AJR  Features
From AJR,   March 1995

When the Watchdogs Don't Bark   

The story of Orange County's imminent financial debacle was handed to the Orange County Register and the Los Angeles Times. But the rivals in one of the nation's most bitter newspaper wars blew it.

By Susan Paterno
Susan Paterno (paterno@chapman.edu) is an AJR senior contributing writer.     

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Perhaps if Chriss Street were a reporter, Orange County, California, would have known it was in danger of going bankrupt a year before it did. But Street isn't a reporter. He's an investment banker with some expertise in bankruptcy who was so worried about his daughter's public school education that he tried to blow the whistle on the county's high stakes investments nearly two years ago.

During the spring of 1993, Street sat in on a routine school board meeting. He was concerned about the district's solvency and started asking questions about money and budgets – the kinds of questions that beat reporters are supposed to ask. When school ofÝicials couldn't satisfy his curiosity about how they were going to cover a $2 million deficit, he demanded to see the budget.

He discovered that officials at the Newport-Mesa school district – along with a few other local school districts – were borrowing money to invest in a county-wide scheme that looked to Street like a giant pyramid scam. If interest rates stayed low, everybody won. But if rates started to climb – as Street believed they would – only investors quick to withdraw their money from the county fund would avoid big losses.

"I didn't care what they did with the county money," Street says. "But my daughter's local school district money, that made me ballistic. This was the money they needed to pay the janitors."

After getting nowhere with county and state officials, Street called the Los Angeles Times and met for a couple of hours with the editor of the Orange County edition and two reporters. He left a stack of documents. "I basically gave them the keys to one of the biggest municipal scams in history," he says. "Nobody called me back."

The news broke last December 2, to a collective, shocked gasp: Orange County – one of the wealthiest counties in the country – was declaring bankruptcy with a near $2 billion loss. The county, long known as the nation's capital for get-rich-quick schemes, and the site of one of the largest savings and loans debacles, went bust under the noses of editors and reporters in one of America's most competitive newspaper markets.

Street blames the local media for failing to fulfill their role as government watchdogs. "I think the local media was despicable in the way they handled it. They're 100 percent at fault. To this day, I don't know why they were so incompetent. They had all the numbers. It defies my wildest imagination why they didn't pursue this story."

The story of how the Los Angeles Times and the Orange County Register neglected to warn the public about the potential impact of the county's investment strategy is a cautionary tale. "It says a lot about the problems journalism has today," says Richard Cheverton, the Register's managing editor for strategies and administration. "We found out about the fund going down the way the L.A. Times found out about it. From a press release. That's pretty reprehensible."

Cheverton says reporters and editors have difficulty framing substantive issues in understandable terms, and the press is steadily abandoning its traditional role of keeping the government accountable. "Neither paper ran a series of articles that says, 'The roof's about to fall in, run for the hills,' " Cheverton says. "It was a terrible failure. We have to admit that. And if we don't, we'll make the same mistake over and over."

From the beginning, reporters and editors were unable to translate the dull complexity of municipal finance into the human drama of lost jobs, closed parks and overcrowded schools. Perhaps that was because the bankruptcy had its roots in the complicated ýnvestment strategy of entrenched County Treasurer Robert Citron, a politician with a track record of producing investment returns twice as high as other treasurers in the state. But higher earnings mean higher risk, accountant John M.W. Moorlach warned in his campaign last year against Citron for treasurer. Like Street before him, Moorlach charged Citron with putting the county on the road to financial ruin and provided reporters with documentation that he says confirmed his allegations. But the story never was told – until it was too late.

Editors and reporters in Orange County cite many reasons neither paper went beyond a recitation of Moorlach's charges to investigate his claims: It was too technical and complicated; reporters could find no easy corroboration of the allegations; and during the 1994 treasurer's race the accusation of fiscal irresponsibility seemed like nothing more than campaign rhetoric.

In retrospect, it's easy to see how Citron got away with betting money that paid for things like teachers' salaries and playground equipment in a high stakes gamble dependent on borrowing money and investing it in complex financial instruments that paid off only if interest rates stayed the same or dropped. (See "Robert Citron's Risky Business")

For a decade, as interest rates steadily declined, Citron was a hero among municipal finance directors. He lobbied for the passage of state laws that made it easier for municipal treasurers to borrow money and bet more on riskier investments. School districts and city councils were so impressed with his high rates of return, they borrowed millions of dollars on their own to invest in Citron's fund. Citron's self-proclaimed success – and the returns he was collecting – were trumpeted in the Times and the Register. Neither paper saw anything amiss.

But there were warning signs. As early as the mid-'70s, a county grand jury warned supervisors to exercise greater control over Citron. In 1987 and again in 1991, the county auditor's office suggested more oversight of the treasurer's precarious investments. And in early 1993, Merrill Lynch offered to buy back the interest rate-sensitive securities it had sold the county after warning of the potential losses the fund faced should rates rise. Had Citron taken the offer, the county would have made $100 million, according to the Wall Street Journal. But Citron declined. He continued to tell the county board that he believed interest rates would stay low.

Citron never hid his strategy: Every year he laid it out publicly in rambling reports. Usually, the board rubber-stamped Citron's recommendations, though no one, it appears, made any effort to fully understand them.

Until a year ago, that is, when John Moorlach, a little known certified public accountant, provided local papers with a chronicle of a crisis foretold. In 1993, before Moorlach decided to challenge Citron for the treasurer's office, he began researching the county's investment portfolio. Interest rates were on the rise at the time and Moorlach was reading stories in the financial press about the potential disaster looming for those pursuing strategies like Citron's.

He obtained Citron's portfolio using the state's freedom of information act. "First I was amazed by the amount of cash he was handling," Moorlach says. "Then I was amazed at how much leveraging he was doing." At one point, Citron controlled $21 billion, Moorlach says, two-thirds of it borrowed.

During the campaign, Moorlach, a Republican, accused Citron of riverboat gambling and gave the media and county supervisors documents that he says showed the huge losses Citron's fund would incur if interest rates rose. His warning went unheeded. Today, county employees face threats of massive layoffs; county pension funds have lost value; and half-built parks stand in vacant disrepair.

"Moorlach handed everybody the story on a silver platter," says the Register's Cheverton. "That tells you something about political reporting today. Maybe if he had said Citron hired an illegal immigrant for a babysitter, somebody would have paid attention."

But few did. On February 7, Moorlach called a press conference to launch his campaign. It was pouring rain. Only one reporter for a local cable channel showed up. Moorlach handed her a press kit with a key question: How can it be that Citron's investments earn bigger returns than any other municipal fund? You can only achieve the highest interest rates in the nation by taking the highest risks, he said. He also sent copies of the press packet to reporters at the Times and the Register. The Times ran a story the next day on page B-10 with the headline: "Citron to face 1st Challenger in 23 Years." No mention was made of the fund's alleged problems. Nothing about the campaign appeared in the Register until March.

By April, both newspapers were framing stories in political terms. Though a Democrat in a largely Republican county, Citron claimed such great returns on the county funds that few Republicans opposed him. Articles written at the time report Moorlach attacking Citron and Citron coming back with a vengeance, accusing Moorlach of dirty politics, smearing his reputation and threatening to cause a run on the fund.

On April 2, the Times quoted Orange County Supervisor Thomas Riley defending Citron: "This is a person who has gotten us millions of dollars. I don't know how in the hell he does it, but he makes us all look good."

While the newspapers reported the twists and turns of the campaign, Moorlach went after the portfolio, using the state's FOIA to obtain what Citron refused to release. "When Citron wouldn't release records, wouldn't that tell you something as a reporter?" Moorlach asks. "Wouldn't that make you want to find out what he's hiding?"

In April, Moorlach picked up a stack of documents from Citron's office. "It was garbage.... [Citron] knew what I wanted and he didn't want to release it. I got more persistent, more precise. I asked for specific documents." Moorlach prayed they would arrFve in time to release them to the media before the June 7 election.

Meanwhile, stories in the national financial press were lending credibility to Moorlach's charges. The Wall Street Journal, for example, reported that some state laws prohibit counties and municipalities from using Citron's investment strategy. "In Califürnia, such approaches are legal, thanks to a legal revision that Mr. Citron says he helped write," the Journal reported. "In the past, some [U.S.] cities and counties have run into trouble by using [these] strategies. Similar strategies caused the collapse of numerous savings and loan institutions in the 1980s."

In early May, Moorlach obtained the proverbial smoking gun, the result of another FOIA request. It was "the evidence I needed to analyze the portfolio," he says. "That's when I knew there was going to be a run on the account. And the last to leave would be asked to turn out the lights."

With the help of numerous bond brokers, Moorlach wrote a one-page summary of the fund showing that of Citron's total $21 billion, $14 billion was borrowed. On May 12, he sent the summary, the fund portfolio and a cover letter to local reporters, along with a list of questions for reporters to ask independent experts. Question 1: "Orange County's returns have outpaced most other municipal funds. Has this been due to taking on more risk than other funds?" Question 2: "Can Orange County provide specific details, including models or stress tests, that support the claim that the pool will have sufficient cash flow even if rates continue to rise?" "This is basic, simple stuff...," Moorlach says. "Do a stress test on that and it'll blow up."

Moorlach waited for the big story to appear, but it never did. The election was looming and reporters had yet to confirm the accuracy of the documents he had given them. On May 31, Moorlach sent a lengthy letter to Orange County Supervisor Tom Riley laying out the likely crisis in chilling detail. The county was headed for a $1.2 billion crash if interest rates continued to climb, he wrote. Copies went to the other supervisors and to reporters. The Times presented the story (on page B-7) in much the same way it had previously: Moorlach accuses, Citron denies, experts equivocate. The Register ran nothing. In the end, the five county supervisors, all Republicans, endorsed Democrat Citron. The Los Angeles Times editorialized: "The cloud drawn over Citron increasingly looks like a bum rap."

Citron won with 60 percent of the vote. Throughout the summer and fall, the Times published no more stories about the fund. The Register ran a piece in September calling Moorlach a doomsayer, and another in October allowing Citron to explain away the fund's mounting losses. Meanwhile the national press – including the New York Times, Wall Street Journal and Washington Monthly – was publishing stories about the dangers of investing taxpayers' money in the same sorts of schemes as Citron's.

Throughout 1994, the Federal Reserve Board raised interest rates six times; each time the fund lost millions of dollars. Citron insisted the losses were only on paper: He planned to hold the securities until maturity and cash them in at face value. But his investors were getting nervous; one quietly withdrew $100 million in early November. About the same time, the assistant treasurer privately went to board members and warned of the fund's impending crisis. The county announced on December 1 that the fund had dropped an estimated $1.5 billion in value. Brokerage firms, anxious about losing the loans they had made, began selling the county's collateral. To avoid a forced liquidation of its assets, the county declared bankruptcy. Citron resigned, and the Orange County district attorney's office and the Securities and Exchange Commission are investigating the fund. Citron's attorney did not return phone calls seeking comment.

Editors at the Times and the Register make no apologies for their coverage. "You dig wells all the time. You don't always hit oil," says Martin Baron, editor of the Times Orange County Edition. "The question is, how long do you want to keep digging the well before you want to try a different field?"

Baron says the Times took the story seriously from the moment investment banker Chriss Street walked into the Orange County office in 1993 and immediately assigned a reporter to look into Street's allegations. "One of our reporters spent a fair amount of time researching that," he says. "She had it on her story list for some time."

The Times published no stories, Baron says, because at the time Street's complaints seemed to be old news. "This was something that had been publicly debated at all the school districts and there had been some controversy on the boards," Baron says. "..It's not like it was some sort of new discovery." And, Baron says, the paper talked to a lot of people but "we didn't find people who were quite as vehement as [Street]. You can't write a story on just what Chriss Street says."

At the Register, with its newsroom without walls, where the traditional beat system has become a collaborative team approach, "there was a lot of tension between business and metro over who was going to cover Citron," recalls former Register Money Editor Neil Wertheimer, who left the paper in July to work as a book editor for Rodale Press in Pennsylvania.

The metro reporters and editors "didn't understand it," Wertheimer says. "Everyone wanted to define derivatives. That's not the issue. The number one issue is leverage. The number two issue is the method used to invest public money. We should have asked: 'What checks and balances are there for public investments?' There aren't any." Wertheimer says he offered to help. Metro editors "said, thanks, but no thanks. I privately met with some editors to say we should be on it. But they declined. And I didn't push it."

Moorlach believes editors at both papers were mistaken when they framed the story as political rather than financial. "It was very difficult on me professionally because I was dealing with people who had no financial expertise. I started believing you c¨uld lead reporters to water, but you couldn't make them think. They should have assigned it to a business reporter. Somebody who understood what I was talking about."

To Register Editor Tonnie Katz it did seem like a political story. "You had a man who had been in office for 30-odd years who had over that time made millions of dollars with this investment strategy for the county," she says. "You had an election in which a seemingly unknown accountant is making some very significant charges about the way Citron ran his office. We did what any good paper does. We tried to check them out. And that was very difficult. We spoke to investors, we spoke to Citron, we spoke to the government officials who supervise Citron, we spoke to Moody's and Standard & Poor's, we spoke to other experts in the field, we looked at the documentation that Citron provided annually about his fund and nowhere were we able to validate the claim that Moorlach was making."

From mid-April to early May, the Times and the Register published a number of pieces on the race, but neither did an independent analysis of the situation. Instead, on April 14, the Times ran a story reporting that one city had withdrawn its $4 million stake in the fund. It said the withdrawal appeared politically motivated: The city was receiving advice from a council member who supported Moorlach.

Between April 19 and May 8, the Register ran six stories, restating Moorlach's charges, Citron's denials and the experts' equivocal explanations. In an April 19 story headlined "Earnings Champ Takes Heat In Treasurer's Race," Citron defends himself by accusing Republicans of character assassination because he supported a Democrat in a local assembly race.

On May 8, the Register ran a story on B-6 reporting that Citron lost $8.46 million, then recouped it by selling other securities at a profit. On May 12, when Moorlach released Citron's portfolio to the press the Register didn't cover it, says Chris Knap, the reporter on the story. He had already obtained a copy of the portfolio from Citron in April, he says, and had sent it to experts who "continued to have confidence in Citron."

In April, the L.A. Times reporters say they too received a copy of the portfolio from Citron's office. Local news reporters Mark Platte and Jeff Brazil sent the document to about a dozen financial experts. "We didn't offer to pay them," Platte says. "We asked them to review the portfolio and make an independent determination about the level of risk. We never asked them to assess the level of risk based on interest rates. We didn't get specific."

The responses were inconclusive, he says. From April 19 to May 5, the Times published five stories, variations on the same theme: "Most of [the experts] said we can't make any determination based on what was sent," Platte says. "So we did interviews with those familiar with Citron and asked them to describe the level of risk. Every person we talked to said: 'It works. We make big money.' "

Moorlach suspects the Times and the Register sent the wrong documents to the wrong experts. He says he didn't receive what he needed to predict the impending crisis until May 2. Then it took him more than a week to analyze the documents. By the time Moorlach released his findings, Richard Nixon had died and was being buried in Orange County. Reporters had moved on to that and other stories.

Moorlach also questions the capability of the experts contacted. Moorlach says reporters should have gone to experts in the municipal bond market and asked, "Would you mind taking eight hours to look into this thing?" Moorlach says, "The reporters didn't do the heavy lifting. Any business reporter would understand [it]."

Times editor Baron disagrees. "We don't have an expert on every subject. We're constantly assigning good reporters to go cover things they're not an expert in," he says. "What we do is talk to the experts. We got the names of people we thought were experts in the field. Any business reporter would have done the same thing."

On May 13, the day after Moorlach released the documents, the Times ran a 382-word piece on B-2 rehashing Moorlach's charges and reiterating Citron's response. In the last paragraph, Moorlach's quote sounds like the frantic wail of a prophet of doom: "If rates continue to soar, couldn't the size of the [losses] top $1 billion? My problem is, why aren't people making a connection here? I have not been screaming fire in a theater. I have legitimate concerns."

Overall, Moorlach says, the Times "at least tried. They were objective, balanced and professional. They just missed the story.... The articles were fair, based on what they understood. Whereas it seemed like [Register reporter] Knap was working for Citron."

Knap denies the charge. He points to a June 3 piece headlined "Moorlach fires another salvo at Citron; treasurer calls the attack the 'dying gasps' of his challenger's campaign." "Look at that article," Knap says. "Moorlach is quoted extensively. We published what he was saying."

Following the election Moorlach's allegations were all but forgotten until September, when Knap chastised him on the front page of the business section: "O.C.'s Sky Didn't Fall." In the piece Knap pointed to stories in the financial press that had described Citron's investment strategies as dangerous. In Derivatives Week a bond expert called it, "a scandal waiting to happen. On Wall Street, we call this..the death spiral." But now, with the campaign over, Knap wrote, "interest rates are leveling out and to tweak a line from Mark Twain, reports of Bob Citron's death spiral appear to have been greatly exaggerated."

The usually affable Moorlach stiffens at the mention of the article. "Knap calls me up and says, 'Everything's fine, nothing blew up, how do you feel about it?' I said, 'Excuse me, you expect interest rates to level out? Just wait.' " On September 15 Moorlach sent a scathing letter to R. David Threshie, the Register's publisher, with copies to Editor Katz and Knap.

It asked: "Why would you allow a political reporter who has a minimal grasp on business issues to editorialize in the lead article in the business section? 'Interest rates are leveling out?' Oh yeah? They went up that very day in a significant way, up to 7.7 percent for the 30-year bond... These issues aren't going to go away. We're talking about a serious chunk of change in taxpayers' dollars. The article would have been more aptly entitled: 'O.C.'s Sky Didn't Fall, Yet.' " No one from the Register responded, he says.

Knap now says he wishes he hadn't written the story. After Moorlach's letter arrived at the Register, Knap wrote a long rebuttal to his editors explaining "how Citron was able to show that bond prices had spiked when the story ran." In November, when interest rates rose again, Knap had to admit that Moorlach was right.

"I've looked at this and wondered, 'How could I have missed it?' The lesson is, when you have someone, even if he pops out of right field, even if he seems to make charges based on politics, you have to look at what would happen if he was right."

Times and Register editors offer different reasons for why they failed to do a computer analysis of the portfolio or send it to independent analysts with the question: What will happen if interest rates rise?

At the Register, money was a factor, says Katz. "It would have cost thousands. Now I'm perfectly willing to spend thousands when I think I'm going to get a return. But you have to have some evidence." Knap, the story's lead reporter, "is like a dog with a bone. If he has...the slightest hint that something is wrong, he's going to follow it and find it." When Knap returned with little more than political allegations, Katz says it seemed "that this was just a negative campaign that [Moorlach] was running."

Though the Times never considered doing a computer analysis, Orange County Editor Baron says he feels the coverage was "the best we could [do] at the time with the resources available.

"It's easy to look back in retrospect and say had [we] asked this or that we would have come back with something different," says Baron. "Our stories outlined generally the principle and the risk and dealt with the issue seriously. We didn't say the fund is on the verge of collapse. I'm not sure it was on the edge of collapse. All the parti-cipants said they were delighted with the fund."

And, says Times reporter Jeff Brazil, what might have happened if the media exposed Citron's gamble and caused a run on the fund? "The newspaper...has a responsibility to the community," he says. "Just because you know something doesn't mean it should go in the newspaper."

Only after the county's bankruptcy have journalists realized the far-reaching implications of the story. Katz says she now sees the story as: "My job is lost, my neighbor's business is going under, my children's schools are hurt, my garbage collection has been taken away." But it began, she says, "as a story of exotic financial transactions and giant numbers.

"This is a very, very complicated story, far more complicated than most general interest newspapers ever have to deal with. Give us a good fire, a good earthquake, a nice hurricane – that's pretty easy to cover. The event happens, we throw all our resources at it and it goes away over time. This is just the reverse. It bubbled, it exploded, but it exploded way up there, in very rarefied turf. We're talking about financial transactions and numbers that really stretch the comprehension of the average reader."

But Neil Wertheimer, the Register's former Money editor, says a routine beat story examining the wisdom of local cities or school districts borrowing hundreds of millions of dollars to bet on Citron's high-risk gambling is precisely the sort of story that often was ignored at the paper.

"City and schools reporters need to become much wiser about finance," he says. "The Register has fallen down on that. I offered many times to teach seminars to city reporters about bond financing and how it operates. But it never occurred.... I was told it was one more huge area that's complicated and the reader doesn't really care about it. Well, they care about it now."

The day after the news of the bankruptcy broke, Katz sat at her desk and read every story the Register had published about the treasurer's race. "I was sitting here going, 'Wow, it's amazing!' I looked at it and said, 'Everything is here. We printed it all. We printed every word of it.' It was there. We printed it before the election. We printed it after the election. But it didn't move anywhere. It was sort of like the story of Bosnia. It was all there and no one reacted."

The Register so strongly believes it told the story of the impending bankruptcy that on January 17 Knap wrote a full page article with the headline: "Did Anyone Listen?" blaming everyone but the media for ignoring the warning signs. "The bottom line is," Knap says, "I laid out that Citron's strategy was risky and most experts were willing to believe Citron. For Moorlach or anybody else to say the Register didn't lay out the charges time and time again is wrong. We did."

But Moorlach says it does no good to lay out charges if the press fails to determine whether they are true. It becomes, he says, "a litany without meaning. The press never understood. If they really understood it, why was there no righteous indignation like there is now? Why was Citron a hero and I was a moron? Because they put reporters on the story who didn't understand it."

A few weeks after the bankruptcy, Moorlach was returning phone calls to the dozens of reporters who were calling for comment. One went to veteran Register reporter Jean Pasco. Knap answered the phone. Moorlach remembers the conversation well.

" 'John,' Knap said, 'You're right, I missed the story.'

" 'Chris,' I said, 'not only did you miss it, you missed the Pulitzer Prize. And I tried to help you. But you missed it. Now transfer me to Jean Pasco.' " l