FIVE-YEAR LOOK BACKS
Today’s theme: “The saddest day in Orange County history.”
The County’s press conference on Thursday hit the printed page around the world Friday morning, December 2nd. And you can bet my Thursday was consumed with reporter calls. Here are bits and pieces that will help explain a good portion of the whole.
G. Gruce Knecht of The Wall Street Journal had a piece on page A4, it was titled “Derivatives Lead To Huge Loss In Public Fund—California’s Orange County Has Lost $1.5 Billion in Aggressive Strategy.”
The fund’s manager, Robert L. Citron, employed an unusually aggressive investment strategy that made the fund extremely vulnerable to rising rates.
“This is a very sad day for Orange County,” said John Moorlach, a certified public accountant who ran against Mr. Citron for county treasurer last spring. “We’re going to have a lot of victims: school kids, taxpayers, roads, everything.”
The news about the loss shook Wall Street firms, particularly Merrill Lynch & Co., which is known to have sold a substantial amount of securities to the fund and is believed to have been a main source of the fund’s borrowings.
The county’s Mr. Citron has long had a reputation for being extremely aggressive in his investment strategies. In fact, many counties and government agencies are prohibited from using the kind of strategy that Mr. Citron employed. But in California, the laws are more flexible, thanks to a legal revision that Mr. Citron said he himself helped engineer.
In its reverse-repurchase transactions, the fund delivered fixed-income securities to a financial institution and received cash in return. The fund agreed to repurchase the securities at a later date at a higher price.
Mr. Citron then used the borrowed funds to purchase other securities. The hope was that the fund would earn a higher yield on the new investments than the rate of interest it had to pay under the repurchase agreement. “Citron has bragged about his great income, but he was gambling,” Mr. Moorlach said.
The net effect of the transactions was to increase the fund’s sensitivity to interest-rate changes. In effect, Mr. Citron was gambling on lower interest rates, and he earned one of the nation’s highest rates of return as long as interest rates kept declining. Mr. Citron said the fund produced an average yield of 10.1% over the last 15 years.
However, when rates began turning up earlier this year, his giant wager began turning against him. In an interview with The Wall Street Journal in April, he said that rising interest rates had forced him to meet $140 million of “collateral calls” from brokers that had lent money to the fund through reverse repurchases and other arrangements.
However, Mr. Moorlach and some traders said that the fund increased its leverage in order to expand its interest-rate bet. “Between March 31, 1993, and March 31, 1994, he invested another $8 billion” in securities that would benefit with declining rates, Mr. Moorlach said. “He was hoping and hoping that rates would go down. He created a recipe for disaster.
The lead headline for the Daily Pilot read “County Investments lose $1.5 billion—Moorlach saddened that his prediction came true.” The article was written by Marc S. Posner. Here are the opening and a few additional selected paragraphs:
Six months ago, John Moorlach, a Costa Mesa resident and CPA, said no one was listening when he predicted the county’s investment fund was a ticking time bomb. On Thursday it exploded and he had calls galore.
From the New York Times, The Wall Street Journal, Barons, CNBC.
That’s just a handful of the names that filled Moorlach’s message screen after word spread that Orange County lost $1.5 billion in bond investments made with a pool of money from some 180 public agencies – including Newport Beach, Costa Mesa and the Newport-Mesa school district.
The $1.5 billion lost is a conservative estimate, Moorlach said, adding the total loss could be as much as $2 billion to $3 billion.
Moorlach says the city of Costa Mesa could have been hit harder by the loss, but he said he continually lobbied Susan Temple, the city’s finance chief, to pull its money out and, in fact, the city had taken $11 million out in recent months.
Allegations that the county’s investment was sitting on an earthquake fault about to produce the Big One were the cornerstone of Moorlach’s unsuccessful bid for the county treasurer’s post in June.
The losses are based on federal treasury chairman Alan Greenspan’s decision to raise the interest rate several times in an attempt to fight inflation, Citron said in [a prepared] statement.
Thursday could have been Moorlach’s chance to boast as Citron’s investment decisions came a topic of national discussion.
Instead, Moorlach expressed sorrow and ire.
“I’m real angry,” Moorlach said. “I’m angry the papers could never figure out the story. Our Board of Supervisors didn’t listen to me (or) meet with me. They just gave me a big brush off.
“I’m also really grieving,” he said. “This is a sad day in Orange County history. This is the big story on the market right now.”
“There are sad consequences when one gambles in the market. [Citron] shouldn’t be gambling with public money.”
Citron should have been pulling out when signs showed that interest rates were going up, Moorlach said.
That’s the same advice he gave trustees of the Newport-Mesa Unified School District earlier this year when they were deciding if they should re-invest nearly $50 million in the county fund.
The trustees voted 5-2 to leave the money in Citron’s pool. Judy Franco and Ed Decker agreed with Moorlach.
We made it to the front page of the New York Times with Leslie Wayne’s “California County Facing a Huge Loss In Sour Investments.” Leslie Wayne would come out to the OC and follow me for a day, only to write a piece with major technical errors. This trait shows up below. I called the public records request response from Citron during the campaign “junk” (see MOORLACH UPDATE – OC Register – April 21, 2009). Oh, well.
Mr. Citron’s actions came under sharp fire in June when he was challenged for the county treasurer post. He won. But his opponent, John Moorlach, a Costa Mesa, Calif., accountant, made Mr. Citron’s investments a campaign issue, calling them “junk.” Mr. Moorlach said: “The good news is that I was right. The bad news, too, is that I was right. Rising interest rates are the kiss of death for this investment strategy.”
The front-page coverage in the LA Times included two articles, “Risky Investment Takes $1.5-Billion Bite Out of O.C. – Officials seek to calm 180 cities and agencies and prevent a run on county’s once high-flying portfolio” and “Portfolio Critic Declines to Crow ‘I Told You So.’” The LA Times put a number of reporters on this topic. For the first article we see Mark Platte and Debora Vrana (and a few other staff writers). They also provided sidebars on “Chronology of a Crisis” and “The Players.”
John M. W. Moorlach, a certified public accountant who ran against Citron this year and was defeated, compared Orange County’s financial crisis to that in Cuyahoga County, Ohio, where the county government shut down its investment fund in October under similar circumstances.
“This is not a great day,” Moorlach said Thursday. “We are praying for him. This is the worst thing you could go through.”
The second lead article was by Gebe Martinez, who covered the campaign.
If there was ever anyone in a position to tell Orange County’s government leaders “I told you so,” it is John M. W. Moorlach, the Costa Mesa accountant and Republican Party activist who sounded the alarm last spring that the county’s investment portfolio was on financially shaky ground.
But on Thursday, as the news broke that the county’s investment fund had plummeted by $1.5 billion this year. Moorlach said he was not taking any delight in being proven right.
Hearing earlier this week that county officials were holding meetings with investors to shore up the credibility of the investment pool, Moorlach said he suppressed the urge to trumpet the news.
“I just kind of bit my lip and said, ‘Everything I predicted is happening,’” Moorlach said. “I didn’t want to be proven correct this way. This is sad. This is going to be the saddest day in Orange County history. This is an embarrassment for Orange County.”
Vindicated by the latest developments, Moorlach was taking telephone calls all day Thursday from East Coast financial writers who knew of his longstanding criticism about Citron’s investment strategy; from political allies who stuck by him when the pressure mounted for him to remain silent; and from allies-turned-foes who were now apologizing for not having listened to him sooner.
“For 15 years I have been managing the portfolio this way,” Citron said in his only comment during the meeting with reporters. “What I did was not irresponsible in any manner, shape or form.”
Moorlach’s opponents “took great delight in beating up on him. They said he didn’t understand. But he did understand,” [Assemblyman Mickey] Conroy said Thursday, as he called on Citron to resign.
In the midst of the political fallout, Moorlach reserved some of his most strident comments for county supervisors, who he claims were never willing to hear him out.
Referring to Board Chairman Thomas F. Riley, who retires at the end of the year, Moorlach said, “What a sad way to go out of office, leaving the county broke.”
Moorlach also singled out Supervisor Roger S. Stanton. “He never returned my calls,” he said.
After the treatment I received from the OC Register, I was not returning calls from the reporters that covered my race, just like I told Publisher David Threshie I would do. They finally had Mary Ann Milbourn call me, and I returned her call. The top-of-the-fold headline? “O.C. fund down $1.5 billion – The treasurer’s investment strategy ” They should have printed this headline six months earlier (but, I’m not bitter). This piece was by Chris Knap.
Similar bets by municipal investment pools have caused several spectacular crashes, most recently the collapse of a Cuyahoga County, Ohio, investment pool that lost $114 million last month.
Many bond industry observers said Thursday that Orange County will not be able to avoid a similar crash, as Citron political opponent John Moorlach, a Costa Mesa accountant, had predicted earlier this year.
“(Moorlach) was absolutely right as rain and now we’re going to pay hell for it,” said Irvine investment broker Grant Bettingen. “(The county) is going to lose $1 billion to $2 billion and they are not going to be able to pooh-pooh that.”
Jennifer B. McKim of the OC Register would be one of the first reporters to receive what would be a small handful of recognitions that I awarded during our annual Treasurer’s Conference. When there is good reporting, recognize it. Jennifer McKim was on to a really big story, one that developed serious legs, and one that resulted in an intereting result. Her story, “Expressing Concern About The 91 Deal – Too much? Too cozy? Details of the sale of the private toll lanes bother some officials,” was one of the pieces that started the ball rolling.
The company planning to pay about $225 million next week to operate the 91 Express Lanes toll route did not ask for an independent third-party appraisal of the project, according to documents released Wednesday.
Some said the price is too high; others questioned whether the buyer and seller are too closely linked for a fair deal.
“My concern is, do we really have an arm’s-length transaction? – and that doesn’t appear to be the case,” Orange County Treasurer John Moorlach said. “We don’t know if they are going to pay too much or not enough.”