LOS ANGELES -- California lawmakers are considering the creation of an oversight authority for Orange County similar to the one that took New York City's finances in hand after a brush with bankruptcy in the 1970s.
The strategy was discussed at last week's inaugural meeting of the state Senate Special Committee on Local Government Investments.
The panel was set up to investigate the Orange County fiasco, and to decide whether tougher local government investment regulations are needed.
At its Dec. 19 meeting in Sacramento, the committee reviewed how the debacle occurred, and discussed whether other California local governments are confronting similar problems.
Also up for discussion was the formation of a state oversight committee modeled after ones that led to the resuscitation of financially beleaguered New York City two decades ago.
Douglas Charchenko, one of five private-sector representatives on the Senate committee, and chairman of the California Public Securities Association, declined to say whether he was for or against the oversight proposal.
However, he said that his group, an independent affiliate of the national Public Securities Association, "wants to be involved" in the oversight discussion.
The group's role would be to make certain that "any resolution of this is evenhanded as it relates to the public, governmental agencies, and the securities industry," Charchenko said.
"From a securities industry point of view, we're eager to make sure as much information is made available" as possible to the committee members so that "whatever solutions" are reached, "they are prudent and provide for evenhanded investment practices going forward," he said.
Committee staff members prepared a report recounting how New York State created a special commission to restore New York City's finances after the city defaulted in the mid-1970s.
"The financial markets found that a reassuring step, and it helped New York City get back on its feet," the report said. "While Orange County's problems are very different from those of New York City, it is conceivable that the situation could evolve to the point where an analogous structure would be helpful."
An oversight authority might lead to a faster "and more constructive" resolution than could be achieved by leaving matters to bankruptcy court, the report said.
"It might be difficult for the county to borrow money to help finance its rehabilitation without some external authority," the report added.
Dean Misczynski, director of the California Research Bureau and one of the authors of the 25-page committee report, said, "It may be that Orange County creates a climate where the legislature is receptive to a more restrictive approach to bond dealing in general."
He said the committee is looking at a range of options. They include a bailout, tighter local investment rules, and legislation to toughen state oversight or to restrict ties between securities firms and local investment officials.
The report prepared for the committee said that right now the state has too little oversight over Orange County for state officials to bear any blame for the crisis.
"A preliminary review of current law, supported by an informal opinion by the state legislative counsel's office, indicates that state officials such as the treasurer, the controller, and others have no specific authority to determine the investment policies of county governments," the report said. "Nor is there specific statutory authority for oversight of local investment policies."
According to the report, the 187 government entities that invested in the Orange County pool are now thought to have lost $2.02 billion, or 27% of the pool. The first estimate was $1.5 billion, the report said.
The investors included 31 Orange County school districts, with 500 schools and 400,000 students, which invested more than $1 billion of their property tax revenues with Orange County. The report said some school districts issued bonds "apparently just so they could speculate with the proceeds. Some restrictions on that kind of transaction may be in order."
The report also said experts believe that Orange County's losses stemmed mostly from its aggressive use of reverse repurchase agreements, and concluded that "some restrictions may be in order."
"In short, the county used its funds to buy securities, used the securities as collateral to borrow more money, used that money to buy still more securities, etc.," the report said.
"The fund had about $7.5 billion of public money invested in it, and reportedly borrowed an additional $12 billion through the reverse repurchase mechanism. When interest rates rose, the market value of the entire string of securities dropped. That's a big part of the problem."
State law explicitly allows local agencies to invest in reverse repurchase agreements, although a county's supervisors must authorize any such deal, the report said. "State law does not appear to recognize the possibility of derivatives, but does not prohibit investments using them," the report said.
California's 58 counties are, by law, political subdivisions of the state.
Reached for comment, Steve Swendiman, executive director of the California State Association of Counties, said Orange County should be viewed "as an anomaly. Orange County is unique in their risk portfolio."
Regarding the Senate committee report, Swendiman said, "My worry, frankly, is that they will rush to legislative solutions rather than doing their due diligence and fact-finding, and they may, really, adversely impact the taxpayer."
If lawmakers "so limit the scope of investment that all you can make is passbook savings, then the real winners are the trustees and banks who hold those funds and make a lot of money off of them -- not the taxpayer," he said.
While "there are no guarantees in investments," Swendiman said "if you look at most counties' investment policies, their absolute first priority is on security, second priority is on liquidity, and the third priority is on yield."
He said the counties association "may become involved" with developing "an educational format for supervisors that would assist them in understanding" their role with investments' oversight.
Swendiman said the association might issue guidelines, or assist counties in analyzing their portfolios.
