money that landowners must pay by Monday. Those billions of dollars are expected to keep the county and its investors afloat.

* Sent Chief Administrative Officer Ernie Schneider to calm fears at a closed-door meeting of city managers and finance directors from across the county. Schneider was unable to say whether cities will get their money from the county’s investment pool, which has plunged at least 20% in value since January.

“I told them it was too early to make a decision,” Schneider said after the meeting, walking quickly toward his car. “We will involve them in the decision-making process. We are all in this together.”

Meanwhile, The Times learned that the county’s auditor warned top officials last year that then-Treasurer-Tax Collector Robert L. Citron was making “risky and unusual transactions” in violation of safeguards designed to keep his investments safe.

As the county sought to halt the financial spiral, the governor made his first significant public comments about Orange County’s bankruptcy. In Sacramento, Wilson said he is sympathetic to Orange County--but does not expect the state to provide any monetary relief.

“The state is eager to be helpful,” Wilson said. “But we are not in a position where we can bail out bad judgments.”

Without state help, county officials turned to Washington, D.C., on Thursday, asking U.S. transportation authorities to advance some of next year’s federal highway funds for use right away.

In Santa Ana, attorneys filed class-action lawsuits Thursday on behalf of bondholders, alleging that the county falsely represented its investment strategies. Named as defendants were Citron, other county officials and Merrill Lynch, which holds $2 billion of the county’s securities as collateral for loans that allowed Citron to boost his ill-considered bets in the financial markets.

The state Department of Corporations announced that it will investigate the relationship between Merrill Lynch and the county treasurer’s office and review the events leading up to the county’s bankruptcy filing for possible violations of state law.

The Securities and Exchange Commission, which first visited the county treasurer’s office in February to examine the portfolio, is trying to determine whether there were possible misrepresentations connected with the investment fund, according to sources familiar with the SEC inquiry. The Orange County district attorney’s office is also reviewing the situation.

Meanwhile, Orange County Superior Court Judge Michael Brenner, who advises the county grand jury, said that the panel contacted him this week, after the bankruptcy was filed, to “explore their options” in a possible investigation of the county’s financial trouble.

On Thursday, school district superintendents and finance officials met in secret to plot strategy for the first time since the financial crisis began and were briefed by legal experts on bankruptcy and bonds.

The meeting was just one of a stream of closed-door sessions held this week by the host of government officials who have been grappling with the nation’s largest municipal financial disaster.

Officials have said they are exempt from the state’s open government meetings law because the sessions are held to discuss pending litigation. But one attorney erupted at the County Board of Supervisors’ now-daily session, chiding members for conducting business behind closed doors and urging all five to resign immediately.

“Sooner or later, you’re going to have to come out here and face the people and admit your lack of leadership in this matter,” said Stephen Johnson, 48, as the board convened early Thursday only to immediately adjourn to another closed session. “You can’t keep going back in that room and hiding.”

Supervisors had spent the day wrestling with the swift succession of brokerages that followed the lead of CS First Boston, which Tuesday sold into the market $2.6 billion in U.S. government agency bonds it held as collateral for loans to the county fund. The sale followed the county’s failure to make $1.2 billion in loan payments that had come due.

Together, seven Wall Street firms this week have liquidated nearly $9 billion of the $12.5 billion in bonds the county had purchased on credit, hoping to boost its interest income. The sales of collateral came after the county failed to make payments due on its loans.

With each collateral sale, the brokerages are believed to have covered their loans--but in the process they may have eaten deeply into the $7.5 billion that government agencies invested in the Orange County pool. That is because the bonds originally pledged as collateral on the loans have tumbled in value this year, meaning that the brokerages needed to sell more of them to cover their loans.

County officials who last week said the pool’s value had declined $1.5 billion since Jan. 1 refused Thursday to put a value on the fund.

First Boston’s action prompted the county to seek federal and state bailouts before reluctantly settling Tuesday on filing for protection under Chapter 9 of the federal Bankruptcy Code. Such a filing is so rare that fewer than 10 cities, villages or counties sought such protection between 1980 and 1990.

The county also defaulted Thursday on a $110-million pension fund bond that came due. The bonds were sold by First Boston in September and included a special provision that allowed investors to demand their money back with only seven days notice. That demand came last Thursday, when the first signs of Orange County’s impending financial failure were announced. County spokeswoman Sandra Sternberg said the effect of the default on county pension funds was unclear.

The collateral sales will provide a crucible for testing how Chapter 9 works.

Lawyers for the county and the Wall Street firms staked out contradictory positions on whether the brokerage houses were allowed to sell the securities they were holding as collateral on Orange County’s loans.

The brokerages declined to discuss their legal positions beyond saying that they believe they are within their rights in selling the collateral.

Bruce Bennett, the county’s $375-an-hour bankruptcy attorney, also would not provide specifics, saying only that he believes many of the county’s investments are sheltered under Chapter 9’s provisions for an automatic stay of such sales.

Hugh Ray, chairman of the American Bar Assn.’s business bankruptcy committee, said Chapter 9 lacks a specific exemption from the stay for complex transactions--known as reverse repurchase agreements--which were prevalent in the county portfolio. But he said that may be an oversight, and that such transactions probably are allowed under Chapter 9.

In the municipal bond market, Wall Street traders said the prices of Orange County bonds improved sharply Thursday from Wednesday, when a few bidders were offering 50 to 60 cents on the dollar for the bonds.

Traders said bids on Orange County and related bonds were in the range of 80 to 85 cents on the dollar, though they said few bond owners were selling at those prices.

Meanwhile, some traders said San Diego County bonds dove in price Thursday as worries mounted about the health of that county’s investment fund.

Overall, California municipal bond fund share prices, reflecting portfolios that include all types of California bonds, fell for a second day Thursday, but by minor amounts compared to Wednesday’s sharp losses.

The elements of the county’s repair plan were announced throughout the day Thursday.

Hayes, the former state treasurer, would oversee the restructuring of the investment portfolio for the next 90 days. The county also said that it had dismissed New York-based Capital Market Risk Advisors and hired Salomon Bros., a leading New York investment bank, as its new financial adviser.

Hayes will report directly to the board. At the briefing, he said he was “strongly urged by Gov. Wilson” to take the job.

“We are fortunate to have a person of Tom Hayes’ reputation, and a firm of Salomon Bros.’ experience, to steer us through this current financial situation and help set the course for the county’s return to financial stability,” Board of Supervisors Chairman Thomas F. Riley said.

Hayes said this is the worst crisis he has seen during two decades in public service, adding that Thursday’s actions by the Wall Street banks to cash in collateral would make “it more difficult to maneuver.”

“We’re going to do the best we can with what’s left and try to preserve as much capital as we can,” he said. “I would have preferred that they had not done that. But they have done that, and now it’s a case for the courts to decide.”

Hayes confirmed that at least two investment banks had made collateral calls Thursday, but neither he nor any other county official would disclose how much the county fund has lost.

“To the degree that there is a loss, there’s going to be financial pain,” Hayes said.

The county’s ongoing cash flow--including payroll and disbursements to pay vendors for service--will go through the treasurer’s office. Hayes said he will handle only oversight and restructuring of the portfolio.

“Hopefully, it is solvable inside of a year,” Hayes said of the largest municipal bankruptcy in U.S. history. By the end of his 90-day term, he added, “hopefully, we’ll have our arms around it.”

But that was little comfort to small vendors such as Sandy Schroeder, who learned Thursday that the county would not be paying them anytime soon.

“They owe us $4,010.13!” said Schroeder, co-owner of Datron Peripherals, a three-person company in Fountain Valley that supplies computer accessories to John Wayne Airport and the Orange County Sheriff’s Department.

“Obviously, I’m not going to do anymore business with them,” she said.

Also on Thursday, the League of United Latin American Citizens wrote to U.S. Atty. Gen. Janet Reno, asking her to convene a federal grand jury for a criminal investigation.

“We have no effective local means to analyze practices of our own county money-changers,” said the letter, which was signed by the group’s state director of urban affairs, Art Montez. “We have been signaling our grave concern about the bent political and economic power structure in Orange County for years.”

* BANKRUPTCY COVERAGE: Related Orange County stories inside. A24-A27, D1, D3

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Thursday’s Developments

Here are the latest developments in the Orange County bankruptcy filing:

* County audit: It was learned that Orange County auditors concluded in 1993 that then-Treasurer-Tax Collector Robert L. Citron violated state government codes to maximize the returns on the county’s investment fund. County elected officials received the report 15 months ago.

* Citron reaction: In his first interview since resigning Sunday, Citron denied allegations of misconduct.

* Lawsuit planned: County supervisors authorized their lawyers to file a federal lawsuit against four Wall Street brokerages that this week have sold billions of dollars in securities they held as collateral for loans to the county. No suit was filed, however.

* New adviser: Former state Treasurer Thomas W. Hayes was named as the county’s financial adviser.

* County freeze: The county imposed a hiring and salary freeze for county workers and at least temporarily stopped paying its vendors.

* Property taxes: Officials directed that property tax money due by Monday be deposited in a low-risk fund instead of the county’s beleaguered investment pool, which like the county filed for bankruptcy protection this week.

* State reaction: Gov. Pete Wilson said he was sympathetic to Orange County--but does not expect the state to provide any monetary relief. “We are not in a position where we can bail out bad judgments,” Wilson said.

* Class-action suits: Attorneys for bondholders filed class-action lawsuits alleging that the county falsely represented its investment strategies.

* State inquiry: The state Department of Corporations announced it will investigate the relationship between Merrill Lynch, one of the county’s chief financiers, and the county treasurer’s office.

* School plans: School district superintendents and finance officials met in secret to plot strategy.

* Gifts: Investment bankers for years showered the county’s elected officials and staff with expensive gifts in hopes of winning a piece of its lucrative bond business.