Panel Says State Should Manage O.C. Finances : Bankruptcy: Advisers warn that Orange County default could damage credit throughout California.

Leaders of a state panel on Wednesday called for Sacramento to take control of Orange County’s fiscal management as financial experts issued their sternest warning yet that any default on county debt could devastate California’s standing in the financial markets.

“Orange County is not just an Orange County problem,” said state Treasurer Matt Fong, chairman of the California Debt Advisory Commission. “It’s a state problem. The county has no more time to sit and deliberate. They must act.”

Fong’s comments came during a public hearing called by the commission on the fallout from the county’s fiscal crisis. After four hours of testimony from representatives of bond holders and officials of leading debt-rating agencies, Fong issued a “fiscal earthquake warning”: that the county must move fast to avoid a default on $1 billion in debt coming due this summer.

Commission members said Orange County’s unprecedented bankruptcy filing has already led to higher borrowing costs for municipalities in other parts of California.

State Sen. Lucy Killea (I-San Diego), who sits on the commission, said she is drafting legislation that would turn the county’s financial reins over to an outside authority--similar to a trusteeship but made up of state and local officials and approved by referendum.

“I’ve just had it up to here,” Killea said during a break in Wednesday’s proceedings. “To help Orange County, I think we have to give them not just a carrot, but a stick too.”

Cities and other agencies with money in Orange County’s loss-ravaged investment pool have $1 billion in debt coming due this summer, and Fong said uncertainty over the possibility of defaults on those loans may come into play as municipalities go to the markets for fresh borrowings in May.

“If Orange County doesn’t get its fiscal house in order, the earthquake will be felt all the way to San Diego and all the way north to Eureka,” Fong said. “Small borrowers will be closed out of the financial markets.”

After the hearing, Orange County Supervisor Marian Bergeson--whom Assembly Speaker Willie Brown mentioned last week as a candidate for trustee if the county were stripped of its fiscal authority--said there was no reason for the Board of Supervisors to relinquish its control of finances.

The board hired William J. Popejoy, former chief executive of American Savings & Loan, 10 days ago as interim chief executive, granting him broad authority that Bergeson said will help speed recovery.

“I think locally we have the ability, with the leadership we now have,” she said. “All the elements of a plan are now coming forward.”

Bergeson said she is committed to ensuring that the county does not default on debt payments due this summer, but Fong said such words fall short of action.

“They’re not looking for the words. They need to see a credible plan,” he said of the county’s bondholders, “a plan that says where the money is going to come from and how it is going to be set aside. . . . I believe this has to happen as soon as possible.”

Fong said Wednesday’s hearing “reaffirmed my gut belief that we are paying--at all levels of the state--an Orange County premium to do business in the state.”

He said the higher borrowing costs that all California government issuers of bonds will have to pay as a result of Orange County’s mistakes could total $200 million annually, translating into fewer tax dollars available for public services.

But many Wall Street analysts saw Fong’s warnings about statewide fallout from the bankruptcy as an attempt to jawbone Orange County officials rather than a reflection of the true impact that might be expected from any default.

Dozens of California municipalities have been able to issue bonds over the past two months without paying significantly higher interest rates than they would have otherwise, analysts say.

And on Wednesday, the state easily auctioned $400 million in general obligation bonds with maturities of between one and 30 years. “Outside of Orange County, the bidding for California bonds is as strong as it ever was,” said one municipal bond trader in New York.

In part, the state and its municipalities are benefiting from the overall decline in market interest rates this year, reflecting investors’ perceptions that the nation’s economy is slowing. As rates fall, more investors clamor to buy bonds, hoping to lock in yields before they slide further.

Panel members and those who testified Wednesday, however, were clearly frustrated with the county’s efforts to allay bondholders’ anxieties about the $1.7-billion loss in the county investment pool and the Dec. 6 bankruptcy filing.

“I’ve never seen so much finger pointing and abdication of responsibility,” Killea said. “I wouldn’t be so concerned if I didn’t think their failure could have an effect on the rest of the state.”

The senator said it remains unclear whether an authority such as that envisioned in her legislative plan could be set up fast enough to deal with borrowings made this summer. But she said she envisions it taking over for the county supervisors for three or four years.

The commission heard testimony from bondholder representatives who warned that if the county defaults on the debt payments due this summer, municipalities throughout the state may have great trouble succeeding in the markets.

“Even if everyone is made whole and paid 100 cents on the dollar, I believe all California issues of short-term notes will pay a price for years to come,” said Steve Permut, senior portfolio manager and manager of municipal research for Benham Capital.

Already, investors outside of California are backing away from state bonds, said Tom Kenny, senior vice president and director of the municipal bond department for Franklin Advisers.

“Those investment decision makers sitting in Boston and Chicago read the papers and so do their bosses,” he said. “When they see reports that Orange County may default on its debt and that the state is doing nothing to help, they simply decide not to buy California paper.”

Kenny said that “it is clear that California and its municipalities will pay higher interest rates in the upcoming note season, if they can access the markets at all.”

Rating agency representatives stressed the need for greater disclosure of financial information and called for the state to play a significant role in steering a recovery.

“It’s clear that the county has a way to go to re-establish its credibility,” said Jane Eddy, western region director of Standard & Poor’s. “Any state involvement in an intercept fund would be viewed positively.”

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Times staff writer Tom Petruno in Los Angeles contributed to this report.