Blame It All on Prop. 13

Three years ago, Orange County filed the largest municipal bankruptcy in U.S. history. Was this just a case of a rogue trader run amok with public funds? Or were there deeper causes that could topple other California counties?

The evidence that has come to light reveals that County Treasurer Bob Citron was the catalyst for the bankruptcy. But he was not the cause. While Citron’s risky investments put the county government in financial jeopardy, the treasurer’s actions stemmed from extraordinary pressures placed on all county governments in California since Proposition 13 passed nearly 20 years ago.

In retrospect, it is clear that a county government was the most likely place for a municipal bankruptcy to occur. County bankruptcies could spread if changes are not made in the way that taxes and services are distributed by the state.

By rolling back property tax rates and limiting the ability of local governments to raise taxes, Proposition 13 crippled county governments. Counties survived only because of a state bailout made possible by a large budget surplus. All that changed during the recession of the early 1990s. Suddenly, counties had to scramble as the state pulled back billions to reduce the state budget deficit.

The state offered help through a series of bills deregulating county investments. County governments seeking new revenue sources were allowed to leverage the public funds they had on deposit and invest the money in risky securities. In Orange County, the Board of Supervisors became accustomed to living off the high interest income generated by such risky investments. Citron’s schemes brought fiscal relief to overcome the loss of state funding without asking voters to raise taxes.

In fact, Orange County was not the only county government in California to rely on risky, interest-sensitive securities to weather severe fiscal stress during the last recession. San Diego County and 14 others did the same and could face a similar crisis in the next economic downturn.

A look back at the Orange County bankruptcy tells us why it should be avoided elsewhere at all costs. County tax funds for transportation will be diverted for years to pay off the bankruptcy debts, siphoning money that would be better spent on improving the infrastructure of this growing region. About 25 cents of every dollar of the county’s general fund goes to paying off Citron’s investment mistakes. Until last week, Orange County still was saddled with a “junk bond” rating by an unforgiving Wall Street. Cities, schools and other local agencies are owed nearly $900 million from the failed county investment pool. Three years later, Orange County’s recovery remains hostage to the pursuit of billion-dollar lawsuits against Merrill Lynch and other financial institutions.

California has been in denial about the link between Proposition 13 and the Orange County bankruptcy. There have been no meaningful changes in state and local government relations as the 20th anniversary of Proposition 13 approaches. As a result, the potential for another county fiscal disaster remains for California’s counties.