A:

In 1994, Orange County announced that its investment pool had lost $1.6 billion. The announcement from the Southern California county seemed as unthinkable as local authorities announcing they had discovered a glacier. Not only was this the largest loss by a local government investment pool, which forced the county to file for bankruptcy, it shattered the pristine image of municipal bonds. The strange story of how the impossible became possible starts and ends with one man - Robert Citron.

As treasurer of Orange County, Robert Citron was considered to be somewhat of an investing whiz. He consistently beat neighboring investment pools by at least 2% and, as a result, a steady flow of cash came his way. Unfortunately, of the schools, cities and districts that rushed to invest with him, very few looked into how Citron was able to produce such amazing returns. In the simplest terms, Citron counted on interest rates remaining low. From this view, the difference in yield on a short-term yield and a long-term yield offered an opportunity for arbitrage, so Citron used structured notes to take advantage of this. Although this increased the risk as well as the potential profit, it was a viable strategy. However, Citron leveraged the entire portfolio to further magnify the gains. And, therein, lied the problem.

Citron did a series of reverse repurchase agreements that allowed him to use his securities as collateral for loans to buy yet more securities. Through this method, he turned the sizable $7 billion portfolio into a $20 billion dollar position. The massive leveraging amplified his gains while interest rates followed his predicted course. In February 1994, however, the Feds began to raise interest rates and Citron's amplified gains turned into amplified losses. As the rate hikes continued, the losses became too much to control. The county was forced into bankruptcy and came up with a recovery plan to float $800 million in bonds. The bankruptcy tarnished the county's image and the municipal bonds were sold at a discount to the treasury. Luckily, the issue proved to be sufficient to protect the investors, schools among them, from insolvency. Citron, however, never served prison time for his actions.

This question was answered by Andrew Beattie.

RELATED FAQS
  1. How are municipal bonds taxed?

    Discover information about trading municipal bonds, specifically the various tax implications municipal bonds have at state ... Read Answer >>
  2. What are the financial consequences of filing for bankruptcy?

    Learn about the various consequences, both positive and negative, that you can expect to result from your filing for bankruptcy. Read Answer >>
  3. What is the difference between municipal bonds and standard money market funds?

    The primary difference between municipal bonds - also known as "munis" - and money market funds is that municipal bonds are ... Read Answer >>
  4. How do I find a good personal bankruptcy lawyer?

    Read how to find a good personal bankruptcy lawyer, and learn how much you can expect to pay for services if you are considering ... Read Answer >>
  5. How can you use a debt service coverage ratio (DSCR) to evaluate municipal bonds?

    Learn how the debt service coverage ratio (DSCR) can be used by investors to analyze the risk level of revenue bonds offered ... Read Answer >>
  6. What is a triple tax-free municipal bond?

    At its core, a triple tax-free municipal bond is just like any corporate bond: it is a debt instrument, a loan given to a ... Read Answer >>
Related Articles
  1. Investing

    Nvidia Stock Falls 4.4 Percent on Jan. 3 (NVDA)

    Nvidia Corporation was the top performing stock on the S&P 500 in 2016, so why has the stock been falling from record highs over the last week of trading?
  2. Investing

    Nvidia Shares Stumble On Citron Call

    Citron Research see shares of NVDA falling to $90, as market seems to be ignoring risks to the company's business in 2017.
  3. Investing

    Mobileye Gets Slammed by Short-Sellers (DLPH, MBLY)

    Mobileye (NYSEL MBLY), a maker of collision avoidance systems for cars, was recently targeted by short-seller Citron Research. In a 13-page report, Citron claims that Mobileye's current valuations ...
  4. Investing

    Nvidia Slides Toward $100.00 Per Share (NVDA)

    Shares of Nvidia have fallen by more than 15 percent since hitting an all-time high in December. Can the stock rebound?
  5. Investing

    Year in Review: Nvidia Corporation (NVDA)

    Nvidia Corporation was the top performing stock on the S&P 500 in 2016. Here's a recap of the stock's 223 percent surge over the last 12 months.
  6. Investing

    Barclays Reiterates Hold Rating on Nvidia (NVDA)

    Nvidia Corp. stock is off 2.18 since the beginning of January. Barclays analyst Blayne Curtis set a Hold rating on the stock and expects further decline.
  7. Financial Advisor

    How to Find the Best Bets in Muni Bonds

    Approach investing in municipal bonds the same as you would investing in stocks.
  8. Investing

    Citron Research: Wayfair Is Like a Ponzi Scheme

    Citron Research cautions that e-commerce giant Wayfair's cash flow is an "illusion."
  9. Insights

    Report of Mallinckrodt Fraud Raises Eyebrows (MNK)

    Mallinckrodt shares tumbled after a short-seller accused its CEO of securities fraud. Analysts say the accusations show holes but doubts on company remain.
  10. Personal Finance

    Where Americans With the Best and Worst Credit Scores Live

    Mississippi and Georgia have a high percentage of people with poor credit scores, while North Dakota has the lowest
RELATED TERMS
  1. ABCD Counties

    Categories of U.S. counties devised by AC Nielsen Company that ...
  2. Chapter 9

    A bankruptcy proceeding that provides financially distressed ...
  3. Municipal Bond Fund

    A mutual fund that invests in municipal bonds, or "munis." Municipal ...
  4. Taxable Municipal Bond

    A fixed-income security issued by a local government such as ...
  5. Municipal Bond

    A debt security issued by a state, municipality or county to ...
  6. Recording Fee

    The fee charged by a government agency for registering or recording ...
Hot Definitions
  1. Tender Offer

    An offer to purchase some or all of shareholders' shares in a corporation. The price offered is usually at a premium to the ...
  2. Ponzi Scheme

    A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns ...
  3. Dow Jones Industrial Average - DJIA

    The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange ...
  4. Revolving Credit

    A line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is ...
  5. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
  6. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
Trading Center