Generous Citron Offer Helped City, Hurt Pool : Bankruptcy: Special deal gave fire-ravaged Laguna more than a $1 million profit. Then pool lost $12 million.

Then-Orange County Treasurer-Tax Collector Robert L. Citron, in a gesture of sympathy for fire-ravaged Laguna Beach, designed a sweetheart deal that allowed Laguna to more than double a $1-million stake in less than a year--but saddled the county’s investment pool with more than $12 million in losses.

According to documents obtained by The Times under the California Public Records Act, Citron offered the extraordinary deal to the city and to Laguna Beach Unified School District with a special promise that not a penny of their money could be lost.

Citron would effectively use the city’s $1 million as a down payment to buy $50 million worth of securities, guaranteeing that the commingled investment pool he managed for nearly 200 public agencies would buy the securities at full price at the end of one year. The school district got a similar but smaller deal.

Reeling from massive property damage and firefighting costs, the city took Citron up on his generous offer.

Three weeks before Orange County filed for bankruptcy on Dec. 6, Laguna Beach cashed in its securities and walked away with its original $1 million, and almost $1.5 million in profit to boot.

But a quirk of timing caused the school district deal to go bust in the bankruptcy. The tiny district, where several campuses were burned in the blaze, was left facing a net loss of about $50,000.

“It was a terrific deal for Laguna Beach. How anybody could make such a deal I just find very, very strange,” said Zane B. Mann, publisher of the California Municipal Bond Advisor newsletter.

“This is really part of the pattern of (Citron’s) shifting money from here to there and obligating it under one arrangement and then using the proceeds some other place,” Mann said. “What if it would have been lost? Who would have paid for it? It seems the pool would have paid. It’s extraordinary.”

The previously undisclosed Laguna deals were among a handful of segregated investments Citron handled for various pool participants and the county itself.

Citron and his attorney, David W. Wiechert, declined to comment on the deal.

City and school district officials said that at the time they simply chalked up to charity Citron’s extraordinary offer.

“No risk, no contract, nothing to sign, nothing to do--just that he was going to find a way for the county to help us,” schools Supt. Paul M. Possemato recalled of Citron’s offer. “It was a magnanimous gesture. We were in dire straits. Anything to help us out was great.”

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Laguna Beach City Manager Kenneth C. Frank said he too asked few questions before approving the deal.

“They wanted to help and they had a way to do it,” Frank said of Citron and his chief deputy, Matthew Raabe, both of whom are under criminal investigation for their involvement in Orange County’s fiscal collapse.

“We had people from across the country who were helping in the aftermath of the fire,” Frank said. “It wasn’t all that unusual at the time.”

Frank said this week that he never met Citron before the county’s financial crisis erupted last November. But in January, 1993, Frank wrote Citron a laudatory letter thanking him for earning the city extra money through the investment pool. And last spring, in the middle of Laguna’s special deal, Frank donated $200 to Citron’s reelection campaign.

In proposing the deal, Citron offered his sympathies to the city, with special condolences to Frank, whose home was among hundreds in the Laguna area destroyed by the firestorm.

Citron made his offer “on behalf of the Orange County Commingled Investment Pool,” and said that at the end of one year, the pool would take the five-year securities off the city’s hands at cost, thus guaranteeing that “the city will have no principal risk exposure.”

“It is a completely safe and appropriate transaction for the investment pool to contemplate,” Citron wrote to Frank and City Treasurer Susan A. Morse. “I have not previously offered this type of investment arrangement to our individual investment participants, because over-use of such an investment could negatively affect the liquidity of the investment pool.”

Citron utilized a reverse repurchase agreement known as a “reverse against itself,” which let him take a government security, pledge it as collateral for a loan, then use the money from the loan to buy the original security. The only cost to the city and school district was to cover the difference between the amount of the loan and the price of the security.

The city thus got $50 million worth of Federal Home Loan Bank securities for only $750,000. The securities paid 6.65% for the first year and the interest on the loan was only 3.39%, allowing the city to earn nearly $800,000 in profit over six months, with a chance to renew the deal for a second six months. The school district did the same thing on a smaller scale, putting up $225,000 to buy $15 million of the same FHLB issue.

Experts said that such reverses are not uncommon in the market, but that investors typically have to pay 5% to 10% of the cost of the security. In the Laguna deals, investment giant Merrill Lynch charged Citron only 1.5%.

“This was a sweetheart deal for Laguna Beach. And he absolved Laguna Beach of any losses . . . which is something (a typical investor) wouldn’t get,” said Peer Swan, president of the Irvine Ranch Water District and treasurer of Pacific Scientific Co. “You and I would not get that deal in the market. You’d have to assume the market risk.”

But the larger pool took the bulk of the risk, because Citron promised the city and the schools that the pool would buy the securities from them at their cost regardless of prevailing interest rates, which could affect the value of the securities.

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Citron has said previously that such guarantees were possible because of his overall investment strategy of holding long-term securities to maturity, when the issuer pays face value. But other investors and experts expressed outrage at the guarantee.

“The No. 1 question on the test (to get a broker’s license) is, ‘When is it permissible to guarantee an investment?’ The bottom-line answer is, ‘Never, ever, under any circumstances,’ ” said Mann, the newsletter publisher.

“We wouldn’t do business that way,” said Los Angeles County Treasurer Larry Monteilh, who runs a similar commingled pool. “Pooled investments are exactly that, pooled. If Laguna was part of the pool, then Laguna would get part of it like everyone else--not the whole thing.”

Rising interest rates, largely blamed for Orange County’s crisis, also worsened the Laguna deals for the overall pool.

By June 15, when the first term of the special deal expired, the Federal Reserve Board had ratcheted up interest rates four times, reducing the difference between prevailing loan interest rates and the returns on the securities. So Citron bought different securities for Laguna Beach and the school district, and transferred the originals to the pool at full price.

There was some additional cost to Laguna: the city upped its ante to $1 million, and the schools also pumped in about $900,000.

In July and August, Citron bought the two Laguna agencies two more sets of securities, each time transferring the old ones to the pool. So at the time of the bankruptcy, the pool held $230 million in long-term securities--some of them the inverse floaters that were among the least valuable in the $7.4-billion pool--as a result of the special Laguna deals.

When the county’s consultants liquidated the hemorrhaging portfolio, $100 million of those securities were sold for 97 cents on the dollar, and $65 million more were sold for 85 cents on the dollar, resulting in losses of more than $12 million. Liquidation values for the other $65 million were unavailable Thursday.

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A quirk of timing put the school district on the losing end of the deal as well. Citron made fewer changes in the school’s investment, so the school district’s securities matured Dec. 15, while the city’s wrapped up in November.

Because the school district still held the securities at the time of the bankruptcy, it was the district that took the liquidation loss--a loss that ate up its entire profit for the year plus about $50,000.

“We haven’t gotten anything,” Possemato said in retrospect.

While Laguna officials viewed the deal as simple generosity, some observers say it is a classic example of Citron using his massive fund to play the hero.

“He had a real Robin Hood complex. He would take what the rich had and give it to someone who needed it,” said John Schotz of Saybrook Capital Corp., financial adviser to the pool participants during the bankruptcy.

John M.W. Moorlach, the Costa Mesa accountant who ran against Citron last spring, said, “It was an ego thing.”

“Early on in the campaign, Citron said, ‘I run this office as if it were my own money,’ and it was true. He just acted as if the whole bailiwick was his, (saying) ‘This is my little baby. Look what I can do for you,’ “Moorlach said.

* BILLS GALORE: Legislators offer a rash of bills to address the crisis. A20

* BREATHING ROOM: O.C. won’t have to set millions aside to pay bondholders. A20