Gonzalez says Maryland county derivatives losses show bill needed.

WASHINGTON -- Rep. Henry Gonzalez, the chairman of the House Banking Committee, has asked Charles County, Md., for information about its recent derivatives losses, warning that such losses underscore the need for Congress to enact pending derivatives legislation.

"Now that local taxpayers have been added to the long list of Wall Street mutual funds and private companies that have been burnt by derivatives, it is even more imperative that Congress pass legislation regulating the volatile and at times risky derivatives business," the Texas Democrat said in a written statement yesterday.

Gonzalez's remarks come as the Banking Committee's subcommittee on financial institutions supervision, regulation, and deposit insurance is preparing to vote on a bill he co-sponsored with Rep. Jim Leach, R-Iowa. The bill would require federal regulators to adopt comprehensive regulations for the derivatives activities of banks, federal credit unions, and government-sponsored agencies.

"Clearly there is a huge number of supposedly sophisticated managers of public funds, mutual funds, corporate and pension funds who don't really understand the arcane risks of derivatives," Gonzalez said in his statement yesterday.

"How many more firms, pension funds and counties are we going to read about losing money due to derivatives before Congress takes action?" he asked.

Gonzalez issued the statement after sending Charles County Attorney Roger Fink a letter asking for details about the county's loss of potentially millions of dollars from investments in derivatives that a former official made in an apparent violation of a state-approved local law.

Charles County has a population of about 105,000 and is located in southern Maryland on a peninsula between the Potomac and Patuxtent rivers. The county has 180 miles of shoreline and is largely rural. However, it is rapidly becoming a bedroom community for nearby Washington and northern Virginia.

The county suffered its recent losses after Stephen R. Johnson, the former deputy treasurer, invested almost all of the county's investment portfolio in inverse floaters, collateralized mortgage obligations, and other risky medium- and long-term derivatives and structured notes during 1992 and 1993.

Under a local law enacted by the state, the county is permitted only to invest in short-term U.S. government obligations.

But the derivatives and structured notes purchased by Johnson were not issued by the U.S. government and had maturities of up to 29 years. Some of these obligations were, however, issued by government-sponsored enterprises such as the Federal National Mortgage Association.

The county began losing money on many of the investments, which pose significant market risks, when interest rates began rising.

The county is suing nine of the securities firms that sold Johnson the derivatives and structured notes in an effort to reverse the transactions and recover the almost $30 million of county funds that were invested in them.

About two thirds of the money has been recovered through out-of-court settlements with some of the firms, Howard Goldberg, a lawyer with Smith, Somerville & Case in Baltimore, said yesterday. The firm is representing the county in the suit, which was filed in the U.S. District Court for the District of Maryland in Baltimore.

On Friday, the county will amend the suit to drop the firms that have settled and to add other firms whose similar dealings with the county have come to light, Goldberg said. The amended suit will probably seek to recover millions of dollars of additional county funds that were invested in similar transactions in which the derivatives or notes have already been redeemed or sold, he said.

County officials have said they hope the out-of-court settlements will prevent Standard and Poor's Corp. from lowering its AA-minus credit rating on the county's $78 million of unenhanced general obligation bonds.

In the letter sent to Fink yesterday, Gonzalez said "this incident is an excellent example of the public policy concerns regarding derivatives."

He asked Fink to describe "the circumstances that led to the sour derivatives investments" and how the investments will affect the county's operations. Gonzalez also asked for copies of any financial statements that failed to uncover the county's investments in these risky products.

According to Goldberg, the accounting firm of Bridgett, Mock & Associates in Waldorf, Md., prepared annual financial statements for the county in 1992 and 1993 that described the derivatives and structured notes as "short-term investments."

Goldberg said the county has hired the nationally recognized accounting firm of Grant Thornton in Chicago to review those statements.

One adviser to the county who did not want to be identified said yesterday that "had the derivatives been pin-pointed in the 1992 audit, we wouldn't have these problems because everyone would have realized they were illegal investments."

Asked if the county might bring legal action against Bridgett Mock, Goldberg said, "Whatever legal fight we have we will prosecute."

Gonzalez asked the county to provide the information to the banking committee by the end of next week. An aide said Gonzalez has not yet decided what to do with the information but is considering holding a hearing on the county's troubles.

County officials and Goldberg said yesterday that they will try to provide Gonzalez with all of the information he is seeking.

"We ordinarily treat correspondence from congressmen with great respect," said Fink.

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