NorthBay biz sits down with Dario Navarro— lawyer, financial analyst, academic and writer—who shares his all-encompassing view of today’s economy.
He could have been talking about average weekly manufacturing hours, the index of supplier deliveries or even the real money supply. Maybe it was a report out of the Bureau of Labor Statistics, a white paper from the Brookings Institute or the monthly Conference Board Leading Economic Index. All of these will provide you an insight into our economy.
Or you could simply ask Dario Navarro.
Navarro isn’t an economist by trade—he’ll be quick to point this out should you apply that particular title to him. He’s a lawyer, financial analyst, former law and business school professor and a writer. If he asked for disinfectant wipes, he’d be a ringer for “Monk,” the TV persona of actor Tony Shalhoub. As it is, he could be a stunt double for the actor if you don’t count the glasses he’s wearing because of a minor contact lens crisis.
At the risk of damning him with faint praise, Navarro is smarter than any three people you know. He has an almost encyclopedic knowledge of economics and monetary policy. On an afternoon in August, he put his economic smarts on display for me in the form of a two-hour interview during which he explained his own views along with those of Milt Friedman, Paul Krugman and, for all I know, Sarah Palin.
OK, Ms. Palin is unlikely to espouse economic doctrine, unless she can see it from her house or it has to do with mythical death panels. At any rate, as Navarro held court on credit default swaps, the FDIC and collateral debt obligations, I scribbled furiously and attempted to pick up through listening and osmosis his gift for understanding all things economic. We’re about to find out if anything stuck.
Meet the man
Navarro, who will soon be opening an office in the North Bay, resides in Hidden Valley Lake, which sounds like someplace where you can get really fresh ranch dressing. Instead, it’s a Lake County community complete with stables, a golf course and a lakeside marina. Navarro finds it easier to concentrate away from the hustle and bustle of San Francisco, where he used to work as an international lawyer.
If education were riches, Navarro would make the titans of Wall Street look like they worked the drive-up window at McDonald’s. He entered college a year early, graduating magna cum laude, Phi Beta Kappa, in three years from Marquette University. Picked up an MPA (master of public affairs) from Princeton. He holds a JD (juris doctor) from Northwestern University School of Law and an LLM (master of law) from Yale Law School. Navarro also studied at Oxford. He’s taught at a number of universities and law schools in the United States as well Japan, Spain and Australia. As if all that weren’t enough, he speaks three languages.
His area of expertise begins with mathematical finance and advanced risk analysis, which dovetails well with my own study of finance and risk analysis on Sundays as it pertains to the NFL. But beyond that, his academic strengths lead him into international securitization deals, venture capital investment, renewable energy project finance, offshore investment fund counseling and financial risk management, especially under the New Basel Capital Accord.
If he wasn’t just a bit nerdy around the edges, he’d be a bloody show-off and difficult to be around. He’s generous to a fault, sending along emails of CARE packages full of economic articles, white papers and treatises in an effort to aid my research efforts. I don’t have the heart to tell him that a fair amount of what he sends is so far over my head I get a nosebleed reading the stuff.
On this day, Navarro wears a tweed sport coat, button down shirt, striped tie and gray trousers, and would have no problem blending seamlessly into the halls of any of the aforementioned institutions of higher learning. Fresh off lunch, he’s warming up at about 125 miles an hour on how things went so terribly wrong on Main Street, Wall Street and, for that matter, Highway 101. I offer him a glass of water but he declines, “I had two cups of coffee with lunch,” he says. This turns out to be about four cups of coffee too many, as his explanations and theories begin doing laps of the room at NASCAR speed while our ace photographer Duncan Garrett snaps away almost as quickly. After a few minor attempts at directing the conversation at a rate safe for human consumption, I abandon all hope, buckle up and cross my fingers.
How it really began
Most economists and academics hold that our present economic straits began with a heapin’ helpin’ of subprime lending, and Navarro doesn’t disagree with this premise. But for him, the stage was set for this economic crater back in 1980 with the passage of the Depository Institution Deregulation and Monetary Control Act and then in 1982 with the Garn-St. Germain Depository Institutions Act.
These laws were signed by Presidents Jimmy Carter and Ronald Reagan, respectively. While Navarro goes out of his way on a number of occasions to tell me the discipline of economics combines elements of both art and science, I mention who signed those laws since the placing of blame is very much a science—and quintessentially American. As a country, we may not always get exactly how it happened, but give us some white hats and black hats so we can pick the real villain out. “The 1980 law eliminated the power of the Federal Reserve [under the Glass-Steagall Act and Regulation Q] to set certain interest rate caps, thereby increasing the flow of funds from new depositors of savings and loan associations—making subprime lending more feasible,” says Navaro.
The 1982 law removed more controls and regulations, thereby inviting the abuses that would culminate in the S&L crisis, as Ronald Reagan and his love of free market economics gave a whole new meaning to the term “trickle down.”
While Navarro points to both of these moves as critical to future economic upheaval, the cherry on top of the subprime sundae was President Bill Clinton’s “disastrous” signing of the 1999 Gramm-Leach-Bliley Act. The act essentially let banks offer investment and insurance services, “setting off a wave of consolidation in the financial services sector and creating a shadow banking industry consisting of a diverse assortment of nonbank financial institutions that were largely outside the reach of prudential banking regulations,” Navarro offers. This would suppose that there was prudential banking regulation, but he’ll get to that sad subject later.
The newfound freedom let bankers make loans and sell them off, shedding the risk of keeping the loans on their own books and creating the process of securitization that would play a significant role in the unspooling of our economy. Not only were bankers and other lenders taking loans they made and selling them off, they were slapping them into packages that were then sliced into “tranches” and sold as bonds to investors. The tranches were rated in terms of probable risk, with safer bonds realizing less returns but being paid first and investors buying lesser-rated bonds getting a larger return and being paid after others had their payday. Ratings agencies—private companies that make a living being paid to rate the credit quality of the bonds—didn’t exactly do a bang-up job. And of course, those folks were paid by the very banks that were bringing the bonds to market, so there’s a built-in conflict of interest similar to having a defense attorney sit in judgment of his own client.
Besides mortgages of questionable worth, the crisis was fueled mightily by sophisticated investment vehicles such as collateralized debt obligations (CDO) as well as credit default swaps (CDS), in some ways the opposite sides of the same coin. CDOs essentially were investment vehicles loaded with loans, asset-backed securities, bonds and the kitchen sink, all sliced into tranches for sale that paid a return that was too good to be true. CDS let investors essentially buy insurance against the failure of CDOs to pay the promised returns. “Ironically, financial innovations designed to assign risks to those who could best bear them ended up creating unprecedented levels of systemic risk due largely to lax or nonexistent regulation of the derivatives market. For example, the one thing most so-called hedge funds failed to do was hedge,” Navarro says, finding his rhythm.
“This appalling state of economic affairs is the direct result of a dogmatic market fundamentalism that actually takes seriously the long discredited notion that an ‘invisible hand’ magically generates the collective good from the individual pursuit of self-interest. The abandonment of prudential financial regulation in the name of market fundamentalism is the root cause of the global economic catastrophe.”
Where we are now
The rest, as they say, is history. Investors pulled back, Wall Street started eating its young and banks stopped lending to other banks—and then to you and me. Investment markets that had been so frothy you thought they were sponsored by Starbucks, began tumbling ass-over-teakettle as the housing bubble burst and asset-backed mortgage securities, hammered by growing defaults, fell off the table with an economy-shattering thud. Bear Stearns went belly up when the Feds refused to intervene. The banks and AIG received billions. Lehman Brothers, Wachovia, Merrill Lynch and Washington Mutual were all snapped up with decidedly mixed results.
A $787 billion bailout is still underway, also with mixed results. The banking system is fairly solid, despite the fact that each Friday is punctuated with the FDIC announcing the latest banks to be shuttered. It certainly doesn’t look as if the car companies will be writing checks to Uncle Sammy anytime soon. At this writing, only 12 percent of homeowners eligible for loan modifications have had their loans reworked, according to the Treasury. This means there’s plenty more foreclosure pain to come. There’s months of home inventory waiting for a day when the banks will stop paying lip service to the notion of making home loans and begin doing business in a serious way. At the moment, unemployment in California stands at a whopping 12.2 percent, and the term “jobless recovery” is quickly becoming an accepted part of the lexicon.
Perhaps the best known of the various federal bailout programs is the Troubled Asset Relief Program (TARP), a program originally fashioned to buy bad loans from banks and other lenders to free up both capital set aside to cover those losses but also to clean up bank ledgers so they could get back to making loans and pushing capital into the economy. However, the program’s focus was altered to simply infuse the banking system with capital to stabilize banks and prepare the economy for the next step, while the federal government received stock and warrants as collateral. “While the capital infusion resulting from the program has given financial institutions an enhanced ability to write-down many of the troubled assets and build loan loss reserves against the future, those troubled assets still pose a grave threat to the solvency of the banking system and its ability to lend until they can be successfully resolved,” Navarro observes.
Navarro, like many critics of the program, points out that then-Treasury Secretary Hank Paulson put taxpayers in a precarious position. “A particularly egregious example of overpayment involved Goldman Sachs, the investment banking firm Paulson headed before his cabinet appointment by President Bush. Paulson paid Goldman Sachs $10 billion for preferred stock and warrants that, at the time of purchase, had an estimated market value of about $5 billion—and he bought them on much less advantageous terms than Warren Buffet had negotiated just 20 days earlier for the same type of Goldman Sachs securities. The transaction amounted to a gift of $5 billion to Goldman Sachs. Such overpayment wasn’t an isolated incident.”
He adds that President Obama has substantially improved the cost-effectiveness of TARP under a new policy initiative dubbed the “Financial Stability Plan,” but plenty of work remains.
And what of TALF, the Term Asset-Backed Securities Loan Facility, the program designed to jumpstart lending in the credit-parched markets where loans are sliced and diced into bonds and capital is recycled? Loans backed by such things as credit card receivables, auto and equipment loans (and later by real estate) have ceased to be acceptable collateral for bonds purchased by investors who are paid off via loan and credit card payments while the capital from the bond purchases recycles to the loan originators. The effect of TALF performing would be to lower borrowing costs and therefore stimulate the economic recovery.
Navarro likes TALF, but has reservations. “The success of the TALF program under Obama is reflected both in the perceived decline in the riskiness of eligible new asset-backed securities and in the recent investment surge in those securities. Still, some investors remain cautious, suggesting this part of an economic recovery remains fragile.”
Early efforts
Much of the talk of late regarding the economy has to do with President Obama’s desire to curb the kind of abusive behavior on Wall Street that caused this meltdown in the first place. Regulatory legislation introduced in July is in stark contrast to the Bush administration’s embrace of free market fundamentals that, in essence, left the markets and their participants to police and correct most movements. “The proposed legislation promises fundamental reform of the regulation of U.S. financial institutions,” Navarro says. “But I want to emphasize that, no matter how well-designed and expertly implemented, such reform will inevitably prove inadequate to the central regulatory task of mitigating systemic risk unless there’s coordinated, simultaneous international financial regulatory reform.”
I mention that, normally, this is how I prefer my reform as well, though G-20 has been less than enthusiastic to my overtures regarding outlawing the designated hitter on an international basis.
Ignoring me, Navarro pushes on. “Given the myriad vulnerabilities of the deeply interconnected U.S. and global economies, another, even more devastating economic collapse could occur, which could rival or even exceed the severity of the Great Depression, and that would be just like ‘déjà vu all over again,’ as Yogi Berra once observed. He might have also added that the current economic crisis ‘ain’t over till it’s over,’” says Navarro, “and, as things now stand, it ain’t over.”
One of the phrases that will no doubt stay with us long after the stupendous collapse of our economy is “Too Big to Fail.” It was applied to AIG to justify the $134 billion in taxpayer cash that was injected into the insurance company. It was used in relation to the $45 billion the Feds sent Citibank’s way, and it’s been used regarding the bailout billions that Bank of America slurped up. Ironically, the reason the Feds felt so strongly about recapitalizing all of the aforementioned companies is that a failure or bankruptcy by any of these major players was thought to carry so much potential for systematic economic failure.
But now that we’ve shelled out the cash, the banks are bigger than ever. For example, JP Morgan Chase, Bank of America and Wells Fargo now each hold more than $1 for every $10 held on deposit in the United States—a level of market monopoly that previously would have triggered antitrust action. Granted, Morgan bought out failed lender Washington Mutual, B of A picked up Merrill Lynch and Wells acquired Wachovia, deals all spurred by the flailing economy, but it’s also worth noting that, in each case, Uncle Sam was at the deal table giving his blessing in an effort to keep things together. Moreover, add Citibank to the mix, and you now have a group of four lenders who originate one in every two mortgages and two out of every three credit cards in the United States.
“It’s at the top of the list of things to fix,” Sheila Bair, chairman of the FDIC told the Washington Post recently. “It fed the crisis and it’s gotten worse because of the crisis.”
The concentration of so many deposits and originations in the hands of so few lenders means consumers have fewer choices, products aren’t efficiently priced and, based on the bailout, banks may assume that, should they get into trouble again due to their own reckless behavior, Uncle Sam will get out the checkbook and begin covering bad bets.
It’s a little thing they call “moral hazard,” and it’s the kind of thing from which movies are made. Witness the documentary “American Casino,” produced by the husband and wife team of Andrew and Leslie Cockburn, and the flick “Capitalism: A Love Story” directed by baseball-cap wearing Michael Moore.
Challenges ahead
So how bad are things now? “The current global economic crisis has been correctly characterized as the worst downturn in U.S. and world economies since the Great Depression,” Navarro says. Don’t sugarcoat it, give it to us straight.
The bailout has, thus far, provided the public at large with the chance to buy new cars with up to a $4,500 government subsidy, supplied us a whole new cuss word—AIG—and plunged bankers to a spot so low on the respect meter that they currently reside below lawyers and even the media. So what does Navarro see as the next move? “I think I’d like to quote Paul Krugman’s answer to a similar query: ‘Damned if I know,” Navarro says, lifting a quote from the Nobel Prize-wining economist and New York Times columnist.
“I can make a few educated guesses about how to extract ourselves from this economic quagmire. First, comprehensive regulatory reform is paramount. Second, it would seem that, despite some shocking excesses, overpayments and mismanagement, the approach taken with TARP did bring some stability to financial markets and should be continued for now. Third, another stimulus package appears necessary to accelerate the recovery, boost production and further reduce unemployment. According to Krugman, the $787 billion stimulus package will only boost the U.S. Gross Domestic Product by $510 billion over the next two years and it will only reduce unemployment by 1.7 percent, so more spending may be required.”
Navarro also wants the Obama administration to take the gloves off and actually have the various acronyms now in charge of soothing financial markets and institutions go beyond supplying them with soft words and cold compresses. “The United States needs to comprehensively reform the lax regulation of financial markets in close coordination with other G-20 countries. A new global regulatory regime must be responsive to the inherently chaotic, unstable nature of international asset markets. The neoclassical model of markets as self-equilibrating, self-regulating, optimizing machines must be discarded as a basis for future reform, because it’s been persuasively disproved by a mounting avalanche of evidence.”
To you and I, this may sound like week 13 on the syllabus from Econ 231, but to Wall Street types, them’s fightin’ words. To free marketers, this is the worst possible idea. But Navarro believes too much deregulation, mixed with too much leverage and too much greed, has become an economic Kool-Aid that has the country shouting at its shoes—and the time to sober up was last year…only he says it this way: “A modern variant of the Glass-Steagall’s separation of commercial and investment banking should be reenacted. I favor strict regulatory oversight of all investment banking operations and limitations on bank involvement in the insurance industry, but not in the precise form those limitations took in the original Glass-Steagall. This is an area that requires further in-depth, empirical research before new reforms are adopted.”
Down time
When Navarro isn’t advocating for stricter economic oversight, the Encino, Calif. native can be found working on behalf of clients who are pursuing a variety of investment strategies. One is setting up a new private equity fund in Southeast Asia targeting investment in natural resources and a separate carbon finance firm focusing on forest preservation in Indonesia. Another client is actively engaged in opening a sports marketing business representing American athletes in China, while another is exploring a move in Canada revolving around neutralizing toxic waste using emission-free combustion technology.
His love of nature has made him an advocate of environmental conservation, championing policy measures to slow global warming and improve public understanding of a cap-and-trade system to fight greenhouse gas emissions. “The United States must make even larger investments in renewable energy than the $70 billion in expenditures and tax credits that the Obama administration passed in February. That amount is really just a drop in the bucket. Over the next decade, the United States needs to spend at least 10 to 20 times that amount to achieve the kind of industrial transformation necessary to even begin to approach energy independence.”
Which, to a lot of people, might sound like work. So what does Navarro do to unwind? “As a lawyer with an extensive background in pro bono civil rights federal cases for American Indians, African Americans and Mexican Americans, I have a deep and abiding revulsion of the torture policies pursued by the Bush administration, which I believe were initiated and maintained in overt violation of international law. While I lived in Madrid, I gave numerous public lectures detailing why it violated the United Nations Charter.”
Navarro is nothing if not focused, passionate and, well, focused and passionate. So what does he do to relax? “One of my favorite pastimes is to simply go hiking and camping in a wilderness area, preferably in the mountains near the sea. That really replenishes my spirits,” he says. “When I was teaching and working north of Tokyo at Tsukuba University, I would return to San Francisco every six months or so and drive up to Humboldt and Del Norte counties to go camping.” Which is somewhat ironic: As Navarro spends his days exploring the economy and law—fields where I’m clearly wandering the wilderness—he relaxes by leaving the GDP behind and exploring the back country.
