BY David J. Lynch

        NEWPORT BEACH, Calif. - County Clerk Gary Granville was worried. In the five days since Orange County disclosed a multibillion-dollar investment loss, he'd been trying unsuccessfully to reach his friend Bob Citron, the county treasurer.
        On Monday morning, Dec. 5, as Granville was leaving another message on Citron's answering machine at home, Citron picked up the receiver.
        How are you? Granville asked.
        "Just fair," Citron replied in a shaky voice. "Just fair."
        Citron had resigned 24 hours earlier and Granville was afraid of what he might do. The treasurer's job had been his life for 24 years.
        Granville tried to bolster Citron, saying he regarded him as a friend. At that, the man once hailed as a financial genius broke down. Sobbing, unable to speak, Citron hung up.
        In the wake of Orange County's Dec. 6 filing for bankruptcy protection, residents have engaged in a predictable cycle of buck-passing and finger-pointing. Most of the fingers have pointed straight at Robert L. Citron.
        But if one's man hubris fueled this crisis, the kindling that turned his flaw into a county's tragedy lies elsewhere: voters' fierce anti-tax sentiment; public clamor for services; and an outmoded county government.
        This is the story of how the nation's fifth-largest county - and one of its richest - lost more than $2 billion of taxpayer money. And why, as a result, officials in thousands of government offices across the country have begun to worry: Are we next?

`The Wizard'
        Citron, 69, is an unlikely star of this or any drama. By all accounts devoted to his work, he is described by colleagues as quiet, serious and loyal. They say he worked tirelessly, rarely taking vacations. His outside interests appear to have been limited to University of Southern California alumni events, lunches at the Santa Ana Elks Lodge and collecting W.C. Fields memorabilia. He and his wife of 39 years have no children.
        Through his lawyer, Citron declined to be interviewed for this story.
        A career government employee, Citron was hired in 1960 as deputy tax collector. He was elected treasurer in 1970 and became treasurer-tax collector when the posts were combined in 1973.
        Citron was the sole elected Democrat in Republican Orange County. He maintained a low profile. To many in the county Hall of Administration, he was best known for the annual Christmas party at his Santa Ana home, which was well-attended by local officials.
        Still, there were hints he craved attention. A quiet man, he favored loud clothes. One Easter he was decked out in a sky-blue blazer, bright yellow slacks and pink tie. Though in recent years he adopted a more conservative style, he still wore the large turquoise jewelry that was his trademark.
        During presentations to the board of supervisors, Citron tended to "toot his own horn," recalls Christine Smith, a board secretary. Former county Democratic Party Chairman Richard O'Neill says Citron "wanted to be a player, but didn't know how."
        He fervently supported USC, where he took graduate business courses but did not receive a degree. The horn on his Chrysler sedan sounds the school fight song. At one memorable alumni function at Citron's home, USC's equine mascot, Traveler, put in an appearance. The county treasurer stood nearby wearing a USC Trojans' helmet and breastplate.

Right place, right time
        Orange County in the 1980s and early '90s was the right place for a man of Citron's abilities. And amid a crisis in local government finance, he became something of a hero to cities and government agencies.
        Beginning in 1978, Proposition 13 limited  property taxes and required a two-thirds popular vote for tax increases. At the same time, a booming economy was attracting tens of thousands of new residents each year, all of whom required public services.
        Those interests often clashed, as they did in March 1990: A proposed bond offering in Irvine to build schools won 62% of the vote - yet failed because of the two-thirds requirement. More recently, local governments faced additional pressures: California's 1990-93 recession depressed tax receipts while the state siphoned an increasing share of local revenues to ease its budget crunch.
        As Orange County grew, residents' anti-tax fervor collided with their demand for roads, libraries and schools. Raising taxes remained political suicide as Fullerton city officials found. Voters there recalled the mayor and two city council members after the officials approved a 2% utility tax in 1993.
        Likewise, throughout the 1980s, polls consistently showed traffic congestion to be among county residents' top concerns. Yet it took three tries and eight years before voters approved a penny-per-dollar sales tax increase to pay for improvements. "It boxed in political leaders (who) have to address residents' expectations for first-class municipal services with a wizened tax base. That led them to higher-risk investment strategies," says Spencer Olin, co-author of a 1991 history of Orange County called Postsuburban California.
        Against this backdrop, Citron appeared a savior. Each year for more than a decade, he saved Orange County from a budget crunch by producing unexpected interest income. The cash helped save popular programs, such as an anti-gang initiative, without higher taxes.
        "They all thought of him as the wizard," says Ralph Clark, a Democrat who left the board in 1986. "It was an expected thing at budget time to hear that there was extra money."
        The past two years, reliance on budgeted interest income deepened. From $37 million in fiscal 1992-93, investment earnings were slated to grow to $164 million in 1994-95.
        As treasurer, Citron invested on behalf of the county and 186 cities, school districts and municipal agencies. The funds that flowed into his investment pool included tax receipts and the proceeds of public bond offerings. Some of his investors - notably many school districts - were required by law to invest in the county pool. Others were drawn by Citron's performance. Yet, as an investor, Citron seemed to have just one idea: Borrow at low, short-term interest rates and invest at higher, longer-term rates. And using the $7.4 billion county fund as collateral, Citron borrowed billions from brokerage houses until he had assembled an astounding $20 billion portfolio.
        Much of that was invested in some of Wall Street's most exotic securities, high-octane investments called "derivatives." In the sedate world of municipal finance, Citron's approach seemed risky and controversial.
        But while interest rates were stable or declining, the strategy made money. Year after year, Citron outperformed the state investment fund. In 1993, for example, the county investment pool returned 8.5% vs. the state's 4.7%.

A cloudy crystal ball
        Citron made no attempt to disguise his strategy. In a 1988 interview with the Los Angeles Times, he spoke of using reverse repurchase agreements to boost yield. His 1993 report to county supervisors specified his reliance on borrowing and on derivatives. "It was not top secret," says Tony Andrade, controller for the city of Garden Grove.
        It hardly seemed to matter. Citron was popular, if viewed as mildly eccentric. Earlier this year, the Democrat was endorsed for re-election by all five Republican supervisors. Board Chairman Thomas  Riley, 82, acknowledged he didn't understand the treasurer's investments but praised him as a "genius."
        Friends say Citron grew addicted to the adulation. And with pride came arrogance. Taxpayers were required to make their property tax checks payable to "Robert L. `Bob' Citron" rather than to "Orange County Treasurer." The treasurer engaged in a series of minor spats with other county officials, including the county's powerful sheriff. His annual reports to the county supervisors smacked of self-congratulation.
        "We will have level if not lower interest rates through this decade," Citron predicted in September 1993. "Certainly there is nothing on the horizon that would indicate that we will have rising interest rates for a minimum of three years. We believe that our comparative higher interest earning rate yields over the next three fiscal years is insured."
        With interest rates at 20-year lows, his strategy of borrowing short and investing long had been tremendously profitable. But within weeks, interest rates began edging up.

`Death spiral'
        Five weeks into 1994, John Moorlach, a tall, bearded accountant from Costa Mesa, announced he would oppose Citron for the treasurer's job. Just three days earlier, the Federal Reserve had raised short-term interest rates for the first time since 1989. Moorlach warned that rising rates made Citron's heavy borrowing and derivatives dangerous.
        At first, Citron brushed aside the criticism, citing his impressive record and the endorsements from county supervisors. Credit-rating agencies gave the county top marks. The Los Angeles Times editorialized in his favor.
        But as Moorlach sharpened his critique, Citron's tone changed. The incumbent had never been particularly tolerant of criticism. Now he complained of character attacks and questioned his foe's motives. "Both Bob and his wife took it very personally," Granville says. "They were just beside themselves."
        Among Citron's investors, the first stirrings of doubt appeared. In March, the administrator of the county's public employee retirement system questioned Citron about a trade press report that warned higher interest rates meant a "death spiral" for the county fund.
        Citron responded March 9: "The recent increase in rates was not a surprise to us; we expected it and were prepared for it." Further Fed tightening was likely, he added, but any run-up in interest rates would be short-lived.
        That same month, Peer Swan, head of the Irvine Ranch Water District, which had invested $301 million with the county, reviewed Citron's portfolio. Swan concluded that the fund could weather a 3 percentage point rise in interest rates. Beyond that, he believed, it would steadily lose money.

They were warned
        For Citron, it was an unsettling spring. After two decades as the county's financial wizard, Citron now faced a three-front war: Moorlach, nervous investors, and the financial markets.
        In April, the city of Tustin withdrew $4 million from the county pool. The withdrawal was a sliver of the $7.4 billion fund. But Citron reacted as if he had been betrayed. He labeled the withdrawal a political plot hatched by Moorlach, Jeff Thomas, a Tustin councilman and Moorlach supporter, and Chriss Street, an investment banker.
        The license plates on Moorlach's butterscotch-colored Bricklin sports car read "DULL CPA." The voluble accountant is anything but. And after 20 years in which Citron was unchallenged, Moorlach's aggressiveness prompted some to defend the treasurer.
        Likewise, the tactics and motives of Moorlach's allies seemed suspect. Street had taken his concerns about Citron's strategy to credit-rating agencies and financial reporters in New York. Thomas sought to convince one investor in Orange County's pool to switch its money to the investment company where Thomas worked. "At the time, it looked very bad," Thomas concedes.
        Citron accused Moorlach and his supporters of undermining the county's credit rating, which would cost taxpayers more in borrowing costs. Moorlach's arguments were dismissed as political rhetoric. And questions faded.
        Still, the usually invisible treasurer's race received substantial attention through the spring. Allegations that Citron's investments would be dissolved by rising interest rates were aired in both the Los Angeles Times and The Orange County Register. On May 31, Moorlach released a public letter to the supervisors.
        "The portfolio is a major bull market bet in the middle of a bear market," he wrote. "If interest rates continue to rise we may incur major financial losses in Orange County."
        In June, Citron was re-elected with 61% of the vote.

No action
        Privately, some county officials were concerned. In May, Supervisor Gaddi Vasquez approached Granville - Citron's friend and the county clerk. Granville, 65, had declined to endorse Citron for re-election. Vasquez wanted to know why.
        "In my heart of hearts, I knew all was not well . . . I wasn't as candid and open with Gaddi as I should have been," he says now. ". . . I didn't want to get involved in a controversy and be disloyal to Bob."
        Still, the supervisors had evidence of problems. A 1991 audit by the county's auditor-controller criticized "careless errors that could affect financial decisions" and said Citron executed investment decisions "without anyone else involved to provide segregation of duties or oversight."
        When the auditors questioned violations of the county's investment guidelines, Citron said "the instances were conscious decisions made to maximize returns." The county portfolio contained a number of securities - low-rated Chrysler  debt and two-year notes issued by a foreign company - that were prohibited by government codes.
        The report, covering the fiscal year that ended Dec. 31, 1991, wasn't forwarded to the supervisors until August 1993, a delay that remains unexplained. Auditor Steven  Lewis has declined comment.
        When supervisors finally received the report, nothing was done.

Changing times
        In four decades, Orange County has evolved from a quiet preserve where orange trees outnumbered residents to a community of 2.5 million. It boasts an $80-billion-a-year economy fueled by international trade and services. County government, however, remains a vestige of the past.
        "Twenty years ago, we were little agrarian, country bumpkins," says Supervisor Harriet Wieder. "In some ways, we haven't come very far."
        Between 1970 and 1990, the population jumped 64%. Corporations such as Rockwell International, Western Digital and Fluor supplanted land owners and entrepreneurs such as hamburger king Carl Karcher on the economic stage.
        Yet, even as the economy advanced, government seemed to stand still. The five supervisors - the county's highest elected officials - preside over a creaky administrative structure that co-exists with 31 municipal governments. In recent years, elected officials have left major decisions to taxpayers acting through the initiative process.
        In a May poll, 56% of residents were unable to name a single county $2.3 billion annual budget - almost seven times the fiscal 1974-75 figure.
        Republican domination has left county politics noncompetitive. None of the five board members faced a serious opponent in the last election. Several were first appointed by the governor.
        "Most of them have been in office a long time and haven't been accountable to anyone," says independent pollster Mark Baldassare.
        With no fear of political challenge, supervisors have little incentive to take on difficult problems. In the aftermath of this crisis, they have shown even less inclination to accept responsibility.
        "This was a man who'd demonstrated 20 years of extraordinary success that allowed us to do things that made Orange County a better place to live," Riley says. "When you've had that kind of success, why would you want to change?"

Asleep at the wheel
        By Labor Day, Peer Swan, 50, president of the Irvine Ranch Water District, was increasingly anxious. Interest rates were rising and he was having trouble getting details of Citron's portfolio. When he finally did, he was shocked.
        Citron had led water district officials to believe he'd begun reducing his borrowing. In fact, he was borrowing more money in a desperate bid to recoup his losses.
        In mid-October, Swan met with Citron in the treasurer's office. It was their first face-to-face meeting. Swan wasn't reassured. There was no sign of the sophisticated computer software needed to evaluate the derivatives Citron had purchased. And the treasurer seemed remarkably sanguine. "He thought interest rates were close to the top and he would be fine," Swan recalls.
        The water district's assessment was more dire. Swan estimated Citron was sitting on a $1.6 billion loss. Swan suggested hiring a professional money manager.  As the meeting broke up, it was clear Citron and one of his leading investors remained far apart.
        It wasn't until Thursday, Nov. 10, that supervisors were alerted to problems with the county fund. Ernie Schneider, the county's chief administrative officer, led a handful of senior officials in briefing the county's elected leaders.
        Moving between the five supervisor offices clustered on the fifth floor of the Hall of Administration, Schneider and Citron played down the situation.
        "We've got a little liquidity problem with the fund," Schneider told one supervisor.
        Citron, who had been sitting silently, added: "It's fixable."
        By Nov. 22, when Schneider briefed Swan, the situation had deteriorated. A significant loss seemed unavoidable. The fund's cash holdings were just $470 million - not the $1.2 billion Citron claimed.
        The county would hold a press conference at the end of the next week. When Swan pressed for details, Schneider said: "I don't feel comfortable telling you what we found."
        Twenty-four hours later, Swan faxed a letter to Citron withdrawing the water district's $301 million. But under fund rules, it would take 30 days for the request to be processed.
        On Nov. 29, the fund's 11 largest investors were told of the problems. And other county officials were aware Citron was in trouble. Granville tried three times on Nov. 30 to reach the embattled treasurer. His messages went unanswered.
        On Dec. 1, a subdued Citron and Matthew Raabe, the assistant treasurer, told reporters at a county press conference that the fund faced a $1.5 billion "paper" loss.
        Over the weekend, the crisis intensified. On Dec. 4, Supervisor William Steiner, at Anaheim Stadium for a Los Angeles Rams football game, was paged on his cellular phone. Investigators from the Securities and Exchange Commission were in Citron's office. Steiner was told the SEC might freeze the fund and appoint former California Gov. George Deukmejian as receiver. "Things were going off the cliff," he said.
        Later that day, Citron resigned.
        Forty-eight hours later, Orange County announced it was filing for protection from its creditors under Chapter 9 of the bankruptcy code.
        Today, the county's loss is pegged at a minimum of $2 billion. The SEC and federal and state lawmakers are investigating. Merrill Lynch is being criticized for selling Citron high-risk securities. And municipalities nationwide face higher borrowing costs.
        Citron remains in seclusion. On a recent weekday morning, his wife answered the front door and referred questions to a lawyer.
        "He was a victim of his personality," says Shirley Grindle, a community activist who knows the ex-treasurer. "He will forever be known as the guy who brought Orange County into bankruptcy."

The fallout Orange County's investment pool has suffered at least $2 billion in losses.

Local governments across the country face higher borrowing costs.

Millions of investors worry about the safety of their municipal bond holdings.

Some of Wall Street's biggest names are under attack for selling high-risk securities to Orange County.

Investigations by the SEC and state regulators likely will stretch for months.

How this story was developed
        The Orange County, Calif., fiasco is the biggest financial story of the year. A local story when it broke, it quickly became a national one. Seventeen days after Orange County filed for banruptcy court protection, every municipality that borrows money has been affected. To help USA TODAY readers understand what happened and why, Money reporter David J. Lynch went to Orange County to talk to people involved. The past two weeks, he interviewed 35 current or former county officials and other people close to the story. Lynch also examined county budgets, campaign fiance records and other documents to piece together the story behind the story.