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. What do cities do with the funds generated from municipal bonds?

    Learn more about municipal bonds, including the various types of bonds issued and the purposes of municipal bond funds, such ... Read Answer >>
  2. 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 >>
  3. How do the returns on municipal bonds compare to those of other bonds?

    Learn how tax-free municipal bonds may provide better returns than other types of bonds, and understand the risks of municipal ... 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 >>
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

    Trader Who Called Valeant Short Predicts Nvidia Decline

    Andrew Left of Citron Research successfully shorted Valeant and other companies. Now he sees Nvidia as the latest target.
  3. 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.
  4. 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 ...
  5. 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?
  6. Financial Advisor

    How to Find the Best Bets in Muni Bonds

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

    Municipalities Free Up Cash With Chapter 9

    Find out what happens to municipalities when they need money, but have no other option than bankruptcy.
  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. Managing Wealth

    Managing Interest Rate Risk

    Learn which tools you need to manage the risk that comes with changing rates.
  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. Commodity Pool

    A private investment structure that combines investor contributions ...
Hot Definitions
  1. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  2. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  3. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  4. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  5. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
  6. Long Run

    A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all ...
Trading Center