BLINDSIDED / ORANGE COUNTY’S FINANCIAL CRISIS : What Now? : Experts on finance and government provide prescriptions for change and lessons for the future. : Finance

The Issues: Orange County’s losing bet on high-risk investments is considered an anomaly of municipal finance not because others don’t use the same techniques--they do--but because Orange County’s wager was so big.

But the county’s fiasco still calls into question how municipalities raise and invest their cash, and probably will lead to calls for reform.

Many municipal funds nationwide are stodgily run and conservatively invested in low-risk government securities. Nonetheless, should there be limits on municipalities’ use of derivatives and other exotic financial instruments?

Should treasurers be required to frequently make public the current value of their investments--what’s known as “marking to market”--even though their investments don’t mature for years? Mutual funds, for instance, already do that.

Finally, the Orange County debacle is partly blamed on the county’s inability to substantially raise taxes, which led the county to seek bigger returns with its high-risk investment strategies. Are there other revenue-raising alternatives?

*

Felix Rohatyn

Senior partner at the investment firm Lazard Freres & Co. Rohatyn played a key role in helping New York City recover from its fiscal crisis in the mid-1970s:

Rohatyn opposes a ban on municipalities’ use of derivatives or financial leverage--the use of borrowing in search of higher returns. But municipal treasurers must be more cautious, he says.

“When you’re investing taxpayer funds as a matter of normal practice, you want to invest those funds, (not) speculate with them,” Rohatyn says.

Rohatyn is against municipalities using leverage--a view that he admits is extreme. Lacking a ban, you should “certainly limit the amount of leverage,” he says.

The funds also should regularly mark to market. “If a mutual fund can do that every day, I don’t see why a municipality using billions of dollars of taxpayer money can’t do the same thing.”

Rohatyn also says using high-risk strategies is no substitute for a municipality’s reluctance to raise taxes, or its voters’ reluctance to approve new taxes. “If you’re so tight with respect to your budgets that you’re having trouble making ends meet, the last thing you want to do is speculate with the funds you do have.”

*

George L. Argyros

a leading Orange County real estate and industrial executive and head of Arnel & Affiliates in Costa Mesa:

Argyros agrees that for any person responsible for public funds, “your primary responsibility should be to protect principal and not try to maximize yield. The priority should be on making safe investments.”

In Orange County, treasurer-tax collector is “an elected office, and there wasn’t enough overview. Nor was there an outside, independent board of advisers--call it what you want--to make sure there were some checks and balances in the system.”

But Argyros says he is not a proponent of marking to market each day, or even each week. That would create such a focus on short-term changes in the funds’ values that treasurers would lose sight of a steady, long-term investment plan, he says.

And using derivatives or other leverage is no way to make up for a lack of tax revenue, he says. “All of government has a problem cutting down and making the tough decisions. The issue is not to tax more. The issue is to do more with what you’ve got and be more efficient.”

As for the cash a municipality does have, “certainly never speculate” with it, Argyros says. “That is just uncalled for.”

*

William E. Straw

A principal with Stonebridge Partners, an investment banking and financial services firm in Brentwood that advises municipal clients:

Straw opposes banning municipal use of exotic financial techniques because there are “some hedging concepts that do make sense for some of these treasurers. But they need to be very conservative. Their responsibility is to protect (their funds’) principal and earn money for their constituents.”

Municipal investment pools should be marked to market “if not daily, certainly no less than monthly,” Straw says. “There should be a public posting of the status.” In Orange County’s case, he says, “it was public information, but it really wasn’t made public, it wasn’t publicized. If they published once a month the status of the accounts, at least someone would have the ability to see the changes.”