Orange County Voices : COMMENTARY ON COUNTY BANKRUPTCY : Recovery Will Hinge on Overcoming New Creditors’ Skepticism : The borrower and its citizens must show they are willing to strive mightily to restore breached faith.

Now that the Orange County Board of Supervisors has decided on an interim CEO, it must focus fully on how to restore the county to solvency and to resolve its bankruptcy.

The major issues facing the county today are immediate and intermediate on the one hand, and longer term on the other.

The first set of issues relates to how to accommodate available cash on hand with the pressing needs of the county and its instrumentalities: Children need to go to school, streets have to be repaired, traffic lights that break must be made to work, libraries have to continue to function, roads must be maintained, people have to be able to do business with their government. The county’s infrastructure--its asset base--must be maintained.

What is at stake is neither conservatism nor liberalism. The issue is what are the minimal essential functions of government for a viable community, what does it cost reasonably and practically for those functions to occur and what is to be done to secure the cash needed to fund those services.The cash available is, over the intermediate term, not sufficient to fund the (county’s) minimum critical needs. As a consequence, whatever the political rhetoric about privatization and cutbacks and no new taxes, responsible and thoughtful citizens need to address urgently how to bridge the gap between what is available and what is required.

The easy and hopeful answer is that institutions will lend. In this view, Orange County will simply go out and find creditors, who right now will accommodate the county’s distress. They know Orange County is a beautiful and vital and dynamic place, with an extraordinary energy and a great future. Surely, they will lend!

Why? Why should they lend? People who lend ordinarily like to know more than anything else--more than how much interest they will be paid or the duration of the loan or the conditions or terms--that they will be paid back.

The best evidence as to whether they will be paid back is whether those who came before them were paid back. If those who came before were not repaid, financial intermediaries in Armani suits, with an elaborate and gilded spiel, will not cause lenders to part with their money.

The notion that significant amounts of credit are available in an atmosphere in which people have not been paid back, and there is no credible plan for repaying them, takes on the aura of illusion.

This is not to say that credit is not available in a bankruptcy situation. It most assuredly is. That credit, when available, is either secured by assets or other compelling assurances that convince prospective creditors that, whatever circumstances gave rise to the default before, new creditors do not stand at risk.

What that means is that prospective lenders are persuaded that they will be repaid. The borrower must define how that repayment will occur.

That brings us to the special, indeed unique, circumstances in the case of a tax-exempt borrower, such as a municipality. When an individual or business borrows, the promise ordinarily made is that on the day the debt is due the borrower will repay the lender out of whatever proceeds are then available: cash on hand, inventory, other assets, even the proceeds of insurance, if need be. Whatever is available will be used to repay the debt. The lender then decides whether that commitment is sufficiently reliable to provide a basis for extending credit.

When a tax-exempt entity borrows, it makes a unique pledge not available to an individual or business: “I pledge to you that on the day stipulated, I will pay . . . and I pledge it to you with my full faith and credit.”

Four critical words, not unfamiliar: full faith and credit. But they are words which, in the context of public finance, have an extraordinary and far-reaching meaning. What “full faith and credit,” when pledged to secure a municipal obligation, has historically been understood to mean--and only in recent years has been definitely interpreted by the courts to mean--is that the tax-exempt borrower pledges that on the day the debt is due it will pay, no matter what. This means that it will, if need be, access its extraordinary prerogative, unique to it, to repay--and that is its power to tax.

The courts have said that on the day debt secured by a pledge of full faith and credit comes due, it is not sufficient for a municipal borrower to say to its lenders, “I’m not repaying you because I don’t have the cash and it’s not convenient to tax.” It isn’t enough for the borrower to say, “I know I pledged that, if need be, I would access my power to tax, but it is not politically possible.” It isn’t sufficient for the borrower to say, “I know I pledged that I would repay even by resorting to new taxes, if necessary; but we will be at an extreme competitive disadvantage if we tax and, therefore, we can’t do it.”

The pledge of “full faith and credit” has specific, profound meaning in public finance. So an entity that doesn’t repay, having pledged its “full faith and credit,” because it decided that it doesn’t wish to tax, is in a very difficult position when it goes back to the public credit markets and says, “Now I want to borrow all over again.”

Quite understandably, lenders think to themselves, “Who are they kidding?” Why is the pledge, the new promise of “full faith and credit,” any more inherently believable this time than it was last time? That is the difficulty of trying to access public credit markets of any kind or significant size to fund or finance even critical needs in the aftermath of a municipal bankruptcy or default.

Is it impossible? No. Can it be done? Yes. But it requires a recognition of what you must do to reassure public lenders; and it requires the development of a thoughtful and comprehensive plan, in order to persuade creditors that the borrower is not a frivolous entity, that there were special circumstances quite apart from local unwillingness to repay, from political resistance, which explain the default and provide absolute reassurance respecting the repayment of future debt.

Thus, the borrower and its citizens must demonstrate convincingly that they are sensitive to perceptions that they have breached faith, that they know they have undermined a valuable asset--their pledge of full faith and credit--and that they are willing to strive mightily to regain it.

It also requires strong, decisive leadership. The revival of New York City following its financial crisis of the late 1970s dramatizes that recovery from such a disaster depends on a crucial underlying factor: the quality of local leadership. That leadership, there should be no mistake, cannot come from the public sector alone; it depends on the business community, those who have the greatest stake in financial revitalization, working closely with elected officials to chart and steer the course to recovery.

In situations such as these, public officials are invariably traumatized, fearful of recrimination and retribution, institutionally incapable on their own of bold initiative and decisive action. They are apprehensive about the limits of public tolerance, sensitive to blame, anxious about their own futures. Only leaders of the business community, less concerned about the political reactions of an exercised constituency, can credibly and effectively outline the appropriate courses of action without which timely recovery is impossible.

Leaders of the business community must come together and join hands with elected officials, assisting them to formulate and execute the often painful policies that are essential for repairing the damage done to the county and its taxpayers. But I caution business leaders to be respectful of the roles and prerogatives of elected officials. This is after all, fortunately, still a democracy. But without an active partnership between the public and private sectors, fully respecting each others’ prerogatives, the job simply will not get done.