Infectious Greed Read Online Free

highly rated entities, such as the Federal Home Loan Bank (as Orange County’s guidelines required). On paper, they looked like very safe, AAA-rated investments.
    But the structured notes contained formulas that essentially were a big bet on interest rates remaining low. For example, one $100 million note paid a coupon of 10 percent minus LIBOR, the short-term interest-rate index. So if LIBOR were 3 percent, Orange County would receive a 7 percent coupon. As interest rates rose, Orange County’s coupon went down, and vice versa. By buying these inverse floaters, Citron effectively was borrowing at short-term rates and investing at longer-term rates. Most of the notes were based on U.S. rates, but Citron also bet that European rates would remain low; he even purchased $1.8 billion of structured notes tied to Swiss LIBOR. 3
    Citron quickly came to believe that $7.4 billion was not a big-enough
bet, so he borrowed as much as he could—about $13 billion—from various banks, including Merrill Lynch. He invested that money in structured notes, too. In all, by early 1994, Citron had made a $20 billion bet on low short-term rates.
    In many ways, Robert Citron was simply a big, public version of Jim Johnsen of Gibson Greetings, the company that had unknowingly paid more than $10 million in fees for the interest-rate bets it bought from Bankers Trust. Like Johnsen, Citron wanted to gamble on interest rates, but was constrained by investment guidelines that permitted only highly rated, short-maturity bonds. Like Johnsen, Citron did not understand how to evaluate the derivatives embedded in structured notes, and he paid more for them than he should have, especially because he frequently didn’t bother to shop around. That made Citron an extremely valuable client to Merrill Lynch. From 1990 to 1993, Merrill Lynch earned profits of $3.1 billion, more than it had earned during its 18-year history as a public company, and a big chunk of the profits—about $100 million—came from Orange County. 4 Merrill earned $62.4 million from Orange County in 1993 and 1994 alone.
    Thus placed in its proper context, the story of Orange County’s losses was simple, and all too familiar. Citron used structured derivatives to bet on low interest rates, just as Gibson Greetings had, and he lost his bets when the Federal Reserve raised rates on February 4. The only difference between Orange County and Gibson Greetings was the size of the bet: millions of dollars for Jim Johnsen, billions for Citron.
    Who was to blame for the losses? Obviously, Citron was at the top of the list. He made all the decisions and hid all the risks. On January 17, 1995, he told a special committee of the California State Senate, “I was an inexperienced investor. In retrospect, it is clear that I followed the wrong course. I will carry that burden the rest of my life.”
    Many public accounts also blamed Merrill Lynch. Michael Stamenson, the top salesman in Merrill’s San Francisco office, didn’t help Merrill’s media relations when he publicly praised Citron’s investment acumen. No one thought Stamenson genuinely believed, as he testified, that “Mr. Citron is a highly sophisticated, experienced, and knowledgeable investor. I learned a lot from him.”
    But while Stamenson may have engineered Citron’s gambling, the structured notes Merrill sold to Orange County were no different from tens of billions of dollars of similar instruments sold by numerous banks to numerous investors. To the extent there were problems with structured
notes, they weren’t specific to Merrill; they were endemic to the financial system. If Merrill was to blame for Orange County, then all of Wall Street was to blame for billions of dollars of losses in 1994.
    In fact, Merrill seemed less culpable than other banks, especially Bankers Trust. Merrill had warned Citron on at least eight occasions, from 1992 to 1994, to reconsider his risky