ORANGE COUNTY IN BANKRUPTCY : How the Fund Fell

Orange County’s now-bankrupt investment pool has lost 27% of what its investors put in, according to Salomon Bros., the county’s financial adviser. Slammed by a strategy that used heavy borrowing to buy long-term bonds, the fund’s value has been whittled to $5.4 billion, including bonds and cash. Here’s what happened:

On Dec. 1, the county said the fund held bonds that would be worth about $20 billion if held to maturity. But because all bonds have tumbled in value this year as interest rates have risen, the county said its fund had dropped about $1.5 billion in market value. In other words, if sold Dec. 1, the county figured the portfolio would have been worth about $18.5 billion.

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Strapped for cash as the cost of its loans continued to surge, the county began to miss loan payments to its brokerage lenders in the days following Dec. 1. The brokerages then began to call in the loans the fund had taken out to buy most of its bonds. Those loans were backed by $11.5 billion of the bonds themselves, which the brokerages then sold in the market last week. As of Monday, Salomon estimated that the market value of fund’s remaining bonds was $7.96 billion.

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But that amount included $2.56 billion in loans still outstanding. Subtracting that sum, Salomon estimated that the actual market value of the securities owned outright by the fund was $5.4 billion as of Monday, including a small amount of cash. That represents a loss of $2.02 billion--or 27%--on the $7.4 billion that government agencies and other investors had on deposit in the fund Jan. 1.

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On Thursday, Salomon began to auction the remaining bonds in the fund. A total of $483 million of conventional bonds maturing in two to four years were sold on Thursday, at prices ranging from 89.5 cents to 94.5 cents on the dollar. The fund is expected to auction its remaining securities--including its more complex bonds, which comprise the bulk of the leftover portfolio--within the next week.

Whether the final loss to fund investors is more or less than the 27% now estimated will depend on the prices at which the remaining bonds are sold.