Lessons from the Orange County Bankruptcy
J. OF DERIVATIVES, Summer 1997
Posted: 9 Oct 1997
On December 6, 1994, Orange County became the largest municipality ever to file for bankruptcy. This dramatic action was prompted by a loss of $1.64 billion on the Orange County Investment Pool that became "realized" as the pool was liquidated.This study provides an update to the Orange County situation and discusses whether the bankruptcy and liquidation were necessary. The bankruptcy decision seems to be justified by the fact that the county was facing liabilities far in excess of its assets. Indeed, the bankruptcy court has ruled that the county's petition was entirely appropriate as it was insolvent at the time of the filing. The liquidation decision, however, involved a substantial opportunity loss, as the subsequent drop in interest rates would have led to a recovery of the portfolio.Whether liquidation was appropriate cannot be judged by the path of interest rates after the fact. The article illustrates how the value at risk methodology could have been used to estimate the risks of the portfolio prior to the facts. By December 1994, there was an estimated 5% probability that the portfolio would suffer a further loss of $1.1 billion or more over the following year.
JEL Classification: G33, G1, H74
Suggested Citation: Suggested Citation