A must read regarding counties and bankruptcy

I spent some time here and there in Orange County, CA and have a lot of family there Yes, it's as beautiful as it looks on TV< and people are even more pretentious.

During that time, the county "went bankrupt."

It was under different circumstances than Erie County (basically, a bad bet on interest rates while investing county funds *ouch*) but this case study gives a GREAT overview of exactly what happened before, during, after, and the aftermath. Please read, as you will be surprised I think.

Here is a great article:
A decade ago, Orange County entered the record books by becoming the largest municipal government in U.S. history to declare bankruptcy. This crisis stemmed from the county's inability to pay back billions of dollars in debts incurred by the county treasurer. A risky investment strategy that was supposed to provide interest income for cash-starved local governments had badly backfired. Left without viable alternatives - and with both state and federal officials ignoring their pleas for help - Orange County government officials decided to file for Chapter 9 bankruptcy on Dec. 6, 1994.

What followed was a roller-coaster ride for county residents. They faced the threat of massive layoffs of public employees and disruptions of essential local services and watched the county's credit rating fall to junk status on Wall Street. A county previously known for its affluent lifestyle and fiscal conservatism suffered a body blow to its sterling reputation and became the object of jokes and ridicule in the national media.

One year later, a bankruptcy escape plan was filed in court. Orange County government officially emerged from U.S. bankruptcy court protection on June 12, 1996.

What are the repercussions of this traumatic episode on the county's psyche? First, there is collective amnesia when it comes to recollections of this painful event. Today, eight in 10 county residents say they remember little or nothing about the dark days of the 1994 county government bankruptcy, according to our latest Orange County annual survey taken last month. Even the long-time, older residents have mostly dim memories of this fiscal fiasco.

Moreover, most Orange County residents do not think that the government bankruptcy has had negative consequences for the local economy or quality of life. Even among the one in five residents who say they recall "a lot" about the bankruptcy, most are also quick to discount its importance to Orange County today.

Beyond residents' remembrances of things long since past, the results from our 2004 Orange County survey indicate that the county has recovered soundly from the deep funk that set in after the bankruptcy filing. Comparing public opinion today to our first post-bankruptcy survey, positive ratings of the county's overall quality of life (90 percent from 68 percent) and the county's economy (69 percent from 19 percent) are both up sharply from what were historic lows.

Other signs of the county's solid economic recovery include the relative optimism evident in the local consumer confidence index today, and the fact that perceptions of the housing market have improved markedly from a decade ago.

Perhaps most surprising to those of us who observed first-hand the bitter disappointment and anger of residents post-bankruptcy is the dramatic turnaround in approval ratings of county government.

In our polls taken right after the bankruptcy, three in four residents admitted to being "angry" at the actions of local officials. Moreover, they blamed both the county treasurer for making foolish investments and the members of the county board of supervisors for not minding the till. Half of the voters said they favored the recall of the county supervisors in office when the bankruptcy began. Their disapproval was loudly heard on June 27, 1995, when voters rejected the "Measure R" half-cent sales tax that was designed to bail the county out of bankruptcy.

Today, county residents are nearly twice as likely as they were in our first post-bankruptcy poll to rate their county government as doing an excellent or good job at solving problems (49 percent to 24 percent). Moreover, solid improvements are evident in residents' perceptions of the county government's efficiency in spending tax dollars and in the belief among residents today that county leaders pay attention to what the people think. The positive feelings toward local government extend to a wide array of services - including police protection, streets and roads, public schools, and parks and recreation - all of which took funding hits in the wake of the bankruptcy.

Is Orange County government in better shape today than it was a decade ago?

Both the state and county governments learned important lessons from the near-calamitous mistakes that led to the bankruptcy, and they took actions that led to a more responsible approach to municipal investments. The state government outlawed the use of the risky investments that had resulted in the bankruptcy and increased the monitoring of the county treasurer's activities by other local officials. In Orange County, the new county treasurer restored confidence with the public, local governments and Wall Street lenders through fiscal transparency, an oversight committee, and solid investments.

Orange County was the recipient of awards for its efforts to reinvent county government in the wake of the bankruptcy. The restoration of a good credit rating was also achieved. In an era when local governments throughout California are being forced to confront the reality that Orange County faced a decade ago - managing fiscal survival without help from the state government and local voters - the Orange County bankruptcy serves as a cautionary tale for struggling municipalities.

Orange County has hit something of a rough patch of late. Over the past three years, two big increases in pensions for county employee groups have led to concerns about the county government's long-term debt, and mismanagement in the county planning department has brought sharp criticism of county executives. Still, the problems do not rival the fiscal crisis the county faced a decade ago.

With the bankruptcy now in the rearview mirror in Orange County, the bigger challenge for the next decade comes from another milestone that coincides with this 10th anniversary. Orange County became a majority-minority county this year - whites are now under 50 percent of the population - and Latino and Asian immigrants and their children will continue to increase in the decade ahead. The new Orange County majority will demand more local services - including public health and public schools - while Orange County's predominantly white voters will prefer to shrink local government.

How Orange County chooses to respond to this demographic shift will ultimately determine if we can look back in 10 years and say that the quality of life and economy has improved, and if we will heap praise on local governments for meeting the challenges of the future.
http://www.ppic.org/main/commentary.asp?i=532

Another source with more detail... if curious

Introduction:
On December 6 1994, Orange County, a prosperous district in California, declared bankruptcy after suffering losses of around $1.6 billion from a wrong-way bet on interest rates in one of its principal investment pools. The pool was intended to be a conservative but profitable way of managing the countys cashflows, and those of 241 associated local government entities. Instead, it triggered the largest financial failure of a local government in US history.

Robert Citron, the hitherto widely respected Orange County treasurer who controlled the $7.5 billion pool, had riskily invested the pools funds in a leveraged portfolio of mainly interest-linked securities. His strategy depended on short-term interest rates remaining relatively low when compared with medium-term interest rates. But from February 1994, the Federal Reserve Bank began to raise US interest rates, causing many securities in Orange Countys investment pool to fall in value.

During much of 1994, Citron ignored the shift in the interest rate environment and the mounting paper losses in his portfolio. But by the end of 1994, demands for billions of dollars of collateral from Citrons Wall Street counterparties, and the threat of a run on deposits from spooked local government investors, created a liquidity trap that he could not escape.

Citron could not have undertaken such a risky investment strategy if his actions had been subject to informed and independent risk oversight, and detailed risk-averse investment guidelines. Following the debacle, Orange County revised many aspects of its control procedures and its financial governance, and established a stricter set of investment policies.


Lessons Learnt:
- Beware the unconstrained star performer, even when he or she has a long track record. Where theres excess reward, theres risk though it might take time to surface;
- If the organisational structure, planning and risk oversight mechanisms of an institution are fractured, it is easy for powerful individuals to hide risk in the gaps;
- Borrowing short and investing long means liquidity risk, as every bank knows;
- Risk-averse investors must tie investment objectives to investment actions by means of a strict framework of investment policies, guidelines, risk reporting and independent and expert oversight;
- Risk reporting should be complete, and easily comprehensible to independent professionals. Strategies that are not possible to explain to third parties should not be employed by the risk averse.
(I eliminated the details, as it is not relevant to this discussion... it regards misinvesting funds, which isn't the case here.)

The Aftermath: Restitution and Recovery
Citron eventually pleaded guilty to six felony counts. However, the charges were largely to do with a misallocation of returns between the county and other municipal entities, and Citron does not seem to have been motivated by personal gain of any direct and obvious kind. He paid a $100,000 fine and spent less than a year under house arrest.
If that seems a lenient sentence, then Orange Countys recovery was also swifter than might have been expected. It had to cut back on spending and social service provision, and in 1995 and 1996 it took on massive additional debt in the form of special long-term recovery bonds to cover its losses. But thanks to increased tax revenues from a buoyant local economy, it was able to exit from bankruptcy in only 18 months.

With new executives in charge, it instituted a series of governance structures and reforms. These included oversight committees, an internal auditor who reported directly to the supervisors, a commitment to long-range financial planning and a stricter written policy for investments. In December 1997, Moodys Investors Service rewarded the county with an investment grade rating for key borrowings.

The new Orange County investment policy statement establishes safety of principal, and liquidity, as the primary objectives of the fund, with yield as a secondary objective. More specifically it prohibits borrowing for investment purposes (ie, leverage), reverse repurchase agreements, most kinds of structured notes (such as inverse floaters) and derivatives such as options. The same document bans the treasury oversight committee and other designated employees from receiving gifts, and obliges them to disclose economic interests and conflicts of interest. The county treasurer now has to submit monthly reports to the investors and other key county officers that contain sufficient information to permit an informed outside reader to evaluate the performance of the investment programme.

On June 2, 1998, Orange County reached a massive $400 million settlement with Merrill Lynch, the firm it held most responsible for steering Citron towards what the county deemed risky and unsuitable securities. Thomas Hayes, who led the countys litigation, said he regarded the settlement as fair while Janice Mittermeier, Orange County CEO in its recovery period, said the resolution assures county taxpayers that those responsible for the losses that caused the countys bankruptcy are being held accountable.

Merrill Lynch maintained as part of the settlement that it had acted properly and professionally in our relationship with Orange County. It cited the costs, distraction and uncertainty of further litigation as the reason it had come to make such an expensive settlement, while assuring its investors that it had already fully reserved against such an outcome.

Together with settlements from more than 30 other securities houses, law firms and accountancy firms that the county held partly responsible for the losses, the money from Merrill Lynch meant that some 200 municipal and governmental agencies could be finally made good. In February 2000, officers appointed by the courts paid out around $864 million to various government entities that had suffered from the collapse. Five years on from the bankruptcy, it was a big day for the smaller creditors. But on the same day, Orange County supervisor Jim Silva reminded local reporters that the county itself was still paying off some $1.2 billion of the recovery bonds issued in 1995 and 1996 and would be for several decades, unless it was able to speed up repayments.

SOURCE: http://www.erisk.com/Learning/CaseSt...angecounty.asp

Exactly why EC should go insolvent.
Start fresh!