Infectious Greed Read Online Free Page B

billion in 1994, even though the Fed’s rate hike had decimated their value.
    Even if the agencies hadn’t been privy to this information, they knew of numerous public warning signs about Citron, including Citron’s own remarks from the previous year. In July 1993, when Citron was asked how he knew that interest rates would not rise, he replied, “I am one of the largest investors in America. I know these things.” In a September 1993 report to the County Board of Supervisors, Citron wrote, “Certainly there is nothing on the horizon that would indicate that we will have rising interest rates for a minimum of three years.” These statements were red flags showing how important the level of interest rates was to Citron’s investment strategy, and how naïve Citron was. In spring 1994, John Moorlach, an accountant from Costa Mesa, California, launched an aggressive campaign to unseat Citron. Moorlach warned voters that
the county was taking on huge risks and predicted a billion-dollar loss. But Citron won reelection, the losses remained hidden, and the rating agencies stayed mum.
    Finally, on December 1, 1994—long after it was clear Orange County had lost more than a billion dollars—Standard & Poor’s finally said it might lower Orange County’s credit rating. 10 The agencies finally downgraded Orange County during the second week of December 1994, as the county was preparing to file for bankruptcy. The downgrades were much too late. Robert Froelich, director of bond research at Van Kampen Merritt, said, “If rating agencies can’t keep track of one of the largest counties in the U.S., what is the value of their ratings on other counties?” 11 Or, he might have said, other companies?
    As Orange County fell into bankruptcy, the major derivatives dealers swooped down to feed on its carcass. First, they made sure their loans would be repaid. In early December, First Boston sold $2.6 billion of collateral the county had posted for its loans. 12 Chapter 11, the relevant section of the bankruptcy laws for companies and individuals, would have prohibited such a sale, but First Boston’s lawyers argued it was permitted under Chapter 9, the little-known and little-used section for municipalities. Other banks liked this argument, and sold collateral after the filing, something most experts agreed was prohibited.
    Freed from the loans they had made to Orange County, the banks began feasting on the county’s structured notes. In 1994, dealers bought back about $20 billion of structured notes, roughly one-fifth of the total outstanding in the entire market. 13 They repackaged the notes and sold off their risks, using swaps and securitizations, the recent innovations by First Boston and other Wall Street firms. They commonly earned fees of about a half percent from these deals, which meant profits of another $100 million.
    Notably absent from these dealings was Salomon Brothers. By this time, its Arbitrage Group had disbanded, and the firm was slow to enter the Orange County fray. 14 Now under the control of Warren Buffett, Salomon was taking fewer risks and having a terrible year; it was well on its way to losing $400 million in 1994.
    Given the spread of financial innovation, the collapse of Orange County seemed, with hindsight, to have been entirely predictable. It was dangerous to have someone like Robert Citron managing billions of dollars, especially when Wall Street firms were inventing new financial instruments to help fund managers place aggressive bets without
regard for investment restrictions. Moreover, many of these new instruments were largely unregulated, so there were no ground rules to prevent fund managers—even municipal treasurers—from putting other people’s money at risk. There weren’t even disclosure requirements related to the new instruments. Given these circumstances, Orange County’s collapse was not only understandable, it