Fong Calls for State to Direct County Finances : Bond crisis: Treasurer warns of a statewide ‘fiscal quake’ if O.C. defaults on $1 billion in debt this summer.

SANTA ANA — Leaders of a state panel Wednesday called for the state to take control of Orange County’s fiscal management as financial experts issued their sternest warnings yet that any debt default could devastate California’s markets.

“What I’m hearing from the investment community is a perceived need to have some kind of oversight from the state,” said state Treasurer Matt Fong, who is chairman of California Debt Advisory Commission. “Orange County is not just an Orange County problem. It’s a state problem.”

Fong’s comments came after the commission’s public hearing in Santa Ana on the fallout from the county’s financial crisis. After four hours of testimony from representatives of bondholders and three of the nation’s largest rating agencies, Fong issued a “fiscal earthquake warning”: that the county must move fast to avoid a default on $1 billion in county debt coming due this summer.

Fong said the commission will review demands made at the hearing that the state step in immediately, but has made no decision.

Commission members and financial experts said the unprecedented bankruptcy filing has already led to higher borrowing costs for municipalities outside Orange County.

State Sen. Lucy Killea (I-San Diego), who sits on the commission, said she is drafting legislation that would turn over the county’s financial reins to an outside authority--similar to a trustee but made up of state and local officials and approved by a vote of the people.

“I’ve just had it up to here,” Killea said during a break in Wednesday’s proceedings. “To help Orange County, I think we have to give them not just a carrot but a stick too.”

Cities and other districts with money in Orange County’s collapsed investment pool have another $1 billion coming due this summer, and Fong said uncertainty over potential defaults may come in to play as municipalities go to market to borrow in May.

“If Orange County doesn’t get its fiscal house in order, the earthquake will be felt all the way to San Diego and all the way north to Eureka,” Fong said. “Small borrowers will be closed out of the financial markets.”

After the hearing, Supervisor Marian Bergeson, who sat on Wednesday’s panel as a host member, said that there was no reason for the county Board of Supervisors to relinquish its control of finances.

The board hired William J. Popejoy, former chief executive officer of American Savings & Loan, 10 days ago as the county’s interim chief executive officer and granted him broad authority which Bergeson said will help speed recovery.

“I think locally, we have the ability, with the leadership we now have,” she said. “All the elements of a plan are now coming forward.”

Supervisor William G. Steiner also said that state intervention is unnecessary. The county can move quickly to resolve the crisis with legislative help, instead of finger pointing, he said.

“I think the Legislature has enough of its own problems without picking up Orange County’s fully,” Steiner said. “They’ve not been exactly the most fiscally responsible body over the last few years.”

Steiner said he agrees with grim assessments that any further delay will send shock waves through the state’s financial markets. “That should be a powerful incentive for the Legislature to go beyond rhetoric to assisting us with our legislative package, including the establishment of the intercept mechanism,” he said.

Bergeson said she is committed to ensuring that the county does not default on debt payments due this summer, but Fong said that words fall short of action.

“They’re not looking for the words. They need to see a credible plan,” he said of the county’s bondholders. “A plan that says where the money is going to come from and how it is going to be set aside. . . . I believe this has to happen as soon as possible.”

Fong said Wednesday’s hearing “reaffirmed my gut belief that we are paying--at all levels of the state--an Orange County premium to do business in the state.”

Fong said the higher costs for borrowing that all California government issuers of bonds will have to pay for Orange County’s mistakes could total $200 million annually, translating into fewer tax dollars available for public services.

Popejoy said Wednesday that a plan outlining how the county can meet its fiscal obligations--both to bondholders and in its own budget--is well in the works. He would not divulge details other than to say that new taxes are “not on the plate.”

“I believe the people of California will see some strong action--not words but action--in two weeks,” he said. “That will show that a plan is firmly in gear.”

Many Wall Street analysts say Fong’s warnings about statewide fallout from the county’s bankruptcy are more of an attempt to jawbone county officials than a reflection of the true fallout that might be expected from an Orange County default.

Dozens of California municipalities have been able to issue bonds over the past two months, and without paying significantly higher interest rates than they would have otherwise, analysts say.

And the state itself Wednesday easily auctioned $400 million in general obligation bonds with maturities between one and 30 years. “Outside of Orange County, the bidding for California bonds is as strong as it ever was,” said one municipal bond trader in New York.

In part, the state and its municipalities are benefiting from the overall decline in market interest rates this year, reflecting investors’ perceptions that the national economy is slowing. As rates fall, more investors clamor to buy bonds, hoping to lock in yields before they slide further.

However, panel members and those who testified Wednesday showed a clear frustration with the county’s efforts to allay bondholder fears since the county posted a $1.69-billion loss to its investment pool and filed for bankruptcy Dec. 6.

“I’ve never seen so much finger-pointing and abdication of responsibility,” Killea said. “I wouldn’t be so concerned if I didn’t think their failure could have an effect on the rest of the state.”

Killea said it remained unclear whether an outside authority could be set up fast enough to deal with impending summer debt obligations, but she envisioned it taking over for supervisors for “three or four years.”

“We can’t just go the same old way,” she said.

The commission heard testimony from bondholder representatives who warned that if the county defaults on debt payments due this summer, municipalities throughout the state may have great trouble accessing the markets.

“Even if everyone is made whole and paid 100 cents on the dollar, I believe all California issues of short-term notes will pay a price for years to come,” said Steve Permut, senior portfolio manager and manager of municipal research for Benham Capital.

“If Orange County defaults on its short-term notes this summer, California cities, school districts and municipalities may be unable to access capital markets.”

Already, investors outside of California are backing away from state bonds, said Tom Kenny, senior vice president and director of the municipal bond department for Franklin Advisers.

“Those investment decision makers sitting in Boston and Chicago read the papers and so do their bosses,” he said. “When they see reports that Orange County may default on its debt and that the state is doing nothing to help, they simply decide not to buy California paper.

“It is clear that California and its municipalities will pay higher interest rates in the upcoming note season, if they can access the markets at all.”

Rating agency representatives stressed the need for greater disclosure of financial information, and also called for the state to play a significant role in steering recovery, particularly taking charge of any intercept fund from which bondholders would be repaid.

“It’s clear that the county has a way to go to re-establish its credibility,” Jane Eddy, the Western region director of Standard & Poor’s, told the panel. “Any state involvement in an intercept fund would be viewed positively.”

Times staff writer Tom Petruno contributed to this report

* D.C. INSOLVENT: A federal takeover of the capital’s finances is seen. A3