O.C. to Liquidate Its Portfolio : Bankruptcy: Judge approves action to prevent further losses. Overseer says fiscal mess ‘is going to be a problem for a number of years,’ but county ‘can get out of it.’

SANTA ANA — Orange County plans to unload its entire portfolio of risky securities as part of a massive overhaul of the county’s debt-laden investment pool, whose participants have lost $2.02 billion--or 27% of their investment--this year, the county’s financial advisers announced Tuesday.

“There was a bet made on the interest rates, and the county lost the bet,” said former state Treasurer Thomas W. Hayes, who is directing the county’s efforts to unravel the financial mess. “What happened is going to be a problem for a number of years to come. Orange County can get out of it, (but) it will be painful.”

Over strong objections from several city and school officials, U.S. Bankruptcy Court Judge John E. Ryan ruled Tuesday that the county can begin selling off its troubled bond holdings. The ruling remains in effect until Friday, when another hearing is set to reconsider the matter.

The county’s bankruptcy lawyer, Bruce Bennett, had argued that a liquidation had to begin for the county to avoid further losses should interest rates rise higher.

According to Salomon Bros., the county’s financial advisers, each percentage point increase in interest rates will trim the portfolio’s value by $300 million.

In other developments Tuesday in the biggest municipal bankruptcy filing in U.S. history:

* Several members of the public, in their first opportunity to address the Orange County Board of Supervisors, blamed the board for the financial crisis. “The fingers should be pointing at all of you,” said Linda Johnson of Dana Point. “You’re incompetent, you’ve been negligent and I think you all should resign.”

* City and school district officials with funds tied up in the frozen investment pool took steps to curb spending. The Irvine Unified School District imposed a hiring freeze and delayed construction projects. In Brea, officials postponed groundbreaking on a $7-million community center. And Huntington Beach indefinitely postponed construction of a restaurant at the end of the city’s famed pier, a project in the planning stages for three years.

* County officials put off plans for an $82-million communication network that police consider a vital update of the county’s antiquated system. It was the first big-ticket item to land on the county’s casualty list.

* Maureen DiMarco, California’s secretary of child development and education, assured the teachers, school officials and parents of Orange County that despite the county’s budget crisis, schools will remain open, all employees will be paid and “business will continue as usual.”

* Richard Marshack, a bankruptcy attorney representing several school districts, said his clients should receive all of their money and not absorb any losses because schools are required by state law to deposit their money in the county treasury and had no say in its investment policy. County officials, however, have suggested that the losses be distributed equally among all investors.

* Gov. Pete Wilson said he had no sympathy for five school districts and agencies that took the extraordinary step of borrowing money to invest in the county pool. “That’s like taking the milk money and playing bingo with it,” he said.

* Lawmakers in Sacramento and Washington called for hearings into Orange County’s crisis and ways to deter other local governments from making such high-stakes investments with the public’s money.

* The Federal Transit Administration announced that $8.8 million should arrive by week’s end--a five-month advance on next year’s transit funds for Orange County. The money will pay for bus and rail operations for the next 100 days.

Wall Street reacted cautiously to the potential liquidation of the county’s remaining portfolio, which holds the savings of 187 government agencies and a number of individuals who were awarded damages in lawsuits. Most bond dealers said finding buyers for the more complicated securities won’t be impossible, but that potential buyers will demand attractive returns to accept the securities.

A picture of the troubled portfolio emerged in greater detail Tuesday, as Hayes laid out the financial predicament and said the immediate goals are to improve Orange County’s liquidity, remove the risk from the portfolio and replace long-term securities with more short-term investments.

The Board of Supervisors followed up with two specific actions. It formally hired Salomon Bros. to manage and help restructure the fund, now valued at $5.4 billion. And the board agreed to free up previously “restricted” county funds--emergency surplus money--to help out the current cash crunch.

“This will enable us to have more flexibility in moving county dollars to critical areas during this bankruptcy process,” said County Administrative Officer Ernie Schneider.

During a news conference, Hayes said “there was still considerable risk” in the county fund. He added that the county’s liquidation would be conducted in “an orderly fashion.” Stressed Hayes: “It’s not a fire sale.”

Despite the turmoil, Hayes said the county retains “an underlying strength” of job growth, low unemployment rate and high household income.

“I want to urge all of you: It is important we don’t panic,” Hayes said. “There’s a diversified economy, and . . . basically, you have good people in this county.”

In federal Bankruptcy Court on Tuesday, city managers and school district officials objected to the county’s plan to sell any of its $5.4 billion in securities that remain.

One attorney who represents Brea and Buena Park said her clients had “been kept in the dark the entire time.”

“It’s remarkably cavalier of the county to waltz into court and say that the wishes of the smaller investors must all be pushed aside,” said attorney Nanette Sanders.

Bennett, the county’s bankruptcy lawyer, urged Judge Ryan to approve the plan during the Santa Ana hearing.

“If we do nothing, the casino stays open and the dice will keep rolling,” Bennett said. “This court needs to help us close the casino and put the dice away and start dealing with the substantial problems.”

Ryan said he would not do anything to “undercut the county’s ability to get control of the situation. It’s important that what happens here reinforces a positive market perspective.”

The hearing was the first since the county filed for federal bankruptcy protection on Dec. 6.

An analysis of the county’s investment portfolio by Salomon Bros. provided the most comprehensive look yet at how much the county’s holdings have deteriorated since early this month, when county leaders announced the investment troubles.

Structured notes--exotic securities that are likely to be the hardest holdings to sell--now comprise 60.1% of the pool, up from 47% as recently as a week ago. The probable explanation is that investment bankers sold a large share of the pool’s better-grade securities as they redeemed their collateral last week on unpaid loans to the county.

Salomon officials said the average maturity of holdings in the pool is now about four years, sharply higher than the 2 1/2 years reported by former county Treasurer-Tax Collector Robert L. Citron as recently as September. Portfolios tend to be much more sensitive to fluctuations in interest rates as their maturities lengthen; with rates going up, the value of longer-term securities tends to get pummeled. County officials said they hope to slash the average maturity to less than six months.

Hayes and William D. Rifkin, a Salomon managing director, hinted in an interview that investment firms that dumped the county’s holdings onto the market last week may not have gotten the best price for them.

They said the more conventional securities among the holdings were currently valued at 95-96% of their face values, but that the investment firms sold the county’s collateral at an average of only 90%. Rifkin later declined to say specifically that the firms had undercut the market, but he did note: “Clearly they sold the securities quickly.”

Residents Angry

The emerging financial fallout has angered many citizens, some of whom addressed the board at Tuesday’s meeting, the first public session to address the situation.

“You were negligent,” Tustin attorney Stephen Johnson told the supervisors. “What won’t work is the current board. Stop blaming others.”

Teddi Alves, a local broker, directed her outrage at Ernie Schneider, the county’s top administrator. “I’m not here to shoot fish in a barrel, but I think there should be layoffs and they should start with you, Mr. Schneider,” she said.

The supervisors split up the tasks of trying to repair the county and assess the damage. Supervisor William G. Steiner met with directors of nonprofit organizations who do business with the county and have outstanding county bills that need to be paid. Steiner said he would support appointing accountant John M.W. Moorlach, Citron’s opponent in the June election, to become treasurer.

Supervisor Roger R. Stanton offered a proposal to identify potential budget cuts and restructure county government operations. Supervisor Gaddi H. Vasquez called a news conference to announce advances in state money for the Orange County Transportation Authority. But he kept reporters waiting for 2 1/2 hours and eventually canceled the briefing because his office was unable to confirm the development.

Supervisor-elect Marion Bergeson, now a state senator, issued a statement calling for the county to adopt a charter ordinance, which would allow the county to privatize certain services and departmental roles, such as the treasurer’s office.

On Monday, county officials cut off all but essential spending related to health, safety and welfare because of the cash crunch.

Vendors still had no idea Tuesday whether they would be getting paid.

At one point, the vendor who supplies toilet paper to the county jails had balked at delivering until he received money up front.

“There’s been a lot of confusion,” said Sheriff Brad Gates, who said the toilet paper was later delivered.

In Sacramento, Gov. Wilson asked Treasurer-elect Matt Fong to lead a task force to review the investment practices of California cities, counties and other public agencies. Wilson, though, said it was too soon to call for a special session of the Legislature, as has been suggested by Assembly Democratic leader Willie Brown.

In Washington, Sen. Barbara Boxer (D-Calif.), a Senate Banking Committee member, called for a fact-finding session Thursday in Anaheim to discuss the financial turmoil. Hayes and state Controller Gray Davis are among the invited speakers.

Rep. Christopher Cox (R-Newport Beach) said the Orange County crisis could have been averted if former treasurer Citron had been required to disclose more about the county’s investment portfolio. As a new member of the House Commerce Committee, Cox called for congressional hearings in January on the matter.

He has proposed reforming federal securities laws to require full disclosure of investment activity. But Boxer contended Tuesday that proposals drafted by Cox for the Republican “contract with America” would make it harder for investors in the Orange County fund to sue successfully if they believed they were victims of fraud.

Lawsuits continued to be filed by bondholders and investors in the county fund.

A lawsuit filed by Los Angeles County residents David and Rosalyn Bare alleged that Citron, Assistant Treasurer Matthew R. Raabe and two investment houses fraudulently led them to believe that the county’s troubled bond pool was relatively risk-free.

The Bares purchased bonds issued by the county and other municipalities that participated in the investment pool.

Their lawsuit is the fourth federal class-action suit filed in connection with the Orange County bankruptcy case, court officials said.

Attorneys involved in the class action suits said they expect them to be consolidated by U.S. District Judge Linda McLaughlin in Santa Ana.

Late Tuesday, a fifth class-action lawsuit was filed in Orange County Superior Court on behalf of hundreds of youngsters and others who invested settlements from car accidents in the county investment pool on the advice of local judges.

The investors include Robin DeLeon, a 14-year-old from Huntington Beach, who received a settlement in April, 1993. The complaint alleges that her guardian, Susan McGivney, agreed to deposit the undisclosed amount in the county pool “on the recommendation of an unnamed Superior Court judge” who presided over the case.

DeLeon, McGivney and the attorneys could not be reached for comment.

Orange County’s business community saw the first signs of trouble resulting from the county’s bankruptcy Tuesday.

Irvine Apartment Communities Inc. said it has shelved plans to refinance $327.3 million worth of its tax-exempt bonds, despite the fact they are in no way linked to the county investment pool.

Under normal circumstances, such refinancing activity is routine. But “you can’t do a refinancing when the (bond) issuer is in bankruptcy,” said Richard Moran, chief financial officer of Irvine Apartment Communities.

Business leaders last week expressed confidence that the bankruptcy was a political issue rather than a business one. But on the heels of the real estate company’s refinancing difficulties, doubts began to surface.

Irvine Apartments watched its stock fall 38 cents a share to close at $15.75 in extremely heavy trading Tuesday. And Moran confirmed that he has been fielding inquiries from Wall Street investors about the effect the county’s bankruptcy could have on the competitiveness of companies based here.

Times staff writers Tom Petruno in Los Angeles; Debora Vrana, Len Hall, Lee Romney, Martin Miller, H.G. Reza, Greg Johnson, Rebecca Trounson, and David Reyes in Orange County; Eric Bailey in Sacramento, and Gebe Martinez, Edwin Chen and Robert A. Rosenblatt in Washington contributed to this report. Correspondents Shelby Grad, Russ Loar, Alan Eyerly, Hope Hamashige and Debra Cano also contributed.

* BANKRUPTCY COVERAGE: Related Orange County stories inside. A3, A26-A31, D1

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Assessing the Damage

County financial advisers Thomas W. Hayes and Salomon Bros. reported Tuesday on the status report of the Orange County investment fund

* Current Loss: About $2.02 billion in value from the $7.4 billion invested by the county, schools, special districts and others. That represents a decline of 27%.

* Future Ups and Downs: With every 1% increase in interest rates, the fund will lose another $300 million in value. With every 1% decline in rates, the fund will gain $300 million in value.

* Assets: About $5.4 billion, after subtracting remaining $2.5 billion pledged for borrowings from securities firms.

* Quick Cash: There is about $230 million cash and investments that readily can be converted to cash.

* Maturity: Fund investments have an average maturity of four years, which the county and its advisers plan to cut to less than six months.

* Working it Out: New investment plan calls for fund to consist entirely of short-term Treasury and government agency securities.

* Portfolio Breakdown: Forty percent of the fund consists of conventional investments, such as fixed-rate corporate and government agency debt. Sixty percent consist of so-called structured notes, primarily “inverse floaters” that lose value as interest rates go up and gain value as rates go down.

Structured notes: 60%

Conventional investments: 40%

Source: Salomon Bros.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

BOND CRISIS: Status Report

BACKGROUND:

On Dec. 6, Orange County government filed the largest municipal bankruptcy in history after suffering a $1.5-billion loss in the county’s investment portfolio, one day after Robert L. Citron resigned as county treasurer-tax collector.

LATEST DEVELOPMENTS:

* Investment banker Salomon Bros. will begin selling off the portfolio under a plan approved by a federal bankruptcy judge.

* Supervisors will postpone buying a vital $82-million emergency police communication system--the first major project stalled because of the financial disaster.

* School officials are working out an agreement to redirect new funds into a separate education account away from the ailing county treasury.

WHAT HAPPENS TODAY:

* 9:30 a.m.--County supervisors will meet in closed session to discuss the financial crisis.

* 10 a.m.--The 20 largest fund creditors will meet at the U.S. trustee’s office in Los Angeles to discuss forming two creditor committees--one for cities and another for banks, vendors, etc.

Compiled by Martin Miller / Los Angeles Times