Tag Archives: California

Let’s Do This Thing!

Everybody keeps telling me to write something positive and to stop harping on gloom and doom in our future.

I really wish I knew how to do that, because every day I search for some signs, or any sign that there is some hopeful event on the horizon that will create a positive impact on our future, but I can’t find any.

I turn on the TV News and without fail, there are varying degrees of sterilized coverage of some economic event that happened three days earlier that will have far greater impact than the newsies imply and is of far greater complexity than they can possibly understand or communicate.

So, they don’t, and America does what? Goes about their business placated by the blind faith that their leaders will figure out how to prevent the world from ending before it does?  Do they say to themselves, “Hey, how bad could it get? After all, we went through some deep shit in the 30’s and we came out alright.”

Cable news is marginally better because at least they have a longer segment in which to explore the charts, data, directions, patterns, history, etc., but it is still not enough. Then, I have to remind myself every day that people just don’t care. Here is what people care about:

TRENDING NOW (from Yahoo web searches ranked by popularity) on this fine day in July:

01 Mariah Carey

02 Sigourney Weaver

03 Harrison Ford turns 70

04 Michelle Obama threat

05 Chevy buy-back

06 F-22 hypoxia

07 Bonnie and Clyde guns

08 Bankruptcy protection

09 GOP vice-presidential candidates

10 Rheumatoid arthritis

So, it is obviously more important to the American people that Mariah Carey and Sigourney Weaver are celebrating Harrison Ford’s 70th birthday, while Michelle Obama has threatened a Chevy buy-back and some pilots are still experiencing hypoxia when they ride in the cockpit of a jet the military never wanted, and Bonnie and Clyde have hidden their guns and filed for bankruptcy protection because the GOP VP candidates have rheumatoid arthritis.

THIS is what the people care about.

How can that be? I haven’t a clue.

And, if I believe we are truly headed for hell, then why don’t I write about what we can do about it and instead of warning people all the time, point out some things that people can do once they know it.

OK. Here goes: If you have a job, no matter how shitty, keep it and shut-up about how shitty it is. You are blessed. It isn’t like they promised it would be. So, what? If you are still in school, stay there. Slow it down. Take fewer courses. Get Mono. Avoid graduation like the plague. Yes, even if you are at Harvard or Stanford. And, yes, even if you will have an MBA. Particularly if you have an MBA. Stay on your parents’ health care plan as long as you can. If you have a government job, you are even more blessed.

If you are an Airline Pilot, a Doctor or Lawyer, you are just fine. Not making very much money, but fine. Don’t buy anything you don’t need. Don’t buy real estate, yet.

If you are an investment banker, you are also fine. In fact, you are great. There will be tons of money to be made on the craziest gambles you’ve ever seen. Derivatives? Nah, child’s play. China? Gold? Corn? Salmon? Copper? You betcha.

If you are a commercial banker, you are screwed. Too bad.

If you are unemployed, find something that only you can do and offer it for sale. Try Fiverr, or the like. Make something up. “I will sing Happy Birthday in my silly hat for $5”. Really.

Stop looking for work if you haven’t already. It is bad for your soul. If you’ve been out of work for a year, you undoubtedly have erectile dysfunction. You may have already joined many who have considered suicide. Don’t do it.

Get creative. Find others and band together in some common cause. Like tearing down the government. Don’t do it like the Occupy movement did. Actually form a political party and talk to the media. Use simple words. Talk slowly. Even though it makes no sense, talk about the government making jobs. Or, find a bunch of people and start a business that capitalizes on the GREATEST DEPRESSION EVER. Put people in need together with people who have. Make something up. Now is the time. Bend rules. The law will be so busy chasing truly bad guys, it won’t have time to worry about you. And, where would they put you? Jail? Who would look after you? They are all out of work too.

If you are a teacher, you are doomed, but at least 40% of you still have jobs. Try to stay out of site and don’t ever complain.

If you’re in the military, stay in the military. Re-up. For anything.

If you are upside down on your house, walk away and start over somewhere. If you have a ton of debt, declare bankruptcy before they change the law again and make it even harder. If you are lucky enough to be on unemployment or other government welfare programs, revel in it and stay on them. They are NOT entitlements. You paid for them in taxes. They are yours. You have earned them.

If you have a ton of money, you will have fun and be able to make lots more by betting against all fiscal progress and economic recovery. Bet against Greece. Bet against European banks surviving. Bet against the dollar. Bet against every bank stock, and bet on every European sovereign bond default.

Oh, that’s not what you meant, huh?

OK. The truth is we live in the modern world. And, no matter what happens in Washington or in our State Capitols, this is still the modern world (it would be easy to say this is still America, but technology now allows our freedoms to enable behavior around the world, so I call this the modern world). We can do anything we want here. You want to know what to do? Then, page down to the end, and I’ll tell you.

In the meantime, the cracks in the ice are getting bigger.  At this point it is really hard to have much confidence in the global financial system at all.  The lying leaders told us that MF Global was an isolated incident.  Well, the horrific financial scandal over at PFGBest last week is essentially MF Global all over again.  And, either no one was watching or no one was telling. They told us that we would not see a huge wave of municipal bankruptcies in the United States.  Well, three California cities have declared bankruptcy in less than a month, and many more are on their way.  They told us that we could have faith in the integrity of the global financial system.  Well, now we are finding out that global interest rates have been fixed by insiders for years, including our own Treasury leader. 

They told us that Greece was an isolated problem and that none of the larger European nations would experience anything remotely similar.  Well, what is happening in Spain right now looks like an instant replay of exactly what happened in Greece.  So who are we supposed to believe?  Why does it seem like nearly everything that “the authorities” tell us turns out to be a lie?   What else haven’t they been telling us? I think I know.

Look, tens of millions of American families are about to go through economic hell and most of them don’t even realize it. For some weird reason, most Americans don’t spend a whole lot of time thinking about things like “monetary policy” or “economic cycles”.  The vast majority of people just want to be able to get up in the morning, go to work and provide for themselves and their families.  Most Americans realize that things seem “harder” these days, but most of them also have faith that things will eventually get better.  Why? I have no idea.

Unfortunately, things are NOT going to get any better.  The number of good jobs continues to decline, the number of Americans losing their homes continues to go up, people are having a much more difficult time paying their bills and our federal government is drowning in debt.  Sadly, this is only just the beginning of how bad it is going to be.

Since the financial collapse of 2008, the Federal Reserve and the U.S. government have taken unprecedented steps to stimulate the economy.  But even with all of those efforts, we are still living in an economic wasteland.

So what is going to happen when the next wave of the economic crisis hits?

If you look at the economic relapse that’s going on right now, look at last week’s abysmal job numbers, look at the housing numbers, understand that all of this is taking place with record monetary and fiscal stimulus. What happens if we remove those supports? What do you think will happen?

Last month, the Federal Reserve’s quantitative easing program ended (QE2 for those of you still counting).  The U.S. Congress and state legislatures from coast to coast are talking about budget cuts.  The amount of borrowing and spending that has been going on is clearly unsustainable, but will the U.S. economy start shrinking again once the current “financial sugar high” has worn off? QE3? It won’t work. Trust me.

Already, most economic news has been bad and almost all true economic indicators are turning south.  And, finally, the American people are becoming increasingly restless.  One new poll has found that 59 percent of the American people disapprove of Barack Obama’s handling of the economy (which is a new high).  According to another recent poll, 63% of Americans say that they feel “not good” or “bad” about how the U.S. economy is performing. It is not surprising that my buddy, Jimmy Carville is predicting a civil uprising.

The official unemployment rate just went up to 9.1 percent, but that figure only tells part of the picture.

There are some areas of the country where it seems nearly impossible to find a decent job.  Millions of Americans have fallen into depression as they find themselves unable to provide for their families.

According to CBS News, 45.1 percent of all unemployed Americans have been out of work for at least six months.  That is a higher percentage than at any point during the Great Depression. Just two years ago, the number of “long-term unemployed” in the United States was only 2.6 million.  Today, that number is up to 6.2 million.

Can you imagine being out of work for 6 months or more? How would you survive? Do you have enough money in the bank to last 6 months with no income? 89% of Americans don’t. Should I repeat that?

 

So is there any realistic expectation that things will get any better?  Well, there were only about 3 million job openings in the United States during the month of April.  Normally there should be about 4.5 million job openings.  The economy has slowed down once again.  Good jobs are going to become even more rare. Unless we can generate 160,000 new jobs each month, we fail to satisfy new demand. And, that is just NEW demand. It says nothing about existing unemployment. In other words, every new job we fall short of 160,000 is one more added to the unemployment number. So, yes, unemployment is growing. It is not coming down as many in the Obama administration would like to believe.

There are millions of other Americans that are “underemployed”.  All over the United States you will find hard working Americans that are flipping burgers or working in retail stores because that is all they can get right now. Most temp jobs and most part-time jobs don’t pay enough to be able to provide for a family.  And there are not nearly enough full-time jobs for everyone.

Sadly, the number of “middle class jobs” is about 10 percent lower than a decade ago.  There are simply less tickets to the “good life” than there used to be. And without good jobs, the American people cannot afford to buy homes. Without good jobs, the American people cannot even afford the homes that they are in now. And, these jobs are NEVER COMING BACK.

U.S. home prices have fallen 33 percent since the peak of the housing bubble.  That is more than they fell during the Great Depression. 28 percent of all homes with a mortgage in the United States are in negative equity at this point.  There are millions of American families that are now paying on mortgages that are for far more than their homes are worth. Millions of American families literally feel trapped in their homes.  They can’t afford to sell their homes, and they are afraid to simply walk away, because as things stand now, nobody will approve them for new home loans for many years to come.

Many Americans are sticking it out and are staying in their homes until they simply can’t pay for them anymore. As the number of good jobs continues to decline, the number of Americans that are losing their homes continues to rise. For the first time ever, more than a million U.S. families lost their homes to foreclosure in a single year during 2010. As the economy slows down once again and millions more Americans lose their jobs, this problem is going to get a lot worse. WORSE THAN TODAY.

Even if they aren’t losing their homes yet, millions of other Americans families are finding it increasingly difficult to pay the bills. Wages have been very flat over the past few years and yet the cost of most of the basics just seems to keep going up and up. According to Brent Meyer, a senior economic analyst at the Federal Reserve Bank of Cleveland, the cost of food and the cost of energy have risen at an annualized rate of 17 percent over the past six months. Have your wages gone up by 17 percent over the past six months?

As 2009 began, the average price of a gallon of gasoline in the United States was $1.83.  Today it is $3.77. American families are finding that their paychecks are going a lot less farther than they used to, but Ben Bernanke keeps insisting that we have very little inflation in 2011.

Most Americans don’t care much about economic statistics – they just want to be able to do basic things like sit on their porch and have a beer, and take their children to the doctor. According to one recent survey, 26 percent of Americans have put off doctor visits because of the economy. Sadly, soon a lot more American families will not be able to afford to go to the doctor. But, ironically, not because Doctors are earning and charging more, but because Insurance companies are.  Doctor’s wages continue to trend down while Insurance company profits continue to trend up.

As the economic situation has unraveled, an increasing number of people are being forced to turn to the federal government for assistance. One out of every six Americans is now enrolled in at least one anti-poverty program run by the federal government. Some of the hardest hit members of our society have been our children.  Today, one out of every four American children is on food stamps. At the moment, approximately 44 million Americans are on food stamps.

But our federal government cannot afford to spend money like this forever.

According to a recent USA Today analysis, the U.S. federal government took on $5.3 trillion in new financial obligations during 2010.  USA Today says that the U.S. government now has $61.6 trillion in financial obligations that have not been paid for yet. Yes, that is trillion! $61.6 TRILLION.  Who is going to end up paying that bill? I know; you don’t care. And neither do I. What I care about is where my next meal is coming from, and how I am going to afford that next gallon of gas. I suspect you do too.

So with so much bad news and with all economic indicators pointing in the wrong direction, are our leaders alarmed?

According to Federal Reserve Chairman Ben Bernanke, “growth seems likely to pick up somewhat in the second half of the year.” I swear to God, the man is on drugs or has a contract clause that forces him to keep repeating the same mantra, no matter what happens. He, and his buddies in Washington and in your State capitol are part of the same disease. The disease that brings us closer every day to Armageddon.

So, what do we do? I said I would tell you what to do, right?

OK. This may seem silly to some of you, but there is absolutely no reason why we cannot all start a new business that is independent of anyone else and relies only on our own creativity and energy. This is not a plug for Crowdfunding. This is a plug for entrepreneurship.  There are many websites around now that provide the ability to post a project and solicit funds to launch it. Kickstarter, Indiegogo and RocketHub are three American sites joined by several in the UK and elsewhere that facilitate anyone with a dream to test the water in the Crowd for enthusiasm about your project. Here’s an example:

http://www.kickstarter.com/projects/readmatter/matter — Might not be your style? How about this one: http://www.kickstarter.com/projects/1220832022/bloc-socks?ref=popular … or … this one: http://www.rockethub.com/projects/8479-social-action-10-months-in-tel-aviv

The point is that you can, and should … DO SOMETHING! Stop waiting for somebody else to do it for you. Stop looking for a job. Stop feeling sorry for yourself.

Grab some buds, and get a dialogue going around some pet idea that you have had in the back of your mind. Maybe it comes from your frustrations as a single mother, as a cabdriver, as a fireman, a teacher, a bricklayer, whatever. There must be 99 ways to whatever you do better, faster, cooler, bigger or more. You can come up with something that maybe a few hundred other people think is a good idea also.

Then, you can post it on these sites and maybe, just maybe, you will raise enough money to start a little company doing that thing. Maybe it takes off. Maybe it flops. In the meantime, you might raise enough to sustain yourself to get to the second or third idea. You know? The one that really works.

This beats sitting around, feeling sorry for yourself and looking at want-ads, doesn’t it? And, you know that will never work anyway, and all it does is bring you closer to depression. Don’t be that guy. Don’t do the stuff that brings you closer to depression. Start something. It takes zero cash. You can do this.

And, though I realize you really don’t care, it is also the way in which we re-start this country and throw all of the old paradigms about banking and central government out the window. It is up to us now. Let’s do this thing!

 

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Home Prices Inching Up? What Does It Mean?

Home prices appear to report higher for the third straight month as “sand states” drift away from the crisis. Sand states are Florida, Nevada, Arizona and California. But, what’s really going on is far more interesting.

For the third straight month in April, American home prices twitched a tiny bit higher as values in the “sand states” further firmed while listings in some key northern cities continued to chill, the Case/Shiller survey reported Tuesday.

The Standard & Poor’s/Case Shiller composite index of 20 metropolitan areas showed a year-over-year decrease of 1.9 percent but a 0.7 percent national bump from March to April on a seasonally adjusted basis (1.3 percent non-seasonally adjusted), led by ongoing price rallies in a clump of warm-weather markets beaten up by the housing slump, including Miami, Tampa, Las Vegas and Phoenix.

“I’ve seen (listings here) jumping just like they did back in the day when the banks were approving everything,” said Michelle Tremblay, a Realtor with West USA Realty in Phoenix.

Since last October, home values in Phoenix have inched 12 percent higher, gaining ground during each of the past six months, according to the Case Shiller index.

From Tremblay’s vantage point, however, those loftier home values are akin to steroid-swelled athletes: synthetically pumped prices caused by banks stockpiling foreclosed properties and purposely keeping them off the market until area prices truly soar. Then those same financial institutions can cash in by selling those properties at fatter profits.

“We can see on the street what’s vacant and what’s not. We’re watching these (foreclosed and non-listed) houses just sit and rot,” Tremblay said. “The banks are letting these houses just deteriorate.

“They’re holding them and releasing them slowly to drive the value up.”

Some Realtors in another so-called “sand state,” California, recently have joined that chorus, offering similar, albeit unproven, theories about banks hoarding foreclosures and thus shrinking inventory in most markets.

In three California cities on the Case Shiller index -– Los Angeles, San Diego and San Francisco – home prices have increased during February, March and April.

Fellow “sand state” cities Miami and Tampa each have posted five straight months of home-value gains. Las Vegas, the largest metro area in Nevada – the fourth “sand state” – in April notched its third month in a row of heightened property prices, according to Case Shiller’s survey.

“Realtors across the country are all talking about the same stuff: the banks are the ones in control right now and they know it and they’re going to make the money again – and again and again,” Tremblay said. Not long ago, distressed homes “were selling, I think, too cheaply. And the banks weren’t making the money that they wanted to. So they tightened their inventory.”

Robert J. Shiller, one of the two developers of the monthly index, agreed that “it is an artificial market in that there is a lot of inventory held off.”

But Shiller, an Arthur M. Okun Professor of Economics at Yale University, sees still another hidden reservoir of prospective properties for sale – “a shadow inventory held off by homeowners who might sell if home prices come back up enough.”

Two weeks ago, market analytics service CoreLogic reported that the “residential shadow inventory” – which includes bank-owned homes – had declined to 1.5 million units in April, representing a four-month supply as well as a 14.8 percent drop from the same month one year earlier. In April 2011, the shadow inventory held a six-month supply of homes – roughly the same level as October 2008 when the housing crash began.

Still, with about 90 percent of American mortgages held by Fannie Mae, Freddie Mac and the Federal Housing Authority, “it’s really a government market now,” Shiller said. “So anyone contemplating speculating in housing has to think about what the government is likely to do. And we’re in limbo right now.

“We have a presidential election coming up. We haven’t resolved what were going to do with Fannie and Freddie – presumably something will be done with them afterward.”

Projecting the direction of home prices in several vital northern cities has grown more challenging the past year. In Boston, home prices have dipped during six of the past eight months, according to Case Shiller. In New York, property values have declined for seven consecutive months. Chicago, up a tick in April, has nonetheless posted seven price drops in nine months, the index shows.

Is any of that political and financial uncertainty perhaps fueling some fall-off in home prices those metro areas?

“I guess it is. People are holding off … People are hoping for prices to go back up (in those cities),” Shiller said. “And we’ll see the shadow inventory converted into real inventory if people start to see the prices go back up.”

But in Chicago, where home prices are off 7.2 percent since last August, the Case Shiller index reports, some Realtors are blaming another segment of the home-financing equation.

“The appraisers are keeping the prices low,” said Patrick Hawkins, a broker with Dream Town Realty in Chicago, so buyers can’t get enough financing, and credit is tighter than ever.

The last time Chicago property values were this depleted on the Case Shiller index: November 2000.

“Buyers are willing to spend a little more money right now. Inventory is low. But the appraisers just are reticent to come in with a strong enough number,” Hawkins said.  “What I’m assuming an appraiser would say is: It’s the market conditions, it’s people not having enough jobs, it’s the economy.

“Appraisers – they’re killing the market. The prices have been driven down, beaten to a pulp.”

It would be nice if the numbers supported a shift in the markets, and that the housing slump had hit bottom. But, based on this data, and in spite of what the Obama Administration dreams about, I am afraid we have a long way to go.


Stimulus Money Goes To Ground.

Under the banner of saving jobs, kick-starting the economy and keeping small businesses and organizations afloat through tough economic times, the US government has handed out more than $840 Billion in federal stimulus money since 2009. Of that, more than $33 Billion went to California.

Some of the largest and most recognized companies in Silicon Valleynearly all of which are flush with cash—were awarded $94 million as either prime recipients or sub-recipients.

Google got $686,681 as a sub-recipient on a contract to reach 14 additional different language audiences for the 2010 Census Integrated Communications Campaign. HUH?

McAfee was awarded $1,579,271 as a sub-recipient on five different contracts from 2009 through the first quarter of 2012. For ???

eBay received more than $4,447,000 on three different grants including a $2.5 million grant to the Office of the Governor of Arizona for the Government Services Fund. For the WHAT?

Applied Materials took over $10 Million to develop and demonstrate an advanced epitaxial growth system for high-brightness LED manufacturers. Somehow, this doesn’t sound like it is going to save jobs, lives or cure cancer.

Scott Amey, General Counsel at POGO, is critical of some of the outcomes of the stimulus bill.

“There are a lot of large contractors that received stimulus money, and it makes you scratch your head and wonder, ‘Were they really in need of receiving that money?’” Amey said. “A lot of people would say no.”

He went on to say, “When it comes to competition in federal contract, you always have a fear that the usual suspects, that the larger contractors, are always going to get the bigger piece of the pie. And then you have the small and mid-sized businesses that are fighting for the scraps.”

Yahoo! got almost $10 Million to build a clean-energy data center in upstate New York. According to federal data, the project created all of 25 jobs. Why can’t Yahoo! build its own data center?

Yeah sure. These guys really need all the stimulus help they can get. Are you kidding me?

Of all the recipients, more than half didn’t create any more than four jobs with the funds.

One of the biggest jokes was PG&E who received  $47,387,955. Twenty-five million dollars of that goes to design and test an underground compressed energy storage system. On our tax dollars? Come On, Man.

Why can’t a huge utility company do these things on their own?  PG&E made $332 Million in NET PROFIT even after absorbing the $550 Million costs of the pipeline explosions in 2010. “That is the whole purpose of the stimulus money.” A PG&E spokesman said, “to encourage innovation and testing new technologies.”

Sam Rosen-Amy, fiscal policy analyst for OMB Watch in the nation’s capital, said there was a tension between getting the stimulus cash “out as fast as possible to people who need it most,” and ensuring the money is being spent in “an effective and responsible way.” And, he admits that some of the smaller companies that should have received money did not.

Among these were two local applications for stimulus dollars that were denied back in 2009. Linda Crowe applied for stimulus funding, twice, so her organization Califa, which represents public libraries, could buy laptops and provide training for unemployed residents.

“It was all connected toward job assistance and for helping people find work,” she said.

“How much did you get?” Stock asked Crowe.

“Nothing,” she said.

Debarag Banerjee and his three business partners at WiViu Technology applied for $1.5 million to hire 13 people and build a video conference system to serve rural hospitals.

“If we got stimulus, funding had come at the right time,” Banerjee said, “we would have been in a much, much different state.”

Banerjee’s company has downsized significantly, and now it’s essentially out of business.

All of the other Silicon Valley companies who received funds wouldn’t agree to an interview with reporters about their stimulus projects or why their corporations needed the money.

If we simply gave the money to Kickstarter, and let them fund projects through the next few years with that $33 Billion, we would create tons of jobs and a lot of wealth. As one simple example, Pebble Watch Co., which just closed its Kickstarter round after raising $7 Million in three weeks has already created 6 new jobs and expects to create another 15 by year-end and they haven’t even begun to manufacture the watches yet. And, when you think about how this all works, it isn’t just the jobs created directly, its the indirect jobs that really count. Microsoft used to create 6 service jobs for every one new hire.

I don’t know whether Banerjee’s video conferencing system to serve rural hospitals makes any sense, but it only would have cost $1.5 Million to find out. That’s a rounding error on $33 Billion.  Or, how about a few bucks for laptops and training for the unemployed?

Instead we have PG&E throwing almost $50 Million into the ground for compressed energy? Really?


The Other Really Big Bubble.

 

 

Municipal Bankruptcy – What if every major city in America declared bankruptcy? Who would bail them out? What if the Student Loan bubble bursts in a few months, or if Congress fails to extend the low interest rates this coming July, or the US Banks are really over-extended in Europe? Interesting questions.

As I had posted earlier a few times, the future of American cities now hangs in the balance, as the truth starts to seep out and the predictions of street analyst Meredith Whitney — on 60 Minutes in December, 2010, that there would be 50 to 100 sizable municipal bond defaults — have started to become famous, because she was right. She may have been off a year or so, but her view is now coming true all over America. Mostly because of run-away pension costs, but also due to amazing acts of administrative stupidity: a $300+ Million incinerator program in Harrisburg, PA that the city had no funds to pay for, or a $4.23 Billion deficit due to un-funded infrastructure spending in Jefferson County, Alabama.

Her predictions came just at a time when federal stimulus money that helped states weather the recession was scheduled to end. States then started passing the fiscal pain down to localities by cutting aid to them. Meanwhile, localities had already been through several years of belt-tightening, with the worst yet to come: the likelihood that property taxes will decline in 2011 and beyond.

The culprit is a decade of over-spending by governments, especially on pension guarantees, and an economic slowdown that refused to flip into a robust recovery. The money just isn’t there. And it’s not going to be there even if local governments raise taxes while cutting employees and services to the bone.

Chriss Street was the treasurer of Orange County, Calif., from 2006-2010. And back in 1994, he warned that Orange County was headed for what would become, in November that year, America’s worst municipal bankruptcy. People didn’t listen then. They’re not listening now.

“State and local government revenues are taxes and fees on the private sector and housing,” Street said. “The bulk of this tax collection is subject by law to an approximately 18-month lag in collection. The recovery in real estate peaked out in November 2010 and economic activity peaked around April 2011. Both real estate and the economy are in substantial decline.” Therefore, tax collection will be falling all through the first half of 2013, and probably beyond.

“Most states, counties, cities and school districts have spent their cash reserves down to the legal minimum,” Street said. “When I speak at national conferences on municipal finance, I ask the question: ‘How many of you have made contingency plans for another 15 percent decline in revenue in the next year?’ I have never gotten a hand raised. Consequently, it is my belief that there is the potential for thousands of defaults in the 50,000 municipal bond issuers in the United States.  Most cities can cut spending, but they cannot cut principal and interest payments without default and bankruptcy.” And, why do you care? Maybe you own Bank stocks. Maybe you might look into your Bank’s position relative to Bonds and debt with munis. Just saying.

Do You Know The Way To San Jose.

An example of where so many cities are going is San Jose, Calif. Unlike some small cities facing bankruptcy, such as Central Falls in Rhode Island, San Jose remains highly prosperous. It’s not a dead-end rust-belt town. San Jose enjoyed the dot-com prosperity of the late 1990s, then the real-estate boom of the mid-2000s. The ensuing real-estate bust was milder there than in most places. It still prospers from being part of Silicon Valley, the epicenter of the world computer revolution that’s booming again, despite the global economic slowdown. Apple’s HQ is a stone’s throw away in Cupertino. Facebook is just a little further north in Palo Alto.

But San Jose officials have discussed bankruptcy as a possible option.

Its prosperity turned out to be its undoing. In the November 2011Vanity Fair, financial writer Michael Lewis wrote, “the city owes so much more money to its employees than it can afford to pay that it could cut its debts in half and still wind up broke.”

The problem for America’s 10th-largest city, population 1 million: “The Internet boom created both great expectations for public employees and tax revenues to meet them….  Over the past decade, the city of San Jose had repeatedly caved to the demands of its public-safety unions. In practice, this meant that when the police or fire department of any neighboring city struck a better deal for itself, it became a fresh argument for improving the pay of San Jose police and fire. The effect was to make the sweetest deal cut by public-safety workers with any city in Northern California the starting point for the next round of negotiations for every other city.”

This ratchet effect also struck areas throughout the rest of California and the United States.

According to Mayor Chuck Reed, a Democrat, “Our police and firefighters will earn more in retirement than they did when they were working. There used to be an argument that you have to give us money or we can’t afford to live in the city. Now the more you pay them the less likely they are to live in the city, because they can afford to leave. It’s staggering. When did we go from giving people sick leave to letting them accumulate it and cash it in for hundreds of thousands of dollars when they are done working? There’s a corruption here. It’s not just a financial corruption. It’s a corruption of the attitude of public service.”

While costs have been ratcheting up for San Jose, city staff levels have been ratcheting down. City staff has been cut from 7,450 to 5,400. The number of staff is the same as that of 1988, before the city added another 250,000 residents. By 2014, the number of city staff could be as low as 1,600. Reed warned, “There is no way to run a city with that level of staffing.”

San Jose’s fate could rest on the decision of voters. As Ed Mendel of CalPensions wrote in December 2011, “The San Jose City Council voted 6-to-5 … to place a pension reform measure on the June ballot that takes on what the Little Hoover Commission called ‘the elephant in the room,’ a way to reduce the cost of pensions promised current workers. As state and local governments face rising pension costs while a weak economy forces deep budget cuts, the San Jose council’s plan is the biggest and boldest proposal yet by elected officials to reduce pension costs widely believed to be legally untouchable. Mayor Chuck Reed had talked about declaring a fiscal emergency to reduce pensions earned by current workers in the future. Now he is talking about the city charter specifying minimum benefits provided by the city’s two independent pension systems.

With the economy still underperforming, there will be no rescue for public budgets. There’s no dot-com boom or real-estate bubble on the horizon. As we have seen, those booms were unsustainable anyway, and just encouraged unrealistic expectations about municipal revenues and portfolios.

What has happened is that at least 12 years of delusions finally are wearing off, and everyone is being forced to meet reality. For most governments, the easy fix, if one could do it, would be just to switch all future pensions for current employees to 401(k) plans. And for those facing bankruptcy, the additional fix would be to cut payouts to existing retirees, as Central Falls (Rhode Island) is trying to do. But employee unions, not surprisingly, are resisting any changes to current benefits.

This is the same discussion that is happening all across America in big and little cities and local municipalities. Bankruptcy doesn’t cure any ills for the cities and particularly for its residents. It simply postpones dealing with the reality for a while. And, in the meantime, your city turns into Vallejo, California, where when you call the Police, they tell you to fill out a form and mail it in. Either the administrators raise taxes or the unions cave on decades-old contracts. One of these things, or maybe both have to give and soon, or Meredith Whitney becomes the smartest guy in the room. And, your police and fire suddenly can’t protect you from harm anymore.


One Canary, Two Canary …

Will Stockton Be the Biggest Municipal Bankruptcy Ever?

I mentioned yesterday, that Stockton is the biggest municipal bankruptcy in US history. I had my cart slightly ahead of my horse. They haven’t filed bankruptcy. Yet.

In recent years this inland port city of nearly 300,000 people has earned several distinctions, none of them good. Twice atop Forbes‘ list of America’s Most Miserable Cities … Second highest violent-crime rate in California … Second highest home-foreclosure rate of all major U.S. metro areas. Now, Stockton is on the verge of another dubious benchmark: bankruptcy. In its third straight year of fiscal emergency, the city faces a deficit of as high as $38 million on its $165 million general fund budget. As required by state law, the city council is in mediation with creditors and unions. If a deal is not reached in the coming weeks — and prospects are bleak — Stockton will become the largest municipality in U.S. history to go bust.

While Stockton has been down on its luck for a long time, many residents insist its fiscal crisis is a function of bad management during the flush years of the housing boom. Long an agricultural hub for Central Valley farms and situated about 80 miles (130 km) east of San Francisco, it went through a steady financial decline that saw its once thriving downtown hollowed out by poverty and crime. Scores of people decamped for the north of the city, or left altogether. Street gangs multiplied. Then, in the early 2000s, the housing boom drew developers back to the region in droves. Plush subdivisions went up overnight to attract families with easy credit who could not afford the Bay Area.

Prior to the housing boom, reckless spending on public-employee contracts put the city’s long-term health at risk, according to active city officials. As coffers started to fill up from the swelling tax base, the sweetheart deals got sweeter. If an employee worked for one month, for instance, they and their spouses were eligible for retiree health care for life, a policy that had the predictable effect of motivating people to quit working early. Today Stockton has 94 retirees with pensions of at least $100,000 a year, Reuters reported, amounting to twice the number of California towns its size. The city’s long-term health liabilities alone amount to more than $400 million.

Meanwhile, Stockton’s urban core was given a face-lift to seduce homeowners. Tens of millions of dollars were poured into building a marquee waterfront area comparable to San Antonio’s river walk, complete with a gleaming sports arena, theater complex, marina and walkway. A celebrity chef was invited to run a restaurant, rent free, on the first floor of the historic Stockton Hotel. When it came time to open, the city paid singer Neil Diamond $1 million to headline a kickoff concert. “Then,” says longtime resident Robert Weaver, 76, “the whole thing ground to a standstill.”

The housing bubble burst, followed by the Great Recession. City revenue streams dried up (plunging more than $50 million compared with prerecession years), slashing municipal services across the board, from public parking to bike police. The downtown quickly reverted to a no-man’s-land: waterfront entertainments were shuttered, the grand hotels given over to low-income and student housing. A fancy high-rise municipal complex that officials had paid $35 million for is now being rented out, leaving the city council to debate its woes in their old building, where a red, white and blue banner out front reads with fitting irony: “Stockton: An All America City.”

“Stockton did something very similar to what many American families did: the city overcommitted to long-term obligations that even under the best of times the city could not afford,” says Bob Deis, the city manager since mid-2010. “So if there was not a recession, the city would have been having the conversation we’re having in four or five years. But then the perfect storm happened.”

Nobody Asked.

“The problem is, nobody asked the question: ‘How do you fund it?’ And consequently there was no money set aside to fund those commitments,” Deis said. “It was an unsound decision and it has similarities to a Ponzi scheme.”

In the 2000s, as housing prices soared in San Francisco and Silicon Valley, buyers from San Jose to Oakland seeking affordable alternatives flocked to Stockton, where starter homes cost around $400,000. Single-family home construction, which had averaged 2,500 units a year from 1991 to 1997, tripled to 7,500 annually from 2003 to 2005, according to Robert Denk, senior economist at the Washington-based National Association of Home Builders.

The city’s population grew 20 percent in a decade, to 291,707 in 2010 from 243,771 in 2000, driven by a surge in Hispanics who identify themselves as Mexican, according to U.S. Census Bureau data. That ethnic group jumped 56 percent in the period, to 104,172 from 66,900, while the black population grew 30 percent and the Asian population rose 29 percent, Census figures show.

Boom Time.

“Money was just pouring into the city coffers for development fees and permits,” Miller said. “Property taxes were going through the roof. It was boom-time.”

“There was an unspoken policy that to keep the unions from complaining about the amount of money being spent on projects, the easiest way to do that was to continue sweetening their compensation packages,” Miller said.

Among those measures were automatic salary increases regardless of whether the city had the revenue to support them. The contract with the fire union required the city to compare its pay with that of 16 cities including Huntington Beach, Anaheim and Torrance. Stockton firefighters’ salaries were required to rank fifth-highest, according to the city’s May 2011 emergency declaration document.

$100,000 Pensions.

Stockton retirees also fared well. The 94 with pensions of more than $100,000 compares with 38 in Bakersfield, which has 347,000 residents, and 35 in Chula Vista, with a population of 244,000, according to data compiled from state pension records by the California Foundation for Fiscal Responsibility, a Citrus Heights-based group that advocates pension reform.

An epidemic of foreclosures reached Stockton in 2007, as the recession left thousands of homeowners unable to afford their mortgages. Home construction collapsed and housing prices plummeted.

Revenue dwindled to an estimated $161.8 million in fiscal 2012 from $203.1 million in fiscal 2009. The city fired 25 percent of its workforce.

In Stockton’s San Joaquin County, assessed property values tumbled almost 11 percent in fiscal 2010, followed by 3.9 percent in 2011 and 4 percent in the current year, according to the county’s website.

Drastic Decisions.

“In the beginning, when this whole economic bubble burst, everyone had the attitude, ‘We’ll just avoid making drastic decisions and in a year or two things will be back to normal,’” Miller said.

The base pay for a Stockton police officer can be as much as $76,860, while a sergeant’s can reach $90,836, according to data provided by the city. In 2010, 87 percent of police officers got additional pay that added 8.7 percent for a canine handler, 4.3 percent for SWAT and 5 percent in “longevity pay” at six years of service. All are included in the calculation of retirement benefits.

“We are now the fifth-lowest paid police organization in the county where we handle the majority of the calls,” said Kathryn Nance, a Stockton Police Officers’ Association board member.

By 2009, city officials began considering bankruptcy.

Bankruptcy Protection.

Fritchen, the council member, asked the city attorney’s office to lay out the pros and cons of bankruptcy protection at a budget committee meeting.

A year later, in May 2010, the city declared a fiscal emergency to deal with a $23 million deficit. The declaration allowed the city to make changes to existing labor contracts.

Crime escalated as the police force was reduced by about 27 percent to 324 sworn officers from 441, according to Pete Smith, a police spokesman. There were a record 58 homicides last year, most involving gang violence, Smith said.

“We’re losing our grip on some of the more troubled neighborhoods and don’t have the ability to police the city as proactively as we did,” Smith said.

In the spring of 2011, Deis met with about 15 police employees and budget officials to seek concessions from the union.

Breaking Our Contract.

“He said if we continue to fight on them breaking our contract, then he is going to push the reset button and go bankrupt and we will all lose,” said Steve Leonesio, president of the police union. The union is suing the city, challenging its authority to reduce benefits under the emergency declaration.

Last year, city officials uncovered bookkeeping errors requiring $15 million in budget cuts that “will have the effect of stripping Stockton’s cupboards bare,” Deis said.

The mistakes included double-counting of $500,000 in parking-ticket revenues and overstating the city’s available balance by an estimated $2.8 million.

On Feb. 24, Deis walked into a news conference at City Hall and announced that the errors and the recession represent “the knockout blow” for the city’s finances. He recommended the city invoke the state bankruptcy law.

“We see no viable alternative,” he said.

Given the city’s huge obligations and shrinking capacity to generate revenue, Deis says it’s critical for Stockton to “break itself from the boom-and-bust cycle.” With guidance from a team of urban-development experts from around the country, city leaders are pursuing a new plan to revitalize the downtown — this time with private money. “We’re investing a huge amount of resources to make this process work”, says Deis, praising the tenacity of the current city council in going after bloated labor contracts to find some fiscal breathing space. “But we’re not in control of it,” he adds.

Stockton is not an anomaly. I am certain that I will uncover countless stories similar to this one, if I were to search every day for the next city about to fail. It is almost as if City governance across this country woke up one day in 2012, four years after the fact and said, “Gosh, there seems to be a recession here. Did something happen while we weren’t paying attention?” Yes, something did. I remember having lunch with Robert Bobb, one of the best City Administrators I have ever met. Bobb said, “Oakland has a chance to become one of the premier cities in America, but I wouldn’t bet on it.” He cited the growing pension problems that has Oakland in its grasp today, and that lunch was in 2003. Jerry Brown’s biggest mistake as Mayor was firing Robert Bobb.

The only way out of this mess is for City Administrators to get out in front of this never-ending problem with ballot measures for tax increases to cover the pension costs, and with contract re-negotiations to try and lower the trajectory of growth in pension debt burden. The city employee’s unions must come to the table with more reasonable proposals to re-cast those agreements in the light of the realities of 2012, and be willing to accept the fact that the money to pay for them is simply not there. We can’t party like it’s 1999 anymore.


Best Job. Ever.

$200,000 Lifeguards to Receive Millions in Retirement

My favorite job in my whole career was lifeguard. I completed the American Red Cross Life Saving class and earned my certification when I was 16. I spent summers at the Russian River in Northern California as a beach guard for Bob Trowbridge who operated the beaches, and the canoe rental concessions at Rio Nido and Johnson’s beach at Guerneville. During the school year, I worked at the Hyatt Hotel in Burlingame, and Santa Cruz at Cowell and Harbor beaches on weekends. The Hyatt was the SFO airport layover lodging for all major airline flight attendants. This was a while ago. I think I made $2.50/hour. I would have happily worked for free.

Things have apparently changed since those simpler, happier days.

My earlier post today focused on municipal government employee pensions in cities like Providence, Rhode Island. It now seems that public outrage over lavish government employee compensation and pensions is becoming more heated as new revelations about excesses seem to crop up every week. The latest: Newport Beach, California, where some lifeguards have compensation packages that exceed $200,000 and where these “civil servants” can retire with lucrative government pensions at age 50. Hmm, should have stayed in the business.

Newport Beach has two groups of lifeguards. Seasonal tower lifeguards cover Newport’s seven miles of beach during the busy summer months. Part-time seasonal guards make $16 to $22 per hour with no benefits. They are the young people who man the towers and do the lion’s share of the rescues. Another group of highly compensated full-time staff work year-round and seldom, if ever, climb into a tower. According to the City Manager, the typical Daily Deployment Model in the winter for these lifeguards is 10 hours per day for four days each week, mainly spent driving trucks around, painting towers, ordering uniforms and doing basic office work—none are actually manning lifeguard towers.

Like many communities across California, the city of Newport Beach is facing the harsh realities of budgeting with less revenue after housing values plummeted. Now the city’s full-time lifeguard force has finally come under scrutiny. Next week the city council will decide if cuts are needed to the full-time lifeguard force where last year the top earner received $211,000 in pay and benefits, including a $400 sun protection allowance. In 2010 all but one of the city’s full-time lifeguard staff had annual compensation packages worth over $120,000.

And, I don’t mean to denigrate lifeguards. They bravely save lives. They are the Fire Department at the beach. I saved lives. This is not trivial work.

Not bad pay for a lifeguard – but what makes these jobs most attractive is the generous retirements. These lifeguards can retire at age 50 with full medical benefits for life. One recently retired lifeguard, age 51, receives a government retirement of over $108,000 per year—for the rest of his life. He will make well over $3 million in retirement if he lives to age 80. Sweet! According to the City Manager, a new full-time guard costs less to hire than what is spent on this one retiree. The city now spends more taxpayer dollars on retired lifeguards than it does on those who are working.

Reports of excessive pay and generous pensions have fueled a debate across the nation over union influence on government spending. Government unions were able to take full advantage of the good old days when surpluses were plentiful and the economic future was bright. They effectively demanded politicians agree to contracts for higher union wages and benefits. Obviously, creating a situation that was simply not sustainable over the long-term.

In 1999, California legislators, including many Republicans, felt very generous with the public’s tax dollars and created “three at fifty” for public safety workers. SB 400 allowed these government employees to retire as early as age 50, well over a decade before their counter-parts in the private sector, and calculate their annual retirement pay at three percent per year or 90% of their final year’s pay. With the ability to spike final year’s pay based on over-time, vacation and sick leave time, uniform allowances, etc., many former government employees now earn more retired than when they worked. There was a domino effect of this incredibly generous law resulting in local communities jumping on board to stay “competitive” by offering local public safety personnel, including lifeguards, the same great deal. I mean, how else can you entice people to take these terrible government jobs? Like, uhmm, Newport Beach Lifeguard.  Thousands of state and local employees are locked into generous pension contracts which the courts have decided cannot be broken despite the lack of budgets to pay for them.

The situation in Newport Beach offers a window into how cash-strapped cities are being forced to deal with the problem. Rather than change the current compensation and pension structure to reflect leaner budgets, as would happen in a private sector company, union mandated contracts simply force cities to cut staff and services, usually from the bottom up. It is the inflexibility of laws governing public unions that led to the situation in Wisconsin where Governor Walker sought to change the collective bargaining rights of government employees over benefits in order to bring some sanity into the budget process. Unfortunately for him and the State of Wisconsin, he didn’t go about it very gracefully.

The real problem for government and taxpayers is the pension liability—the amount pension funds are unable to cover due to declining investment funds, which by law, puts taxpayers on the hook to make up the difference. As I mentioned earlier, according to a Stanford University study, California taxpayers are facing a pension liability that could exceed $500 billion, a figure the non-partisan Little Hoover Commission says will “crush” government.

As bad as Newport Beach’s situation is, it pales in comparison to some other cities in California. The city of Fresno currently spends 53 cents of every payroll dollar on pensions. The state average is 31 percent and is expected to rise significantly in the next few years. Ultimately, as the system is currently structured, everyone but a few priviledged retirees will lose. Government will try to raise revenues by increasing taxes on Californians who are already the highest taxed citizens in the country, essential services will have to be cut, even essential government employees will have to be laid off, and the public will become increasingly enraged as they learn that 50 year-olds, who are fully capable of working, are living off golden parachute retirements at the expense of the taxpayer and the community services they thought they were supporting.

Lifeguard tryouts at Newport Beach, CA

The City Manager in Newport Beach is proposing to cut over 25 percent of the full-time lifeguard staff, believing the winter work can be done with fewer employees. If that is the case, simple efficiency and fiduciary responsibility with tax dollars should be enough to compel the city council to vote in favor of this change. Unfortunately, the underlying problem of overly generous compensation, early retirement incentives and taxpayer obligations to cover lifetime health benefits and “limousine” pensions is not being addressed. Without immediate reforms future staff cuts are inevitable and will be much more painful for this city than just laying off a few lifeguards.

Until local and state governments everywhere are willing to either raise taxes, or glut the aging labor contracts that everyone signed in good faith, these problems will only persist and will likely get worse. And while I doubt that many taxpayers are willing to continue to pay $108,000 a year and full benefits for 50 year old, retired lifeguards, we can probably find even more egregious examples lurking beneath the radar.  Although, the retired lifeguard image thing is pretty rich.


Too Bad Our Congress Isn’t This Smart.

My Buddy, Jerry Brown, is Smart to Compromise with Millionaire’s Tax Plan.

In recent weeks it was becoming increasingly clear that Governor Jerry Brown’s tax measure proposal was headed for defeat, because it included an unpopular sales tax hike. Numerous polls showed that it was trailing the rival Millionaire’s Tax — which proposed to only raise income taxes on the wealthy — by a substantial margin. Backers of the Millionaire’s Tax also had repeatedly — and rightly — rebuffed requests by Brown to drop their more popular measure in favor of his less popular one. So Brown, instead of pushing on with his doomed measure, decided to strike a deal with the sponsors of the Millionaire’s Tax and combine the two measures into one. It was a smart move.

There’s no doubt that the state’s beleaguered finances need a serious revenue boost. Budget cuts over the past few years have devastated funding for higher education, social services, state parks, and other important programs. The new compromise measure will bring in an estimated $9 billion annually if it passes.

Although Brown is already taking criticism from moderates — the Chroneditorial board today said that he “caved” — the deal makes sense politically. Tax measures are never easy to pass in California, and Democrats and progressives likely need a united front to be successful. Republicans were never going to endorse either tax measure, while infighting and competing measures threatened to divide traditional alliances on the left. For example, the California Federation of Teachers was backing the Millionaire’s Tax while the state’s other major teachers’ union, the California Teachers’ Association, was supporting Brown’s plan.Now, the two influential unions will be working together for the same proposal. In fact, virtually all the major unions in the state are expected to endorse the new tax measure. 

And while the new plan has flaws, the decision by the Millionaire’s Tax sponsors to strike a deal with Brown was understandable, too. With two measures instead of one, opponents of the Millionaire’s Tax — i.e. Big Business and the wealthy — would have likely spent heavily to defeat it. Unfortunately, negative advertising works all too well in this country, and as a result, the Millionaire’s tax — as popular as it was — probably faced a tough fight. As such, we may have been left with two losing tax measures: Brown’s less popular one, and a Millionaire’s Tax battered by a barrage of negative ads financed by the One Percent.

The rich, of course, will probably go after the compromise measure, too. But at least Democrats and progressives will be united in their fight to pass it. Brown’s position as governor also will help. Big Business may be reticent about directly taking on the new proposal out of fear of angering him — and then not getting what they want on other issues.

The new compromise measure, if it passes, will increase income taxes on the wealthy at a higher rate than what Brown had proposed. Individuals making more than $500,000 a year, and couples making more than $1 million, will see a 3-percent-tax hike, which is the same as what the Millionaire’s Tax proposed (the governor had proposed a 2-percent increase). The new measure also lowers Brown’s proposed sales tax increase from .5 percent to .25 percent. The Millionaire’s tax would have left sales taxes as is.

At the same time, the new measure would raise taxes by 1 percent on individuals who make more than $250,000 a year, and couples who make more than $500,000 (which is the same as what Brown originally proposed); and by 2 percent on individuals who make more than $500,000 a year, and couples who make more than $600,000 a year (Brown had originally proposed a 1.5 percent hike). The Millionaire’s Tax would have only increased taxes on incomes above $1 million. The compromise also discards the Millionaire’s Tax proposal to hike taxes by 5 percent on incomes above $3 million.

The main drawback, of course, to the compromise deal is the sales tax increase. Sales taxes are regressive because they impact low- and middle-income wage earners the most. They’re especially a bad idea in a state in which low-income people already pay a higher effective tax rate (10.2 percent) than the wealthy (7.4 percent), when considering all taxes.

Nonetheless, the prospect of a united, winning campaign to raise revenues and help avoid further devastating budget cuts outweighs the sales tax flaw in the compromise deal. Moreover, the compromise plan will still help level the tax playing field in California, because it will raise taxes much more on the One Percent than on the 99 Percent.


Don’t All Fifth Graders Know Calculus?

How Khan Academy Is Changing the Rules of Education

If you don’t already know about this, you will be absolutely blown away!

Matthew Carpenter, age 10, has completed 642 inverse trigonometry problems at KhanAcademy.org.Matthew Carpenter, age 10, has completed 642 inverse trigonometry problems at KhanAcademy.org.

“This,” says Matthew Carpenter, “is my favorite exercise.” I peer over his shoulder at his laptop screen to see the math problem the fifth grader is pondering. It’s an inverse trigonometric function: cos-1(1) = ?

Watch a video here: http://www.youtube.com/user/khanacademy/featured

Carpenter, a serious-faced 10-year-old wearing a gray T-shirt and an impressive black digital watch, pauses for a second, fidgets, then clicks on “0 degrees.” Presto: The computer tells him that he’s correct. The software then generates another problem, followed by another, and yet another, until he’s nailed 10 in a row in just a few minutes. All told, he’s done an insane 642 inverse trig problems. “It took a while for me to get it,” he admits sheepishly.

Carpenter, who attends Santa Rita Elementary, a public school in Los Altos, California, shouldn’t be doing work anywhere near this advanced. In fact, when I visited his class this spring—in a sun-drenched room festooned with a papercraft X-wing fighter and student paintings of trees—the kids were supposed to be learning basic fractions, decimals, and percentages. As his teacher, Kami Thordarson, explains, students don’t normally tackle inverse trig until high school, and sometimes not even then.

But last November, Thordarson began using Khan Academy in her class. Khan Academy is an educational website that, as its tagline puts it, aims to let anyone “learn almost anything—for free.” Students, or anyone interested enough to surf by, can watch some 2,400 videos in which the site’s founder, Salman Khan, chattily discusses principles of math, science, and economics (with a smattering of social science topics thrown in). The videos are decidedly lo-fi, even crude: Generally seven to 14 minutes long, they consist of a voice-over by Khan describing a mathematical concept or explaining how to solve a problem while his hand-scribbled formulas and diagrams appear onscreen. Like the Wizard of Oz, Khan never steps from behind the curtain to appear in a video himself; it’s just Khan’s voice and some scrawly equations. In addition to these videos, the website offers software that generates practice problems and rewards good performance with videogame-like badges—for answering a “streak” of questions correctly, say, or mastering a series of algebra levels. (Carpenter has acquired 52 Earth badges in math, which require hours of toil to attain and at which his classmates gaze with envy and awe.)

Initially, Thordarson thought Khan Academy would merely be a helpful supplement to her normal instruction. But it quickly become far more than that. She’s now on her way to “flipping” the way her class works. This involves replacing some of her lectures with Khan’s videos, which students can watch at home. Then, in class, they focus on working problem sets. The idea is to invert the normal rhythms of school, so that lectures are viewed on the kids’ own time and homework is done at school. It sounds weird, Thordarson admits, but this flipping makes sense when you think about it. It’s when they’re doing homework that students are really grappling with a subject and are most likely to need someone to talk to. And now Thordarson can tell just when this grappling occurs: Khan Academy provides teachers with a dashboard application that lets her see the instant a student gets stuck.

“I’m able to give specific, pinpointed help when needed,” she says.

The result is that Thordarson’s students move at their own pace. Those who are struggling get surgically targeted guidance, while advanced kids like Carpenter rocket far ahead; once they’re answering questions without making mistakes, Khan’s site automatically recommends new topics to move on to. Over half the class is now tackling subjects like algebra and geometric formulas. And even the less precocious kids are improving: Only 3 percent of her students were classified as average or lower in end-of-year tests, down from 13 percent at midyear.

For years, teachers like Thordarson have complained about the frustrations of teaching to the “middle” of the class. They stand at the whiteboard, trying to get 25 or more students to learn the same stuff at the same pace. And, of course, it never really works: Advanced kids get bored and tune out, lagging ones get lost and tune out, and pretty soon half the class isn’t paying attention. Since the rise of personal computers in the early ’80s, educators have hoped that technology could solve this problem by offering lessons tailored to each kid. Schools have blown millions, maybe billions, of dollars on sophisticated classroom technology, but the effort has been in vain.

Khan’s videos are anything but sophisticated. He recorded many of them in a closet at home, his voice sounding muffled on his $25 Logitech headset. But some of his fans believe that Khan has stumbled onto the secret to solving education’s middle-of-the-class mediocrity. Most notable among them is Bill Gates, whose foundation has invested $1.5 million in Khan’s site. “I’d been looking for something like this—it’s so important,” Gates says. Khan’s approach, he argues, shows that education can truly be customized, with each student getting individualized help when needed.

Not everyone agrees. Critics argue that Khan’s videos and software encourage uncreative, repetitive drilling—and leave kids staring at screens instead of interacting with real live teachers. Even Khan will acknowledge that he’s not an educational professional; he’s just a nerd who improvised a cool way to teach people things. And for better or worse, this means that he doesn’t have a consistent, comprehensive plan for overhauling school curricula. All sour grapes from ineffective educators and bureaucrats who have been around education too long.

Whatever Khan’s limits, his site has become extremely popular. More than 2 million users watch his videos every month, and all told they answer about 15 questions per second. Khan is clearly helping students master difficult and vital subjects. And he’s not alone: From TED talks to iTunes U to Bill Hammack the Engineer Guy, new online educational tools are bringing the ethos of Silicon Valley to education. The role these sites can (or should) play in our nation’s schools is unclear. But classes like Thordarson’s are starting to find out.

Teachers have long known that one-on-one tutoring is effective, but in 1984, the education scholar Benjamin Bloom figured out precisely how effective it is. He conducted a metastudy of research on students who’d been pulled out of class and given individual instruction. What Bloom found is that students given one-on-one attention reliably perform two standard deviations better than their peers who stay in a regular classroom. How much of an improvement is that? Enough that a student in the middle of the pack will vault into the 98th percentile. Bloom’s findings caused a stir in education, but ultimately they didn’t significantly change the basic structure of the classroom. One-on-one instruction, after all, is insanely expensive. What country can afford one teacher per student?

Cool Schools

“We’ve always known that one-on-one is the best way to learn, but we’ve never been able to figure out how to do it,” Khan explains when we first meet at his small, four-room office in downtown Mountain View, California. A hoodie-clad 34-year-old with big brown eyes and a mass of jet-black hair, Khan leans back in his chair as he talks, cracking a steady stream of jokes. He has a kinetic sort of wit; he’s like a nerdy, South Asian-American Seinfeld, except for the occasional “y’all” that punctuates his speech, a vestige of a youth spent in New Orleans. His desk is made out of old telephone poles and is scattered with books on investing, physics, and heart disease—subjects for upcoming videos. Khan keeps up a breakneck pace of productivity: He has recorded every one of the videos on the site himself and produces up to eight new ones each workday. His offerings run from the straightforward—science and math topics like “Pythagorean Theorem 2,” “Dirac Delta Function,” and “Why Gravity Gets So Strong Near Dense Objects”—to the quirky, including a series of muckraking analyses of the Geithner bank bailouts. It helps that he has a ton of formal schooling, including three degrees from MIT (a BS in math and a BS and MS in computer science) as well as a Harvard MBA. But he also frequently goes outside his areas of expertise, hitting Wikipedia, the web, his personal library, and his long list of brainy friends to bone up on new topics until he feels competent. His office contains several Idiot’s Guide to … books.

Khan never intended to become an education revolutionary. Talented at math in high school, he initially hoped to be a Richard Feynman-style theoretical physicist, before realizing he was far more likely to make his mark in computers. After finishing at MIT and working for a few Silicon Valley dotcoms, he headed to Harvard Business School in 2001, where he claims his main motivation was to get married. (“I’m dead serious,” he says. “Silicon Valley in the late ’90s was the absolute worst place to find a wife or a girlfriend.” He found one and married her—a med student who’s now a doctor in Mountain View.)

After business school, Khan went to work for Wohl Capital, a hedge fund, where he researched companies to find solid investments. At Wohl, he learned how to quickly orient himself in unfamiliar territory. (He also amassed an epic store of mental trivia. While we’re having lunch, he casually mentions how many eggs the average chicken lays in a year: “It’s 260!”) Dan Wohl, his boss, discovered that Khan seemed unusually driven to teach. “I’d come back to the office,” Wohl says, “and giant math equations were scrawled across the board.” Khan was training the junior staff in the nuances of finance. “It’s not the usual cutthroat Wall Street thing to do,” Wohl adds. “But he had this natural gift and a really selfless approach.”

Then, in 2004, Khan’s 13-year-old cousin Nadia, who lived across the country, asked him for help in math. Khan agreed to tutor her on the phone. To illustrate the mathematical concepts he was describing, they’d log into Yahoo Messenger and Khan would use the program’s drawing window to write equations while she watched remotely. When they couldn’t meet, he’d just record a lesson as a video, talking through the material while writing in Microsoft Paint.

One day Nadia told him she didn’t want to talk on the phone anymore; she wanted him to just record videos. Why? Because that way she could review the video as many times as she wanted, scrolling back several times over puzzling parts and fast-forwarding through the boring bits she already knew. “She basically said, ‘I like you better on the video than in person,’” Khan says.

A lightbulb went off: Khan realized that remediation—going over and over something that you really ought to already know—is less embarrassing when you can do it privately, with no one watching. Nadia learned faster when she had control over the pace of the lecture. “The worst time to learn something,” he says, “is when someone is standing over your shoulder going, ‘Do you get it?’”

He also discovered that the state of math education in the country was pretty awful. He began tutoring several other cousins (word had gotten around the family: free lessons!), and he was disturbed to find that their grasp of the basics was shaky. Even on simple division questions, they answered tentatively and slowly. Khan wanted to get the kids to the point where they could confidently bark back these answers—they had to have this kind of automatic mental processing before they could handle more-advanced material.

What his cousins needed, he decided, was drilling. He programmed Java modules that would fire questions at them automatically. If they got 10 questions right in a row, the software would push them to the next level, which had harder problems. (As a bonus, he could peek at the database online to make sure they were actually doing the practice.) Though Khan didn’t know the academic terminology at the time, he was implementing classic “mastery-based learning”—requiring students to prove they’ve conquered material before advancing.

Kami Thordarson uses Khan Academy in her fifth-grade class. Some kids are already learning calculus with it.Kami Thordarson uses Khan Academy in her fifth-grade class. Some kids are already learning calculus with it.

Word soon spread to the rest of the world. Khan discovered that thousands of people were watching his videos on YouTube. Some were students mystified by physics, others were adults brushing up on basics before relaunching a stalled college degree. Khan gradually became more and more absorbed in his site, staying up past midnight crafting new videos and software lessons. Email messages poured in from fans, startling him with their intensity.

“You made me realize that anyone can learn the material when it is presented in the right way,” wrote Tom Brannan, a 19-year-old about to enter a Pennsylvania college. After dropping to a C in math, Brannan learned enough from Khan to ace his last few high school tests and now plans to pursue a degree in computer science. “I had been struggling with the unit circle, essentially trying to learn it out of the textbook,” Brannan wrote. “I watched your videos and it all clicked.”

In 2009, Khan decided to turn his hobby into a full-time job. He formed a nonprofit and got a small donation from Ann Doerr, wife of Silicon Valley investor John Doerr. Demand had taken off; now tens of thousands of people were watching his videos every month. Khan quickly got to work recording more clips in his closet.

Then, last summer, he received a text from Doerr, who was attending the Aspen Ideas Festival: “Bill Gates is talking about your stuff onstage.” Khan dialed up the online video from Aspen and watched Gates, whom he’d never met, singing his praises; indeed, Gates revealed that his own kids were using Khan Academy as a study aid. (“I shit a brick when I saw that,” Khan says.) He met with Gates soon after and received $1.5 million from the Bill & Melinda Gates Foundation. Google kicked in another $2 million.

“Math is the killer,” Bill Gates says. If you ask people why they didn’t pass the police exam or land that nursing job, “math is often the reason.”

“Math is the killer,” Gates told me recently. His foundation had researched unemployment and found math to be a significant stumbling block. “If you ask people, ‘Hey, there are these open nursing jobs, why don’t you go and get one?’ math is often the reason they give for not applying,” Gates says. “‘Why didn’t you pass the police exam?’ Math.”

In the new era of popular, YouTube-friendly education videos, Khan’s site is unique in that it’s ruthlessly practical: It’s aimed at helping people master the basics, the humble bread-and-butter equations they encounter in elementary and high school. Traditionally, these kinds of videos can be dry and difficult to slog through. But Khan manages to pull off his lessons with a casual air that keeps the viewer engaged. He says his relaxed approach isn’t faked—it’s a result of the way he prepares. He never writes a script. He simply researches a topic until he feels he can explain it off the cuff to “a motivated 7-year-old.” (Preparation can take anywhere from 10 minutes with a familiar subject like algebra to nearly a week in the case of organic chemistry.) Khan also never edits. Either he nails the lecture in a single take or he redoes the entire thing until it satisfies him.

Khan suspects there is a hidden power in the fact that he never appears onscreen in his videos. The only visual is his handwriting, slowly filling the screen. “That way, it doesn’t seem like I’m up on a stage lecturing down at you,” he says. “It’s intimate, like we’re both sitting at a table and we’re working through something together, writing on a piece of paper.”

After you’ve listened to a lot of Khan’s stuff, instructional videos by for-profit educational firms begin to sound gratingly phony. At his desk, he pulls up a YouTube video about how the sodium-potassium pump in a cell membrane works. As the video plays, a singsongy female voice-over fills his office with the cloying, condescending tone of a teacher who’s convinced her students are idiots. “I mean, I can’t pay attention for one minute to that,” he says.

Several students I spoke to also pointed out that Khan is particularly good at explaining all the hidden, small steps in math problems—steps that teachers often gloss over. He has an uncanny ability to inhabit the mind of someone who doesn’t already understand something. “He explains things step by step, rather than assuming you already know how to get from A to B,” Brannan says.

“It’s just super-impressive that Sal explains stuff so well,” Gates says. “The fact that one guy can do so many subjects is pretty amazing.”

Last November, Khan Academy made the jump from hot new website to actual classroom tool. Khan had coffee with a member of the Los Altos school board who suggested that the district try using Khan’s system. Three schools offered up classes as test subjects—two fifth-grade classes (including the one run by Kami Thordarson) and two seventh-grade classes.

Khan thought he could offer teachers crucial new insight into how students learn. He envisioned a dashboard system that would track students’ individual statistics, showing them and their instructors how many videos they’d watched, how many questions they’d answered, and which ones they’d gotten wrong or right. Normally, of course, teachers fly blind. They use quizzes, homework, and their own observations to try to figure out how much their students understand, but it’s a crude process. Day to day, it’s hard to know what a student is and isn’t learning. A dashboard, Khan says, can change all that.

When Matthew Carpenter wants to push ahead, he can watch Khan Academy videos at home.When Matthew Carpenter wants to push ahead, he can watch Khan Academy videos at home.

In the fall of 2010, flush with the infusion of money from Google and Gates, Khan hired a programmer, Ben Kamens, and a designer, Jason Rosoff, and tasked them with, among other things, building the dashboard. These sorts of performance-measuring apps have become increasingly common in the business world, so the duo didn’t think teachers would be terribly impressed by their software. Wrong: They were astounded. “We’d go collect some data and make a chart, and the teachers were blown away—every time,” Kamens says. “This isn’t taxing the edge of technology. But they were completely shocked, as if this had never existed before.”

Among those impressed was Courtney Cadwell, a seventh-grade math teacher at Egan Junior High in Los Altos. When I visited her class, she pulled me over to her laptop and showed me her kids’ statistics. She flicked through screenfuls of colorful charts illustrating what subjects the kids were working on and how many videos they’d watched and problem sets they’d done. The software even told Cadwell how many minutes the students had worked at home.

“Oh my gosh,” she exclaims when she gets to one student’s account. “Kristofer, he’s working on systems of equations and subtracting fractions?” Clearly, even after working with the system for almost five months, it still has the ability to surprise her. A look at the data shows that the students seem to advance in spurts: A kid will grind away at a subject, seemingly stuck, until suddenly something clicks and he vaults forward, sometimes going on a tear and mastering several new subjects in a day or two.

Cadwell has already gotten so used to these metrics that she feels unmoored in her other classes, where they’re not yet using the system. “In those, I get to a quiz or a test and I’m blindsided when they don’t know something—or when they ace something.”

Cadwell needs all the help she can get: She teaches remedial math to the school’s struggling students, some of whom come from immigrant families with parents who don’t speak English and can’t easily help with homework. When her seventh-grade class arrived last fall, some barely had third-grade math skills. But by being able to target her students for special help exactly when they needed it, Cadwell saw stunning results: The class’s test scores improved more than 106 percent in half a year. One girl I met in the classroom had advanced an astonishing 366 percent. “I hated math,” the girl tells me cheerfully. “But now it’s actually fun.” She began the year unable to do basic fractions; during my visit, I watched her plow through complicated long division, carefully working problems on the Khan software.

Borrowing another trend in software, Khan’s team also added gamelike rewards to the interface. They came up with a welter of points, badges, and awards that kids can vie for. The Los Altos teachers were surprised—almost flabbergasted—by how powerfully the rewards motivated their students. When I visited the fifth-grade class of Kelly Rafferty at Santa Rita Elementary, the room teemed with kids milling around the school’s laptops, checking out one another’s latest achievements and trying to help each other on various modules. Rafferty pointed to a boy pecking away at division problems. “He’s done something like 500 multiplication problems,” she said. “Could I ever get him to do 500 of anything? No. So it’s funny the things that motivate them.” She noticed that one student had worked on problems at home from midnight to 2 am the night before.

Of course, kids who’ve grown up on computers are quick to spot the weaknesses in Khan’s system. They discovered ways to cheat on the drills: In the logarithms unit, for example, they noticed that the third multiple-choice answer was always the right one.

Some students also told me they were unsettled by their teachers’ ability to monitor precisely how much work they’ve done. “I just think that’s kind of awkward,” Maddy Zib, 12, said to Cadwell the day I visited. “It’s like you’re able to spy on our progress! I know you’re the teacher and that’s your job … but it’s just a bit weird.”

Not all educators are enamored with Khan and his site. Gary Stager, a longtime educational consultant and advocate of laptops in classrooms, thinks Khan Academy isn’t innovative at all. The videos and software modules, he contends, are just a high tech version of that most hoary of teaching techniques—lecturing and drilling. Schools have become “joyless test-prep factories,” he says, and Khan Academy caters to this dismal trend. Khan’s approach “suffers from this sort of ‘school über alles’ philosophy: They’re not going to question anything the schools do. They’re not going to challenge any of the content.” Stager admires the fact that Khan is trying to improve education, but he says research has shown that kids who are struggling at math won’t be helped by a “filmstrip.” Sounds to me like Mr. Stager has been in education a little too long.

As Sylvia Martinez, president of Generation YES, a nonprofit focusing on technology in the classroom, puts it, “The things they’re doing are really just rote.” Flipping the classroom isn’t an entirely new idea, Martinez says, and she doubts that it would work for most kids: If they can’t understand the lecture in a classroom, they’re not going to grasp it better when it’s done through a video at home.

Khan’s critics are mostly “constructionists.” This school of thought holds that kids lose interest in math because it’s so often taught as a bunch of mechanical routines you follow to solve problems disconnected from everyday life. Constructionists argue that it’s better to give kids activities that let them discover the principles of math and physics on their own—for instance, having them play around with kid-friendly programming languages like Logo. “Students ‘fumbling around’ is actually where the learning happens—and there’s no shortcut for this process,” Martinez wrote in a blog post savaging Khan’s system. Gates and Khan claim they’re trying to shake up the classroom, but Khan’s critics say he’s not being radical enough.

Salman Khan approaches education with the mindset of a Silicon Valley entrepreneur: Make something cool and people will use it.Salman Khan approaches education with the mindset of a Silicon Valley entrepreneur: Make something cool and people will use it.

As you might imagine, Khan heatedly rejects the notion that he’s promoting a return to rote learning. “It’s the exact opposite!” he says: The more that teachers flip their classrooms—with students watching his lectures at home—the more time is freed up for creative activities during the school day, like arts, games, or collectively brainstorming more abstract stuff. “You’re actually liberating the classroom; you’re making it more human,” he says. He takes a dim view of the constructionist idea that students won’t really understand math unless they discover each principle on their own. “Isaac Newton would not have invented calculus had he not had textbooks on algebra.” Bill Gates is even more scathing: “It’s bullshit,” he says. “If you can’t do multiplication, then tell me, what is your contribution to society going to be?”

Another limitation of Khan’s site is that the drilling software can handle only subjects where the answers are unambiguously right or wrong, like math or chemistry. And Khan has relatively few videos on messier, gray-area subjects like history.

And Khan and Gates both admit there’s no easy way to automate the teaching of writing—even though that subject is just as critical as math and students score equally poorly on it in national tests. Khan thinks one way to teach writing online is with peer review—have kids upload their writing so that the entire class can read and comment on it. (Many teachers, in fact, already do this.) In the next year or so, he wants to launch a community section of Khan Academy, where students can help each other with writing. He envisions students posting questions they can’t solve and getting guidance from other students or teachers around the world, any time of day; those who offered the best help would get voted upward.

Even if Khan is truly liberating students to advance at their own pace, it’s not clear that the schools will be able to cope. The very concept of grade levels implies groups of students moving along together at an even pace. So what happens when, using Khan Academy, you wind up with a kid in fifth grade who has mastered high school trigonometry and physics—but is still functioning like a regular 10-year-old when it comes to writing, history, and social studies? Khan’s programmer, Ben Kamens, has heard from teachers who’ve seen Khan Academy presentations and loved the idea but wondered whether they could modify it “to stop students from becoming this advanced.”

Khan’s success—and tech-darling status—has injected him into the heated wars over school reform. Reformers today, by and large, believe student success should be carefully tested, with teachers and principals receiving better pay if their students advance more quickly and getting canned if they fall behind. They’re generally in favor of privately run charter schools and hotly opposed to the seniority rules of the teachers’ unions, if not the existence of unions altogether. Though the ranks of reformers include many Wall Streeters and Silicon Valley honchos, Khan himself winces when I apply the label to him. He says he has no particular animus toward the public school system; in fact, his experience with Los Altos has shown him that public school teachers can be as innovative as anyone else. “Don’t call me an education reformer, all right?” he says. “We’re not out to fight some political battle. We’re out to build stuff that’s useful.”

Khan doesn’t seem to care whether he changes the school system. Indeed, he’s leery of working too closely with school districts, because it would require him to adhere to their rules and expectations. Until now, he has followed his own instincts in building his library of videos and software—recording the subjects his cousins needed, then gradually adding those that he found interesting or that he thought students would benefit from. But schools have a firm curriculum they have to march through, and the Los Altos teachers often find they’re moving on to subjects that Khan hasn’t covered in detail.

Khan is gamely attempting to fill those holes. But he’s not breaking his back, because he doesn’t want the school system and its byzantine standards determining what he does with his site. Indeed, he argues, trying to serve taskmasters in different districts in 50 states is one of the reasons so many educational software companies produce such dull sludge: Much like teaching to the mythical “middle” of a class, the process strips teaching materials of any eccentricity and playfulness. “I don’t want to be a vendor,” he says with a shrug.

In essence, Khan doesn’t want to change the way institutions teach; he wants to change how people learn, whether they’re in a private school or a public school—or for that matter, whether they’re a student or an adult trying to self-educate in their kitchen in Ohio. Or Brazil or Russia or India: One member of Khan’s staff—now up to 13 people—is spearheading a drive to translate the videos into 10 major languages. It’s classic startup logic: Do something cool, do it quickly, and people who love it will find you.

In the spring, Cadwell’s principal visited her classroom to see how Khan Academy was working out. The students were watching a video with their headsets on. Each was viewing it in a slightly different way, pausing and rewinding the parts that confused them and writing down notes—which is precisely what customized learning ought to look like. But Cadwell realized that, as she sat there watching, she—the teacher—appeared to be slacking. “It was just very weird when the kids had their headphones on, all watching the same video and listening to the same information, but I wasn’t in control of it!” she says.

But the principal didn’t object. As more high-quality lecture materials go online, teachers and administrators alike are beginning to realize that when it comes to simply explaining something, there’s probably someone out there who’s doing it better. So, they tell me, why compete? Focus instead on offering the sort of fine-grained, personalized help that only a live teacher can offer.

As it happens, even some teachers who’ve never heard of Khan Academy are already practicing some of Khan’s ideas: They flip their classrooms and use free tools like Google Docs to make their students’ learning as visible and trackable as possible. Many teachers are resourceful, and they’ll use any tool at their disposal—sanctioned or not. It could be that the kind of fundamental changes promised by sites like Khan Academy are going to upend the classroom, no matter what happens at the district or state level.

For his part, Khan says he’s now considering starting his own private school, as a way to see just how much you could wrap learning around Khan Academy. His ideas are intriguing: Among other things, his school wouldn’t divide kids by age; teenagers would mix in with kindergartners. “I have no research to back this up,” he says, “but younger kids act more mature around older kids, and older kids act more mature around younger kids.” If the classrooms were fully flipped, students could spend more of the school day doing creative activities. He’d use board games to teach negotiation, and he’d teach history backward. (“Why are the Israelis and Palestinians pissed at each other? Let’s go back a couple of years. Wait—they were pissed at each other even then! So you go back even further …”) He also thinks he’d teach kids subjects that have more real-world applicability—like “statistics, law, accounting, and finance. Why are you teaching people civics? Teach them law. That’s more relevant, and you learn civics at the same time.” He calculates that it would cost only $10,000 per child, “affordable for professional couples out here.”

If Khan does start such a school, he’ll have a powerful advantage. He’s been posting videos online for five years and students have answered more than 50 million questions in his software: Khan and his team are now sitting on a massive pile of data about how people learn and where they get stuck. He plans to mine the information to discover previously invisible patterns. How many times do students need to view the statistics video before they can answer questions about the subject? If you examine all the kids who stumble on, say, fractional division and basic algebra, can you predict what other subjects they’ll have trouble mastering? In the long run, Khan believes, such data mining could help him create customized lessons that are perfectly keyed to each kid’s learning style.

But in the meantime, he’s got videos to record. Back at his office, he slips on his headset. His next video will be about diabetes, and he’ll use the subject to sneak in some tricky, Khan-style math—calculating how many teaspoons of sugar are floating around in your bloodstream. “It’s almost 1 teaspoon per average-size human at any point in time!” he says somewhat gleefully. Then he turns around, hits the record button, and starts talking.


Audit Uncovers Extensive Flaws in Foreclosures.

So, now that I am back in the saddle, here goes: 

An audit by San Francisco county officials of about 400 recent foreclosures there determined that almost all involved either legal violations or suspicious documentation, according to a report released Wednesday.

Phil Ting, the San Francisco assessor-recorder, found widespread violations or irregularities in files of properties subject to foreclosure sales.

Anecdotal evidence indicating foreclosure abuse has been plentiful since the mortgage boom turned to bust in 2008. But the detailed and comprehensive nature of the San Francisco findings suggest how pervasive foreclosure irregularities may be across the nation.

The improprieties range from the basic — a failure to warn borrowers that they were in default on their loans as required by law — to the arcane. For example, transfers of many loans in the foreclosure files were made by entities that had no right to assign them and institutions took back properties in auctions even though they had not proved ownership.

Commissioned by Phil Ting, the San Francisco assessor-recorder, the report examined files of properties subject to foreclosure sales in the county from January 2009 to November 2011. About 84 percent of the files contained what appear to be clear violations of law, it said, and fully two-thirds had at least four violations or irregularities.

Kathleen Engel, a professor at Suffolk University Law School in Boston said: “If there were any lingering doubts about whether the problems with loan documents in foreclosures were isolated, this study puts the question to rest.”

The report comes just days after the $26 billion settlement over foreclosure improprieties between five major banks and 49 state attorneys general, including California’s. Among other things, that settlement requires participating banks to reduce mortgage amounts outstanding on a wide array of loans and provide $1.5 billion in reparations for borrowers who were improperly removed from their homes.

But the precise terms of the states’ deal have not yet been disclosed. As the San Francisco analysis points out, “the settlement does not resolve most of the issues this report identifies nor immunizes lenders and servicers from a host of potential liabilities.” For example, it is a felony to knowingly file false documents with any public office in California.

In an interview late Tuesday, Mr. Ting said he would forward his findings and foreclosure files to the attorney general’s office and to local law enforcement officials. Kamala D. Harris, the California attorney general, announced a joint investigation into foreclosure abuses last December with the Nevada attorney general, Catherine Cortez Masto. The joint investigation spans both civil and criminal matters.

The depth of the problem raises questions about whether at least some foreclosures should be considered void, Mr. Ting said. “We’re not saying that every consumer should not have been foreclosed on or every lender is a bad actor, but there are significant and troubling issues,” he said.

California has been among the states hurt the most by the mortgage crisis. Because its laws, like those of 29 other states, do not require a judge to oversee foreclosures, the conduct of banks in the process is rarely scrutinized. Mr. Ting said his report was the first rigorous analysis of foreclosure improprieties in California and that it cast doubt on the validity of almost every foreclosure it examined.

“Clearly, we need to set up a process where lenders are following every part of the law,” Mr. Ting said in the interview. “It is very apparent that the system is broken from many different vantage points.”

The report, which was compiled by Aequitas Compliance Solutions, a mortgage regulatory compliance firm, did not identify specific banks involved in the irregularities. But among the legal violations uncovered in the analysis were cases where the loan servicer did not provide borrowers with a notice of default before beginning the eviction process; 8 percent of the audited foreclosures had that basic defect.

In a significant number of cases — 85 percent — documents recording the transfer of a defaulted property to a new trustee were not filed properly or on time, the report found. And in 45 percent of the foreclosures, properties were sold at auction to entities improperly claiming to be the beneficiary of the deeds of trust. In other words, the report said, “a ‘stranger’ to the deed of trust,” gained ownership of the property; as a result, the sale may be invalid, it said.

In 6 percent of cases, the same deed of trust to a property was assigned to two or more different entities, raising questions about which of them actually had the right to foreclose. Many of the foreclosures that were scrutinized showed gaps in the chain of title, the report said, indicating that written transfers from the original owner to the entity currently claiming to own the deed of trust have disappeared.

Banks involved in buying and selling foreclosed properties appear to be aware of potential problems if gaps in the chain of title cloud a subsequent buyer’s ownership of the home. Lou Pizante, a partner at Aequitas who worked on the audit, pointed to documents that banks now require buyers to sign holding the institution harmless if questions arise about the validity of the foreclosure sale.

The audit also raises serious questions about the accuracy of information recorded in the Mortgage Electronic Registry System, or MERS, which was set up in 1995 by Fannie Mae and Freddie Mac and major lenders. The report found that 58 percent of loans listed in the MERS database showed different owners than were reflected in other public documents like those filed with the county recorder’s office.

The report contradicted the contentions of many banks that foreclosure improprieties did little harm because the borrowers were behind on their mortgages and should have been evicted anyway. “We can deduce from the public evidence,” the report noted, “that there are indeed legitimate victims in the mortgage crisis. Whether these homeowners are systematically being deprived of legal safeguards and due process rights is an important question.”


How To Stay In Your Home Without Paying Your Mortgage – Legally, and Without Shame.

walk away from your mortgage

I know a lot of people who are underwater on their mortgages right now. And, I’m not talking Henderson, Nevada. I live on the Central Coast here in California. Home of Carmel, Pebble Beach and Carmel Valley. Not low-end real estate. I know a woman who just walked on her $4.5 million second home in Pebble Beach which the bank just now sold for $1.6 million (after 9 months on the market). I know a real estate lawyer (ironically) who walked from his $2.7 million home in Pebble Beach which is now in the hands of his mortgage holder. They both held the same view. They looked at their living situation as they would their business and made a hard business decision. Why would you continue to make $18,000/month mortgage payments on a property that was worth less than half of what you paid? And, has no reasonable chance of returning to that valuation in say, the next ten years.

Most financial advisers have been counseling “strategic default” for the last year or so.

Mitt Romney and Bain Capital do this all the time, and they certainly have no shame. The first thing you have to do is to accept the fact that this is not a morality issue. Yes, you committed to do certain things when you signed that real estate mortgage contract with your lender, and now you are reneging on that agreement. Accept that for what it is, and move on. It does not make you a bad person.

So, I am about to suggest a process that is little known and not well understood that will allow you to stay in your home for at least a whole year, and depending on which State you live in and the depth of difficulty surrounding your particular real estate market, up to two years and beyond. It will also allow you to either pay-off your debt and/or build up a nest egg which might help you buy another property in the future.

Before you do anything, make sure that your state is one in which your mortgage holder does not have recourse to come after you personally for your debt (non-judicial foreclosure states or “one-action” states). That is, make sure you can just walk away from your mortgage. You can do this in California and in 19 other States. If you have a second mortgage, the mortgage holder has no recourse and will simply write it off. That will happen long before your first mortgage holder takes any actual legal action. Yes, that does affect your credit score.

So, after you have verified that your state is a non-judicial foreclosure state, you can begin. The housing crisis has created a huge mess in the mortgage and banking communities. Banks initially had no idea how to handle it, weren’t staffed to do so, engaged in robo-signing of documents required for foreclosure, ceased doing any foreclosures for about 9 months while the Fed looked into their lending and processing practices and have just now begun to come out of it. But it will be a long process and one that can benefit you.

Stop making payments. Start with the loan modification request. Your lender will send you document requests and you should comply, supplying everything they ask for. The first round usually takes 30-45 days. You may find that they send another request for exactly the same documents they originally requested. This is a good sign. This means that they have assigned your case to a document servicing company. I know a guy who worked through the process for 7 months before he was finally denied. He submitted the same documents 7 times at the lender’s request and wrote six letters pointing this out. Each month, he would receive a document request exactly or similar to the prior month.  When he was finally denied, he was not given a reason even though on paper, he was qualified under the bank’s own terms.

This is clearly a game played by the banks to “show” that they are in compliance with the Obama Loan Modification program. Your bank has no interest in modifying your loan.

But, I digress. Once your lender has denied your loan modification request, they will set a foreclosure sale date on your property within 30-60 days of the denial. By now, you should have been in your property, rent-free for at least 6 months.  Now, it is time to begin the short-sale process.  All lenders are required by law to offer you a short-sale option prior to foreclosure.  A short-sale is a sale at a price below the amount you owe on your mortgage and must be approved by your mortgage holder with a committed sale date. After your mortgage holder approves the short sale, find a real estate agent who’s experienced with short sales and make sure that he or she submits your short sale paperwork 14 days before the upcoming sale date. Then, after the short sale is submitted, continue to call the lender to confirm that they’re either going to cancel or extend the current sale date. They almost always agree to extend.

Once the sale date is extended, continue to delay the escrow as long as possible with a potential buyer. This buyer can be anyone – your mom, your best friend or another acquaintance who’s willing to help you out. Your buyer should cancel your contract during the period in which they can (depends on the State you are in but usually 14-21 days), then start the process all over again in about 30 days,  with a new buyer in order to continue to delay the sale. The size and strength of your lender will determine how easy this process will be – Chase or Bank of America, for example, are so buried in overdue paperwork that delaying the sale for as long as possible will be a breeze.

Eventually, (probably 6-9 months later) the lender will get sick and tired of dealing with you, and they’ll tell you they’re no longer willing to extend the foreclosure sale date (meaning that the property will be heading to auction). Don’t worry – we’re not done!

Once the auction arrangements are made (buying you another 30-45 days) you will need to file a Bankruptcy petition, and this must be done forty-eight hours before the auction sale date. You don’t need to actually go through with the bankruptcy – you only need to file the petition, as this requires the auction trustee (a 3rd party hired to foreclose for the lender) to extend the sale date! Usually, the sale date will be canceled completely or often postponed for at least 90 days – buying you enough time to re-submit a new short sale and virtually guaranteeing that your home’s file gets lost in “lender outer-space” for a long time.

It is important that you file a Chapter 13 bankruptcy. In a Chapter 13 bankruptcy, you have a few weeks after filing to provide details on all your assets and liabilities to the trustee. If you fail to do so, the bankruptcy will be canceled, which is ideal, since you only filed the petition to cancel the sale date. This process is completely legal, as anyone can decide to file a bankruptcy and change his or her mind a few weeks later.

So, as you can see, this process can buy you 2 years and maybe even more. Whatever your mortgage payments, if you put that money in the bank each month instead, you should have a pretty good nest-egg before you have to move. This will go a long way toward a down payment, or pre-paid rent on your next place, as your credit will not look so good to your new landlord.

You have rights and you should not be intimidated by the bank and all of the letters and notices you will receive throughout this process. They are intended to scare the crap out of you, and they will. But, just hang in, follow this process and enjoy the 24 months or more of rent-free living while you re-build your war chest and prepare for the next round. Good luck!