ORANGE COUNTY IN BANKRUPTCY : Agencies Seek Court’s Permission to Sue O.C. : Bankruptcy: Water districts want ban on legal actions lifted so they can try to recover their property taxes.

As Orange County disposed of $634 million of its riskiest holdings Thursday, disgruntled public agencies took their boldest steps yet toward parting ways with the county’s recovery plan, going to Bankruptcy Court to demand the return of property taxes frozen in the fiscal debacle.

In the largest sale yet of its most troublesome investments, the county resold $634 million in so-called derivatives to their original issuer, the Federal National Mortgage Assn. The price paid--about 91 cents on the dollar--appeared to delight county officials, who said it was more than the complex securities would have brought in the open market.

Meanwhile, the Yorba Linda and Santiago County water districts asked the U.S. Bankruptcy Court to lift its ban on all legal actions against the county. That would allow the districts to sue the county in state court for return of about $100,000 in property taxes collected on behalf of each district before the county’s Dec. 6 bankruptcy filing.

In other developments Thursday:

* Eight part-time county employees were fired in the first step of what is expected to be a drastic reduction of the county’s 18,000-member work force.

“Everyone is important,” said Ernie Schneider, the county’s top administrator, who laid off the five staff members and three interns from his own office. “But . . . we have to cut costs where we can. And the first cuts are the extra help and temporary people. That is the first cut we make. It is a very difficult situation.”

* The cash-poor county fell into technical default when it chose to suspend payments on $169 million of bonds sold in June, a move signaling the county’s deteriorating financial position. County leaders, worried about their cash flow, say they will not set aside $53.4 million in regularly scheduled principal payments due on the notes this summer.

* The county informed a dozen cities that $2.7 million in promised park grants will be indefinitely postponed because of the bankruptcy filing. The move jeopardized park projects from Yorba Linda to Costa Mesa.

* The Board of Supervisors turned over box loads of documents subpoenaed by U.S. Securities and Exchange Commission investigators. Among the items subpoenaed were the supervisors’ calendars, diaries and personal bank statements. The SEC has launched a broad investigation into the relationship between supervisors and brokers who did business with the county.

* U.S. Bankruptcy Judge John E. Ryan approved a request by Orange County and Bank of America to sell $277 million in securities that lawyers and county officials said will pay some of the county’s debt to the bank and provide the county with $4 million to $5 million in cash.

* The county’s bankruptcy attorney approved Supervisor William G. Steiner’s request to release an additional $921,048 to nonprofit organizations for services--such as mental health care for cancer patients and shelter for the homeless--provided before the county filed for bankruptcy. The latest round of payments brings the amount paid to nonprofit contractors to nearly $4 million.

Elsewhere, a major bond ratings agency decided not to downgrade the investment pools of Solano and Monterey counties, whose holdings had come under scrutiny in the wake of Orange County’s massive bankruptcy filing.

Standard & Poor’s concluded that “no rating action is warranted at this time,” even though the two counties have pursued an aggressive investment strategy.

The legal challenge by the two water districts could lead the way for other special districts, school districts and cities to sue for their share of property taxes.

“What (the districts) are saying is: Property taxes and special assessments that were collected by the county on their behalf never became the property of the county,” said Ronald Rus, a lawyer for the two water districts. “Those monies . . . should be turned over.”

A day earlier, the Huntington Beach City Council voted to sue Orange County if an agreement for releasing tax revenue is not reached by Jan. 6. Costa Mesa officials have said they may do likewise.

“Put it this way,” Rus said. “There are a number of municipalities and special districts who are similarly poised but are waiting to see if the county can solve this problem in the next few days.”

The county layoffs, meanwhile, follow an announcement last week by top managers that the county would need $40.2 million in cutbacks and savings in the wake of the largest municipal bankruptcy in U.S. history. County leaders have since revised that estimate, saying the budget deficit could be triple that amount in the next six months.

The eight people laid off Thursday were part-time workers, earning $9 to $17 per hour. The person with the longest tenure had been in Schneider’s office for three years.

Employee union leaders said the county had unfairly targeted workers with the least protection.

“When somebody in management screws up, instead of starting at the bottom they ought to start at the top and work their way down,” said Bill Fogarty, executive secretary-treasurer of the Orange County Central Labor Council, AFL-CIO. “Laying off extra help is not taking responsibility for it, it’s blaming the workers who had nothing to do with the problem.”

A woman who has worked in the county administrative office for the past 13 months tearfully filled her car with boxes Thursday with the help of co-workers. She declined to discuss the situation but said she had been let go. She said that she had been hired as extra help and had been working hard to become a full-time employee.

Another measure of the county’s financial adversity was its announcement that it would not set aside $53.4 million in principal payments due this June on bonds, known as tax and revenue anticipation notes. The Board of Supervisors said it would omit December and January payments that were to be set aside until June, when the county is required to pay off the $169 million of bonds sold last June to meet its annual operating needs.

“The uncertainty we face with regard to the current financial crisis makes it impossible to commit funds for all but essential short-term operating needs,” said Gaddi H. Vasquez, chairman of the Board of Supervisors.

A technical default is a warning to bond holders that the county is not setting aside funds to pay off the bonds when they are due. A true default occurs when the county misses a payment.

But in a more positive move, officials elected to make interest payments due in just four days on $815 million of other county bonds.

“There’s some good news today and some bad news for the county’s bondholders,” said Jane Eddy, a director with Standard & Poor’s. “But the most profound signal and most promising sign to us is that they are making the January interest payments.”

While the Board of Supervisors voted to make good on $3.9 million in interest payments due Jan. 3, the payments must be approved by the Bankruptcy Court. And rating officials said time is running out.

“It’s not clear to us whether the wheels of the Bankruptcy Court will turn fast enough to make the payments on Jan. 3,” said Barbara Flickinger, an assistant director with Moody’s Investors Service, another bond rating agency. “It’s cutting it pretty close. And it makes things pretty shaky.”

Meanwhile, former state Treasurer Thomas W. Hayes, the county’s financial consultant, said the county has “successfully completed about one-half of the restructuring” of its beleaguered investment portfolio--”which is much faster than we’ve anticipated.”

He said he is sticking to his estimate that the county will lose about $2 billion on the sale of the portfolio.

Hayes also said the board’s action Thursday was an important move to try and boost confidence on Wall Street.

“Access to credit is absolutely essential,” he said, noting that the county will eventually need to borrow for cash-flow purposes.

“If you can’t borrow for cash-flow purposes then you cannot match your expenditures, which go out on a relatively even keel and the revenues, which come in with property tax and sales tax around Christmastime. There’s a mismatch. So if you can’t get to the credit markets to cash-flow borrowing then you’re not going to be able to pay your bills during the slow revenue times of the years,” he said.

Even with the board’s actions Thursday, Hayes said it was going to be difficult to go to the credit markets because of the bankruptcy. But “by paying the interest payments . . . we’re saying the county wants to work with them.”

How much the county intends to borrow is uncertain, Hayes said.

“At a minimum we will be doing cash flow financing that’s done every year and we’ll be looking at other alternatives as well. This does not mean that the county is going to borrow its way out of this,” he said.

As the Orange County financial crisis ended its fourth week, the committee that represents a cross-section of investors intensified discussions of just how members want the bankruptcy resolved.

The committee of seven of those investors is expecting to review a skeletal disbursement plan drawn up by the county’s bankruptcy attorney, Bruce Bennett, as early as next week and will offer suggestions then, said Patrick Shea, the committee’s lead attorney.

“This committee has been successful in channeling the interests and perceptions of a very diverse group of constituents through the committee and presenting them to Bruce Bennett. That is a colossal benefit to the debtor and a tremendous show of good will,” Shea said.

“It can only last so long,” he said. “It’s clear to me that we only have a few weeks left of goodwill.”

Shea said the county and investors are mulling a handful of approaches to the settlement, and several investors have already gone directly to Bennett with their ideas.

Wally Kreutzen, financial director of the Transportation Corridors Agency, said his agency had not yet taken a formal position on the plan, but “clearly the committee’s interest is the return of 100 cents on the dollar.”

Bennett said the county’s plan may not be drafted until the middle of the month.

After repeated requests for data from Arthur Andersen & Co., the accountants retained by the county, investors have become increasingly frustrated. Committee members will work over the weekend to formulate a list of the information they need from the county, one attorney said.

Late in the day, county officials scrambled to correct an accounting blunder that is holding up disbursements to about 50 agencies with money in the pool.

Arthur Andersen left the agencies off a Bankruptcy Court-approved list that is crucial to distributing emergency funds, said Stan Oftelie, executive director of the Orange County Transportation Authority and chairman of an investor committee charged with reviewing requests for money.

Under Bankruptcy Court rules, Oftelie said, the investment committee can only approve payments to investors on the list.

Oftelie said the missing investors and the amount they contributed to the fund were somehow consolidated with others whose names appear on the list.

“The numbers still add up, but the irony of it is we can’t pay them,” he said. “We can’t give them funds unless we know how much they have in the pool.”

The committee found out Monday that some agencies had been left off the list when those agencies requested funds, Oftelie said. Arthur Andersen officials and county representatives were trying to correct the mistake, he said, but it could take a week before funds can be distributed.

* PARKS GRANTS

$2.7 million for cities’ recreation projects is suspended. A26

* NOTES SOLD

Fannie Mae buys back $634 million in risky securities. A27