Regulators Blame O.C. Actions, Not Lax Rules : Congress: Federal officials express sympathy but tell Senate panel there is no need to tighten regulations.
Federal Reserve Chairman Alan Greenspan and other top regulators expressed sympathy Thursday for Orange County’s fiscal plight but said they see no reason to make major changes in the rules governing use of the securities that contributed to the county’s debacle.
“It would be a grave error to demonize derivatives or blame them for the loss,” Greenspan told the Senate Banking Committee, referring to the complex investments--linked to changes in interest rates or other market indicators--that cluttered the county’s investment portfolio.
“Derivatives did not cause the Orange County problems,” said Arthur Levitt Jr., chairman of the Securities and Exchange Commission. “The fault lies in a failed investment strategy involving the use of borrowed money for speculation.”
The hearing was the first of several planned by Congress to examine the circumstances of the affluent county’s stunning fall into bankruptcy.
Sen. Barbara Boxer (D-Calif.) told her committee colleagues that “hundreds, maybe thousands” of workers will be laid off, health clinics will have to curtail services, law enforcement budgets will be cut and parents may have to do volunteer janitorial work in schools.
But rather than endorse new restrictions on investing and markets, the regulators used their testimony to underscore their belief in derivatives as a vital tool to moderate the risks of a fast-changing financial world.
In other developments Thursday:
* Facing imminent layoffs, Orange County employees got another dose of bad news, learning that they will lose 10% of the retirement money they have invested in a deferred compensation program. County officials say 1,832 employees have $85 million deposited in the plan.
Labor representatives derided the move as “another unfair and cruel action by the county” that forces workers to bear the brunt of a problem others created.
* A team of 10 investigators from the county district attorney’s office searched former Treasurer Robert L. Citron’s Santa Ana home, seizing documents and cassette tapes related to the county’s investment pool. Citron resigned two days before the county declared bankruptcy Dec. 6 and is the subject of a criminal investigation.
* The state attorney general’s office has assigned an investigator to work with local prosecutors in its probe of Citron and his office. The state investigator will join six attorneys and 20 investigators from the district attorney’s office and two state Department of Corporations investigators.
* A majority of the Board of Supervisors indicated that they support naming John Moorlach, the Costa Mesa certified public accountant who ran against Citron last spring, as the county’s new treasurer. Moorlach said he expects to start work sometime after income tax season ends April 15.
In the meantime, Thomas E. Daxon, the interim treasurer, has named Moorlach to head a committee being set up to oversee the investment portfolio, which has plunged $2.02 billion in value over the past year.
* Supervisors also indicated that school districts and other depositors in the ill-fated county portfolio should not expect to receive 100% of their money back. “I think it’s really unrealistic for them to assume that,” said Supervisor Roger R. Stanton. “Nobody’s going to get that.”
* The county’s budget ax reached the county registrar of voters office, where 12 employees--more than one-quarter of the work force--were laid off. They were part of the 72 General Services Agency layoffs announced Wednesday. Registrar Don Tanney said he did not expect the layoffs to cause major reductions in service.
At the auditor-controller’s office, four employees were fired. One employee described it as “Black Thursday.”
* In Sacramento, Assemblyman Mickey Conroy (R-Orange) said he will introduce a bill that would allow the county to contract with outside companies for special services, such as employee training, accounting and legal work. The legislation would be a first step toward privatizing local government services in the wake of the bankruptcy filing.
At the Senate Banking Committee hearing in Washington, securities regulators said repeatedly that the problems of Orange County, though regrettable, were apparently isolated.
“We can hold all the hearings we want, but we will never eliminate risk in a capitalist society,” said Sen. Phil Gramm (R-Tex.). “As terrible as what happened in Orange County is,” Gramm said, it can be blamed on Citron, “who used excessive leveraging.”
In their testimony, federal officials stressed that the huge size of the Orange County debacle was the result of leveraging--that is, the county’s practice of using securities as collateral to borrow more money to invest in a bet that interest rates would drop.
However, the regulators and senators agreed that more disclosure of information about municipal finance would help alert investors and politicians alike when public money is put at risk.
Levitt said he believes such data can be obtained by exhorting brokers to get more information from states, counties and cities about their investments and then make it available to potential bond buyers.
But Boxer and the chairman of the House Banking Committee, Rep. Jim Leach (R-Iowa), want to go a step further. They are sponsoring similar bills giving the SEC powers to require local governments to provide the same disclosure documents issued by corporations selling stocks and bonds.
“It is unclear whether a purchaser of the bonds issued by Orange County or other governmental entities knew of the fact that the Orange County investment fund was experiencing serious losses or that the fund was pursuing a risky leveraging strategy or that the fund was investing in derivatives,” Boxer said.
In addition, Boxer said she is encouraging the SEC and the Commodity Futures Trading Commission--both of which are investigating the Orange County debacle--to determine if brokers who sold derivative securities to the county acted properly.
“It is one thing if you have a 13-year-old daughter and you let her run wild,” she said, comparing the Orange County Board of Supervisors to a negligent parent. “But it is another thing if a 25-year-old runs wild with your daughter. Then he bears some responsibility.”
Levitt agreed with Boxer that the municipal securities market “has been largely obscure to investors.” But he expressed confidence that voluntary efforts could solve the problem, rather than giving his agency formal powers to require prospectuses and disclosure reports from government agencies. Preparing such disclosures would be “an enormous undertaking” and could cause market disruption, he said.
In his testimony, Levitt disclosed for the first time that 35 money market funds holding a total of $545 million in Orange County notes were given financial help by their parent firms with the SEC’s permission.
To date, he noted, no money market funds have had to break their stable $1 a share price in the wake of the county bankruptcy. However, if the prices of Orange County securities keep falling and a fund’s advisory firm won’t provide support, the $1 line could shatter, Levitt warned, noting that the SEC is closely monitoring money market funds.
On Wednesday, Orange County officials had offered their bleakest assessment to date of the county’s finances, confirming that they are short $172 million needed by July 1 to keep the county afloat.
But officials at a major bond rating agency said Thursday that the county also is on the hook for at least $1 billion in principal and interest payments on just its short-term debt over the next seven months.
“This is a huge debt hole,” said Barbara Flickinger, a director at Moody’s Investors Service. “They have a very serious problem here, because these borrowings must all be paid from one year’s revenue stream.”
The bonds--all sold last year--that the county must pay back by the end of July include $200 million of annual notes, a $600-million taxable note sold to reinvest in the county investment pool and more than $100 million in other taxable notes. The debt-service costs would be even higher than $1 billion if interest payments on other smaller, but longer-term, debt issues sold by the county are included, Moody’s officials said.
The county’s financial advisers said Wednesday that they are weighing a restructuring of the short-term notes and efforts to sell new bonds to pay off pool investors and other creditors.
“They have no money coming in, and they can’t get to the money they have to pay this stuff off,” said Karen Krop, a vice president with Moody’s.
On Thursday, the county sold $740-million worth of structured corporate securities for $671 million, county officials said. The county plans to hold another auction today for the remainder of the derivatives.
As investigators struggle to make sense of the county’s fiscal crisis, a team from the district attorney’s office arrived unannounced at Citron’s Santa Ana home at midday, armed with search warrants.
Citron’s attorney, David Wiechert, confirmed that the investigators combed the entire house, snapping photos and collecting documents and cassette tapes before leaving. They spent about 75 minutes at the home. Only Citron’s wife, Terry, was there when the investigators arrived, Wiechert said, adding that she was near tears when her husband and attorney arrived.
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“I’m absolutely astounded that under the circumstances they would invade Bob and Terry’s home with 10 law enforcement agents,” Wiechert said. “I don’t think there was legitimate law enforcement purpose for this search.”
On Dec. 19, investigators had obtained a warrant to search Citron’s former office in Santa Ana, carting away boxes of records and computers. According to the original search warrant, the probe centers on whether Citron warned investors that the county’s investment fund was losing value.
Chief Deputy Dist. Atty. Maury Evans declined to comment Thursday on the search. Citron also refused to comment.
Wiechert was also upset that the investigators seized Citron’s notes from conversations with his attorney, despite Wiechert’s protests during the search that those items should remain confidential.
News that Moorlach is on the verge of gaining the treasurer’s office that he lost to Citron by a nearly 2-to-1 margin last fall seemed one more bit of evidence of how Orange County has been turned upside-down by its fiscal fall.
The accountant has become something of a folk hero by virtue of his warning last spring that Citron’s investments were risky and subject to heavy losses. Moorlach has been making the rounds of local civics groups, giving speeches about his skill in examining the former treasurer’s portfolio and recalling his prediction that the county’s finances would crash.
“I couldn’t believe how right I was,” he had told many people.
Lately, Moorlach has been meeting almost daily with top county officials who have been courting him for the treasurer’s job. On Thursday, Supervisors Stanton, William G. Steiner and Marian Bergeson said they would support his appointment as treasurer.
Rosenblatt reported from Washington and Platte and Vrana reported from Orange County. Times staff writers Jodi Wilgoren, Matt Lait, Tracy Weber and Lee Romney in Orange County also contributed to this story.
* MORE BAD NEWS: County workers will lose 10% of their retirement money. A3
