Lawsuit Exposes Orange County Financial Crisis

The ballooning Orange County financial crisis continued its downward spiral as the State of California filed a lawsuit to force return of $73.5 million of property tax revenue the County skimmed from local schools and community colleges last November. It seemed bizarre at the time that the supposed “Most Conservative County in America” would increase spending by $145.8 million, then grab the school’s cash and cancel planned layoffs of 490 union workers.

The new lawsuit has caused increased scrutiny of other dicey actions by the County. The biggest shock came from the recently released Orange County 2010-11 Audited Financial Report, which discloses the County is short $30,146,000 in Reserves and out of accounting compliance:

“The County General Fund maintains a Reserve for Contingencies which was established through the Strategic Financial Plan (SFP) process. The target amount for this reserve is 15% of ongoing annual general purpose revenues (excludes fund balance available and one-time amounts and transfers), or $91,446. This compares to the Government Finance Officers Association (GFOA) guidelines for funding contingencies at 15% or higher. The June 30, 2011 balance is $61,300, approximately $30,146 below the revised target”

The Reserves would have been even more out of compliance, if the County had not skimmed cash from unspent budget savings by the former County Treasurer and other Departments to plug the depleted County Reserves. According to the Orange County Executive Office’s County of Orange FY 2011-12 Proposed Budget Key Budget Massage:

The County increased General Fund Reserves by $17.2 million. The increase was primarily associated with the transfer of reserves of unallocated Fund Balance Available (FBA).

This appears to demonstrate that the County knew the underspent budget dollars they were skimming from the Treasurer and the accounts, generally belonged to the schools as the Treasurer’s largest client.

I also learned that the Orange County Employee’s Retirement System last July delayed lowering by ¼% to ¾% their annual expected rate of return assumption until this July 2012, conveniently after the June elections. Given each ¼% reduction in expected return increases pension liabilities by $750 million; the current $3.75 billion unfunded pension liability is soon slated to skyrocket to an outrageous $4.5 to $6 billion unfunded liability.

The lawsuit against the County was filed by California Department of Finance, and the State Associations of Community Colleges joined in filing their suit in Orange County Superior Court, across the street from the County. The suit alleges that the county has taken “the extraordinary step of flouting the law and illegally redirecting property tax revenue payments from schools and community colleges to the county’s own general fund.” The state wants the court to order the county to pay property taxes directly to the schools.

According to the Sacramento Bee, Orange County spokesman Howard Sutter tried to seem puzzled that the State would try to help schools recover their $73.5 million of tax revenue. The real issue in the litigation is that the State took away some favored subsidies for Orange County, and the County retaliated by taking school money hostage to force the State to revive the subsidy:

While the county has been proactive in discussing this issue with legislators and school officials, the Department of Finance and Attorney General’s office have made no contact with the county regarding this matter. The county is disappointed the state has now resorted to filing a lawsuit. We are evaluating the merits of their suit and cannot comment on its specifics at this time until we have had time to completely review their claims.”

For the last six months Orange County has used the schools and community college’s cash to bolster their sliding cash and reserves. The local schools have tried to avoid the ruinous cost of litigation by accepting a guarantee from the County that at some point in the future, the County would lend the schools money at no interest cost. But with the State and the Community Colleges both suing the County, there is a high probability that the Court is going to require the $73.5 million to be escrowed with an independent trust company.

Orange County’s payroll is $65 million every two weeks. The loss of the schools’ money, higher pension costs and restrictions against skimming County accounts are real risks to cash flow for the County of Orange. Litigation will eventually require document discovery and depositions. It will be fascinating to see how Orange County tries to spin their precarious financial position.