Orange County Crisis Calls for Some Cool Consideration

To cut through the wild rhetoric in the game of chicken between Orange County and creditors who hold the bankrupt county’s notes and bonds, some undramatic facts should be understood.

Bankruptcy is expensive but not necessarily fatal--unless the county tears itself apart in recrimination, with residents blaming far-off financiers and local real estate developers and threatening to default on debts.

This is a critical moment for Orange County in ways that go well beyond finance; how its people handle the debt crisis will reveal what stuff the community is made of.

Meanwhile, before anyone jumps off a cliff, it would be wise to consider just what’s involved.

Most of the $1.3 billion in debt coming due this summer--and in jeopardy because money must be raised to pay it--consists of one-year notes that will be extended or rolled over at one-half to three-quarters of a percentage point in added interest. That amounts to a 16% to 25% interest hike on existing notes, or roughly a $5-million to $7.5-million extra burden falling on the county and cities and school districts.

That’s what the cost will be whether voters approve or reject the sales tax proposal on June 27--although if they turn down the tax, other ways will have to be found to pay the notes.

Then there will be an added charge on future debt, not only in Orange County but throughout California and the nation. Tax anticipation notes sold this June to give communities and school districts working capital for the new fiscal year will carry about a one-quarter point interest rate increase, according to traders of municipal debt.

Why will other communities be tarred with the brush of Orange County’s bankruptcy? Because until last December, notes were not supposed to carry a risk of bankruptcy. “Notes were sold with an irrevocable pledge that designated tax revenues would pay the obligation,” says Zane Mann, publisher of the California Municipal Bond Advisor newsletter in Palm Springs.

Thus, the county’s bankruptcy injected a new level of risk for all notes. That’s one reason financial markets think the bankruptcy declaration was wrong to begin with. “If county officials were competent, they could have negotiated a work-out agreement,” says one trader of municipal debt.

Markets prefer compromise to collapse. Today municipal debt traders at major banks and brokerage houses predict that when county notes come due this June and August, negotiations will succeed in working out new maturities and interest rates--just as would happen in private business.

In the aftermath of such negotiations, county and cities, school districts and agencies would adjust their budgets to reflect their loss in Robert Citron’s investment pool--ultimately perhaps as little as 10 cents on the dollar.

Credit ratings of cities, schools and agencies would be as they were before the crisis. The county’s rating, which has gone from AA to CCC, or junk--in effect, the county cannot borrow--would return over time to some investment grade.

But if the original bankruptcy was a blunder, there is a possibility of further blunder in default--and that would throw all credit ratings, county and community, out the window.

The county is considering default on grounds that about $600 million of borrowings to invest in Citron’s fund were “unconstitutional”--although county attorneys had attested to their constitutionality so that they could be sold to investors in the first place. Such rationalization is childish, say bankruptcy lawyers.

Talk of default is mixed up with widespread opposition to the proposed sales tax increase from 7.75% to 8.25%. If the tax increase doesn’t pass, default could loom (although, as we’ve seen, work-out negotiations are a less dramatic probability).

But what’s remarkable in Orange County today is the Boston Tea Party atmosphere surrounding such questions, as if stiffing creditors would strike a blow for freedom.

One position is that the county’s creditors are mere speculators and unworthy of being paid. In fact, the county’s notes are owned largely in money market mutual funds, which are in turn held by millions of Californians.

Another position is that financial markets wouldn’t punish Orange County’s strong economy too much even in default because California investors are eager for tax-exempt issues. But that, says a trader, ignores the fact “that investors are already demanding a higher yield on California paper because there’s a blot on its name.”

Many see the crisis as a chance to redirect county politics. Says political science professor Mark Petracca of UC Irvine: “If the county can’t borrow for roads and sewers, the big developers can pay for infrastructure and raise the price of the houses.”

Others see opportunities to shrink government through privatization rather than tax increases. Says lawyer Hugh Hewitt of Irvine’s Hewitt & McGuire firm: “The Mile Square golf course (in Fountain Valley) could be privatized; Corrections Corp. of America is here trying to buy the jail” in Santa Ana.

Such ideas on the county’s structure are worthy of debate but beside the point today, when the question is, simply: Will Orange County fulfill its obligation to pay its debt? If the answer is no, the long-term consequences may not be pretty.

For the saddest aspect of the crisis is the underlying anger and disunion it has revealed in prosperous Orange County. New York City two decades ago had a far worse financial problem, but state and local government, private and public officials pitched in and worked out a solution for all the residents. There was unity in a raucous place not known for it.

In Orange County there is disunity. And that is not a good omen for its future, for reasons far beyond finance.

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A Problem in Subtraction

Because Orange County in the new fiscal year won’t have the cushion of interest that ex-Treasurer Robert Citron’s investments used to provide, many expenditures must be cut sharply. The fiscal 1995 and proposed fiscal 1996 budgets, in millions of dollars:

Public protection: 1994-95,$106.9 and 1995-96, 83.3

Court system: 1994-95, $53.5 and 1995-96, 36.8

Health services: 1994-95, $40.3 and 1995-96, 25.7

Community, social services: 1994-95, $74.1 and 1995-96, 54.1

Environmental resources: 1994-95, $3.5 and 1995-96, 0.7

General government: 1994-95, $80.9 and 1995-96, 61.4

Capital improvements: 1994-95, $10.9 and 1995-96, 6.4

Capital acquisition: 1994-95, $4.3 and 1995-96, 4.1

Insurance, reserve and other: 1994-95, $88.1 and 1995-96, 2.4

* Source: Orange County Financial Restructuring Plan