Five Years After a Very Costly Lesson

Five years ago today, at 4:52 p.m., Orange County did the unthinkable and declared bankruptcy, becoming an instant and enduring symbol of government greed and foolish risks.

Memories of the meltdown have faded, but its legacy lingers. Orange County still holds the distinction of being the largest government ever to seek protection from its creditors. And while the turbo-charged economy has helped propel its rapid recovery, the county still owes more than $1 billion. Paying the interest on that debt will cost taxpayers more than $800 million by 2027, the year the bonds are expected to be retired.

Those tax dollars otherwise could have been used on parks, libraries, health care, law enforcement or building new jails--an example, critics say, of some of the untold, untallied costs of the bankruptcy.

The county weathered those dark and chaotic days and emerged the better for it, a leaner and more focused organization, some say.

Losing $1.64 billion almost overnight jolted officials into long-range financial planning and instituting more checks and balances. Since then, the entire culture of county government has changed, with fewer managers and more workers focused on delivering services, said Jan Mittermeier, Orange County’s chief executive officer.

But have the reforms immunized Orange County against future financial ills? Could the bottom drop out again?

Yes, say the experts.

While there is a small chance of a repeat crisis, many of the core problems persist. The county remains dependent on state revenue and vulnerable during weak economies. And, some say, politicians are too influenced by special interests.

“Are there politicians who would take the risk of destroying schools, roads and flood control to find money to fund their pet programs? Absolutely,” said Chriss Street, a Newport Beach financier who, with current Orange County Treasurer John M.W. Moorlach, tried to warn people before December 1994 about then-Treasurer Robert L. Citron’s precarious house-of-cards portfolio.

“The same kind of borrowing practices are still out there,” Street said. “The speculative investments, the little guys and the big guys are still looking to the government for money to fund their projects. There are a lot of people slurping at the trough.”

Mark Baldassare, senior fellow at the Public Policy Institute of California, points to Los Angeles and San Diego counties, which have had brushes with financial collapse. And then there is Ventura County, where the county administrator recently quit after just four days on the job, citing the county’s financial troubles.

“Counties lack the tools to be able to respond to a changing economic environment,” said Baldassare, who wrote a book on the bankruptcy. “There is a lack of control and flexibility. And that hasn’t changed.”

The county’s current treasurer says he takes several steps toward safeguarding the public’s money, including refusing to pump up investments with borrowed money or aggressively recruiting investors.

Moorlach said he regularly discloses his office’s finances and investments. Most important, he has two oversight committees monitoring his investments.

“There was no oversight of Mr. Citron, and he opposed it every time it was even brought up,” he said.

Such steps also mean that the investment pool no longer reaps the same legendary returns as it did when it held taxpayer funds from the county and 200 schools, specialized districts and all but two Orange County cities.

Now, just two small special districts and the county make up the investment pool that contains about $2.75 billion, a far cry from the $21-billion bubble that burst in December 1994.

In the early ‘90s, investors were enchanted with Citron and his hefty earnings, the results of winning bets on low interest rates. The earnings came as the rest of the region was struggling: California’s long recession had eliminated 57,000 payroll jobs, and real estate values had tumbled.

So alluring were Citron’s big returns that the county and many other governments issued municipal bonds for no other purpose than to pour more funds back into the investment pools. The idea was to earn more interest from Citron than had to be paid to bondholders, and collect the difference.

Citron was doing much the same: He had taken a more than $7-billion treasury, borrowed another $14 billion from brokerages, and invested heavily in bonds that were sensitive to interest-rate changes.

It all fell apart when the Federal Reserve repeatedly bumped up interest rates in 1994 to curb inflation, and the value of Citron’s securities--and the interest they paid--plummeted. Citron blamed Merrill Lynch & Co., his chief investment house. The county sued Merrill and other firms, contending the investment strategy was so reckless it was illegal.

Merrill officials maintained it had acted properly, warning Citron of the risks. But the brokerage agreed to pay more than $450 million to settle the county’s civil charges and end a criminal investigation.

Additional settlements brought the county’s recovery to more than $860 million, about half the losses.

Under the terms of the plan that got the county out of Bankruptcy Court, schools recovered 97% of their losses, cities and public agencies 93%. The county recouped 35 cents on every dollar lost.

The bankruptcy’s repercussions extend beyond Orange County.

The county’s reputation is forever tarnished, said Bruce Whitaker, a Fullerton activist and vocal government critic.

Orange County was portrayed as a well-heeled deadbeat, particularly after voters refused to raise the sales tax to pay off short-term obligations. Instead, the county pressured bondholders into accepting a year’s delay in payments, then took on roughly $1 billion in new long-term debt to pay the old debts.

“They effectively borrowed their way out of the bankruptcy,” Whitaker said.

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The uproar also shined a spotlight on the municipal bond market. But in the end, no significant national laws were passed to restrict brokerages in their dealings with local governments, said John C. Coffee, a securities-law specialist at Columbia University Law School.

But there remains a very real lesson: No one ever should allow a municipality to run risks high enough to conceivably end in such disaster, Coffee said.

Merrill also has changed the way it does business.

“We’ve learned to monitor our relationships with public entities even more carefully than we’ve done in the past,” Merrill spokesman Bill Halldin said.

It’s easy--too easy--to imagine a situation similar to the county’s bankruptcy occurring again, Coffee said. For example, commercial banks still provide interest-rate “swaps” that can be used to hedge against financial risk, or to make the kind of ill-advised bets that brought down Citron.

As for those entrusted with funds, temptations to gamble will always surface when the pressure is high enough, Coffee said.

“Once you start losing, the addict at the racetrack will bet the mortgage money on the eighth race trying to make up the losses on the first,” Coffee said.

Baldassare said the only lesson to be learned from the bankruptcy is that county government is capable of making some very foolish mistakes. Today, the economy is strong and state coffers are overflowing. But that won’t always be the case.

“Next time there is a serious downturn in the economy, counties like Orange County will still be very vulnerable,” he said. “We haven’t fixed the core problems.”

Mittermeier agreed.

“You are always vulnerable when you are dependent on someone else for your resources,” she said.

December 1994 forced county government onto a crash diet. About 3,000 of the 18,000 county workers were let go. County officials began charging user fees at parks, slashed fees for trash haulers to attract more business, postponed improvement projects, and kept buses on the road longer before replacing them. Surplus property was also sold off, bringing in about $12 million.

Selling John Wayne Airport was discussed at one point, but federal restrictions wouldn’t allow that, Mittermeier said.

The county emerged from bankruptcy protection in June 1996 but some worry that the true impact of the bankruptcy has yet to catch up with the county.

“There are pressing unmet needs that the county faces every day because we don’t have the luxury of discretionary dollars because we have to pay off this huge amount of debt,” Orange County Supervisor Todd Spitzer said. “The lasting legacy from the bankruptcy is that voters cannot afford to be complacent about who they elect.”

For his part, Citron pleaded guilty to six felony counts of fraud and misappropriation of funds. He was ordered to pay a $100,000 fine. He avoided jail time when he entered a daytime community service program working at the sheriff’s commissary. Now 74, Citron volunteers at a local food bank.

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There are still some legal fights ahead. Still to be litigated is a lawsuit against Merrill Lynch by 14 cities and public agencies that lost money in the bankruptcy and reserved the right to sue on their own behalf. That lawsuit is pending in Contra Costa County Superior Court.

Matthew R. Raabe, Citron’s chief deputy, was convicted of fraud and sentenced to three years in prison. He spent 43 days in custody before being released pending an appeal.

And Michael G. Stamenson, the Merrill Lynch salesman who earned millions in commissions from his dealings with Citron?

“There was no disciplinary action,” said Halldin, the Merrill spokesman. “He’s working with our counsel in preparation for the litigation that still exists. He is still an employee in good standing.”