The Way To Do It   

Cleveland's Plain Dealer blew the whistle on the dangerous financial strategy of the Cuyahoga County treasurer, sharply reducing the amount of taxpayer money lost.

Though Orange County reporters and editors say they did all they could to break the bankruptcy story, two reporters in Cleveland showed how they might have done it better. Last October 7, Plain Dealer reporters Joel Rutchick and Timothy Heider exposed similar investment strategies of Cuyahoga County Treasurer Francis Gaul. Three days later, commissioners shut down Gaul's fund. Though the county lost $115 million, Rutchick says, "we were told by the county commissioners that the financial consequences would have been far greater had we not broken the story."

Like Orange County Treasurer Robert Citron, Gaul was running for public office at the time. Gaul's strategies were similar to the investment practices of Orange County's, with at least one important difference: The Cuyahoga County treasurer hid his borrowing from county commissioners, forcing government reporters Rutchick and Heider to dig into public documents for answers.

While they were investigating the treasurer's dangerous investment strategy, other reporters covered the political race. During the campaign, Heider and Rutchick did no stories associated with Gaul's election. "If we had been covering the race, it would have been more difficult to do the story," Heider says.

For the two reporters "a paramount question was: What happens when interest rates rise?" says Rutchick. After poring over piles of financial data, the reporters determined the amount of money leveraged, or borrowed, then discovered – due to rising rates – that investors stood to lose hundreds of millions of dollars. They then hired a financial expert "to tell us if we were right," Rutchick said. "And if we weren't, to tell us what the accurate picture was."

When it turned out the reporters were right, no one discussed withholding the exposé to prevent a run on the fund. "We had an obligation to tell the investors of their risk," says Heider. "If they decided to take their money out, that seems to be the result of the paper doing the responsible thing: Getting at the truth and printing it." The loss was one of the largest ever by a single public fund in municipal finance history.

The media in Orange County failed because they didn't do all they could, says Fred Smoller, media critic and a professor of political science at Chapman University in Orange, where he teaches classes on media and politics. "This is one more wake-up call that the media better get back to basics, they better start covering government – and the political process – the way the framers of the Constitution intended. The media is the only business to have a constitutional amendment protecting it. In exchange, they're supposed to provide citizens with the information they need to make intelligent choices about government."

But would it have been possible, based on the documentation provided to the media Citron challenger John M.W. Moorlach, to expose the coming debacle?

Moorlach gave me a copy of the portfolio he provided to the media. I asked a government bond expert who works for a major retail brokerage firm to examine it. After scanning the 23-page document, the bond expert concluded that Citron was involved in high stakes, speculative gambling, made riskier by his investments in interest rate-sensitive instruments in foreign countries. "I'm scanning the statement and I see Deutsch, that's a red flag," he said. "Now you've entered German interest rates into the equation, their inflation, their economy, and that opens up a whole new sea of risk."

(Because of legal issues that developed after the broker analyzed the portfolio and was interviewed, AJR agreed to allow him and his firm to remain anonymous.)

The portfolio reflects a roughly $2 billion deficit that was covered by borrowed money and it shows Citron sold short – he borrowed assets he didn't own with the hope of selling them, then buying them back to make a profit. But as interest rates kept climbing, it became clear that the the institutions that loaned the county assets realized they weren't going to get back what was owed them. (See "Robert Citron's Risky Business") "Lenders looked at the growing debit in the account, realized the county was paying high rates of interest and demanded back what they had loaned," the analyst says. "Orange County was forced to sell low. That's why they went bankrupt. You could project that pretty well from the statement."

A five-minute inspection told him the portfolio reflected an extremely risky strategy. A lengthy, expensive computer analysis would have quantified the impact of rising rates on the value of the fund. "You couldn't have pinned it down to the decimal point, but you could say, historically, based on past performance, this is the kind of debit or profit you're going to have. You'd have to have a fairly expensive computer analysis that would take a lot of hours. It would probably take a certified financial analyst to do it. But it could be done."