Personal Finance: Conservative Investing

When it comes to white-shoe, old-money banking, Brown Brothers Harriman and Co. could give Mortimer and Randolph Duke a run for their money. Down to its mahogany-paneled walls, the nation's oldest and largest private bank epitomizes traditional business conservatism on Wall Street. Once counting Prescott Bush—President George W. Bush's grandfather—as a partner, the firm only just admitted its first female partners in 1998. But how much can even the über-rich who have access to institutions such as Brown Brothers insulate themselves in the market when the Dow slips below 8600 points? Because it is a private partnership, Brown Brothers does not release detailed financial results about the roughly $45 billion it manages, but as Wall Street's losses pile up, and adventurous banks crumble, Brown Brothers' partners aren't losing nearly as much sleep as many of their peers. To find out the secrets to their success, NEWSWEEK's Katie Paul spoke with Charles Blood, a financial strategy director at Brown Brothers, about weathering the economic crisis, how to keep your money safe, and why he thinks things could get better in just six months. Excerpts:

NEWSWEEK: Since you take a long-term view of the economy, what's your take on how bad this situation is? Charles Blood:
Everything keys on how we go through this part of the slowdown, perhaps recession. We'd like to say we've got a two-year view, but the more relevant question is how we are going to get through the next six months. Up until three weeks ago, outside of the financial or housing sectors, the economy was actually pretty strong, surprisingly strong. GDP kept coming in positive—below its normal rate, but positive.

What changed?
Three weeks ago, post-Lehman weekend, money-market rates went up very sharply for most borrowers. That's a big deal. Not only are there credit-flow questions, but also the price has gone up for everybody. That increases the risk that this moderately positive GDP number could tilt over into a recession.

So you don't think we're in a recession yet?
Not if you think of recessions as negative GDP. But out in the real world, it certainly feels like a recession: Unemployment's going up, retail sales are going down, income growth is slow or negative, and people are struggling with the consequences of high gasoline prices. By any standards that normal people use in living their lives, it would be a recession.

What do you see that's promising about the economy at this point?
We're almost at the point that it's bad enough that it's good. The credit crisis seems to be approaching climax. On the other side of that comes the rebound. Now we're trying to figure out where the bottom is. Six months from now, I think we'll be talking about an economy that has bottomed and started to improve.

What are the indicators that the bottom is on its way?
One of the classics is that the stock market bottoms. At that point, you just turn on a clock and expect that the economy will bottom six months later. The stock market now looks like it's getting close to a low. That's a risky thing to say, because it might take another month or two. We're not in the early stages in all of this. But the main thing we have to see before we can make any legitimate projections about the economy is for interest rates to go down. Nothing's going to happen while we're in this acute credit crunch. That will be the first sign that we're on the road to healing.

Are there any safe havens left?
If you need money right away, it's the classic things—treasury bills, short-term deposits at the best banks. If the question is more about whether or not investments will be OK, well, it's not universal.

It seems like one supposed safe haven is crumbling after another. People have been advised to look to commodities, emerging markets, money-market funds and so on, but one by one, they're all being called into question.
I think money market funds are still safe. All their investments are short to begin with, and there's now a Treasury guarantee overlaying it. That's one of the programs designed to get us through the crunch. But those other things never struck me as safe. Who can be surprised that commodities or emerging markets are volatile? When it looked like volatility was only on the upside, we may have liked it, but that didn't make them safe. The same could be said for stocks.

Is the definition of safety shifting now? Have we been unreasonable in our expectations for high returns, and are fundamental changes in the system required to downplay the obsession with high returns each quarter?
Yes, that's shifting already. People got used to higher returns. First, we got used to high numbers because inflation was high. Then, we went from stocks being very cheap in the early 1980s and housing being cheap to both being more expensive, so it wasn't unusual to make 15 or 20 percent or more per year. Lost in all that shuffle is a financial truism: Over the long run, stocks return about 9 percent. So, if you're disappointed by 9 or 10 percent, as a prevalent view has been, well, expectations will just have to come down.

What would you recommend people do with their cash now, whether they're working with a long or short time horizon?
The advice I give, I try to take it myself: Don't think you have to make a decision today, don't think it's one single decision. If you're not sure, chop it up into smaller pieces. If you're thinking about stocks, don't put all your stock money to work at once. Make four decisions. Make 10 decisions. Put one-tenth of the money in. Take small steps, so you don't lose sleep over any one step.

Wall Street historian Ron Chernow has expressed concern that the size of these bailouts threatens to tax the federal government's resources so much that they won't be able to achieve their goal of restoring confidence. Do you agree?
I don't. A lot of this is recycling money, not spending money outright. The $700 billion is not spent, gone and never coming back. There will be at least some return on those assets they're buying.

But isn't the concern that most of that money might not come back?
Yes, it hinges on what price gets paid for those assets. There are a lot of smart people trying to figure that out, and the answer is not clear yet. We won't know the net cost of this thing for five years. People worried about the same thing during the Savings and Loan crisis during the 1980s, but the net cost of that turned out not to be as bad because of the recycling.

It seems like there's a complete lack of confidence in government and financial leaders. Do you think there's good reason to trust that they're doing what they have to do?
I think yes, because there's constant evidence of their willingness to do more. Today, there were already three announcements on the Federal Reserve Web site. They're not being dissuaded because the numbers are getting large. It's like Texas Hold 'Em, in that the scale of the bets can get big real fast and people get scared out. They're not getting scared out.

How much is Brown Brothers feeling the pinch? Why have you been unscathed compared to other banks?
The pinch has been minimized because we didn't get involved in the risky areas to begin with. As a commercial bank, we don't underwrite securities, which is what caused most of the problem for the big investment banks. Brown Brothers didn't get from 1818 to today as a partnership by taking extreme risks. There is a longer-term view here. Because we don't have stockholders to report to and we don't have to make quarterly profits, there's not this need to look good for each quarter and deal with the consequences later. There's a culture of conservatism in business dealings that emanates from the structure of the firm.

But you're not completely insulated, obviously.
Of course not. We manage people's money and the markets are down, so we feel it that way. We are a very big custodian firm for mutual funds and other banks. So we have to be prepared for things to slow down some, for profits to be less. But we as a firm never got involved in things like credit derivatives and subprime mortgages. So we didn't get the upside, but we don't get the downside. Our cycles are much more muted than many others'.

Is there a lesson in that? Or is that something that's only affordable if you're starting out with $10 million, as many of your clients do?
On this side of the cycle, it's easy to say that everyone should have done what we did. The Brown Brothers model is not the prescription for everybody. Having said that, it's easy to say now that the very aggressive firms had too much leverage. Somewhere between where we are and always have been and where they ended up, there's a more normal operating style, which will come back.

So it's just that the median shifted too far in the other direction?
It certainly did. With the decision to allow the big investment banks to increase their leverage in 2004, the same loss they once might've survived became much more threatening. But it will take years to know what the lived reality of the changes in the financial system will be like.