Orange County's $1.6B derivatives bankruptcy — the treasurer who bet on interest rates

Robert Citron was the treasurer-tax collector of Orange County, California, for 24 years, from 1970 to 1994. He managed an $8 billion investment pool on behalf of the county and 200 local government agencies. Citron was a political fixture — he was never seriously challenged for reelection because he consistently delivered above-market returns without raising taxes, and the county supervisors and local agencies trusted him completely.

Citron's strategy was to borrow money through reverse repurchase agreements and invest the proceeds in inverse floaters and other derivatives that paid off when interest rates fell. He leveraged the county pool to between 158% and 292% of its value. For years, the strategy worked — interest rates fell through the late 1980s and early 1990s, and Citron's leveraged bets produced handsome returns. The portfolio grew to $20 billion in notional value. At the first sign of trouble, Citron began relying on a mail-order astrologer and a psychic for interest rate predictions.

In 1994, the Federal Reserve raised rates six times, from 3% to 5.5%. Citron's leveraged inverse floaters collapsed. Credit Suisse First Boston demanded collateral and blocked rolling over $1.25 billion in repos. Orange County had no cash. On December 6, 1994, the county filed for Chapter 9 bankruptcy — the largest municipal bankruptcy in US history. The loss was $1.64 billion. Citron pleaded guilty to six felony counts and was sentenced to one year of work release. 3,000 county employees were laid off.