Other Counties Seek to Defend Fund Strategies

Orange County’s plunge into financial chaos is reverberating around the state as county treasurers are being forced to defend their use of risky investment practices that once produced high returns but are now generating paper losses.

Some admit with chagrin that, like former Orange County Treasurer-Tax Collector Robert L. Citron, they made what proved to be a losing bet--that interest rates would continue falling into 1994.

A number of these county investment officers have tied up a large percentage of their funds in disappointing strategies that were intended to squeeze out extra returns for schools, cities and other local government agencies.

Many borrowed sizable sums--issuing hundreds of millions of dollars in government-backed notes--believing they could boost earnings for local agencies by reinvesting the money at a higher interest rate. This once-successful approach is now being abandoned as unprofitable--and potentially dangerous if handled improperly.

Among the counties that employed some of the same investment practices that led to Orange County’s downfall are San Diego, San Bernardino, Solano, Sonoma, Monterey and Placer. But the treasurers in each of these counties insist that they manage their investments more carefully than did Orange County.

They point out that they did not invest in high-risk securities nearly to the extent that Citron did in Orange County. Most also point out that so far their losses on these investments are relatively minor and exist only on paper because no liquidations have been forced. Further, these investment funds all remain solvent, they say.

In interviews and in detailed memos to their county boards of supervisors, these elected officials are doing their best to to distance themselves from Citron and the investment tactics that sent Orange County to federal court seeking bankruptcy protection.

Many bristle when they are mentioned in news reports about Orange County’s misfortunes and fret over the damage that can result if their local government investors lose confidence and suddenly withdraw large amounts of cash.

Unless there is panic, these treasurers uniformly say, they will be able to restructure their investments and survive very well, with their rates of return reduced but the principal still intact.

Richard Larsen, the assistant treasurer in San Bernardino County, was one of several financial officers who expressed bitterness at being mentioned in news reports as using some of the same strategies deployed by Orange County.

He said the phone had been ringing off the hook with people wanting to know if their investments are safe.

“The first question they ask is: ‘Are you like Orange County?’ ” Larsen said. “It’s been hectic, and we are trying to let them know that we are not like that.”

However, like Orange County, San Bernardino County has relied heavily on reverse repurchase agreements, which account for about a third of its $2.4 billion in investments. Reverse repurchase agreements are deals in which owners of a security use it as collateral to borrow money and invest the money in another security, which often takes longer to mature.

In times of falling or stable interest rates, these investments are highly profitable, but they can go sour when interest rates rise. (As market interest rates rise, longer-term bonds decline more sharply in value than shorter-term ones because investors are less willing to take the chance of earning sub-par returns for extended periods.) But Larsen and others say that, if the investments are made wisely, the reverse repos are a good way to squeeze out additional income from their investments.

“We will modify our position downward because of all the scrutiny of them and the fact that people don’t understand them,” Larsen said.

Unlike Orange County’s Citron, San Bernardino investment officials have avoided exotic investments such as so-called inverse floaters, which are investment contracts that decline in value if interest rates rise.

And few of the county fund’s investors have the option of pulling their money out on short notice. Larsen said that about $90 million of the portfolio could be withdrawn and that much of that was money from the city of Chino Hills. Larsen said the city has indicated it is willing to leave the money in the account.

“The biggest thing we need to do is inform people about what’s going on,” Larsen said. “Then the uncertainty goes away.” On Monday, Standard & Poor’s Rating Group announced that it had reviewed San Bernardino County’s investments and found no reason to downgrade the county’s credit rating.

Last week, the rating agency reached a similar conclusion about San Diego County’s investment pool. Although the fund showed $357 million in paper losses from its $3.3-billion portfolio, county Treasurer Paul Boland had only a small amount of his assets tied up in a reverse repo.

However, San Diego County has invested 26% of its fund in a variety of derivatives, including inverse floaters. About 25% of the money held in the fund belongs to cities and special districts that can withdraw their shares whenever they like.

Boland is among several treasurers who are doing their best to reduce panic by their investors to prevent what would be the government investment equivalent of a run on a bank.

He has been trying to persuade these governmental units to stand by his fund so that he will not have to sell assets for a loss to satisfy unexpected cash demands. However, he has announced that he will sell as much as $400 million in holdings at a loss to meet all the fund’s expected needs.

In Placer County, Treasurer Jenine Windeshausen said that her fund, with $370 million in investments, now shows a paper loss of about 7% of its value.

But like many of the treasurers interviewed, she emphasized that losses on paper won’t materialize if the investments are held until they mature.

“I have managed the portfolio for the last seven years and we have not had actual losses,” Windeshausen said. “That reflects our long-held conservative investment philosophy.”

However, her portfolio is now being reviewed by rating agencies because of its heavy reliance on derivatives, including some of the exotic kinds that contributed to Orange County’s demise. Windeshausen said that most of the derivatives she has invested are holding their value. (Derivatives are investment contracts that “derive” their value from underlying securities.)

About 15% of the worth of her fund has been used in reverse repurchase agreements, but she plans to reduce that to zero by April. “We have decreased our use of that strategy as (interest) rates started to go up,” she said.

Monterey County Treasurer Lou Solton complained that since the Orange County collapse he repeatedly has had to explain why his reverse repurchase agreements--about 40% of his $575-million investment pool--are safer than Orange County’s. “To be blunt, it’s getting to the point of frustration,” he said. “We somehow are ending up on the list.”

And it isn’t just reporters who are asking the questions. Last week, Solton issued a nine-page memo to the county’s Board of Supervisors and others explaining his investment strategy.

“Before discussing the characteristics of the investments, I want to clearly state for the record that Monterey County is not and will not become subject to any cash-flow crisis that would cause an ‘Orange County’ condition to arise,” he wrote.

In Sonoma County, Assistant Tax Collector Thomas C. Ford complained that Orange County’s fall had tarnished the reputation of all county investment officers.

Ford said the Sonoma County’s $800-million portfolio had 6% in paper losses. Reverse repurchases represent about 20% of the fund, he said, arguing that they have not proved to be a problem.

He compared his county’s policy, which includes some modest risk-taking, with the play-it-safe strategy of many other county treasurers. “I laugh when I read columns that the public is being protected by naive treasurers (who take no risks,)” he said. “Most are not doing a very good job.”

In Solano County, the $427-million investment fund has lost about 5% in paper value. The county has made extensive use of reverse repurchase agreements--more than 40% of its portfolio, said Treasurer Bobby D. Stow. And 30% of the investment is in derivatives, including some that gambled on interest rates falling and others tied to a rise in rates.

For two years in a row, he has issued $26 million in notes so that he can turn around and invest it--making money off of the difference between the interest rate the county pays and what it gets on its investments. But now, in a climate of rising rates, he says he must abandon that strategy, which earned more than $1 million over the past two years.

In the aftermath of the Orange County crisis, counties that have stuck by a more conservative strategy can now gloat about their more solid approach to investments.

Riverside County Treasurer R. Wayne Watts said that he has purposely shunned exotic investments such as reverse repurchases and inverse floaters.

And giant Los Angeles County, with its $6.6-billion investment portfolio, has managed to resist the pressure to pump up returns in a period of financial tightening for local governments. Only 3% of the total is in reverse repos, said Joe Spillane, compliance auditor for the Los Angeles County Treasurer-Tax Collector.

Jacobs reported from Sacramento; Kennedy from Los Angeles. Times staff writer Alan C. Miller in Washington also contributed to this story.

* BANKRUPTCY COVERAGE: Related Orange County stories inside. A3