The news should not have been so startling; county treasurer Robert Citron is known throughout California for his unusual approach to managing money. While many local treasurers see their job mainly as safeguarding public funds, Citron has aimed to earn enough to ease the tax burden on Orange County’s 2.5 million residents. He’s done it by taking risks that leave most of his counterparts shaking their heads – and producing investment returns that leave them in the dust. Last year, when a similar state-run investment pool yielded 4.55 percent, the local agencies that parked their spare cash with Citron took away 7.84 percent. Orange County’s governments were so happy with that performance that they were slow to ask questions. Only one city, Tustin, pulled its money, although rumors that others wanted out sparked Citron’s announcement last week. ““The people in charge fully knew what they were doing and fully disclosed to other people what they were doing,’’ says Richard Larkin of Standard & Poor’s, the bond-rating agency. ““This was not something done by one person in secret.''
Citron achieved his high-flying record with repurchase agreements, deals in which he temporarily sells bonds to a dealer and reinvests the proceeds to get more bang for each investment buck. Repos are old hat for money managers, but few governments rely on them as heavily as Orange County. The $20 billion fund included just $7.8 billion in local money and more than $12 billion in borrowings. ““You’d call it very aggressive investing,’’ says Seattle’s investment officer, Rod Rich. Most of that money was invested in U.S. Treasury bonds. The rest went largely into derivatives, complex financial instruments that, in this case, were designed to pay the owner more if market interest rates fell and less interest if they rose. Both types of investments were golden as interest rates fell during the early 1990s. Both have plummeted since the Federal Reserve started to hike rates last February. Fund managers everywhere are showing losses, but Orange County’s are unusually large because, by borrowing heavily, Citron had essentially tripled his bet that rates would fall. While headline writers were quick to blame derivatives, sources tell Newsweek that most of the losses may be in run-of-the-mill Treasury bonds.
So, will taxpayers in Irvine and Anaheim have to ante up $1.5 billion? The answer isn’t clear. Citron aide Matthew Raabe insisted last week that the $1.5 billion represents only what the fund would lose if it had to sell everything now. ““We hope to be able to work this out without anybody taking any losses,’’ he said. Fat chance. While all of the investments eventually pay out at 100 cents on the dollar, local governments will need money to build roads and pay teachers, forcing premature sales at a loss. Investment bankers may want cash, too, as collateral for loans. And if some of those derivatives have stopped paying interest – an issue Citron’s office refused to clarify – towns and school boards may not get the income they were counting on. Belatedly, Orange County has learned the most basic lesson of investing: if there are extraordinary returns, there are probably extraordinary risks attached.
