Real-World Lessons : Professors Use O.C. Fiscal Crisis as Classroom Material

Nobel Prize-winning economist Merton Miller knows that a classroom teacher is only as good as his material.

So the University of Chicago professor quickly incorporated Orange County’s unprecedented bankruptcy into a lecture early this year to MBA students on the role of corporate and public boards of directors.

“Horror stories always attract students’ attention,” said Miller, who won a Nobel Prize for economic research in 1990.

And all the better, he said, if the bad news is from Southern California.

“This one is so delicious to a lot of people because it involves one of the wealthiest areas of the country,” the laureate said, “and people always take a little secret satisfaction in the discomfort of someone you secretly don’t care for.”

Even as Orange County slashes payroll, cuts government services and readies a sales tax proposal for a June ballot, college and university professors are picking through the remains of the county’s investment debacle for lessons that can be applied in the classroom.

“My job is to train these kids to be alert, critical citizens,” said Fred Smoller, an associate professor at Chapman University in Orange who’s blending the county’s crisis into courses on American government and media. “I’m using it to show what happens when people don’t pay attention (to government) and let a small group of people choose their leaders.

“This tragedy is good for business--my business,” Smoller said.

Professors regularly scan newspapers for breaking news stories that will pump up interest in complex but necessary subjects. In recent weeks, professors have used Orange County’s bankruptcy, the Barings bank failure, Mexico’s ailing peso and the dramatic weakening of the U.S. dollar to help students grasp difficult concepts or research powerful economic forces that are inadequately explained on the nightly news.

Finance professors have held up Orange County’s failed bond pool as an example of what can go wrong when highly complex investments are coupled with heavy borrowing; likewise, political scientists are scrutinizing the media’s role as a societal watchdog.

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“When you’re talking about a topic that looks complex or is very theoretical, it’s always nice to be able to apply a real-world situation,” said Dennis W. Draper, a USC business professor who has used Orange County’s fiscal woes to illustrate the problems and promise of esoteric financing tools and highly leveraged investments.

In a bit of serendipity, the county entered U.S. Bankruptcy Court just days before Draper’s upper-level finance class was scheduled last December to tackle so-called reverse repurchase agreements, one of the complex investment strategies that led to Orange County’s downfall.

“This issue was really hot, so I moved it up,” Draper said.

Smoller used the bankruptcy in an introductory course on American government for a hands-on lesson in balancing budgets. For two days, students weighed social services against public safety. Some took strong offense at the county’s decision to cut its budget, in part, by laying off innocent employees.

“They really wrestled with it,” Smoller said. “The lesson was that it’s hard to come to consensus.”

Jack Broughton, a Chapman University finance professor, said there’s no shortage of real-world developments with a direct link to the classroom.

“I do like it when something like this (bankruptcy) happens,” Broughton said. “That may sound somewhat perverse, but I cull the newspapers for stories that are relevant. So, when something like this (bankruptcy) happens, it’s really a wonderful thing.”

Broughton used Orange County’s fiscal woes to “illustrate the use of leverage, an often illusory concept. “In this situation, leverage played a central part in the problem,” Broughton said. “Students have read numerous newspaper articles, so I can illustrate (the county’s problems) with a balance sheet.”

Headlines sometimes drive enrollment in classes. Broughton reported that a class on derivatives doubled in size to 24 students immediately after Orange County’s problems surfaced.

Some professors use financial disasters to caution students about the pitfalls that abound in the real world.

Orange County and the Barings bank failure are “a way to get across to students that there’s no such thing as a free lunch,” said Jim Bodurtha, a professor at the University of Michigan’s Business School. “Nobody wants to be involved in a $1.5-billion loss.”

Professors also use the news to help students learn to craft solutions that will hold up in the real world.

USC Law Professor Jennifer Arlen has directed a student to research possible regulatory responses to Orange County’s situation that would prevent similar losses from occurring elsewhere in the country.

The student initially sided with Orange County, which has alleged that Merrill Lynch & Co. sold it risky investments in violation of federal and state law. “He was inclined to say that something happened, Merrill knew and, therefore, Merrill Lynch should be liable,” Arlen said.

“But there are huge costs associated with that (proposed solution), so I’m forcing him to go back to the drawing board,” Arlen said. “What I’m trying to get him to see is that figuring out what the problem is does not necessarily lead to the solution.”

Arlen also refers to Orange County during discussions of the legal responsibilities that agents--in Orange County’s case, former Treasurer Robert L. Citron--have to their constituents. “He did not appear to behave with the county’s money as he would have with his own money,” Arlen said.

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Daniel J.B. Mitchell, a professor at the Anderson Graduate School of Management at UCLA regularly uses news developments to flesh out core issues for a course that delves into California’s economy. Instead of textbooks, students hear from a string of experts, including a former Los Angeles County supervisor, a representative from the Immigration and Naturalization Services and a Los Angeles County deputy sheriff who discussed riot control.

Mitchell also incorporates breaking news into annual visits to the on-campus center where UCLA researchers prepare economic forecasts. This year, Mitchell’s students tweaked the annual forecast by factoring in the recent peso devaluation. But if Orange County’s fiscal woes had surfaced in the fall, students might have been calculating the economic impact of the unprecedented bankruptcy on Southern California.

Eventually, professors will set Orange County aside and move to the next in the inevitable string of financial and economic disasters, said Miller, the Nobel Prize-winning economist from Chicago.

“I know how important this is to people in California,” Miller said. “But people tend to forget that there are disasters going on throughout history. This one is not that central to the life of the Republic.”

And, as those calamities make news, Miller will appropriate them for classroom discussion. Quipped Miller: “They lend an air of verisimilitude to what would otherwise be bland and boring.”

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Lessons From the O.C. Bankruptcy

Business professors nationwide are using Orange County’s bond debacle to teach students about a number of subjects, including:

* The dangers of borrowing money to buy complex and volatile investment products

* The problems and promise of esoteric financing tools

* Regulatory responses that would prevent such losses

* Governance issues facing boards of directors

* Balancing social service budgets with public safety

* The media’s role as a societal watchdog