If any good emerges from the financial fiasco in Orange County, Calif., it may be heightened public awareness of the dangers of excessive debt.
Debt is an essential ingredient in modern life, from purchases of homes and automobiles to the use of credit cards for buying now and paying later. But the misuse of debt can be a recipe for agony at best and disaster at worst.
The principle applies in the area of investing, whether it is followed by a multibillion-dollar institution, such as Orange County, or an individual stretching for a little better return on his or her money.
The Orange County affair developed from "leveraging" -- a popular term in high finance -- an $8 billion investment fund created from taxpayers' money. The county treasurer borrowed about $12 billion to try to improve the fund's performance. The strategy worked for a while, producing higher-than-usual yields. But when interest rates turned upward and kept climbing, the risky plan backfired.
Now, the wealthy county is suffering the consequences and the fallout reaches far beyond the borders of California.
Sadly, it's not just a big West Coast county that overdid "leveraging." While its woes grew out of fancy interest-rate gimmicks dreamed up by big Wall Street firms, an untold number of individuals are on the hook in personal investments that have turned sour because of escalating costs on borrowed money.
"The virus is moving from Wall Street to Main Street," said Thomas Tew, a securities lawyer in Miami who specializes in cases involving exotic financial instruments.
"We have 30 to 40 cases in our office right now," he said, referring to arbitration or legal claims against brokerage firms.
Those cases deal mainly with collateralized mortgage obligations, which are intricate securities backed by mortgages. They are known popularly simply as CMOs.
"Private leverage in CMOs is creating havoc," said Mr. Tew, whose clients became heavily indebted to acquire some of those instruments.
Investors are complaining they were unaware of the risks when they agreed to buy CMOs.
Unlike stocks and bonds of well-established corporations, CMOs are not supported by an active trading market that would enable owners to get out quickly and with limited damage when the going gets tough. Mr. Tew thinks there are more than a billion dollars in CMOs held by wealthy individuals in South Florida.
"CMOs represent the application of the Orange County situation to the retail investment market," Mr. Tew said. "People looking for higher returns when interest rates were low were persuaded they could get better yields by investing in CMOs."
Some of those investors were done in by "margin," a word describing the practice of borrowing against the value of stocks, bonds and other securities. The term may make the strategy palatable, but it has been the undoing of many an unsuspecting buyer.
When the value of securities backing up a margin loan drops, brokers issue "margin calls," insisting the debtor come up with more money. No one is immune from them.
In the late 1970s, the super-rich Hunt brothers of Texas got margin calls after they borrowed heavily to finance an attempt to corner the market in silver. When silver prices dropped, the Hunts' inability to cover their obligations sent the stock market plunging. Horrors, thought Wall Street. Even the oil-rich Hunts can't pay their debts.
Robert Stovall, a New York money manager, had a classic explanation for the market's reaction to the Hunt affair.
"It was like that scene in the Wizard of Oz," he said. "They pulled back the curtain and there was an ordinary man standing there."
Robert Citron was the "wizard" who engineered Orange County's dive into excessive debt, seeking higher returns on an otherwise sound investment portfolio. As the elected county treasurer, he did it with the best of intentions.
Now, his reputation is sullied, he's lost his job and the risky strategy he pursued has left Orange County in bankruptcy. Like the wizard of Oz, Mr. Citron has been reduced to the status of ordinary man.
Orange County's plight, like that of the CMO investors, is an old story with a modern twist. Whether it is called margin, leverage or something else, risky borrowing is perilous.
Benjamin Franklin had a phrase for it. In his "Poor Richard's Almanack," he wrote:
"He that goes a-borrowing goes a-sorrowing."