ORANGE COUNTY IN BANKRUPTCY : The Long and Winding Road to Consensus

If the Orange County bankruptcy were a fable, its moral might be this: The best laid plans of barristers, bankers and bureaucrats often get rewritten.

And so it has gone for more than nine months, with deals being cut and reshuffled, plans invented, tossed aside and reinvented.

With the Legislature’s approval Friday of the so-called “consensus plan” already embraced by the county’s Board of Supervisors and the committee representing other local governments, the blueprint for recovery may finally be etched in stone.

It is actually more a mosaic of plans A through Z, with some components created in marathon negotiations just a few weeks ago.

But the conceptual underpinnings--diverting money from various county agencies to the county’s general fund, and getting cities and special districts to forgive the debts they are owed by the county unless there is a windfall from litigation--have been themes of the recovery discussions since last December.

The consensus plan, in many ways, comes full circle to the first broad outlines for recovery the county offered back Jan. 5.

Bankruptcy attorney Bruce Bennett said then that the county would refinance its outstanding debt and slash operations, which it has. He also suggested that every agency with money in the county’s collapsed investment pool must share in its staggering $1.7-billion loss, and that the ultimate debt repayment must come from the deep pockets on Wall Street the county blamed for the debacle.

“It’s an evolutionary process. Had we not gone through all the other phases, we wouldn’t be where we are right now,” Supervisor Marian Bergeson said recently. “Solutions tend to be evolutionary.”

Still, some of the ideas that were repeatedly suggested by citizen activists, think tanks and some of the county’s creditors--ideas such as selling the airport or transferring it to the transportation authority; privatizing the landfill system and the jails; massive, across-the-board salary cuts; and diverting future property tax growth to the recovery effort--never made it past the negotiating table.

Christopher Varelas, the Salomon Bros. vice president who has served as the county’s principal financial adviser, said that what has changed throughout the case is not the options being considered, but the political environment.

“The trickiest part of this case,” he explained, “was determining when the landscape would be receptive to various notions.”

Before there was any plan at all, there was a philosophical faceoff between the main constituencies in the case.

Floating trial balloons in the press, the two sides tested the legal theories they threatened to bring to U.S. Bankruptcy Judge John E. Ryan, who would control everything from the distribution of the scarce remaining county dollars to the ultimate accounting of who owed how much to whom.

Bennett called the investment pool a mutual fund and said everyone who had money in it would have to suffer equally the loss it had sustained. The investors countered that it had truly been a trust fund, and demanded that the county repay them every cent before taking anything for itself.

Even at this point, outsiders in government and on Wall Street who had no stake in the case were focusing on what everyone would eventually agree was the top priority: avoiding default on $1 billion in short-term notes and thus retaining the integrity of the $3-trillion municipal bond market in which investors assume governments will make good on their payments.

But most local officials were treating the entire $2 billion in debts owed to bondholders, vendors and pool investors--dubbed “Citron’s crater” for the longtime Treasurer-Tax Collector, Robert L. Citron, who had managed the pool.

County officials and those representing the nearly 200 government agencies that had money in the pool retreated into top-secret summits with local business leaders in search of a compromise that would avoid an expensive courtroom battle. They emerged with what became widely known as Plan A--largely because of the county leadership’s complaints that there was no Plan B.

The goal of Plan A was an ambitious settlement with the government agencies that would repay them 100% of what they were owed--eventually. They would get about 77% back in cash. Schools would get 13% more, and others 3%, in “recovery bonds” the county vowed to make “good as gold” in June. The rest would come in a series of claims--some dubbed “hope notes” because of their dubious prospects--that the county would pay if it could.

The settlement was enthusiastically embraced by nearly all the cities, schools and special districts involved, and given a stamp of approval from Ryan in May. More than $4 billion was distributed to the local governments in one day, and the bonds were sold as planned, giving the agencies a second pay day.

But as they celebrated, many forgot to look at the fine print: Reaching the goals of the settlement agreement would cost money.

To put Plan A into place, Salomon Bros. offered a package of revenue raisers, some requiring approval from state lawmakers, others from county residents.

The county hoped to raise about $150 million by refinancing the county’s Teeter notes, based on delinquent property tax filings, $300 million to $500 million by importing trash and $150 million by selling off various buildings, parks and other properties it didn’t need. Most important, the county asked voters to fork over about $135 million a year for a decade by upping the local sales tax from 7.75% to 8.25%.

Taken individually, the tenets of Plan A met mixed reviews: The Teeter refinancing and sales of “recovery bonds” to repay pool investors went brilliantly, and remain a part of the current consensus plan. An auction of county assets brought only about $70 million, and the trash plan fell short of expectations; those revenues are counted in the current plan, but at far smaller levels.

But the linchpin, the sales tax, was summarily rejected by voters. Plan A was dead.

“I think what we had to do was try the tax approach,” former County Chief Executive Officer William J. Popejoy, who got the tax on the ballot and then was among its biggest backers, said in retrospect. “When that door was closed, and there still was a recognition that the problem remained, it opened some new doors.”

Alongside the defeat of the sales tax, the county also won a major victory, convincing bondholders to extend the maturities on their short-term debt for a year, and thus preventing--or, at least, delaying--the disastrous default. This both gave the county breathing room and helped focus creditors’ attention on repaying the bond debt to preserve the borrowing markets for the county itself and the other governments involved in the case.

Throughout the months-long debate over the sales-tax proposal, residents and local officials were clamoring for a Plan B, pushing county leaders to reveal what they would do if their first option failed. Though Bennett, Varelas and Popejoy said there was no plausible backup, Supervisor Roger R. Stanton--one of two on the five-member board to oppose the sales-tax hike--offered his own Plan B shortly before the election.

Stanton suggested that the county raise $700 million by selling John Wayne Airport to the Orange County Transportation Authority and put the waste management system on the market as well. He requested state legislation to help transfer money from restricted county accounts to the general fund--which has become a key provision of the consensus plan--and said the county should not repay its own portion of the investment loss. And he urged the cities and other governments to forgive the county’s outstanding debts, some 20% of what each had in the investment pool when it went belly-up.

After the sales-tax gambit failed, others in the case scrambled to find Plan Bs of their own. Everyone had a different version, and from the melding of the minds in the summer heat, the so-called consensus emerged.

Looking back, many key players said the passage of time was key because it allowed the county to convince its creditors that it really was too broke to pay. Plus, both politically and legally, the county had to first prove it could not raise revenue on its own before it could begin raiding others’ wallets.

By August, Orange County’s state legislative delegation had tired of sitting on the sidelines waiting for the supervisors to brings ideas to them for a stamp of approval and came up with a plan of its own: Transfer money from the flush OCTA to the cash-starved county, and force the cities and special districts to wipe off the debt, accepting their share of the loss.

Meanwhile, the cities and districts put together their own Plan B. They called themselves the “family of governments,” and offered to forget about what the county owed them--if the county would hand over the keys to prize assets such as the airport and landfills.

But the numbers in the “family of governments” plan didn’t exactly add up. And the legislative delegation had made a great leap in its plan, bypassing the need for voter approval to shift transit funds to the bankruptcy recovery.

Meanwhile, the county’s finance team had crafted its own menu of solutions to the looming debt problem.

From the county’s perspective, there have been only two potential plans from Day One: Either use the county government’s power to raise money--hence the sales-tax hike that was the centerpiece of Plan A but was bludgeoned at the polls--or take money from someone outside the government.

After June 27, officials considered the first option exhausted, and turned their attention away from the county itself. Varelas and his team went to the records room to page through the budget books of special districts. What resulted was the tax-shifting proposal, dubbed Project Alpheus after the river Hercules supposedly diverted to bring water where he needed it.

Varelas suggested taking $35 million to $75 million in transit-tax funds that did not require voter approval and giving it to the county. He also outlined plans to take property tax money from water and sewage districts, and to raid the sales-tax dollars on which cities rely.

The threat of losing their revenue, plus the legislative pressure to forgive the outstanding debt, combined with the slow realization over time that the county simply could not pay them back to convince most players among the pool investors that they could not continue demanding a 100% pay-back.

Round Two of the summit talks, again brokered by the uninvolved business leaders, began.

The consensus plan that went up to the Legislature was a combination of ideas. The main source of revenue would, indeed, come from a shift of OCTA funds to the tune of $38 million annually for 15 years; but some money from the county would be sent back to OCTA to support the bus system. Another $12 million would be transfer from restricted accounts within the county--a move pool investors and outsiders had been hammering from the beginning. Some money would still come from the refinanced Teeter bonds, the trash-importation plan and the asset sales, though the big-ticket items, such as the airport, would stay put.

But as Bennett had suggested from the beginning, the pool investors would agree not to collect the rest of what they are owed, some $750 million, except through litigation against Merrill Lynch & Co., or other private firms.

The county’s problem got solved, in part, when the problem was passed around. If they can’t recoup millions in litigation, the local agencies will likely have to cut services or raise fees--a cost that may prove greater than the sales-tax hike would have.