Default on Debts Would Hurt O.C.--but How Much? : Bankruptcy: Some say county’s quality of life would steadily erode. Others see little lasting impact.

If you fail to pay your electricity bill, it’s pretty clear what will happen: The lights will go out.

But what would happen if bankrupt Orange County defaulted on its debts, as is ominously predicted in the event voters reject a sales tax increase? The consequences are far more murky.

While almost everyone agrees that Orange County’s cities, schools and special districts would have to pay more in interest when they tried to tap the Wall Street money machine, there is little consensus on just how hard a blow it might be, or what that could mean for the average citizen.

Some optimists suggest that Orange County--with its dynamic, entrepreneurial economy--can easily weather a default. They say recent threats by some of the nation’s biggest mutual fund managers to boycott California municipal bonds if Orange County defaults are overblown.

“I don’t see the sky falling at all,” said Dale Dykema, co-chairman of Citizens Against the Tax Increase, which is fighting the half-cent sales tax, Measure R on the June 27 ballot. “There will be some temporary consternation, I’m sure. But there are so many other potential solutions. We’ll just be forced to look at those.”

But others see a far more gloomy future if the county fails to pass Measure R and ends up walking away from its obligations, which include more than $1 billion in bond debt that comes due this summer. They suggest that action--known in financial circles as repudiation--could be the final nudge that sends the quality of life in Orange County spiraling slowly downward.

“This wouldn’t be some big jolt like an earthquake that everyone feels at once,” said Wayne Wedin, chairman of the Orange County Business Council. “People would feel the effects at different times in different places. But one day everyone would wake up and realize Orange County has changed for the worse.”

With the costs of borrowing driven up by a default, progress on big-ticket projects--everything from freeways to community parks--would at the very least be slowed, pessimists argue.

“I can absolutely guarantee you it won’t be good,” said Stan Oftelie, executive director of the Orange County Transportation Authority. “There will be a significant extra cost to borrow. There would be less bus service, and freeway projects would simply be built slower.”

Even cities and schools with no connection to the bankruptcy could face an interest rate penalty or be forced to secure pricey bond insurance or letters of credit, raising the cost of selling bonds for cash-flow purposes and capital improvements.

Such seemingly arbitrary penalties have precedent. After the Washington Public Power Supply System defaulted in 1983 on a $2.25 billion nuclear power bond deal, municipalities throughout the northwestern state were hit with higher interest rates.

“There’s guilt by association, and some of the reasons behind it are just emotional,” said Dick Larkin, a managing director at Standard & Poors, a Wall Street rating agency.

Even so, those penalties were far from fatal. The state of Washington issued new bonds a few months after the power supply system’s default at a yield estimated at about four-tenths of a percentage point above market rates. And that sort of interest-rate premium on bonds issued within the state disappeared within a year.

Still, it does mean paying more and getting less. “If you can’t borrow money as easily,” Larkin said, “the roads don’t get built, the school doesn’t get fixed, the jail doesn’t get new bars on the doors.”

Elected officials would decide the priorities, but cuts would have to come somewhere--the police department, the libraries, lifeguards. Fees, meanwhile, could shoot up. Potholes could sit unrepaired even longer. Pupil-to-teacher ratios at schools, already alarmingly high, could head even higher.

“If I have to spend even $36,000 more each year paying interest, that means one less teacher,” lamented Michael Fine, financial services director at the hard-hit Newport-Mesa Unified School District. “It makes an already tight financial environment even more difficult.”

At the 21,000-student Irvine Unified School District, officials hope to build four new schools in the next five years to accommodate a growing student body. State building funds have evaporated, so the private financing market is the obvious alternative. But a default could hurt.

“It would create substantial difficulties for local agencies to go back and get preferred rates or even normal rates,” said Tom Burnham, school board president. “The additional debt service might mean we don’t have enough money to build all four schools.”

Whether the penalty would hit that hard is difficult to predict. Opinions from market experts and municipal officials vary greatly on the size of any post-default hit on Orange County agencies.

If history repeated itself, county government could be frozen out of the bond market for years as investors shy away from an entity that didn’t keep its financial promises. After New York hit the fiscal skids in the 1970s, the city didn’t tap Wall Street on its own for nearly a decade.

That freeze could have implications beyond the obvious. For instance, big Orange County developers who have historically gotten kid-glove treatment from the county might rush instead to have their projects annexed to nearby cities. The reason: With the county unable to sell the bonds needed to build roads and sewers, the developers would have to turn to the cities to access Wall Street.

But market experts say that cities in Orange County and around the state could be stung at least temporarily by interest rate penalties and requirements for more credit guarantees simply because of their geographical proximity to the epicenter of the $1.7-billion investment debacle. Many predict a penalty of 0.5 to 1 percentage point on top of the normal market interest rate.

It may not sound like much, but that extra cost adds up fast for big-ticket projects financed over several decades.

Anaheim, for instance, continues to enjoy a healthy credit rating. Later this year, city officials hope to market a $145-million bond sale for the planned 45,000-seat baseball stadium to house the California Angels. If that issue were shackled with a 0.5-point penalty because of fears inspired by an Orange County default, it would mean $22 million in additional cost over the life of the 30-year borrowing.

City officials are confident they won’t have to pay that sort of hefty premium. And even a penalty as high as 1 point wouldn’t kill the deal, they insist. But the inflated cost of borrowing would almost certainly be passed on to the fans, either with higher ticket prices or slightly costlier hot dogs and nachos.

Even highly rated borrowers like Anaheim are already paying because of the county’s bankruptcy declaration back in December.

This week, Anaheim is marketing $22 million worth of tax revenue anticipation notes, an annual rite of spring to tide them over until property taxes arrive in December. In the past, Anaheim hasn’t needed to take any extra measures to enhance the salability of its notes or bonds. But in this year’s post-bankruptcy climate, they felt obliged to spend $46,000 to purchase a letter of credit from the Union Bank of Switzerland to guarantee that money will be available to redeem the notes when they come due.

“This is a temporary situation,” said Keith D. Curry, managing director of Newport Beach-based Public Financial Management Inc., which is handling the deal. “They probably won’t need this sort of thing once the situation in Orange County is stabilized.”

Amid the campaign for Measure R, however, most officials are finding it easy to predict tough times if the county doesn’t pay its debts.

“We’re already beginning to see some of the effects,” said Paul Nussbaum, special assistant to Orange County Chief Executive Officer William J. Popejoy. “Those effects would just be multiplied” with a default.

“The market acceptance of bond issues would be affected--not just the county’s issues, but all the others,” he said. “And that’s a tax that no one gets to vote on.”

Nussbaum and others predict that marketplace perceptions after a default would cause housing prices to fall and hurt the county’s ability to attract and retain business.

“We’re not going to turn into a Third World country, but I don’t think it’s subtle in terms of the buyer,” Nussbaum said. “Uncertainty does affect consumer confidence.”

Some local agencies worry they could suffer simply because the words Orange County are part of their moniker. The Orange County Transportation Authority, for instance, currently enjoys a good credit rating and has only tenuous links to the county--two supervisors sit on the board. But will Wall Street pay heed to such details after a default?

“We don’t know how discerning they’ll be,” said Oftelie, the agency’s chief. “We hope they’ll understand there’s a difference between the transportation agency and any agency that defaults.”

Oftelie, for one, doesn’t think Wall Street is bluffing about shying away from California municipalities.

“I don’t think they’re blowing smoke,” he said. “They’re saying, ‘Who needs it? There’s plenty of fish in the sea. We don’t need a stinker.’ The attitude could be buyer beware if anything has a California name.”

But others say that’s hyperbole designed to scare voters into backing Measure R.

“Wall Street is not going to go away from Orange County,” said Mark Thompson, a political consultant shepherding the campaign against Measure R. “There’s just too much money here. We’re too rich of a county to ignore.

“[Orange County Sheriff] Brad Gates may say they’re going to hurt. But what does that really mean?” Thompson added. “Maybe they have to fire 10 jailers. You run the numbers for schools and find out they lose $40,000 or $60,000 or $100,000 on short-term borrowings. All that means is they restructure their budget a bit so it doesn’t hit in the classroom. And that’s all it means.”