Orange County, Calif.'s pooled investment fund, which has approximately $7.5 billion in assets, has experienced a paper loss of 7%, or about $1.5 billion, a county official said late yesterday.

Robert Citron, the country's treasurer and tax collector, said in a press release that repeated increases in interest rates have caused a decline in the market value of the county's investment fund.

Although Citron was not specific about the exact causes of the investment pool's losses, market sources said declines occurred in part due to a leveraging strategy used to increase the value of the portfolio and possibly due to some investment in derivative securities.

In January of this year, the fund had a total market value of $20 billion. The preliminary estimate of the current value is about $18.5 billion.

The fund manages the operating and reserve moneys of approximately 180 public agencies.

"They leveraged up a pool of assets of about $7.5 billion to about $21 billion," one market source said. "It was a very bullish position to be in."

News of the losses makes Orange County one of the latest municipalities to take a big hit from derivative securities or other speculative investment strategies.

"The basic synopsis of the problem is that rapidly rising interest rates have affected bond funds nationwide, including the Orange County investment fund," a county spokeswoman said.

At a press briefing late yesterday, county finance officials announced that a management team has been formed to deal with the problem.

The county has hired Capital Market Risk Advisors to reposition the fund's investments by Dec. 15, according to a press release. Capital Market Risk Advisors is a business consulting firm.

A county spokeswoman said that the county was encouraged by the decision of the Orange County Transportation Authority, which has nearly $1 billion in the pool, to remain in the pool. Transportation authority officials had been considering abandoning the pool because of concerns about the return on their investments.

According to market sources, to increase the value of its investments, Orange County employed a strategy sometimes referred to as a reverse repurchase agreement. Through the process, the county would lend out securities that it purchased, using the cash received from lending out the securities to purchase additional securities. Merrill Lynch was one of several firms that may have sold securities to Orange County as part of its leveraging strategy, the sources said.

The losses that Orange County experienced are similar to those faced by closed-end mutual funds whose leveraged positions collapsed as short-term rates rose.

Citron has been criticized for his investment approach, which leverages the money of the pool through the use of reverse repurchase agreements.

The strategy allows the pool to borrow money against the market value of its securities. The strategy works well in a falling rate environment; but when interest rates rise, market value falls and additional collateral must be posted for the remaining term of the reverse repurchase agreement.

In the past, the investment strategy has enabled the pool to outperform the market. But earlier this year, as interest rates began to rise the pool posted $215 million in collateral calls to brokerage firms.

Over the last 15 years, the return on the fund has average 10.10%. The return has averaged 8.60% for the last five years.

A spokesman for Merrill Lynch & Co. denied that Merrill has had any problems related to Orange County.

"There is absolutely no truth to rumors of any margin calls by Merrill Lynch relating to Orange County, losses by Merrill Lynch on dealings in Orange County, or litigation against Merrill Lynch by Orange County," a Merrill spokesman said.

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