Citron, Not Derivatives, Takes Blame at Hearing : Securities: Heads of Fed and SEC and Senate panel members say gamble on interest rates, not the exotic investments, were main cause of bankruptcy.

To hear federal regulators and Senate Banking Committee members talk about it, Orange County’s financial woes were not caused by exotic investments, but by a former county treasurer’s “riverboat gambling” attitude and by a Board of Supervisors that closed its eyes to the risky investment strategy.

Already brought down by a financial disaster that led last month to the largest municipal bankruptcy in U.S. history, Orange County’s reputation got kicked around a little more Thursday during the first day of a Senate Banking Committee hearing on possible reforms in the securities industry.

“Orange County had plenty of warning signs for those that were willing to see them,” said Sen. Robert F. Bennett (R-Utah). “It was those who did not want to see them who ultimately got themselves in trouble.”

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Among those who refused to see the oncoming trouble, some Senate Banking Committee members concluded, were the political leaders who had once hailed longtime county Treasurer-Tax Collector Robert L. Citron a “hero” for the high return on his investments.

Demonstrating the irony, Bennett read the now-legendary quote of former Board of Supervisors Chairman Thomas F. Riley, who nine months ago said of Citron: “This is a person who has gotten us millions of dollars. I don’t know how in the hell he does it, but he makes us all look good.”

On Thursday, Orange County didn’t look so good in the eyes of the Senate Banking Committee. It was quite a departure from the county’s past reputation as a fiscally conservative, tightly managed county guided by strong Republicanism.

One by one, banking committee members used Orange County as a case study of what not to do, an example of risky investments and bad management, with little oversight by county government leaders.

“I seriously doubt whether the citizens of Orange County had any idea that funds earmarked to run schools and build roads were being wagered in a high-stakes game of interest-rate roulette,” said Chairman Alfonse M. D’Amato (R-N.Y.) as he began the hearings.

“There’s nothing wrong with taking more risk if you know what you are doing,” said Sen. Carol Moseley-Braun (D-Ill.). “The Orange County taxpayers did not know. Orange County breached its public’s trust.”

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In brief displays of partisanship, Bennett and Sens. Phil Gramm (R-Texas) and Lauch Faircloth (R-N.C) placed the blame on Citron, a Democrat. Bennett and Faircloth noted that Citron’s challenger in the June election, Republican John M.W. Moorlach, tried to warn the public but was largely ignored during his campaign.

Bennett also distributed copies of a letter Moorlach sent last May to Riley, a Republican, which predicted the collapse of the county’s investments portfolio.

Much of Moorlach’s criticism centered on the use of derivatives, which have come under increased scrutiny as the result of Orange County’s crisis.

However, the chairmen of the Federal Reserve Board and the Securities and Exchange Commission told the committee that the bankruptcy was not sparked by derivatives but by bad judgment.

SEC Chairman Arthur Levitt Jr. told the senators that derivatives are “something like electricity: dangerous if mishandled, but bearing the potential to do good.”

While limiting his comments on Orange County because of a pending SEC investigation, Levitt said other municipalities and states have management controls to protect the security of their investments.

“The (Orange County) supervisors clearly did not do their job,” Levitt added.

Fed Chairman Alan Greenspan said Citron bet heavily on a hunch that interest rates would not go up.

Citron “was involved in a very simple type of transactions, but they were leveraged up to his chin, and that so long as he continued to do that and interest rates continued to go lower, he was getting a very substantial rate of return,” Greenspan said.

“But he embarked upon a whole series of very risky strategies in which, when he was right, was extraordinarily rewarded,” Greenspan continued. “But instead of taking those excess returns and putting them in escrow for a rainy day, they effectively were consumed in the budget of Orange County.”

Irritated that the heads of the federal regulatory agencies seemed to be downplaying the risks associated with derivatives, Sen. Paul S. Sarbanes (D-Md.) argued that the money of “widows and orphans” could be invested in derivatives without their knowledge.

Turning to Sen. Barbara Boxer (D-Calif.) for an assessment of the severity of Orange County’s problem, Sarbanes added: “The consequence of that now is that orphan children are going to have an impact on their education and widows are not going to go to senior citizens’ centers. They are going to find them closed.”

Without assessing blame, Boxer repeatedly expressed amazement at the Orange County case.

Boxer has introduced a bill that gives the SEC the power to require governments to make full financial disclosure when they issue bonds. The SEC supports more disclosure.

She asked Levitt about a 1991 county auditor’s report’s finding that Citron had made questionable transactions totaling more than $50 million “at the request of the (Wall Street) broker Merrill Lynch to help the broker meet financial statement ratios” required by the SEC.

“Because we are involved, obviously, in studying the facts surrounding Orange County, I really don’t wish to comment on that at this time,” Levitt said.

“It’s extraordinary that this relationship developed,” Boxer replied. “It appears as if this county . . . wound up doing favors for a broker, and that’s just a shocking point.”