Special Series: Bankruptcy Didn’t Make the Sky Fall In Orange County

March 6, 2012 - By admin

Editor’s Note: This is the first in a CalWatchDog.com Special Series of 12 in-depth articles on municipal bankruptcy.

MARCH 6, 2012

BY CHRIS REED

Overwhelmed by enormous unfunded liabilities for retired employees’ pensions and health care, local governments throughout California are increasingly contemplating what once seemed unthinkable: declaring Chapter 9 bankruptcy to hold off creditors, to buy breathing time to reorganize and to attempt to reduce costs by any legal means necessary.

This fiscal crisis is outwardly downplayed or dismissed by the state’s public employee unions, who insist that claims of strained finances at all levels of California government are either exaggerated by alarmists unfamiliar with the ebb and flow of pension investment portfolios or the fabrications of anti-government ideologues.

But that these same unions know the crisis is real is manifest in their successful push to get the Legislature to pass Assembly Bill 506, by Assemblyman Bob Wieckowski, D-Fremont. Gov. Jerry Brown signed it into law on October 9, 2011. It ends local governments’ ability to unilaterally declare bankruptcy. Instead, it requires that they first go through a mediation process or hold a public hearing at which they would declare a state of emergency and certify that they will be unable to meet their obligations within 60 days.

This obstacle may make some local officials think twice. But in an era in which San Jose Mayor Chuck Reed – a liberal Democrat – openly speculates about his city being forced to switch to a volunteer fire department, crushing financial pressures are certain to prompt many governments to consider Chapter 9. In so doing, many will look to the most famous municipal bankruptcy in U.S.history: Orange County’s Dec. 6, 1994, declaration that it could no longer pay its bills.

Does Orange County’s Chapter 9 adventure raise any red flags for local governments considering bankruptcy?

Not a one.

But is the county’s highly positive experience truly instructive for local governments in general?

That’s another matter entirely, because Orange County’s story is an unusual one.

Speculative Gambles

The bankruptcy was triggered after failed speculative gambles by county Treasurer Robert L. Citron resulted in a $1.64 billion loss in county investment pools. The immediate reaction was one of shock and dismay, with grave warnings of profound long-term damage to Orange County’s quality of life.

Transportation officials feared crucial highway projects would have to be postponed or cancelled, yielding gridlock in fast-growing south Orange County. A portfolio manager at Scudder Funds said what “the future residents face [is the] cannibalization of every county service.” The executive director of the Associated General Contractors of Southern California said the bankruptcy’s impact was “like a nine on the Richter scale.”

Instead, a mix of new and old county leaders, working with former state Treasurer Tom Hayes and a Salomon Brothers team, stabilized the county’s fiscal picture in fairly short order. They persuaded creditors to hold off a year, froze salaries, put off infrastructure projects, pared services (particularly social services) and reduced the county work force from 18,000 to 15,000, primarily through attrition and dropping vacant positions, not layoffs.

Critics of these moves said county leaders had consistently insulated the middle class and rich from the effects of the bankruptcy, showing a cruel indifference to how cuts in social services hurt the poor. But perhaps because progressives had been making this same argument long before the bankruptcy, it barely resonated beyond the pages of the alternative OC Weekly newspaper. 

No Serious Disruption

“There wasn’t any kind of serious disruption over the long term for the residents of the county,” Mark Baldassare, author of “When Government Fails: The Orange County Bankruptcy,” said in a recent interview. “It was shocking, it was surprising, it was something that caused a lot of frustration, but for the average county resident, it didn’t matter that much.”

County leaders made one misstep: asking county voters to raises the sales tax by a half-cent for 10 years to bring in $1.35 billion. Portentously described in a Los Angeles Times headline as a “Referendum on O.C.’s future,” Measure R was rejected on June 27, 1995 in a landslide – 61 percent to 39 percent – by voters incensed that county leaders expected them to pay for a mess they didn’t create. This led to stark warnings from Wall Street credit-rating firms and familiar media complaints that voters wanted services but didn’t want to pay for them.

Soon, however, voters were vindicated, as the county and local agencies that had invested heavily in the county’s investment pools – the biggest creditors – worked out a complex deal. Under the deal, transit and other funds were diverted on an emergency basis and promises were made to give to pool members initial proceeds of lawsuits against Merrill Lynch and other county investment advisers.

On May 15, 1996, a bankruptcy judge gave the go-ahead to the county’s recovery plan. On June 5, 1996, the county was able to sell $880 million in long-term bonds to cover its short-term debts. This allowed county officials to emerge from bankruptcy on June 12, 1996, prompting a jubilant celebration on the steps of a Santa  Ana courthouse. On Feb. 27, 1997 – just 814 days after the bankruptcy declaration triggered an avalanche of sky-is-falling warnings from the media, politicians and Wall Street – Fitch Investors Services gave its highest rating, AAA, to Orange County’s investment pools. And on Feb. 24, 2000 – after unexpectedly successful litigation yielded $865 million from the Wall Street firms that worked with Citron on his speculative gambles – the 200 agencies that had invested with Citron were made nearly whole, given checks or wire transfers that brought their recovery on their investments to from 94 percent to 97 percent. 

Soft Landing

In March 2011, at an American Enterprise Institute forum on municipal debt, Pat Shea, an attorney representing 175 of the cities, water, school and sewer districts with investments, reflected on the outcome: “Five years afterwards everyone, at least on my side – within government, within the family of government – every one of them would say this worked out as well as it possibly could for every member of government.”

The long-term cost to Orange County taxpayers of repaying the $880 million in bonds, of course, has been vast. But even on that front, the news has not been all bad. In June 2005, Orange County’s supervisors OK’d a plan under which the bankruptcy debt would be repaid by 2016, 10 years ahead of schedule.

Yet in reviewing Orange County’s history to determine what lessons it offers, those lessons may not be quite the tidy package that the county’s rebound would suggest.

The circumstances of how the county lost its way are nearly without precedent in U.S. history, having relatively little in common with the retirement benefits crises now bedeviling so many local governments. Citron for years managed to generate above-average returns in the county’s investment pools, with a key strategy to gamble on derivatives that would yield high returns if interest rates remained low. Even as Orange County became, by one report, Merrill Lynch’s biggest customer and its heavily leveraged investment holdings topped $20 billion, Citron continued to operate with little or no scrutiny.

A 1985 Orange County Grand Jury report warning of the risks posed by such an informal investment arrangement was ignored. In spring 1994, warnings by Newport Beach CPA John M.W. Moorlach that Citron and the county risked disaster if interest rates continued to rise were largely disregarded by the media and dismissed by county supervisors and bureaucrats. With Moorlach a candidate to replace Citron as treasurer, the assumption was that his warnings were driven politically. Moorlach’s simple explanation – that Citron’s above-average returns were driven by unusually risky investment strategies – went largely unexplored in the media, who were as shocked as county residents by the December 1994 bankruptcy.

Strong Economy

Soon after, with Citron forced out of office, Moorlach appointed to replace him, and new sobriety driving decision-making, the county began to turn the corner – but with immense help from a source unlikely to help current local governments on bankruptcy’s brink. That source: a sharply rebounding Orange County economy.

Venture capital investments tripled in the first quarter of 1995 compared to 1994, and a huge building boom quickly gathered steam. Entrepreneurial high-tech firms, especially in software, aerospace and telecommunications, helped the county move out of the shadow of Silicon Valley and sharply grow international trade. By December 1997, the county unemployment rate was down to 2.7 percent. That year, Orange County had $2.6 billion in annual exports to Japan, South Korea ,China and Taiwan alone. Tax revenue grew steadily, helping push up the county’s total budget from $3.45 billion in 1995-96 to $4.01 billion in 2000-01.

In a 2004 symposium on the 10th anniversary of the Orange County bankruptcy, Moorlach acknowledged the central role of the economic recovery in minimizing the county’s pain.

“Only a county like Orange County could have come back from such a dramatic loss,” he said. “We’re just a dynamic economic powerhouse. Some other counties – I don’t know if they would have fared as well.”

This sharp boom helped the county to escape bankruptcy with relatively modest downsizing of government. Similar bonanzas seem unlikely to come to the rescue of many ofCalifornia’s struggling government agencies.

Unique Situation

“Orange County was very unique,” said Baldassare, now president and CEO of the Public Policy Institute of California. “It doesn’t really have much to do” with the present straits facing other local governments in the state.

This doesn’t mean Chapter 9 is a bad choice for local governments overwhelmed by red ink – just that their path back to stability isn’t likely to be as clean and straightforward as Orange County’s.

But there is a powerful lesson to be learned in how Orange County’s leaders behaved after the county emerged from bankruptcy. That lesson: Even after as wrenching an event as a bankruptcy declaration, leaders can’t be counted on to be fiscally responsible. The bankruptcy fiasco was still a very fresh memory when Orange County supervisors and top bureaucrats put the county back on the path toward severe financial problems of a more conventional sort.

The bankruptcy did trigger the changes and cutbacks discussed above. But by July 1999, when I began a two-year stint covering the county government for The Orange County Register, county leaders increasingly showed the same old casual attitudes about spending and oversight – accompanied, incongruously enough, by a vast sense of accomplishment and enormous self-regard.

Bad Habits Return

County Executive Officer Jan Mittermeier, hired in 1995, was a huge improvement over the feckless executives of the pre-bankruptcy era. But the accolades coming her way – including her November 1998 selection as one of Governing Magazine’s Public Officials of the Year – as well as to county supervisors for the county’s rapid rebound produced an insufferable climate at the Hall of Administration. There was a self-congratulatory subtext to interviews, events and board hearings that was impossible to miss. And it continued even as supervisors made decision after decision that treated taxpayer funds cavalierly.

In 1998, the Performance Incentive Program (PIP) was initiated for county workers, billed as an easy, smart way to incentivize superior performance. But an Orange County Grand Jury report in 2003 detailed how PIP amounted to disguised bonus program in which at least 95 percent of employees were being given annual 2 percent raises.

In June 2000, county supervisors voted unanimously to give themselves a 6 percent raise for a third straight year. They also gave nine senior county administrators a 14 percent raise.

But the most devastating decisions involved pensions.

Pension Spiking

In December 2001, supervisors Jim Silva, Todd Spitzer, Tom Wilson, Cynthia Coad and Chuck Smith – all Republicans who claimed to be fiscal conservatives – approved a 50 percent retroactive increase in the pension formulas for 2,000 sheriff’s deputies, allowing them to earn up to 90 percent of final pay in retirement.

“It’s a mind-blower,” Moorlach said in a recent telephone interview. “Not one of those supervisors called me up [in his role as a member of the county retirement board and as county treasurer] to ask if it was a good idea.”

The pension boost was passed so quickly and with so little fanfare that it didn’t even make the pages of The Orange County Register or The Los Angeles Times. The Nexis news archive shows no contemporaneous media coverage of any kind.

A subsequent pension proposal – to provide a 62 percent retroactive increase in the pension formulas for more than 14,000 county workers – drew far more advance attention. But it was nonetheless enacted in August 2004 on a 3-2 board vote, with the support of self-styled Republican fiscal conservatives Silva, Wilson and Bill Campbell. Their fig leaf: a requirement that affected county employees had to pay more toward pension costs when funding lagged.

Even with that concession, however, the unfunded liability for the Orange County Employees Retirement System soared from $85 million in 1999 to $3.7 billion on Dec. 31, 2009, the most recent figures available on the OCERS website. In the process, the pension system went from being 98 percent funded to 69 percent funded.

‘Funny Money’

Moorlach, who left the county treasurer job in 2006 to replace the Assembly-bound Silva on the county board, expresses amazement at how quickly Orange County’s rebound went sour.

Supervisors didn’t “seem to treat money like it’s real. It’s all funny money, and it will keep coming” was their attitude, he told me.

Moorlach believes the county is now well-managed, with appropriate safeguards and smart long-term planning. But he described how difficult it was for county leaders to replace $48 million in vehicle license fees taken by the state government in June 2011. And he noted that, in the next fiscal year, additional pension costs alone will be $53 million.

As in 1994, he said, “We are dependent on what the investment markets will do.” That year, when Citron’s offbeat investments tanked, bankruptcy became inevitable. “Now, we have to place all our bets on the stock market [portion of the county’s investment portfolio] doing 12 percent a year” – for the indefinite future.

Moorlach’s conclusion: By themselves, board members Silva and Wilson“caused more financial havoc” than the county boards which failed to oversee Citron.

And so in short order, Orange County went from being a nationally recognized model of smart governance to just another California government in which elected officials and top bureaucrats blithely showered taxpayer funds on public employees.

Spending Every Tax Dollar

Chriss Street is an Orange County investment banker who succeeded Moorlach as county treasurer from 2006-2010 and who also voiced alarms about Citron’s strategy before it went haywire. Street has a particularly astringent view of the relevance of Orange County’s second self-created fiscal debacle.

Even in a county buffeted by a recent bankruptcy, “Governments and politicians by their nature will try to find a way to spend every dollar possible and push the liability for that spending into the future, either through borrowing or creative accounting,” Street said in a phone interview.

Far from acting prudently with taxpayer funds, Street said, government officials instead work overtime to enable their spending schemes by crafting narratives that depend on “false impressions of spendable cash flow.”

In other words, they lie now and let the public pay later.

Orange County’s experience in the 1990s does show a Chapter 9 municipal bankruptcy filing can help local governments when it comes to the “pay later” part of this disastrous public policy one-two punch. But the blithe way the county government created a fresh fiasco illustrates a larger truth about the need for citizens to show perpetual and eternal vigilance in monitoring their leaders.

“One of the common failings among honorable people is a failure to appreciate how thoroughly dishonorable some other people can be, and how dangerous it is to trust them,” Thomas Sowell once observed. In less than 20 years, Orange County’s citizens learned this painful lesson twice.

Reed is an editorial writer for The San Diego Union-Tribune, former KOGO talk-show host and editor of Calwhine.com.

———————–

CalWatchDog.com’s Special Series on Municipal Bankruptcy:

Broke Municipalities Look to Bankruptcy Option

Bankruptcy Didn’t Make the Sky Fall In Orange County

Local Governments Face Bankruptcy Quandary

Bond Holders Seek Governmental Transparency

 

 

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Comments(18)
  1. Rex The Wonder Dog! says:

    In December 2001, supervisors Jim Silva, Todd Spitzer, Tom Wilson, Cynthia Coad and Chuck Smith – all Republicans who claimed to be fiscal conservatives – approved a 50 percent retroactive increase in the pension formulas for 2,000 sheriff’s deputies, allowing them to earn up to 90 percent of final pay in retirement.

    LOL @ “conservatives”, they are money whores nothing more.

    I don’t think the number of deps was 2000, I think OC SD has less than 1500 sworn deps.

  2. Beelzebub says:

    The manufactured economic bubble of the late 90′s saved Orange County. Such economic bubbles will be impossible to reproduce in the future. So any County or City that declares bankrupcy today will be screwed beyond belief. If Orange County suffered a bankrupcy today it would be devastating.

    Everything you see today in the economy – to include the stock market – is based on artificial drivers – bailouts, ZIRP, money printing and spending deficits. Without those drivers the economy would collapse. But each of those artificial drivers has a cost. Mid term the drivers themselves will collapse the economy. The stock market is in a bubble today. It has not grown based on economic prosperity and REAL earnings. It has grown due to artificial stimulus. It is no longer a barometer of the economy. It is being pumped by the oligarchs because if the stock market fails to grow the pension funds collapse. So the oligarchs are manipulating it. When it crashes (which it must do eventually) watch out below!!!

    Politicians only care what happens while they are in office. That’s why they voted for these huge retroactive pension give-a-ways. They knew the effects wouldn’t be felt until they were out of office. OC Supervisors Pat Bates and Bill Campbell were in the State assembly in 1999 and BOTH voted for SB 400 which opened the door statewide for the huge pension increases. All of them are political whores – republicans and democrats alike.

  3. Beelzebub says:

    More warnings today that Greece is on the precipice of default. The latest so-called ‘EU resolution’ has unraveled. A default would include all externally held bonds. So if Greece screws external bondholders why would Italy, Spain, Ireland and Portugal ? This could be a black swan event depending upon whether the dominoes start to fall. If they can’t keep it contained – watch out below!!!

    This will carry over into our economy and push more cities and counties over the cliff.

  4. Beelzebub says:

    And so it begins. Looks like Stockton might have some company! :D

    “L.A.’s top budget official warned Tuesday that the city can no longer afford to pay raises that are due to roughly 20,000 of its workers July 1, according to correspondence obtained by The Times”

    http://latimesblogs.latimes.com/lanow/2012/03/la-budget-chief-says-city-cannot-pay-raises-promised-to-20000.html

  5. Rex The Wonder Dog! says:

    LOL….I see soem over comped LA City employees taking some haircuts soon!

  6. queeg says:

    OC and San Diego will face layoffs and maybe Bk’s…..LA is over….an unmanageable morass!

  7. Beelzebub says:

    PPIC reported today that support for Brown’s tax on the rich and increased sales tax has dropped to 52%. Just 2 months ago the same poll questions got a 68% approval.

    This is starting to look a little like props 1a thru 1e back in 2009. They started off strong in the polls and then fell through the floor.

    Maybe there is hope afterall.

  8. Rex The Wonder Dog! says:

    PPIC reported today that support for Brown’s tax on the rich and increased sales tax has dropped to 52%. Just 2 months ago the same poll questions got a 68% approval

    OK, I have said it before, I will say it again, the pension sales tax is DOA, I don’t care what any poll says. It is DEAD.

    These same polls had the Arnold tax extension passing 2 years ago-and we all know how that worked out. The polls also had San Diego barely rejecting a similar pension sales tax 2 years ago that went down by a 3-1 margin when the vote time came.

    There is simply no way a pension sales tax is going to pass when gov GED employees are becoming multi millionaires at age 50 and college grads with 20, 25, 30 years and more experience cannot find jobs or are mowing lawns to make ends meet.

    I guarantee it.

  9. SeeSaw says:

    Get real, Rex. You can only be a multi-millionaire, unless you possess money and property, that would bring you a million+, if you redeemed it all, at once. There are basically no multi-millionaires made, from pensions, at the age of 50. You are a lousy predictor–nothing you have ever predicted, has panned out, for you. The pensions are going to be paid, whether or not there is a very small tax increase. Services will suffer, though.

  10. Rex The Wonder Dog! says:

    There are basically no multi-millionaires made, from pensions, at the age of 50.

    ANY gov dork who retires today, or in the future, is a mutli millionaire, that is the VALUE of their VESTED pension. That is a well known fact and “seesaw spin” does not chnage the facts of life.

    For cops it is MUTLI-MILLIOARE, as high as $10 million.

    So once again seesaw, you prove you do not have the math skills to TALK SHOP HERE WITH US :)

  11. Rex The Wonder Dog! says:

    Get real, Rex. You can only be a multi-millionaire, unless you possess money and property,

    A pension is a “property” right seesaw, I guess they didn’t teach you that in your GED courses ;)

  12. Beelzebub says:

    Read this:

    Stanford studied the 24 largest municipal (city/county) pension systems in CA. Most of them are funded at about 50%. Many consume 15%-20% of total expenditures for the municipalities. Shocking study. It puts it into perspective just how much danger the pension systems are in. No wonder the government is artificially pumping the stock market. Next time it crashes these pension ponzi’s are going to implode!

    http://siepr.stanford.edu/system/files/shared/pubs/papers/pdf/Nation_More_Pension.pdf

  13. Rex The Wonder Dog! says:

    The jig won’t end until it does implode. Greece bond holders took an 80% haircut, expect to see that in public pensions too, namely any pension over %60K will be subject to a major haircut-and if you have a $200K pension and it is cut to $60K that is a 70% haircut.

  14. Beelzebub says:

    The unions are grasping at straws, rex. The union leaders know full well that the math doesn’t work. But they are scared to tell the workers that it’s time to take big pension haircuts now to save the system since it would be career suicide. The workers would toss them out. So they keep propagating the LIE that the pension systems are solvent and there’s nothing to worry about.

    Orange County and OCERS are in much bigger trouble than is being talked about. Read that Stanford study. The City of San Diego is in big trouble too. When is San Diego going to vote on the pension issue? June or November? That is going to be a huge ballot measure with widespread ramifications. The unions will try to use the courts to get it overturned. Count on it!

  15. Rex The Wonder Dog! says:

    The unions are grasping at straws, rex. The union leaders know full well that the math doesn’t work. But they are scared to tell the workers that it’s time to take big pension haircuts now to save the system

    Beelz, what we are now witnessing is the END of the 3%@50 scam, and with it the other retro enhanced scams like 2.7% and 2.5% @ 55. These pensions will not be paid in the very near future b/c it is impossible to sustain them. These were a fraud, a rip off, a wealth accumulation vehicle for a special interest who gave big $$$$ to get them.

    Whoever came up with 3%@50 did it as a scam. It was a public union cop in the CHP, and they thought the scam would work, but it didn’t, and it won’t in the future.

    In less than 10 years (2007) the scam started going sideways. Today it is in full free fall. You cannot pay multi million dollar pensions to anyone, but especially rank and file, non educated, gov employees. That is the bottom line. This is the end.

    It truly was, and is, now a Ponzi Scheme. Charles Ponzi would have been proud to see his scam working so good in the public secotr under a pretext of legitimacy.

  16. Beelzebub says:

    Even if they discontinue the 3%@50 scam for new hires – it still does not solve the problem that they created in the short or mid term. There is no way that they will be able to finance the next crop of retirees over the next 10 years. We won’t see any benefit from the reduction of pensions for new hires for 25-30 years. That’s doesn’t help us now. None of these people want to face the truth. It’s like they have their foot to the floorboard and that brick wall is getting closer and closer. The whole time they’re telling us to hold on tight and everything will be okay. It’s insane.

  17. Rex The Wonder Dog! says:

    San Diego votes in June on the 401K pension reform- reform for everyone except police. Police should have been included also IMO.

  18. SeeSaw says:

    This is a serious subject, Rex. It is not necessary for you to insult, my degree of education. I have a couple years college–no GED–and I have had economics and accounting courses. Yes, I understand that a pension is a property right–but, nobody with a pension, is allowed to cash in its future, aggregate worth, in place of its current worth, like they would a piece of real property. In order to have ten million dollars, the retiree, who makes over $100k a year, would have to bank every pension penny, for 30 years, without spending a cent, along the way. Be realistic, and stop the spinning, Rex.

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