Infectious Greed Read Online Free Page A

interest-rate bets. But Citron ignored all warnings, including those from prestigious Goldman Sachs, which disapproved of Citron’s risks and refused to sell him any structured notes. When Goldman criticized Citron, he responded with an angry letter, saying, “You don’t understand the type of investment strategies that we are using. I would suggest that you not seek doing business with Orange County.”
    The central problem for Merrill and other banks was not necessarily selling structured notes (as troubling as it might seem for Merrill to be selling securities with complex embedded formulas to an antediluvian client like Citron). Instead, the problem was that Merrill had played a dual role of derivatives salesman and bond underwriter. In this second role, Merrill and other banks had arranged new Orange County bond issues and sold them to the public. Unfortunately for Merrill, the public disclosures related to those bond issues did not mention Citron’s risky interest-rate bets. That meant that even if Merrill had dealt properly with Citron in selling structured notes, it arguably had violated the securities laws by failing to disclose risks associated with Orange County’s bonds.
    The other blameworthy parties were the credit-rating agencies. Just as Standard & Poor’s and Moody’s had been critical to the development of new financial instruments at First Boston and Salomon Brothers, the agencies had played a central role in the collapse of Orange County.
    First, they had given AAA ratings to the structured notes Orange County bought, even though the market risks of those notes were much greater than those of more typical AAA-rated investments. That enabled Robert Citron to fit his large interest-rate bets within the technical boundaries of Orange County’s investment guidelines, even though the structured notes he bought were riskier than any highly rated bond in existence when the guidelines were written.
    Second, both Standard and Poor’s and Moody’s gave Orange County itself their highest ratings through December 1994, when the county filed for bankruptcy. These high ratings gave confidence not only to Orange County residents, but also to investors in the county’s bonds.
Investors in many conservative bond mutual funds—including those at Franklin Advisors, Putnam Management, Alliance Capital, Dean Witter, and many others—had purchased Orange County’s bonds, precisely because of the high credit ratings. 5
    The rating agencies collected substantial fees for rating Orange County’s bonds (S&P made more than $100,000 from Orange County in 1994 alone). 6 They collected even greater fees for rating structured notes. These fees raised questions about whether the agencies had been objective in assessing Orange County’s risks. More than six months before Orange County’s bankruptcy, the agencies had learned about Citron’s losses on structured notes, but they kept this information secret, and didn’t adjust their ratings in response.
    For example, according to notes taken by a rating-agency analyst, on a telephone conference call with the rating agencies on May 9, 1994—seven months before the agencies downgraded Orange County’s debt—Matthew Raabe, Citron’s assistant treasurer, candidly discussed the county’s risks, noting “DISASTER” and “danger!” and concluding that if interest rates rose one percent, Orange County’s collateral would be “gone.” 7 At another meeting, officials from the rating agencies learned about large numbers of “inverse floaters.” 8 In addition, Raabe explained that Orange County was not “marking to market” its portfolio, meaning that it wasn’t recording changes in value over time, even as interest rates increased. 9 In other words, if Orange County had paid $20 billion for structured notes in 1993, they were still recorded as being worth $20