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Counting Their Losses in Wealthy Orange County

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Education officials in California are picking through the rubble of Orange County's apparent financial disaster to determine whether schools there could lose millions of dollars.

Orange County, one of the wealthiest areas in the country, filed for bankruptcy protection last week as it struggled to put its fiscal house in order. The move added another layer of complexity and confusion to the county's announcement Dec. 2 that it had suffered huge investment losses.

The county's investment fund essentially serves as a bank in which the county's 27 elementary and secondary school districts deposit operating expenses.

Early indications were that all schools would remain open, and county officials issued a written statement saying that all employees will be paid.

County school officials confirmed that paychecks were being processed late last week for about 30,000 classified employees.

But in the long run, officials said, the week's events could disrupt school finances, credit, and operations. The biggest question is whether schools will get back the $1 billion they have in the fund. According to county estimates, districts with big stakes in the fund include Irvine ($105 million), Newport-Mesa ($82 million), and Saddleback Valley ($62 million).

Disaster Relief

The day after the bankruptcy filing, state and local officials were still calculating the fallout.

"I must sound like someone who has been handed the Challenger disaster and been asked to figure it out," said Maureen DiMarco, Gov. Pete Wilson's education adviser, referring to the 1986 space-shuttle explosion.

Officials were particularly concerned about several districts that had borrowed money to invest in the county's fund.

Schools are required by state law to deposit most state and federal aid with the county, officials said. But the fund had been performing so well--averaging a nearly 10 percent rate of return, some said--that a few districts took out loans to add to their ante.

The 17,500-student Newport-Mesa school district must pay off a loan worth $47 million--more than half of its $90 million budget for the year--in June, said Superintendent Mac Bernd.

The county guaranteed the principal from Newport-Mesa's investment at the time it was made and again last month, Mr. Bernd said. But he said he is worried that if the county's losses are severe, it may have to break its word.

If that happens, Mr. Bernd said, "we'll be in a huge legal wrangle."

Previous California court cases involving municipal bankruptcies suggest that the state has an obligation to keep schools open, state officials said.

If the need arises, "the school districts will probably have first call on the dollars in the state treasury," said Patrick Keegan, an assistant superintendent with the state department of education.

State officials were wrestling with the question of whether it was safe to continue funneling funds to schools through the county. Other options included sending checks directly to schools or distributing them through neighboring districts.

Amid the uncertainty, district superintendents had few answers to the questions and concerns raised by employees and by vendors who sell to the schools.

In an area where the median house value is three times the national median of $78,300, the bankruptcy has shocked many.

Risky Business?

Although state officials said analysts will comb records to determine what led to the crisis, an aggressive investment strategy got the early blame.

Using funds from public agencies as collateral, the county reportedly borrowed extensively to triple its investments and buy "derivatives"--complicated investment vehicles whose value is tied to changes in market rates and prices.

The county's derivatives were tied to interest rates, and when rates rose this year, the strategy apparently backfired. A few days before filing for bankruptcy, the county announced that the investment pool had slipped $1.5 billion, 20 percent of its original value of $7.5 billion.

State and local finance officers who have been following the Orange County crisis said derivatives are not a popular financial instrument for public-investment funds. A 1994 U.S. General Accounting Office survey of 3,400 local-government finance officials found that only 4 percent managed investment portfolios with derivatives.

Not all derivatives are risky propositions, finance experts said. Orange County might still avert serious trouble if lenders keep their money in, and lenders do not force it to sell off investments.

"If people don't panic, and keep their wits about them, there may be a way out," said Jeffrey I. Chapman, a professor of public administration at the University of Southern California.

Regardless of the outcome, Orange County schools can expect last week's events to taint their reputations in the bond market, according to James A. Connelly, the superintendent of schools in Bridgeport, Conn.

The city of Bridgeport's petition for bankruptcy in 1991 was denied, but the school district there has not been able to issue a bond since then because of poor credit ratings, Mr. Connelly said.

"The bond markets do not want to deal with counties that even talk about bankruptcy," he said. "It makes you a pariah."

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