Merrill Blames Orange County for Losses : Finance: Brokerage, responding to suit over failed investments, says officials caused debacle by filing for bankruptcy.

In its first detailed response to Orange County’s damage lawsuit, Merrill Lynch & Co. contended this week that county leaders and their lawyers--not the brokerage--caused taxpayers to suffer $1.64 billion in losses when they caused a panic among the county’s lenders by imprudently filing for bankruptcy last December.

Lawyers for the Wall Street firm argued that county officials mistakenly believed that the investment banks, which had loaned the county billions to invest in high-risk securities, would be barred from selling off the county’s collateral by the “automatic stay” provisions of the U.S. Bankruptcy Code.

Contrary to the county’s belief, the bankruptcy filing triggered a massive sell-off, causing “unnecessary losses [to county taxpayers] due to premature liquidations at unfavorable prices,” Merrill Lynch argues. Lawyers for the brokerage firm also argued that the county should not have “precipitously forced the resignation of [County Treasurer-Tax Collector Robert L.] Citron without a suitable replacement.”

The Wall Street firm’s lawyers said county officials should have followed a “viable workout plan” they had been presented with, which would have enabled the county to meet its immediate cash needs and hold on to its securities until it could sell them later at better prices.

The firm’s arguments were contained in its answer to a $2-billion damage suit the county has filed in U.S. Bankruptcy Court in Santa Ana.

Merrill Lynch sold Orange County most of the securities in the county-run investment pool, and the county blames the brokerage firm for the resulting financial debacle. Merrill Lynch denies any wrongdoing and is seeking to place blame on the county in its newly filed response.

Merrill Lynch confronted the county’s arguments that the multibillion-dollar reverse repurchase deals engineered by Merrill Lynch for Citron violated debt limits imposed by the California Constitution.

Reverse repurchase agreements are transactions in which securities are used as collateral for loans, which are then used to buy other securities paying a higher rate of interest. In the case of Orange County, the problem arose when rising interest rates began affecting the short-term, variable-rate loans, and the long-term fixed securities began losing value.

Orange County’s argument that Merrill Lynch should be held responsible for the county’s losses, the firm contends, “threatens the reliability and stability of the federal securities markets,” and if upheld by a court “would cause chaos within the municipal investment community.”

Bruce Bennett, the county’s lead bankruptcy lawyer, disputed the brokerage’s assertion that the county was given a plan to work its way out of the crisis. “If there was such a plan, neither I nor any of the other professionals representing the county had ever heard of it,” he said.

Instead, Bennett said, Merrill Lynch officials recommended to former state Treasurer Thomas W. Hayes, who was appointed to restructure the collapsed investment pool, that the county liquidate its portfolio.

C. Dana Hobart, a lawyer with the Los Angeles firm of Hennigan, Mercer & Bennett, which is representing the county in its lawsuit against Merrill, described the brokerage’s response as “scare tactics.”