O.C. Bankruptcy Wasn’t Needed, Economist Says

Orange County’s fiscal problems weren’t severe enough to warrant a bankruptcy filing in late 1994, and the county could have earned as much as $1.8 billion by sticking to its hotly disputed investment plan, according to a study released Wednesday by a Nobel Prize-winning economist and paid for by Merrill Lynch & Co. Inc.

“The financial condition of the Orange County Investment Pool did not mandate bankruptcy,” Merton Miller, a University of Chicago finance professor and winner of the 1990 Nobel Prize in economics said during a press conference in Costa Mesa. “The county at the time had cash . . . real cash in the amount of $646 million.”

“From what I know about bankruptcy, this is not a pre-bankruptcy condition,” Miller said. “The numbers don’t demand it.”

Miller’s study marked the latest round of sparring between Merrill Lynch, which funded the study, and Orange County, which is suing the brokerage firm for $2 billion over losses suffered by the county’s investment pool prior to its unprecedented bankruptcy filing on Dec. 6, 1994.

County officials immediately disputed the premise and methodology of the well-known economist’s study.

“Miller’s course of action wasn’t even on the county’s menu,” said Chris Varelas of Salomon Bros., which is guiding the county’s post-bankruptcy investment strategy. “The county would have had to go out and borrow another $10 billion to $14 billion to earn the kind of return he was talking about.”

And, during an afternoon telephone conference call arranged by the county’s bankruptcy attorneys, a professor at UCLA’s Anderson Graduate School of Management described Miller’s premise--that the county should have held onto its pre-bankruptcy investments--as counter to state laws prohibiting government agencies from using the types of investments in the now-failed pool.

“The question in December 1994 was: Not knowing what would happen to interest rates, should the county continue to speculate,” said professor Bradford Cornell. “I find it amazing that Miller suggests that the county . . . after discovering a $1.6-billion loss, should have stayed at the table to try and make it all back.”

Miller castigated county leaders for their decision to follow what he called the “Queen of Hearts” strategy--dumping its pool holdings in a fire-sale fashion rather than sticking with the existing plan. “It was off with their heads,” Miller said.

Miller maintained that if the county had stuck with the original investment strategy of former county Treasurer-Tax Collector Robert L. Citron, the value of investments in the failed investment pool would have increased by about $1.8 billion from Dec. 1, 1994, to March 29, 1996.

Several months of studying the county’s portfolio left Miller with “no idea at all” why county leaders opted for bankruptcy, which in turn forced a continuing wave of budgetary and service cutbacks.

In its lawsuit against Merrill Lynch, Orange County alleges that the giant brokerage firm sold the county financial instruments that were inherently risky, and that Merrill and other Wall Street firms knowingly permitted Orange County to borrow billions more than state law allows to gamble in securities markets.

Merrill Lynch denies any wrongdoing and argues that the county caused its own losses by following an ill-conceived investment strategy.