Our guest on the podcast today is author Zachary Karabell. He's written numerous books about global history, economics, and politics. His latest is called Inside Money: Brown Brothers Harriman and the American Way of Power.
Inside Money: Brown Brothers Harriman and the American Way of Power, by Zachary Karabell, 2021.
"Zachary Karabell: How a Boring Bank Shaped the Rise of American Power," by Jane Wollman Rusoff, ThinkAdvisor.com, July 30, 2021.
The Leading Indicators: A Short History of the Numbers That Rule Our World, by Zachary Karabell, 2014.
"Capitalism Doesn't Have to Be This Way," by Zachary Karabell, The Atlantic, May 21, 2021.
"The Capitalist Culture That Built America," by Zachary Karabell, The Wall Street Journal, May 14, 2021.
"Fannie, Freddie, and the Destructive Dream of the 'Ownership Society,' " by Zachary Karabell, The Atlantic, Aug. 10, 2013.
"A House Is a Home--Not an Investment," by Zachary Karabell, The Atlantic, Sept. 13, 2013.
Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends on It, by Zachary Karabell, 2009
"Trump Got China All Wrong. Now Biden Is Too," by Zachary Karabell, Foreign Policy, March 24, 2021
"China's Didi Crackdown Isn't All That Different From U.S. Moves Against Big Tech," by Zachary Karabell, Time, July 9, 2021.
Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance and retirement planning for Morningstar.
Jeff Ptak: And I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.
Benz: Our guest on the podcast today is author Zachary Karabell. He's written numerous books about global history, economics, and politics. His latest book is called Inside Money: Brown Brothers Harriman and the American Way of Power. Zachary, welcome to The Long View.
Zachary Karabell: Thanks for having me, Christine.
Benz: Well, thanks so much for being here. Our first question relates to the book. We want to talk about your latest book, Inside Money, which is about Brown Brothers Harriman. That firm has always kept a pretty low profile, so I'm wondering what put them on your radar and made you think that they would be a good subject for this book.
Karabell: It is a very good question, given that it is a firm that, for the entirety of its 200-plus years, has studiously and assiduously shunned the spotlight and has treated every day in which their name does not appear in one form of news or media or another as a good day. Which is very different than the JPMorgans or E.H. Harrimans or Goldman Sachs today, which in some respects, had an ethos or have an ethos a little bit more of wanting to imprint their name on the annals of history. And those types tend to make for better, more gripping, stirring, heroic, villainous, famous, infamous narratives.
My reasons for writing about Brown Brothers: I guess, number one is what is that mode of a firm and an entity that's survived, in part with an ethos of being part of the story and not the story, tell us about sustainable capitalism. Two: I wanted to write about the role of money in constructing American power in the 19th century, and then about the way in which the men who made the money of the 19th century--and they were all men, and they were all white men, and they were mostly white Protestant men--how did those men take their sensibility and their perceived formula for success and construct the domestic and global economic system that in many ways we live with and live under, for better and for worse today? And Brown Brothers was, because they've been around from the creation and basically nobody has been around either as long as them or through the present--and that in and of itself was not a reason to write about them, right? Living long is not necessarily living interesting--but because they were at the center point of so many crucial moments in the evolution of the United States and in the definition of the world we're living in, I think they became, if not the perfect foil, then the perfect exoskeleton for that story and that narrative.
Ptak: Why have the firm's leaders always made the choice to stay out of the spotlight? You alluded to it before. It's unusual. So why did they make that choice?
Karabell: Yeah, I think part of it stems from the particular personality of Alexander Brown, who is the paterfamilias, who's the patriarch who creates this thing that eventually evolves into Brown Brothers and then merges with Averell Harriman's firm in 1929, which is how you get Brown Brothers Harriman. He really was this kind of Irish immigrant to Baltimore, linen merchant, who then evolves into one of the richest citizens of Baltimore and his four sons, from Baltimore to New York to Philadelphia to Liverpool and their various offshoots, including Alex Brown in Baltimore and Brown Shipley in the U.K. His letters to his children are full of Poor Richard's/Polonius type of hectoring advice, a lot of which has to do with: Those who are speculative or garner too much attention are also those who in times of problem and duress are the objects of ire and attack.
And he got that intuitively. And then the firm a little bit in the 1830s and 1840s, because they were so successful into the 1850s, becomes the subject and the object of the celebrity preacher of the day, Henry Ward Beecher, who uses Brown Brothers as the thing he rails against to say that American society has lost its way, lost touch with God's word, and has embraced mammon and greed and avarice even though Brown Brothers wasn't actually particularly greedy or avaricious. And I think that experience also solidified in them the notion of mostly harm can come from too much public profile and not a lot of good. Combined with the fact that they really did believe in a noblesse oblige, older view of hierarchical society where elites had a responsibility to serve and to treat their “to the manor born” as something that gave them great responsibility. And I guess the final reason is they really did believe that their firm and the business of a merchant bank and that a bank was to serve clients first and not their own self and not their own wealth and not their own ego, which didn't mean they didn't have ego, and it didn't mean they didn't get wealthy. They had both, and they certainly did. But that ethos really coursed through them generation after generation, partner after partner, down until the present day, and that's partly why the partners of the firm were, I would say, initially trepidatious and a little bit anxious when they knew that I was going to write this book.
Benz: I wanted to ask about that. How did you gain access? I mean, it seems, obviously, like you've leaned on a lot of original source material. But did the firm welcome you in to do interviews? How did that work?
Karabell: I guess, luckily for me, the firm on its self-designated 150th birthday in 1968--and I say "self-designated" because one of the things I talk about in the book is I think they kind of made up their founding date, and I actually think their founding date should be more like 1800 when Alexander Brown flees Belfast and sectarian violence and sets up shop in 1800--but they commissioned a corporate history in the '60s. And they employed a gentleman for, I think, more than three years, who assembled all the papers of the firm back to Alexander Brown, including private letters and family memorabilia. And all of that was deposited at the New York Historical Society in the 1970s and is open to the public.
So, even if Brown Brothers had been determined to thwart my attempt to write a book, it wouldn't necessarily have mattered for the historical perspective because everything is no longer in the firm's offices. It's all at the New York Historical Society. And, you know, selfishly, it was incredibly easy for me to do the research because I live five blocks from the New York Historical Society. So some of the easiest research I've ever done logistically; I could roll out of bed, get coffee, and go to the archives. And I don't write a huge amount about the firm in the past 30 to 40 years because a lot of the business of the firm in that period, custody and foreign exchange clearance, a lot of the necessary aspects of the financial-services world, but not really stunning narrative. And part of my point in the book is: What's wrong with a firm that does really well doing necessary tasks that aren't the stuff of legend and headlines? But because they're not the stuff of legend and headlines, there wasn't a lot to write about from a narrative, popular history, making these larger points, perspective.
So I do talk a bit about the firm in the ‘80s and ‘90s. And I did interview a partner, and I did want the firm's goodwill. I mean, this is their history. It's also the history of the United States. And it's a way of writing about the financial history of our entire nation. So, it's a lot more than just about the firm. But I certainly wanted the buy-in because while it exposes some uncomfortable aspects of the firm's history, their involvement in slavery, their culpability in reducing a lot of Central America to U.S. imperial vassalage, their exclusionary elitism, none of which sits easily in our contemporary world. It is ultimately a book that honours their place in shaping the world that we're in. And I certainly wanted them to see that and have their goodwill, as I would about anybody, and ultimately, that's exactly how they received the book.
Ptak: The firm certainly has a rich history. You've done a great job of laying that out. But as you mentioned, it'll be unfamiliar to a number of our listeners. So maybe it makes sense to level-set--just to talk in layman's terms about what the firm does for those who maybe aren't familiar with its operations and then we can delve into how it is they go about their business. You want to talk about that for a minute?
Karabell: Yeah. They have had a lot of incarnations over 200-plus years, as I suppose almost any entity that has evolved over time would. So the business they did in 1800 and the business they do in 2021 are, if not completely different, you know, substantially different. So, for the first, let's say, 30 years of Alexander Brown and his sons acting as merchant bankers, they were involved in the physical trade of goods--first, transatlantic linen and then a whole slew of stuff, mostly that was manufactured in England and then shipped to and then sold in the United States.
But what made them so important and ultimately so rich was they very quickly--Alexander and particularly his eldest son, William, who was in Liverpool--first of all they become a massive player in the U.S. cotton trade in the 1820s and 1830s, controlling as one family firm as much as 15% of the cotton trade by the 1830s, which was an incredibly lucrative and massive aspect of U.S. trade. But they also decide--I guess, for two reasons--to get out of the physical business of owning ships and having cargo. One because, as a risk-averse family, shipping goods is always risky, particularly in those years where you never quite knew if the ship would sink, you didn't know whether there'd be a financial crisis in the two or three months it took to get across the Atlantic. And it couldn't really scale without massive investments, right? Building ships was really costly.
So, they quickly get into the financing of the cotton trade and writing these things called letters of credit, which are quite arcane, but without which there isn't really any international trade. Because, in a nutshell, what letters of credit solved was if you're a seller of cotton, or any good in the United States, before you part with your stuff, you want to know that somebody on the other side is going to pay for it. And if you're a buyer of cotton in England, you want to know that you're going to get cotton if you part with your money. And the only way to solve for that problem was for someone to promise each side that payment would be made and goods will be delivered. And that's essentially what Brown Brothers starts arranging through these letters of credit. And they take a small cut of those letters each time.
By the 1840s, they're less and less involved in physical trade, and they're more and more a paper merchant. And their paper becomes one of the most trusted currencies in the world. Because there is no dollar that's trusted. The British pound is, but it's not controlled by Americans. And that's really what makes them incredibly rich. They also, frankly, were morally opposed to the slave system, even though they were massively involved in it and beneficiaries of it. I suppose you could call that hypocritical, but it was also true for many Northern merchants and businesses that were just deeply immersed in the cotton trade. You know, one of the reasons Lincoln says, in the 1850s, you can't have a half-slave and half-free nation is that so much of the American economy by the 1850s was profiting from slavery, that you weren't really half-slave, you were kind of all-slaves when it came to the economy. And the only way to change that was to really begin to end the slave system.
So that's kind of what they do for the rest of the 19th century. They are really a paper merchant. Their letters of credit become traveler's letters of credit. And I guess the best way to understand that is, for those who remember American Express Traveler's Checks--you know, before you could travel around and just stick your card in an ATM, you needed something that you could travel around the world and pay with, and they are letters for a lot of the late part of the 19th and for the 20th century were that. When Woodrow Wilson goes to the Paris Peace Conference in 1918 to negotiate the peace, he brings with him $10,000 of Brown Brothers traveler's letters to pay for whatever he needs to pay for in Paris. It will come as no surprise, he didn't spend a lot of money in Paris, but he could have.
And then in the 20th century, they start becoming more of what we would define as a merchant bank, and they did that, too, at the end of the 19th century, doing episodic deals. But they were never a huge player in the railroad trade in the 1880s, ‘90s, the way JPMorgan was, in the way Collis Huntington and Stanford and E.H. Harriman, in particular, who I obviously write a lot about in the book. Because it was just too risky. It was too speculative. Most of the people who funded the railroads initially lost their money. It was the people who bought the bonds after they had gone bankrupt for pennies that made the money and that wasn't really Brown Brothers’ style.
And then into the 20th century, they move into wealth management. They become one of the really early creators of what we now know as the wealth management industry where they had clients who were asking them what to do with their money, and they started advising them how to invest their portfolios. Which to us today is like the most obvious thing in the world, but in the 1930s it was a new thing, as well as the growth of the modern mutual fund industry, which Brown Brothers was intimately involved in, packaging portfolios for their clients, particularly after Glass-Steagall, and they hive off their investment bank. Which ironically becomes over time Drexel Burnham Lambert, which is the home of Michael Milken, and you have this kind of lovely thing in the book of the contrast between Brown Brothers and its ethos of public service and keep a low profile and serve your clients. And their kind of bastard stepchild of Drexel Burnham Lambert, which really defined the go-go, get everything you can, as quick as you can, as much as you can ethos of the ‘80s that I think in many ways defines the financial world today.
So, that's the three-minute overview of the firm. There's obviously more there there, but I guess that gives you some flavor.
Benz: I want to follow up on the risk-aversion idea, which you've hit on a few times. And you make the point in the book that the firm's partnership structure encouraged that sort of circumspection because the partners knew that they were all personally on the line for the decisions that they would make. Can you expand on that?
Karabell: Sure. And that partnership structure was totally typical in the 19th century, right? So, there was nothing unusual about Brown Brothers having a partnership structure. Most financial firms were a privately held partnerships well into the latter part of the 20th century. So, in that sense, the contrast is between how Wall Street used to be and how it became, or how the financial world used to be and what it became. Because Brown Brothers, unlike a lot of the firms that we now know and are familiar with--Morgan Stanley and Goldman Sachs and JPMorgan and, you know, you name it--all of which went public in the '80s and '90s. Merrill Lynch, I think, actually went public a little before then.
Brown Brothers stayed a partnership, and I am hardly the first person to note the stark difference in incentives that those different structures create. So, if you're a private partnership, every deal that you do involves partner's capital, which means you are personally liable for loss as much as you are personally betting on gain. And I think that changes the risk/reward perception. Where the public shareholder one, particularly at size, most of the risks of doing transactions get externalised. Right?
So, think about it today--I'll just use Tim Cook as an example, not because I'm picking on Tim Cook and Apple, just it's a familiar one. Tim Cook could do an acquisition or some deal with Apple that could potentially, if it goes very well, gain him $10 million in personal compensation. And again, I'm not saying he's doing that deal for that. I'm just saying he could do a deal and that could be the result. It's almost impossible to imagine a deal that would personally lose him $10 million. And, in fact, Apple, much like the financial giants of 2008-2009, if a deal goes really badly--yeah, he probably could lose his job. But the losses would probably be not only absorbed by the mass of shareholders but potentially by the government. You know, Apple today is probably just as too big to fail as AIG was in 2008. And that just doesn't pertain in a partnership, you know, your losses are your losses. And that creates a different attitude toward risk. When you're on the hook for the downside, it does curtail just how much you're willing to wager or put on the line for the upside. If you're not nearly on the hook for the downside, you'll wager, if not infinite, a whole lot on the upside because you gain a lot personally.
The other aspect that's really different is the definition of what's it for. What's the purpose of a firm? What was the purpose of Brown Brothers and then Brown Brothers Harriman? If you'd ask the partner, certainly by the turn of the 20th century, and they're eventually steeped in these ideals of service and these ideals of trust and these ideals of the public good is intimately tethered to private gain. Private gain is intimately tethered to public good--that a private entity cannot thrive endlessly if the community in which they're embedded is suffering or not thriving, and that as a thriving private entity, or as a wealthy private individual, you have a responsibility to serve that public good and to augment it in so far as you can. The notion of shareholder capitalism--as in the only definition of a firm's purpose is to return maximum gain to shareholders--that definition of capitalism would have struck them as bizarre. And they were just as capitalists, you know, they did deals, they wanted to gain money, they got rich. I mean, we're not--this was as real capitalism as any. But that notion of capitalism and the purpose of a firm, they had a much more expansive or a much more constrained or contextualised idea that a firm is part of a larger entity, is part of a larger society, that wealthy people--particularly those born into great wealth, right? These were people who knew generationally--Alexander told it to his kids, his kid told it to theirs, the partners told it to younger partners--they knew that at certain point that they were born on third base, and they didn't pretend that they weren't. They acted like “OK, if we're going to get born on third base, what are our responsibilities?” much the way some European aristocrats eventually start developing a sense of, “What are our responsibilities to this world, given that we are privileged?” And that really shapes the firm, and I do think shareholder capitalism in the ‘80s, combined with celebration of more and more and more, rather than what is enough, changes the financial world, changes the nature of the culture in that world--and not for the better.
Although, and we'll go on from this, I do say in the book, and I have said in multiple interviews, you don't want a financial world composed only of Brown Brothers, right? Brown Brothers never would have, like, given Tesla seed capital or any capital, right? They're not into speculative, and you need someone to provide speculative capital. It's just the ratio and the balance within the financial world has gotten way too skewed toward the golden ring and not nearly celebratory enough of the mundane daily necessity of boring finance. And in some ways, you know, Brown Brothers is a celebration, today at least, of boring finance, although they, too, recently sold part of their business, and we'll see what they become in the future.
Ptak: Building on that, we did want to ask you to reflect on the global financial crisis at the center of which one could argue sat these very large, publicly traded financial institutions--a few of which you mentioned--the question we're going to ask is whether you think the system has been shored up since then? Or do you think similar risks remain based on your previous answer? It sounds like you still think there's a lot of work to do.
Karabell: I think there's a lot of work to do culturally. I do think in the large banks, that the multiple, not just legislative, you know, Dodd Frank, but a whole series of other rulemaking by the Federal Reserve, rulemaking by the Comptroller of the Currency, rulemaking by the bank regulators, really has constrained a lot of the financial world in its exposure to risk, in the kind of traditional money centers and big banks, let alone asset managers. You know, hedge funds are a little different, although they, too, rely on the capital and credit extended by those large banks, which every now and then seems to get out of hand. I mean, there was a huge blowup of a hedge fund in 2021--Archegos, which most people had never heard of--because they had been presumably extended a level of credit based on past performance that proved unwise.
I don't think there's the level of risk, systemic risk, within the financial system. I do think there is still an ethos of the huge payday--again, somewhat less so within the large banks, more so on the periphery and private institutions and hedge funds and private equity, venture capital. And I'm admittedly guilty of painting with a broad brush. There are always exceptions to every rule. But I don't think that the culture in the financial world has changed. I think the constraints have increased. I think the risk is less. But I don't think that culture of public service, and by public service, it doesn't mean you go into government, right? One of the interesting things about Brown Brothers in the ‘40s and ‘50s, just like Goldman Sachs in the ‘90s and the aughts, was the number of partners who went into very high roles in government. And that's partly what made it interesting for me to write the book--people like Robert Lovett, who became Secretary of Defense, Prescott Bush, the progenitor of the Bush family political dynasty, but the money comes from Brown Brothers and also from the Harriman's and Union Pacific. And then Averell Harriman himself, who serves multiple roles in government, including U.S. Ambassador to Moscow under Roosevelt, Administrator of the Marshall Plan, which was a massively important role in the late ‘40s, Governor of New York, and then Assistant Secretary of State for East Asian Affairs and therefore part of the whole Vietnam quagmire.
But public mindedness, right. And I think if anything, there are even more stark lessons for tech firms today, particularly public firms, which much like the financial firms, pre-2008, were and are in many ways either blithely indifferent to the negative consequences of their actions on society and highly focused on the positive ones. I mean, there are immensely positive aspects that the tech world has created. We couldn't have survived the pandemic, the way we did financially, without a lot of these tools that these tech firms have created. But the indifference to what is the effect of what we do on the larger society? What's the most balanced way to create guardrails, right? The partners of Brown Brothers, weirdly enough, in 1933 were quite supportive of Glass-Steagall, which was the major first New Deal reform, and the creation of the Securities and Exchange Commission because they felt like, “Look, first public trust has badly eroded because of the Great Depression, so any kind of regulatory framework will help restore public trust and that will help us do business and that will be good for our shareholders and that will be good for our franchise.” And because they felt like some rules were really important. And you know, the tech world today, I guess, occasionally says “Sure, regulate us, please,” but they're not doing a whole lot to shape what that would be or instill an ethos. So, I think culture within a lot of large companies is still deeply problematic. I'm a really strong believer in culture. It's something we can all shape and should and need to, individually, collectively within our own firms. Morningstar certainly had a culture for years about what it believes to be right and wrong, which you know, some might agree with and some might disagree with, but it's a clear sense of values, and I think that's absolutely vital and often missing.
Benz: Our backgrounds all relate to investing and the asset-management industry. When you're thinking about end investors in mutual funds and other financial products, is there a corporate structure that is better for them? So, is a fund fielded by a partnership type firm better than one fielded by a publicly traded asset manager? Do you have any opinions on that?
Karabell: Yeah, I'm not sure that shapes the asset-management industry quite as much, right? Because you're not putting deal capital at risk in the way that you are in traditional banking or underwriting or securities issuing. So, the difference between BlackRock and a privately held asset manager in terms of its perception of fiduciary responsibility to its clients, I'm not sure is as dramatically different as it is in other aspects of the financial-services world. I mean, it is interesting to me that Brown Brothers does give birth in many ways to the modern asset-management/money advisory industry--one because of Glass-Steagall, they lose part of their business. So they're looking for what can replace what investment banking used to be? So, there's a self-interest to their innovation of wealth management. But they do start realizing they've got all this knowledge of the world, they're constantly looking at companies in terms of, "Should we loan the money? Should we help them issue securities?" Again, pre-1933. "Why don't we use that knowledge to help pick stocks or assess the creditworthiness of its bonds and help our particularly wealthier clients in those years invest, and we'll take a fee." But because they were only taking a fee, they weren't really taking a massive brokerage fee. Right? They weren't driven by commissions. They were driven by advisory. It's sort of the birth of this modern fiduciary idea of: We can earn a fee to benefit our clients' retirements and help them navigate the confusion of the markets. Robert Lovett and Bush write a pamphlet in '34, '35 called "Scattered Wealth." And they do what everybody does today. Morningstar does this, too. It looks at different portfolios. They're like, you know, the portfolio of X companies in 1990, if you had held those for 20 years would have been awful, even though they look great in 1990. But if you've done something else in 2000. The same kind of exercises, right? Looking at how you need to be dynamic and constantly reassessing, and you need expert advice, and it's hard to navigate.
So, they really helped create that sensibility, which then becomes this multi-trillion-dollar, in terms of assets, and certainly multi-billion-dollar in terms of revenue industry. But I don't know that just because the nature of that industry, per se, when it's no longer about brokerage commissions, and it's almost never, it's increasingly rare for the mutual fund and asset-management industry to be driven by commissions. There are certainly aspects of it but less and less and less. And that I think is the more important thing than the public/private. Meaning is the person you're entrusting your money with being driven by, they're profiting from transactions? Are they profiting from your profit? And you want the interest to be aligned, you want them to profit from your gain, not just from churn and transactions.
I think, you know, 20 years ago, that was more in doubt. Again, I think Morningstar has been pretty adamant about that being a vital necessity, i.e. the people you entrust your money with are doing well only when you do well and not irrespective of you doing well. And I think, increasingly, that's a lot of what defines the asset-management and the mutual fund and the advisory industry. But it's not what defines investment banking and private equity and venture capital. And I'm not saying those are bad industries. I'm just saying it's a different incentive structure.
Ptak: Just building off of the research that you've done for the book and the sort of observations you've gleaned throughout your career: If investors are looking to take the measure of an investment firm to entrust their money with, what do you think they should focus on to ensure that the firm would likely be a good steward? I'm sure that there's different sort of concepts and principles that you've already touched on earlier in this conversation, but maybe you can bring that together. If you were trying to do that, what would you focus on?
Karabell: You know, certainly: Is that firm client-centric? Right? Is their business model focused on you doing well? And that can be hard to glean, right, because nobody's marketing material says, "Actually we're in it for ourselves." Right? Like, that's not the headline of any brochure, or you don't click onto the web page of a company, and it says, "50 years of inordinate benefit for us." So, everybody says they are client-centric, and everybody talks about how much they're dedicated to serving you. And Brown Brothers' archives were full of the firm's brochures from the '30s, and '40s, all of which tout their--first of all, they tout being private and small, which is interesting, right? They're always saying a limited number of clients. So part of what they were trying to say to their prospective clients is, "If you join us, you'll get more focus and attention, because you're not just one of gazillions, you're one of a few. And so we have more bandwidth to pay attention to you." As we know, size in and of itself is not predictive of good customer service or caring about your clients. But I do think trying to suss out the degree to which a firm in its compensation for itself is, in fact, benefiting mostly when you as a client are doing well. And not just benefiting from you being a client. And that can be everything from performance fees, to, I guess, asset-based fees, to some degree, get around that, right? The more you have, the more your advisor has, the less you have, the less your advisor has--so they have an incentive to make sure you have more.
Obviously, performance matters, too, but it doesn't matter, like the only thing. Otherwise, you'd only invest with people who are really hot the past year or two, and that would probably be a really bad decision because, as you all know well, just in the ebb and flow of what works and what doesn't, most places have some ebb and flow. And usually, once they've done really well, they sometimes have a few years where they do less well, just statistically. Those are the sorts of things I think are really, really vital. And I do think you can find them. I also think survivorship, you know, the bias of the industry today is such that it's harder and harder to find people who really do reek of pure self interest.
And again, I'm not a purist here, I think, self interest is always part of it, like, “Am I going to make money?” Not just, “Am I going to make you money?” And that's part of the system we're in. Some people think that's a problem. Some people think that's glorious. Either way, it is what it is. But the thing that I found really striking about Brown Brothers was the degree to which it maintained a level of knowing who they were and not being driven by the fads of the day to change their stripes to follow the next 10x, or the next something. And I think that's important, too, right? There's a difference between evolving with the times and grasping for the next gain. So, I think there's that, too.
Benz: In the book, you wrote about how Brown Brothers Harriman endured multiple economic and market shocks. And the catalysts were certainly all different, but the underlying conditions were the same, where the system would build up these excesses and they would eventually have to be wrung out. I know that you're a student of economic history; you've written about many of these issues. Do you spot any underdiscussed risks in the system today?
Karabell: What's interesting about Brown Brothers and if you read Alexander Brown's letters, which I doubt most people will, but you could at least read the book and read a few of them. His general take was: There is always a crisis looming, but you're never going to know what it is, and the time to be prepared for it is before and not during and certainly not after. You know, meaning the only surety is that something will happen. Everything else is unclear: when, how much, to whom, what the catalysts will be? You can never really be--again, this is the Alexander Brown and Brown Brothers approach to risk, right--you can't really be specifically prepared, you can only be generally prepared. And again, the time to be genuinely prepared is now. We certainly found this in spades during the pandemic, right, the time to have enough personal protective equipment is before, not during when everybody needs it.
The reason why it's called “stockpiling” is you do it in anticipation of needing it at some future date when everything goes to hell, not scrambling around while it's going to hell, trying to figure out what to do. And I think that's the right approach to our present and future in that there are the risks that everybody looks at that sometimes come to bite you. I mean, everybody knew there was a housing bubble in 2006, 2007. But everybody didn't know the derivative exposure being held by these large financial institutions on their own books. They knew there was going to be a housing bubble that would pop, but you couldn't really have known that it would almost trigger a global financial meltdown. I mean, yes, after the fact, the four guys in their underwear who were warning about this in their basements in 2007, suddenly became heroic figures. But there's always like four people in their basements warning about some Armageddon. And if we listen to each one of them each time, you'd be wrong a lot more than you'd be right.
I don't know what the next crisis is going to be, and I don't know what's going to trigger it, and I don't know what's going to cause it, and I don't think anybody does. And I think trying to inoculate yourself from those specifics means you're probably going to spend a lot of money and a lot of energy trying to protect yourself against something that might happen and not necessarily protecting yourself against that which inevitably will happen. And again, the only way to do that is to think about your risk tolerance and figure out what you can lose and what you can't and how much and when and what your time duration is. Rather than trying to figure out like, “Oh, my God, I saw that it's actually going to be a meteor shower in 2026. That's going to knock out the power grid throughout the northeastern part of the United States. And so I'm going to buy up a lot of wind farms in Tulsa.” I mean, if that were true, that'd be great. Right? And more power to you if you believe that to be true. But I think that's an awfully hard one to fully game out.
Ptak: Maybe shifting to your career and investing more generally: You were head of global strategies at Envestnet and president of Fred Alger before that, but you're not involved in the investment business on a day-to-day basis anymore. And that seems somewhat unusual. Many people stay in the financial-services industry for their whole career. What prompted the shift for you?
Karabell: Yeah, for me, I have a quirky background in that I really started my career, whatever that means, as an academic. I got a Ph.D. I got a Ph.D. in history and international affairs and thought I was going to be an academic. I decided I wasn't going to do that. I moved to New York to be a writer. I got involved in writing more and more about the financial world and day trading, because everybody was day trading in 1999. I wrote a few books. I wrote a few books about American history. I wrote a book about the election in 1948. And then I wrote a book about the sort of stock market frenzy of the late '90s in the context of American dreams of a better world. So, I knew something about finance, and I knew something about the financial industry, and had interned at various firms in college and decided I didn't want to be in that world and was probably going to join some Silicon Valley startup and briefly be worth a lot of money until I was worth nothing. And then 9/11 happened. And at the time, I was dating someone who's dad, Fred Alger, had started this large financial firm. And he called me up on 9/11 and said, "You got to come work for my company. We got to save the company." Thirty-five people had gotten killed, including David Alger, who was the president. And one of the only people who survived was her sister's husband, Dan Chung, who's now CEO of Alger. So I started working at Fred Alger on 9/11. And got more and more drawn into the business. Ended up marrying the girlfriend. So my entry into the financial world was more some weird combination of nepotism, tragedy, and skill than it was, "I'm going to be in finance."
I started a China fund. I got really involved in Chinese investing. And it was a world that I had some facility and familiarity with. And so I kept doing different things. At Envestnet, I'd known Bill Crager and Jud Bergman. And they had asked me to come join. So I end up having this 20-year career in financial services, briefly ran a hedge fund, somewhat more inadvertently than advertently. And throughout that time, I kept writing and writing articles and writing books. I was on CNBC for seven or eight years as a regular on “Fast Money.” So, for me, it's less that I left the financial-services industry than I rejoined the writing part of that. And while it's true that I don't manage other people's money, I do manage my own and my family's and do a lot of private investing. I just don't do so in the roles that I did before or run a company in the roles that I did before.
And it's not sort of like “been there, done that.” I think part of the Brown Brothers book came out of a, you know, there's a lot about the asset-management world that I respect deeply. There's a lot about the deal-making part of Wall Street that I have real issues with in terms of the culture. And part of what the Brown Brothers book is a reminder that other cultures are possible, have been in place, can be chosen, and would be a whole lot better for society if they were. This notion of you can't pursue private gain, completely detached from public good. And in fact, if your private gain is of some x level, you actually do have a moral responsibility to attend to the world in which you live in a constructive fashion. And I think the more firms that embrace that, the better we will all be.
Benz: You referenced your experience in China, your interest in China. So, I want to spend a few moments here talking about the Chinese market. We've now had a few guests on the podcast suggest that China is probably the best place in the world for active fund managers to add value because the market, in their view, is quite inefficient and dominated by novice investors. Do you concur with that?
Karabell: I think that if you're going to try to invest domestically in China, like in the Chinese A-shares market, which none of us can do individually anyway, so you are sort of forced to do that through professional managers who have allocations and quotas. I suppose there are a few ETFs you can buy and a few funds you can buy that give you proxy or even direct exposure to China A-shares, but you and I couldn't, you know, doesn't matter how much money you have, we can't just go buy Shanghai- and Shenzhen-listed A shares. So, there's a caveat to that statement of: If what you want is to invest in the domestic Chinese equity market, you have to hire a professional money manager to do so actively. With a few exceptions, again, there's a couple of A-share listed ETFs and there are some through some of the more higher-end wealth managers, you can find some funds. So maybe less than it's like the best place to do it--the flip side is more like, it's the only way you can do it.
And in terms of the China market, per se, there's been so much noise and massive sell-offs based on the Chinese government particularly cracking down on its own tech companies, that you do have a very favourable valuation moment, which in no way says that things couldn't keep going down, right? But it is one of those times all out Warren Buffett of like, “Be greedy when others are fearful and fearful when others are greedy.” There's a lot of fear about China. There's certainly a lot of political fear. There's a lot of cultural fear. There may be, you know, an inevitable unfortunate coldish war. I think that's the wrong analogy, but we all get the point emerging between the United States and China, which is not preventing capital flows. That might make China a very attractive long-term investment opportunity simply because there's so much conviction that it's not.
But look, I continue to invest probably more in China than many. Sometimes that's been really good. Sometimes that's been quite bad. And I do think it is the most significant other economy in the world that has its own extraordinary peculiarities, closed capital account, etc. But I think it's something, particularly after the past six to 12 months of real challenges to the Chinese equity and financial markets, some of which is inflicted by the Chinese government, some of which is created by the tension between China and the United States, that there are some really good long-term possibilities there.
Ptak: So for those committed bargain-hunters who have China in their sights because it's sold off the way it has, any advice, counsel, you would offer to them, given the experiences that you've had investing in that market and examining the companies that comprise it?
Karabell: Yes. I mean, every time I invest in something, right, if I buy shares of Alibaba, which has been halved because Jack Ma is under, well, he's not under house arrest, but he's basically been told to be quiet. You know, just because it's down 50% doesn't mean it couldn't be down another 50%. And I think that's an important thing to tell ourselves. And that's true of any U.S. stock as well, right? No company is beyond radical and massive declines, particularly short-term ones. And I think that's a little more true of the China names just because whatever portion of that valuation is driven by investors like us, Americans or Europeans who think, "Oh, this is really interesting and opportunistic." You know, that money is more promiscuous. It's much more liable to flee at the slightest hint of problem. So, you have that kind of added problem, right? Meaning the bargain-hunter you just talked about, who goes, "Wow, all these Chinese Internet names, massive companies, billions of dollars of revenue in valuation, and they are selling for half of what they did a year ago. This is a great time to buy." And I might agree with that, right? But then they go down 20% and the same person who thought that on Tuesday, is like, "I'm out of here. I don't know what's going on. I don't want to lose any more money." And so the volatility increases, and the selling pressure increases much more than the buying pressure. I just think that's something to be mindful of--the degree to which these names can trade somewhat irrespective of their intrinsic business because of the peculiarities of who buys them, why they get bought, and when they get bought.
Benz: Well, Zachary, this has been a fascinating discussion. We've really enjoyed chatting with you today. And thank you so much for taking time out of your schedule to be with us.
Karabell: Absolutely. My pleasure. I love a wide-ranging discussion that goes from Belfast in 1800 to whether or not you should buy an ADR on the listed exchange of a Chinese company in 2021. I mean, that really gets through a lot of the history of the world in the past 221 years.
Benz: We covered a lot of ground.
Ptak: We very much enjoyed it. Thanks again.
Karabell: Thank you.
Benz: Thank you for joining us on The Long View. If you could please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.
You can follow us on Twitter @Christine_Benz.
Ptak: And @Syouth1, which is, S-Y-O-U-T-H and the number 1.
Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
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