Lessons Learned the Hard Way
The recent release of transcripts reminds us that Orange County’s financial fiasco resulted from a colossal accumulation of unnecessary errors by individuals. The losses did not result from some grand conspiracy, but from a lack of diligence.
The repercussions of the December 1994 implosion of the Orange County Investment Pool, constructed by former Treasurer-Tax Collector Robert L. Citron and his numerous cohorts, will touch just about everyone in the financial world.
The issues I raised during my candidacy against Citron in early 1994 included oversight, marking to market, leverage, complex derivatives and full disclosure. There were major gaps in state investment codes, in Security and Exchange Commission disclosure requirements and in accounting promulgations.
Subsequently, many new laws, regulations and pronouncements affecting financial professionals have been implemented. The successful lawsuits by the county against many of its former professional financial firms have shown that malpractice is ugly and expensive and must be avoided. Also, municipal employees have been reminded that jail time and substantial financial penalties result from gross negligence, willful misconduct or both.
Let’s review what we’ve learned about the responsibilities of municipal stewardship:
Investment policy statements: If you don’t have an investment policy, then write one, and fast. State law now requires governing bodies to review it every year. Our policy has received an award from the Municipal Treasurers Assn. of the United States and Canada.
Oversight: Oversight committees are now required by state law. We have a four-member committee, approved by the Board of Supervisors, that meets on a quarterly basis.
Investments: Investments must be in compliance with the investment policy statement. The oversight committee must perform an annual compliance audit. Orange County does this daily (internally), quarterly and annually.
Leverage: The days of infinite reverse-repurchase agreements are gone. The limit in California now is 20% of the portfolio. Borrowing is prohibited by our policy.
Derivatives: The Financial Accounting Standards Board (FASB) recently issued Standard 133, which becomes effective in mid-1999, requiring companies and municipalities to record derivatives on their financial statements at fair market value. Our policy prohibits the use of complex derivatives.
Reporting: Quarterly reports are required by state law. We issue ours monthly.
Values: Investments must be marked to market at the end of every reporting period. This has been made mandatory by the accounting profession’s Government Accounting Standards Board (GASB).
Auditors: Internal auditors will find it much easier to shout when irregularities are found, instead of burying the discoveries in a lengthy report. External auditors will find GASB 31 and FASB 133 exposing any Citron-type pool early in the game.
Elected officials: The voters want supervisors to supervise. The excuses of “trusting staff” and being caught up in the “herd mentality” do not cut it anymore. You are respected for your willingness to be a public servant, but be a “wanna-do” and not a wannabe, please. Understand your job and its responsibilities, and do it.
Rating agencies: If you charge a municipality to issue a severely deficient rating, then you cannot hide behind the 1st Amendment’s protection of free speech. Our Constitution is much too precious to be abused for financial gain. Standard & Poor’s is becoming a better reviewer of local government investment pools. Our investment pools have received the highest possible ratings, “AAA/V-1+,” from Fitch IBCA.
Journalists: Since we’ve touched on the 1st Amendment, the days of gullible and lazy reporters are over (I wish). The necessity for doing the “heavy lifting” has been reaffirmed. Failing to drill down to the truth of a story of such large proportions will haunt reporters for the rest of their careers.
Voters: Your job is that of a business owner hiring a manager. Those holding public offices work for you. Please interview them. Get involved in the electoral process and vote intelligently. Tragically, in the final analysis, the blame for Orange County’s bankruptcy will be laid at the feet of its voters.
We can never stop the complacency, greed and deceit that Orange County incurred. However, I believe that it is highly unlikely another “Orange County” municipal meltdown will happen again in this country.
We have all learned and we are smarter now. The chairman of any municipality, such as former Supervisor Tom Riley (April 2, 1994), should not be caught saying, “I don’t know how the hell he does it.” Because, as one local investment expert, Grant Bettingen, observed (Dec. 2, 1994), “there will be hell to pay.” And we did.
Fortunately, the past is the past. Let’s now enjoy a more competent and accountable future.
