Orange County’s Iceberg Dead Ahead

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Contributed by Chriss Street. Newport Beach, CA.

Like the Titanic a hundred years ago that ignored warnings and ran full-speed into a massive iceberg, Orange County is taking enormous financial risks rather than addressing its gapping cash-flow deficit. The county quietly entered into $518 million of illiquid and unsecured interest rate wagers, mostly financed from payroll and savings accounts of local schools and other government agencies. With spending rising, revenue falling, and liquidity drying up, the danger of hitting another iceberg is becoming extreme.

Despite falling property and sales taxes, Orange County inexplicably increased spending by $145.8 millionfor this fiscal year, which ends on June 30, 2012. In an exceptionally selfish move to bail-out the county’s gapping budget shortfall, the Orange County Treasurer in November skimmed off $73.5 of property taxes that belonged to local schools and community colleges.

My last report (here) detailed how three weeks after the schools’ money was hijacked, the Orange County Auditor-Controller made material financial disclosures in the county’s 2010-2011 Comprehensive Annual Financial Report, stating that Orange County had a $30,146,000 shortfall in “Reserves for Contingencies.”  Fifteen days later, he resigned.

In response to a legal demand served on the Orange County Auditor-Controller’s office under the California Public Records Act, an internal memo was obtained titled: “Second Report—General Fund Level Available Financing.”  The document dated March 28, 2012, is an internal communication from the Orange County Assistant Auditor-Controller to the County Executive Officer, with copies to the Board of Supervisors. The chart below from the document divulges in green that snatching $73.5 million of schools’ revenues positively increased the county’s total “cash” by 63% to $200 million.

But it also cautions in red that the county’s “Fund Balance Available,” which is the source of liquidity to pay the county’s $65 million bi-weekly payroll, is expected to sink to $23.6 million by June 30, 2012. The Assistant Auditor-Controller sternly warned: “Any future use of reserves could potentially worsen today’s difficult cash situation.” Two days later, he retired.

January last year, Orange County first revealed its intention to borrow up to $320 million from itself to pre-pay pension costs because its expenses for retiree benefits had ballooned. “When you think of the concept of borrowing from ourselves, we ask, ‘Why not?’” said John Moorlach, Chairman of the Board of Supervisors and former treasurer. “Who’s a better credit than yourself?”

Yet he already had inside information that the county only had half the total cash and 13% of the liquidity necessary to secure the transaction alone. He knew the county would have to rely on deposits from local schools and others governmental agencies controlled by the county treasurer, in order to have the cash to complete the transactions. Despite the safety and liquidity risks, Orange County placed $287,872,000 of unsecured Pension Obligation Bonds yielding 1.82% in the county treasurer’s comingled investment account and locked in a $15.1 million profit for itself. Then, on August 28, 2011, Moorlach warned, “The County of Orange, which went bankrupt in 1994, is a bankruptcy candidate again.”

Regardless of these risks, Orange County sold another $229,880,000 of Pension Obligation Bonds on January 18, 2012, yielding .85%. According to the Orange County Treasurer’s latest monthly report, the Treasurer bought at least another $72 million bonds. The prospectus for the bond sale makes no mention of Moorlach’s bankruptcy concerns. The financial projections states that Fund Balance Available will increase from $41 million to $42 million, whereas we now know that the Fund Balance Available will fall to $23.6 million.

It’s time to stop the reckless financial engineering in Orange County so that Moorlach is not proven right. Captain Edward John Smith of the Royal Mail Ship Titanic knew of risks but continued to run at such high speed that when his lookouts spotted the iceberg there was no time to turn away and spare the lives of 1514 people. Orange County also knows of the dangers of its financial engineering, yet its leadership is once again willing to gamble with taxpayer money intended for children’s educations. Readers may scowl that this type of gross incompetence and irresponsibility can only happen in Orange County. But I suggest you might want to look into any financial shenanigans happening in your county.

Cross-posted from Chriss Street’s blog www.chrissstreetandcompany.com

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