Banks could slap Gardena this week with hefty penalties for failing to pay $25.6 million in debt. Most of the long-overdue bill, equal to more than three-fourths of the annual municipal budget, dates to a decision a dozen years ago that many see as reckless: Despite repeated warnings of the financial risk, local officials pushed their city into the insurance business.

The unprecedented for-profit company they founded, Municipal Mutual Insurance Co., is now under state supervision. To stay afloat, city officials have considered declaring bankruptcy, raising taxes or even closing a city department.

Gardena is suffering. Gift-shop owner Carol Luna sees a city in decline and is thinking of moving away. City officials "spend their money foolishly," she said.

The Associated Press, seeking to account for how things went so wrong in Gardena, found a trail of no-bid contracts and other special deals, government doublespeak, and warnings unheeded that show how vulnerable any town can be to unchecked officials who gamble with the public's money and trust.

A few people did well as the insurance venture bled cash, according to the AP investigation, which was based in part on documents obtained through open-records requests. Consultants and financial specialists earned millions and the former city manager spent lavishly on four-star hotels and travel.

How could this happen in Gardena, whose name evokes its simpler past as a center for berry growing? Home to 60,000, it's ethnically diverse, blue collar and six square miles small - a place where lunch lines get long at Giuliano's deli, kids splash in the municipal pool and homeowners expect potholes to be fixed.

Now, however, there is scant money to repair streets and sewer lines. The municipal pool is part of the public property backing bonds that bankrolled the insurance venture. Some officials doubt that the pool - or parkland, or the police station - will be handed over to creditors.

The financial outlook is bleak. In a city with a tight budget, the possible higher interest payments to banks are "not likely to be sustainable," according to Standard & Poor's, the Wall Street rating service. And a recent survey of the credit strength of California cities already placed Gardena alone at the bottom.

It's unclear whether the banks - Japanese-owned Sumitomo Trust & Banking Co., which has most of the debt, and Union Bank of California - will go to court to attempt to extract the higher payments, which a city official said could cost an extra $1 million a year. Officials at both banks declined comment; negotiations with the city are continuing.

Gardena seems an unlikely launching pad for an insurance industry revolution. No government in America had ever tried to become State Farm or Allstate.

Across the nation, municipal entities have defaulted in recent years on bonds issued to support other atypical ventures, such as golf courses and marinas, according to a study by Fitch Ratings. And neighboring Orange County suffered default following losses in a high-risk investment pool.

But Gardena officials became persuaded that a homegrown insurance company could provide coverage for Gardena while earning millions of dollars through policies sold to other cities.

The business the city founded in 1993 was supposed to turn government investments into profit - but people connected with Municipal Mutual describe it as the little company that couldn't.

Weeks before Gardena was scheduled to borrow $15 million on the bond market, a financing team led by Prudential Securities walked out on the deal.

The problem: The city didn't have any commitments - beyond Gardena itself - to buy the insurance it wanted to sell. If it didn't sell policies, the company couldn't repay the bonds.

It was "clearly a risky program and it caused (Prudential) not to want to proceed," said David N. Lund, a former Prudential director who worked on the financing.

Yet Prudential's findings were not detailed in City Council minutes, which described Prudential's sudden exit simply as a "business decision."

The city then rewrote its own rules to pay another underwriter $500,000 - nearly 70 percent higher than the previously estimated fee, according to records obtained by AP. Without the change in city law, the size of the payment would have been impermissible.

The new underwriter, John C. Fitzgerald, would enjoy a profitable relationship with Gardena. He not only handled the financing for the insurance company, he was hired with a second, no-bid contract for the bond sale for a home-loan program that failed and left the city with $6 million in debt.

Over a five-year stretch, city records show, Fitzgerald's firm earned more than $2 million in fees from Gardena, including $1.1 million tied to the insurance company.

State records show Municipal Mutual lost $900,000 in 1994, its first full year, and $688,000 in 1995. But Fitzgerald counseled that refinancing the company's initial $15 million debt, this time for $20.8 million, would increase long-term borrowing costs but give the company "more time to get on its feet" and give Gardena "breathing room."

Current City Manager Mitchell Lansdell, who was an assistant city manager at the time, described Fitzgerald's proposal this way: " ‘I can save the day. (It will) just cost you money.' " He and other city officials compared the refinancing plan to using one credit card to pay off another.

In a telephone interview, Fitzgerald said his fees reflected "normal market conditions" at the time. If there is fault, he said, it rests with those who managed the insurance company and home-loan program, not the company that provided the financing.

"It's unfortunate, but I just don't know anything about the management of the programs," Fitzgerald said. As for the insurance company, "We just acted as the financing conduit. We didn't come up with the idea."

When Municipal Mutual was licensed for business in the fall of 1993, City Councilman and local political power Mas Fukai declared it was "cause for celebration." But financial documents prepared for the bond sale provided a chilling appraisal - an assessment of "a high degree of investment risk" conspicuously omitted from public proclamations.

"There is no assurance that insurance policies offered by the company will be salable," the documents stated presciently. "No assurance can be given ... that the company will be able to make payments for the benefit of the city."

Crucial business calculations the city used to justify its investment turned out to be flat wrong. Instead of fulfilling projections of $50 million in business within a few years, with profits climbing above $1 million, the company lost money from day one.

Gardena relied mostly on data compiled with the help of outside advisers, some of whose employees would later work at Municipal Mutual. In time, a company designed to run without full-time employees had a $500,000 payroll along with 401(k) retirement benefits for workers.

Randall Doerschel was one of those who tried to warn the city. With a group of alarmed businesspeople, the soft-spoken insurance salesman confronted then-City Manager Kenneth Landau.

" ‘You really are opening a can a worms that could harm the city. It's just not all that easy to dabble in insurance," ' Doerschel recalled cautioning Landau. "We tried to tell him, ‘You are going down the wrong path.' "

But the city manager pressed forward. Eventually, Landau would spend tens of thousands of Municipal Mutual's money - including after he was effectively separated from the company - some for overseas travel, four-star dinners and $725-a-night hotel rooms in Manhattan.

Former Mayor Donald Dear, a schoolteacher, said if he had been "more sophisticated in the ways of business" he might have seen red flags along the way to creating Municipal Mutual, "the biggest mistake I ever made politically."

Dear mostly blames Landau, who piloted the idea through the City Council and later was sentenced to three years in prison for embezzling city money not related to the insurance company.

Fukai, the influential councilman who pushed to create the company and later served as its chairman, had a stroke years ago and declined through his wife to be interviewed.

Gwen Duffy, a former Council member who also served on the company's board, said she felt taken advantage of by consultants who earned large fees helping set up the company, then later worked there.

Management and consulting fees in 1993-94 reached nearly $1.5 million, records show. Advisers earned tens of thousands more setting up the company.

Dennis Evans - who advised the city in the early 1990s, later worked for Municipal Mutual and is now the sole caretaker of the shell it left behind - disputed that projections were polished to sell the idea to Gardena, or that management fees were excessive.

"It was their concept and their idea," Evans said, faulting the city for taking too long to get into the marketplace. "It's sad, because it could have been great. It's just too bad."

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