ORANGE COUNTY IN BANKRUPTCY : From the Testimony

Here are excerpts from the statements presented Tuesday by key witnesses testifying before the state Senate’s Special Committee on Local Government Investments:

ROBERT L. CITRON, EX-TREASURER-TAX COLLECTOR

* Offers apology

“First, and foremost, let me express my deep sorrow to the people of Orange County for the financial crisis that has arisen. As treasurer, I followed an investment course that I believed was prudent and suitable to meet the county’s growing financial needs. In following that path, I relied on the expert advice of financial professionals. In retrospect, it is clear that I followed the wrong course. I will carry that burden the rest of my life. I am not here seeking to place blame or shirk responsibility--I am here simply to tell the truth.”

* Claims inexperience

“I was an inexperienced investor. I had never, nor have I ever, owned a share of stock. My primary training was on the job. Due to my inexperience, I placed a great deal of reliance on the advice of market professionals. This reliance increased as the number and types of investments permitted by the Government Code were liberalized, and as financial instruments became more complex. This is not to say that by the time derivatives were first sold to the county, almost four years ago, that I didn’t consider myself to be an experienced and successful treasurer. The county achieved many years of extremely high returns during my tenure. However, in retrospect, I wish I had more education and training in complex government securities.”

* Advice from Merrill Lynch

“In late 1992 and early 1993, Merrill Lynch recommended, after an analysis of Orange County’s portfolio, that the county lower its risk profile in the area of derivatives. The county followed this advice by purchasing predominantly fixed callable instruments in mid-1993. Merrill Lynch also offered to buy back certain derivatives on March 31, 1993. These derivatives represented some of the most profitable instruments in the portfolio as they were paying some of the greatest returns. The treasurer’s office decided not to accept Merrill Lynch’s proposal due in great part on its reliance on the economic analysis of Merrill Lynch Chief Investment Analyst Charles Clough. Clough stated that a period of low interest rates would last for three to five years, and perhaps for a decade. This would enhance the value of the county’s derivatives. . . . During this time frame, Merrill Lynch guided the county toward purchasing more leveraged derivatives that fluctuated inversely to inverse rates. Mr. (Michael G.) Stamenson’s recommendations seemed to be in the county’s best interests. (Stamenson was the county’s broker with Merrill Lynch.) By the end of 1993, income generated by the county’s portfolio was second only to property taxes as a source of revenue to the county. It was very important to maximize the return on the county’s investments.”

* Investment philosophy

“It was my investment strategy to use the county’s large cash reserves in periods of rising rates to cover the increased cost of borrowing. It was also my philosophy to hold the county’s securities to maturity to avoid sustaining any loss in the principal value of the securities. Before the bankruptcy, I sincerely believed that these philosophies were sound. My adherence to these philosophies is a matter of public record. In retrospect, they were unable to weather the fastest interest rate hikes in history.”

MATTHEW RAABE, ASSISTANT TREASURER

* Extent of knowledge

“My knowledge of the county’s investments comes from information provided to me by others who had direct and primary responsibility for such investments. Beginning in approximately 1992, I was assigned responsibility for responding to inquiries about the pool from pool participants and others with information about the pool. I also participated in occasional internal discussions about the pool’s investment strategies and the general workings of the pool. On the other hand, there were limits to my working knowledge. I did not, for instance, understand how quickly and to what extent the structuring of individual securities would affect the portfolio as interest rates continued to increase . . . “

* Complexity of derivatives

“I have come to realize in the past 2 1/2 months that those of us who are untrained in the complicated and somewhat bizarre aspects of derivatives and government agency securities cannot begin to suggest how to regulate their use. It is now clear to me that even when I first addressed my concerns to county officials, I did not have a full understanding of the magnitude and nature of the problem we are now facing. Indeed, it was not until after an intensive evaluation by outside experts was conducted in November and December that I learned generally of the magnitude of our problems.”

MICHAEL STAMENSON, MERRILL LYNCH BROKER

* Expresses regret

“I, like everyone here, very much regret the burdens and anxiety imposed on the people of Orange County by this calamity. I cannot lose sight of the enormous personal pain that this situation has produced. . . . “

* Role of Citron, Merrill Lynch

“For my part, I made recommendations to Mr. Citron about what he might buy, with an eye toward achieving his stated investment objectives of holding until maturity and increasing the county’s interest income. Often he solicited these recommendations. Sometimes he accepted our recommendations, sometimes he did not. But one thing should be clear: Bob Citron controlled the Orange County portfolio. Merrill Lynch did not; I did not.

“Bob Citron was highly qualified to make these decisions for Orange County. I have known him since 1975, and there is no doubt that he was and is a highly sophisticated, experienced and knowledgeable investor, fully versed in the advantages and risks associated with the securities that he purchased from brokerage firms, including Merrill Lynch. I learned a lot from him, since he was doing reverse repurchase transactions before I even knew what that term meant. . . . “

* Disclosure of Risk

“Some have suggested that although Merrill Lynch understood the risks associated with the investments Orange County made, we did not disclose them. That is not true. In fact, we gave him an analysis that showed him what would happen if interest rates continue to rise. We explained the risks of each security the county treasurer’s office purchased, whether we were first to suggest the investment or, as was the case on many occasions, he had discussed a proposed investment structure with other dealers and requested our input. . . . He was fully aware of the risks associated with his strategy. His investment strategy was not irrational. In fact, Mr. Citron had enjoyed unprecedented success with his investment strategy. Based upon our relationship, and his track record, I respected his judgment, his understanding of his investment objectives, and his understanding of the potential risks of his investment strategies.”