Delanceyplace.com 7/27/09 - Derivatives

In today's excerpt - Robert L. Citron, the elected treasurer of Orange County, California, who succumbed to the aggressive overtures of Wall Street salesmen and bought inappropriately complex derivatives, resulting in the loss of $1.7 billion in 1994 that bankrupted the county and stunned the financial world:

"Robert L. Citron fit the Republican stronghold of Orange County, which travel guides have described as 'the most like the movies, the most like the stories, the most like the dream.' For Citron, the 1980s and 1990s were like a dream. He became one of the nation's best-known municipal treasurers, and his investment strategies produced consistently high yields, approaching 9 percent during the early 1990s. Citron had a reputation as a proud but stubborn man, not unlike John Wayne, for whom Orange County's airport is named, or Richard Nixon, who was born in Orange County.

"Like many of Orange County's 2.6 million residents, Citron lived in the past. He wore oversized turquoise Indian jewelry, garish neckties, polyester suits, pastel slacks, and white-patent leather shoes. He was an avid supporter of the University of Southern California, which he had attended in the 1940s. His car horn played the USC Trojan fight song, and his desk was adorned with a bronzed lump of horse manure from Traveler, USC's mascot. At treasurer's dinners Citron gathered colleagues around the piano to sing 1940s standards. He kept investment records on index cards, ledgers, and even a wall calendar. He ate lunch on the Formica tables of the Santa Ana Elks Club or Western Sizzlin'. His one nod to technology was dividing his lunch tabs to the penny on his wristwatch calculator. Citron refused to visit Wall Street and had been to New York only four times in his life. He was hard working and never took vacations, preferring to spend time with his wife in their modest ranch-style home in Santa Ana.

"The secret to understanding Citron was that, as one former Merrill salesman put it, 'he knows thirty percent of what he thinks he knows.' For example, although Citron appeared to be a faithful USC alumnus, he had failed numerous courses there and never graduated. Citron often demonstrated his ignorance in public. In one television interview he was showing off for a reporter how he used a row of color-coded telephones, each connected to a different broker. While he was saying, 'Now I'm talking to Merrill. ... Now I'm talking to Solly [Salomon Brothers],' he inadvertently bought bonds he didn't want and had to call a broker to reverse the trade. Citron was known for rambling and incomprehensible oral presentations, so much so that the county's board of supervisors eventually forced him to put his thoughts in writing - although that didn't help much. An example from a September 26, 1994, report read, 'We do not have the large inflationary wage increases, runaway building, both in homes, commercial, and those tall glass-office buildings. ... Few, if any, tall office buildings are being built.' Few, if any, Orange County employees understood Citron's concerns about tall buildings. At another point Citron seemed unable to grasp the concept of 'buy low, sell high,' and he flubbed by buying securities at the highest offered price. ...

"On Tuesday, January 17, 1995 [after the loss became known], Robert Citron and [Merrill Lynch derivatives salesman] Michael Stamenson delivered prepared statements in an all-day hearing before the California Senate Special Committee on Local Government Investments, which had subpoenaed them to testify. It was a pitiful display. Citron left his wild clothes at home, testifying in a dull gray suit and bifocals. He apologized and pleaded ignorance. He said, 'In retrospect, I wish I had more education and training in complex government securities.' Stuttering and subdued appearing to be the victim, Citron tried to excuse his whole life: He didn't serve in the military because he had asthma; he didn't graduate from USC because of financial troubles; he was an inexperienced investor who had never even owned a share of stock. It was pathetic."

Frank Partnoy, F.I.A.S.C.O., Norton, Copyright 2009, 1997 by Frank Partnoy, pp. 155-157, 165.