Since more disclosure on the lobbying front is being demanded of late, the first LOOK BACK (January 21) will show my personal history of transparency when there has really been a problem. I was more than happy to work with someone from the other side of the aisle. It’s just too bad the experience left a bad taste in my mouth.
Pensions & Investments continued their editorials on our bankruptcy filing (January 23). One rightfully went after the credit rating agencies, which has a positive update in the January 24 LOOK BACK. The other had a great investment tutorial on risk and return, that is a timeless piece and a great read.
I responded to Hugh Hewitt’s column on how to resolve the loss allocation, which was the big issue of the day (January 24). Five years later, our credit rating would receive a big jump up. And, five years after that, we would feel the repercussions of the second ill-advised pension enhancement made in 2004.
FIVE-YEAR LOOK BACKS
An odd pairing occurred when both I and State Treasurer Phil Angelides agreed on opposing a legislative proposal. Meg James of the LA Times covered it in “Finance Report Backers: Remember O.C. – Angelides, Moorlach defend requiring counties to submit investment data to Sacramento. Others say the rules are costly.”
When I served as Treasurer, I was providing monthly reports to the State Treasurer’s office, even though it was only required quarterly. We were preparing reports for the Supervisors and the participants, what was so difficult about doing one more? And why the state thought that it cost so much is a topic for another discussion. But, the extra set of eyes made sense to me.
What was awkward is that Phil Angelides recommended that we do a joint editorial on the topic. I forwarded him a draft proposal and never heard back. But, I did see one of his staff quoted on the matter and that staff member used a line that was lifted from my draft. Awkward. Live and learn.
State Treasurer Phil Angelides is opposing a plan to scrap a 5-year-old law requiring counties to send quarterly investment reports to the state, and questioning whether lawmakers are ignoring the lessons of Orange County’s bankruptcy.
"Those who forget history are doomed to repeat it," Angelides said Wednesday after a legislative analyst recommended that California abandon its stepped-up reporting requirements, adopted in the wake of Orange County’s fiscal meltdown.
The cost of the requirements, estimated at about $3.5 million a year, is "significantly more than the Legislature anticipated," analyst Elizabeth G. Hill wrote Tuesday in a seven-page report to the Senate Local Government Committee, which requested the review last summer.
Hill’s analysis is certain to rekindle the debate over whether the state should be a watchdog over local government, as well as the relevance of reams of financial data that counties must compile.
An Inland Empire lawmaker contends the reports would do little to prevent another bankruptcy like Orange County’s. Instead, he said, the paperwork is simply filling space in some warehouse.
"We’re paying a lot of money for very little," said Assemblyman Bill Leonard (R-Rancho Cucamonga). "We may have been overreacting to require the counties to submit so much data that is just filed away in Sacramento."
Angelides says the reports play an important role by shedding light on local investment practices. Angelides and Orange County Treasurer John M.W. Moorlach called the program an "inexpensive insurance policy." Based on the documents, Angelides’ staff finished a report earlier this month that found that California’s county treasurers have about $32 billion invested, most at low risk.
"I still see a need for this disclosure," said Moorlach, who was elected after Orange County’s bankruptcy. "It doesn’t hurt to have another set of eyes looking at these reports."
State officials have gone back and forth over the necessity of making counties file the documents. The state has demanded since 1933 that county treasurers make public filings. Sixteen years ago, the requirements were bolstered after San Jose had problems with its investments. In 1990, then-Gov. George Deukmejian persuaded lawmakers to relax the requirements. The Legislature did, only to quickly restore the rules after Orange County’s bankruptcy.
The exact cost of the program was difficult to determine, Hill wrote. However, last year, the state set aside $15 million to reimburse local governments and school districts for complying with the reporting requirements since 1995.
The laws have forced counties to adopt policies to guide their investment decisions, and some treasurers have even placed the reports on county Web sites, Hill wrote. But other reforms have gone further to improve the climate for making sound investments. Now counties are legally required to diversify their portfolios and avoid the risky schemes employed by former County Treasurer Bob Citron.
Barry B. Burr of Pensions & Investments returned with another blistering editorial in “Credit Raters Miss Many Danger Flags.” Here are the first three, a middle, and the concluding paragraphs. One would have hoped that the rating agencies had improved their policies and processes. Regretfully, as we learned recently from their Structured Investment Vehicle (SIV) ratings, they have not.
Two disturbing aspects of the Orange County financial debacle, both revolving on accepting responsibility, deserve attention.
For one, users of the credit rating services of Standard & Poor’s Corp. and Moody’s Investors Service Inc. hardly can take reassurance in knowing Orange County has given them no reason to change their policies in rating such debt.
For the other, Orange County, while filing suit against Merrill Lynch & Co. to recover $3 billion in losses from the risky leveraged strategy, has forgotten its own liability to investors in its securities who relied on its trust. Regardless of whether the county wins anything from Merrill Lynch, investors should have cause to hold the county responsible for their losses.
John W. M. Moorlach (sic), who opposed Mr. Citron in last spring’s election and made the pool’s riskiness the campaign issue, noted at the time the risk of rising interest rates and increasing calls on the pool’s collateral were harming its liquidity; and he presciently forecasted the pool’s ultimate $2 billion-plus loss.
Without question, the credit ratings proved worthless on Orange County. Any user of them has to wonder how reliable the companies’ recent assertions that no other situation in the order of Orange County is out there lurking. The raters’ policies and processes need tougher internal scrutiny and improvement.
Pensions & Investments also had this clever piece on risk and return, titled “Risk Amnesia.” You can see how Citron and I became fodder for national publications and books as time wore on. Since this editorial takes on the feel of a financial sage, I’m providing it in full.
The past 12 months should have driven home a key investment lesson: Risk and return are like twins – they are rarely found far apart.
However, greed apparently causes many investors to forget just how close the relationship is. As one grows, so does the other.
Return is the good twin, giving investors a reward for surrendering their capital to others for a time.
Risk is the evil twin, threatening to consume the capital so it can’t be returned to its owners when it is due.
The fact that the two usually are found together was reinforced on at least a half-dozen occasions in 1994, beginning with the collapse of Askin Capital Management and ending with the Orange County investment pool disaster.
In virtually all of these cases, investors were pursuing above-market rates of return with what they believed were strategies that eliminated or greatly reduced market risk.
But risk and return are twins not easily separated at birth. Anyone who attempts to sell to an institutional investor an investment vehicle that purports to successfully separate them for more than relatively brief periods is either a charlatan or a fool. Any institutional investor who buys such a product expecting long-term above-market returns with little or no risk certainly is a fool.
Most investment professionals are not fools. Few trustees of pension funds or other institutional investment pools are fools either. But greed can bring on amnesia.
For a time the evil twin is forgotten, while the good twin is feted. And risk often conveniently stays out of sight for a time.
This is what happened with Askin Capital and the Orange County affair. For some time the investors saw only positive return from the investment strategies, and so they forgot about the risks.
Indeed, the above-market returns earned by Orange County’s then-treasurer, Robert L. Citron, who resigned in December, went on for several years, and few voices were heard complaining that Mr. Citron was ignoring the risks.
Only his rival in the most recent election for the treasurer’s office, John M. W. Moorlach, can claim credit for that.
Mr. Moorlach, in effect, warned the evil twin was merely hiding and eventually would step forward to spoil the party – as indeed it spectacularly did.
Interestingly, few significant pension funds were caught up in any of the financial disasters of 1994, although a few had small amounts in Askin Capital’s portfolios through pooled vehicles.
Pension funds might have avoided the disasters because of the conservatism encouraged by the Employee Retirement Income Security Act; by the professionalism and experience of their staffs; and by the oversight generally built into their structures.
Under ERISA, the fiduciaries are personally responsible and financially exposed if something goes wrong on their watch. They have an added incentive to look around carefully to see where the evil twin risk is lurking when they find return attractive.
Nevertheless, pension fund executives and trustees should take the time to study the disasters of 1994, even though they apparently avoided them. By studying them they may, like generals studying disastrous campaigns of the past, learn from others’ mistakes and misfortunes.
If nothing else, they may learn more of the guises under which the evil twin hides.
After reading Hugh Hewitt’s Daily Pilot column on how to handle the losses, I submitted my own column (see my MOORLACH UPDATE – January 13, 2010). It made it to the front-page, top-of-the-fold, with “Moorlach: Cities should pay for their losses—Costa Mesa CPA says the county, state and federal governments should not bail out municipalities.” With everything going on the previous seven weeks following the County’s bankruptcy filing, it was my first chance to speak in an editorial format. As you can imagine, the cities crying to be made “whole” and to receive “100 cents on the dollar” were not amused. When all was said and done, the method for allocating the losses turned out to be a blend of both of our proposals.
It was nice to see Hugh Hewitt weigh in on what should be done with the Orange County Investment Pool losses. Hugh was the only member of the media who endorsed my candidacy and understood the issues that I was running on. He is, in my estimation, a very brilliant man.
However, I have a disagreement with his editorial. Let me give it an “A” for efficiency and a “D” for logic. It does deserve a “C” for sincerity. After all, when was the last time you saw an attorney want to reduce legal fees? But this can be done by forming cooperative agreements, considering the use of law firms on contingency fee arrangements, or being co-plaintiffs with the county.
There is a need for the county to consider borrowing to replace lost funds. It is a viable option for many of the municipalities to resolve their cash flow concerns. This is especially true for those municipalities that have immediate short-term needs for those funds.
It would certainly be most efficient for the county to issue the debt. It can loan the proceeds to any of the 187 participants in the pool by serving as a “depository.” One borrower is more efficient than two or more and warrants giving the high grade to Hugh.
Municipalities have two ways to replace their investment losses. They can borrow from the county’s depository and repay it over a period of time. Or they could do without the loan and replace it internally over time.
Let’s take Costa Mesa as an example. It has lost some $1.1 million. It can be replaced by setting aside, say, $100,000 per year in its budget for 11 years. It doesn’t need a bailout from the county, the state, or Washington, D.C. Costa Mesa should responsibly handle its own misjudgment and misfortune. That would be the honorable thing to do.
Just like Costa Mesa, every other participant has to realize that the money is lost. It’s gone. Let’s grow up. The county will not and should not have to make the participants “whole.” Many of the participants had a choice of putting their funds in the pool. They discarded all of the warning signs, speculated, and lost. Tough break. Even those who were mandated to have some of their funds in the pool never publicly complained about the risks that were taken. We’re all culpable.
I see no reason why the county should pay the participants “100 cents on the dollar.” It’s not a slogan, but an empty mantra. The Board of Supervisors missed the gravity of the situation. But so did the county administrative officer, the elected auditor-controller, and the city and finance managers for 186 other agencies. Even the usually diligent press missed it!
Now Hugh wants every citizen of Orange County to share the burden of paying “100 cents on the dollar” to all fund investors who are not countywide agencies. I call it a bailout. It deserves a low grade.
The cities of Garden Grove and San Juan Capistrano never went in. The city of Tustin knew the emphasis on yield would head one into “a nasty business.“ the Mesa Consolidated Water District certainly saw the dangers and stayed clear. Why should they now share the cost with those who tossed caution to the wind?
Why should Orange County make Mountain View whole? They had a copy of the portfolio and could have realized the potential for market losses. Why make Montebello or Milpitas whole?
The city of Irvine borrowed some $62 million. Its Unified School District joined forces with Newport-Mesa to borrow some $50 million to invest. And the Irvine Ranch Water District had more than $400 million in the pool before Peer Swan, its president, started the “proverbial” run on the bank! Why should the citizens of Costa Mesa pay for a city that went full tilt up silly hill?
Let’s assume some rough numbers and do some calculating. Here they are:
1. Orange County has a population of some 2.6 million people.
2. Costa Mesa and Newport Beach have approximately 100,000 people each.
3. The money lost by the county is some $600 million.
4. The money lost by the participants is some $1.1 billion.
If Costa Mesa and Newport Beach residents had to pay their respective share of the entire $1.7 billion loss, then we have a liability of about $654 per man, woman and child, less any net settlements from successful lawsuits.
However, if Costa Mesa were only responsible for its proportionate share of the county’s $600 million loss, it would cost about $231 per person. Add to this the loss for the school district’s roughly 23% haircut on its reserve funds and its “borrowing to invest” fiasco, we have a loss of roughly $19 million to distribute, totaling some $95 per person for Costa Mesa and Newport Beach.
Costa Mesa’s approximate $1.1 million loss, is a result from its failure to withdraw all of its funds in time, or any of its Redevelopment Agency and Sanitation District funds. This results in another $11 per person. The total bill for each Costa Mesa resident is $337.
Sharing the loss under Hugh’s proposal means a 94% increase in costs to Costa Mesa residents because its neighbors were not paying attention. Newport Beach’s cost per resident would be $363 because they have some $2.7 million more in losses, due to a higher balance left in the pool. Take responsibility for our actions. But everyone’s? Just don’t do it.
The school district has larger problems. Borrowing may be necessary with a much longer payoff period to resolve their indiscretions.
As the state did mandate their operating funds (not its surplus or reserve funds) be in the county treasurer’s pool, the district may want to consider holding the state of California liable for a portion of its loss, and not the county of Orange. That is something that the school districts can pursue collectively. After all, where was the state’s oversight of our treasurer?
Let each municipality fend for itself. Call it “tough love.” Each municipality should face up to the consequences of its own decisions. I am responsible for my own actions, businesses are, so why not government agencies? It will let its voters know exactly what their elected officials and hired staffs have created.
Government is local, and the voters will have the opportunity to deal with this issue at their ballot booths.
I disagree with Hugh Hewitt’s “utilitarian” approach. If we do not let our elected leaders and their hired staffs live with and work through this situation appropriately, then I believe they are bound to make the same errors again in the future.
Tom Cahill of Bloomberg Wire Service announced great news in “Orange County, CA Debt Earns Investment Grade Rating From S&P.” Getting a rating upgrade is the goal. Getting it from S&P, after our fun litigation battles, was a good first step.
Orange County, California’s credit rating was raised five notches to “A-“ by Standard & Poor’s Corp., marking its first investment grade rating from the credit rating company since the county’s 1996 (sic) bankruptcy.
S& P said the ratings upgrade reflects the county’s strong financial performance since it emerged from bankruptcy and reduction of debt. The upgrade from “BB” marks a rare leapfrogging of the “BBB” lower investment grade rating category. It covers $58 million in pension obligation bonds. S&P also raised its issuer ratings on the county to “A.”
The move comes six months after Orange County ended three years of litigation against S&P over charges that the McGraw-Hill Cos. Unit should have warned officials about investments by former County Treasurer Robert Citron that lead to $1.69 billion in losses and the nation’s largest municipal bankruptcy.
“Eureka, we found it,” said John Moorlach, Orange County Treasurer, echoing the words of James Marshall after his discovery of gold at Sutter’s Mill 152 years ago today. “Let’s just hope (the litigation) is behind us now and we can all move forward.”
The credit rating action follows a similar move by Moody’s Investors Service in September, which boosted Orange County’s debt to “A1.”
S&P denied that there was any connection between the end of litigation with the county and the upgrade.
The ratings are still shy of S&P’s “AA-“ ratings for the county before the bankruptcy.
This week’s issue of the Orange County Business Journal had two small items. The first was an Executive Summary on Government. The second was an ad promoting the “Dialogue with Jim Doti on KOCE” program featuring me, under the title “O.C.’s Financial Health,” produced by Chapman University. I’ll provide the executive summary below (remember this is five years ago) and Chapman President Jim Doti may want to repeat this show to see just how much of what we discussed that could happen that has become a sad reality today.
County officials expect 814 workers, three times the average, to retire in July after supervisors last year approved a more generous pension plan that came under fire from county Treasurer John Moorlach and others who called it fiscally irresponsible.
Disclaimer: You have been added to my MOORLACH UPDATE communication e-mail tree. In lieu of a weekly newsletter, you will receive occasional media updates, some with commentary to explain the situation, whenever I appear in the media (unless it is a duplication of a previous story).
I have two thoughts for you to consider: (1) my office does not usually issue press releases to get into the newspapers (only in rare cases); and (2) I do not write the articles, opinions or letters to the editor.
This message should appear at the bottom of every e-mail you receive. If these e-mails should stop arriving in your mail box, it will be because your address has changed and you did not provide a new one. If you do not wish to receive these e-mails, then please e-mail back and request to unsubscribe.