O.C. Bankruptcy Move Too Early, Critics Testify : Hearing: Witnesses before House subcommittee attack supervisors’ decision to seek protection from creditors.

Orange County’s decision to declare bankruptcy last December just as its investment pool collapsed was criticized Wednesday at a House Banking subcommittee hearing convened to consider whether the federal government should impose new rules on municipal investments.

The strategy to declare bankruptcy in order to hold off a run on the county’s investment pool was questioned by a number of witnesses, including the county’s departing chief executive officer, William J. Popejoy, and California Treasurer Matt Fong. Also testifying were a Securities and Exchange Commission official and municipal bond analysts who expressed fears that if Orange County defaults, other local governments may follow.

As a result, investors may demand higher interest rates and other forms of protection in the future, the witnesses suggested.

“It is too early to tell if Orange County is an isolated incident or the beginning of a fundamental change in how municipalities view their commitment to general obligation bondholders,” testified Christopher A. Taylor, executive director of the municipal Securities Rulemaking Board, which monitors securities dealers.

The two-day hearing, designed to find out what has been learned from the county’s historic $1.7-billion loss, drew varied opinions on whether Congress should require more municipal bond information or simply leave scrutiny in the hands of the states and the financial markets.

“One lesson we should not draw . . . is the wrong-headed notion that Chapter 9 [bankruptcy] may be an alternative to responsible but unpopular decisions to fulfill the [financial] obligations incurred by local governments,” Paul S. Maco, director of the SEC’s Office of Municipal Securities, said in a strongly worded rebuke to the Orange County Board of Supervisors’ action to declare bankruptcy.

“Chapter 9 should be a last resort, not an easy way to avoid debts, or a safe haven for faint-hearted officials,” he said.

In a series of pointed questions by Rep. Ken Bentsen (D-Tex.), Orange County Board of Supervisors Chairman Gaddi H. Vasquez explained that once local officials knew of the impending financial meltdown--too late to avert a run on the county’s assets--the board “believed [bankruptcy] was the only viable option available to us.”

“I would certainly hope the lessons learned from this experience will result in the development and implementation of provisions that will never again put any county in this country in that position,” Vasquez said.

The county’s bankruptcy attorney Bruce Bennett accompanied Vasquez to the hearing but was not called as a witness.

The bankruptcy “reversed the established principle of municipal finance that governments have a moral obligation to repay their debts based on their full faith and credit,” said Richard Larkin, managing director of Standard & Poor’s, a bond rating agency. He emphasized the need for the county to meet its obligations to prevent a permanent damage to the stability of the municipal bond system.

“In order to maintain the security of the municipal finance market, to repair the crack before it spreads, it is important to ensure bondholders are made whole in this instance,” Larkin added.

While many questioned the county’s decision to declare bankruptcy, subcommittee Chairman Richard H. Baker (R-La.) and Bentsen, the only two members who presided over most of the hearing, also pressed representatives from the SEC and the bond rating houses on why they did not detect the instability of the county’s investment pool.

Maco responded that inquiries were made of the county during the spring of 1994, following local newspaper reports questioning the investments of former Orange County Treasurer-Tax Collector Robert L. Citron.

But he said documents provided by the county did not indicate the use of derivatives, and that while the investment strategy appeared “risky,” it did not violate state law.

Without any evidence of fraud, the SEC did not have any reason to take any action, Maco said. “Simply put: We did our job,” he said.

Because of an ongoing investigation by the SEC in the wake of the county’s financial collapse, Maco said he could not comment on whether the agency now believed it had been misled by Citron or other county officials.

However, the SEC maintained it already has the authority it needs to impose rules that will require more disclosure of information to municipal bond investors. But Baker said after Wednesday’s session that “taxpayer losses can be averted, in my judgment, with better disclosure standards, so ultimately, yes, there will be legislation that we will propose.”

During the hearing, Baker also asked Larkin if the lack of information about the county’s shaky portfolio could have been because of “omission or misrepresentation or fraudulent.” Larkin replied that none of those scenarios could be ruled out in Orange County’s case.

Daniel N. Heimowitz, executive vice president and director of public finance for Moody’s Investors Service Inc., warned against any effort to repudiate debts. No matter what the legal justification, the effort would be “an attempt to put a moral gloss on what really amounts to a way to stiff its creditors,” he said.

In defense of the county, Vasquez outlined numerous steps officials have taken recently, including a one-year rollover of the debt in order to buy some time to raise money to pay the debt.

Orange County voters last month rejected by a wide margin a proposed half-cent sales tax increase to help repay the outstanding debt.

The ill-fated sales tax proposal “received at best lukewarm support from most county officials, and was actively opposed by a number of city councils,” said Heimowitz. “We believe these events are beginning to fray the edges of public trust.”

Representatives of the municipal bond rating houses expressed doubts that the county will be able to repay notes that become due next July.

Bentsen wanted to know if the state of California had plans to help Orange County recover. Bentsen and others opposed any federal intervention in Orange County’s case.

“I don’t see and I don’t think the state has any kind of a plan to do any kind of a bail out,” Fong said.

He said the state would appoint a trustee only if one of three conditions are apparent: the county asks for it; the county is unable to provide services; or if the “county totally repudiated its obligation.” Fong said none of those conditions exist.

“I believe that with the success of the rollover strategy, it now gives the county a year’s time to work out some solutions,” Fong told the panel.

Even though Citron took the brunt of the criticism for causing the bankruptcy, Bentsen also demonstrated through his questioning of Vasquez that county supervisors did not properly monitor the county’s investments.

For example, Vasquez conceded he did not know whether the board or Citron hired the county’s independent auditor to review the health of the investment pool. He also said he had relied on the county staff to read the official statement accompanying a July, 1994, sale of $600 million in taxable notes, which pledged the county’s commitment to repay the debt.

Times staff writer Jodi Wilgoren and David Phinney of States News Service contributed to this report.

* DECISION DEFENDED: O.C. officials say filing Chapter 9 was their only choice. A14