A critical examination of the US economy: the Orange County bankruptcy case

Abstract

Fiscal irresponsibility and abuses in the proper use of derivatives resulted in the largest municipal failure in US history (at the time). Orange County's fiscal stress and its resulting bankruptcy were attributed to massive financial mismanagement by the county's treasurer, and his actions caused the loss of $1.6 billion. This being said, the 1994 bankruptcy of Orange County, California was caused by a variety of additional factors. This paper provides an analysis of the bankruptcy and explores the role of Robert Citron, the county's treasurer, as well as the influence of derivatives, the presence of political pressures, and the inadequacy of accounting reporting standards and regulatory organisations. Additionally, an analysis of the contemporary misuse of financial derivatives that helped spark the 2008 global financial crisis is also presented. An overview of the role of derivatives in the 2008 crisis is included to further highlight the disastrous consequences of their misuse. Areas of emphasis include the unregulated over-the-counter (OTC) derivative market and the lack of any informative reporting standards for such instruments. The paper concludes with a review of current accounting standards regarding derivatives, namely the Dodd-Frank Act of 2010.