CA Lawsuit Exposes Orange County Financial Crisis

Contributed by Chriss Street. Newport Beach, CA.

The ballooning Orange County financial crisis continued to spiral out of control as the State of California filed a law suit to force return of $73.5 million of property tax revenue the County skimmed from local schools and community colleges last November. At the time, it seemed bizarre that the supposed “Most Conservative County in America” would increase spending by $145.8 million, then grab the school’s cash and cancel planned layoffs of 490 union workers.

The new lawsuit has caused increased scrutiny of other dicey actions by the County. The biggest shock comes from the recent Orange County 2010-11 Audited Financial Report, which states the County failed to be in accounting compliance due to a $30,146,000 shortfall in cash Reserves:

The County General Fund maintains a Reserve for Contingencies which was established through the Strategic Financial Plan (SFP) process. The target amount for this reserve is 15% of ongoing annual general purpose revenues (excludes fund balance available and one-time amounts and transfers), or $91,446. This compares to the Government Finance Officers Association GFOA) guidelines for funding contingencies at 15% or higher. The June 30, 2011 balance is $61,300, approximately $30,146 below the revised target.

The Reserves would have been even more out of compliance, if the County had not skimmed cash from budget spending reduction by the former County Treasurer and other County Departments to plug some of the depleted County Reserves. According to the Orange County Executive Office’s Key Budget message in the County of Orange FY 2011-12 Proposed Budget: The County increased General Fund Reserves by $17.2 million. The increase was primarily associated with the transfer of reserves of unallocated Fund Balance Available (FBA)

Unallocated Fund Balance Available is generally referred to as day to day check-book-cash. The County knows the Treasurer has the right to recover his costs from investing the school, county and others deposits. Since the schools are more than 50% of the Treasurer’s deposits, they were entitled to more than 50% of the multi-million dollar budget savings achieved during the former Treasurer’s term. The County must have been so desperate to not report an even worse audited financial statement, they skimmed all the budget savings and transferred it to County Reserves.

It also appears that last July the Orange County Employee’s Retirement System pension plan delayed lowering their annual expected rate of return assumption by ¼% to ¾% until this coming July 2012, which conveniently falls after the June elections. Given that each ¼% reduction in expected return require unfunded pension liabilities to rise by $750 million; the current $3.75 billion underfunding of the pension is about to skyrocket to a $4.5 to $6 billion liability!

The lawsuit against the County was filed by the California Department of Finance and the State Associations of Community Colleges in Orange County Superior Court, just across the street from the County offices. The suit alleges the county has taken “the extraordinary step of flouting the law and illegally redirecting property tax revenue payments from schools and community colleges to the county’s own general fund.” The plaintiffs are demanding the court order the Defendant County to return the money to its rightful owners.

The real issue in the litigation is that the State took away some favored subsidies for Orange County and the County retaliated by taking school money hostage to force the State to revive the subsidies. According to the Sacramento Bee, the Orange County spokesman, Howard Sutter, pretended to be surprised the State would try to help schools recover their $73.5 million:

While the county has been proactive in discussing this issue with legislators and school officials, the Department of Finance and Attorney General’s office have made no contact with the county regarding this matter. The county is disappointed the state has now resorted to filing a lawsuit. We are evaluating the merits of their suit and cannot comment on its specifics at this time until we have had time to completely review their claims.

For the last six months Orange County has used the schools’ and community college’s cash to bolster their backstop their dwindling cash and reserves. The local schools have tried to avoid the ruinous cost of litigation by accepting a guarantee from the County that at some point in the future, the County would lend them money at no interest cost. But with the State and the Community Colleges both suing the County, there is a high probability that the Court is going to require the $73.5 million be transferred from the County to a bank trust account for safe-keeping.

Orange County’s payroll is $65 million every two weeks. The loss of the schools’ money, higher pension costs and restrictions against skimming County accounts present real risks to Orange County’s cash position. Litigation will eventually require document discovery and depositions? It will be fascinating to see how Orange County tries to spin their precarious financial position.

Cross-posted from Chriss Street’s blog

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