Happy 2009

This is actually a new-for-2009 Waterford crystal ball, approximately 10 feet in diameter, weighing over 12,000 pounds, covered with 2,668 crystal triangles, and illuminated by more than 32,000 LEDs.  Happy big bad bright New Year.

Actually, Dear Reader, I imagine many of you, as I, will be just as pleased to kiss 2008 goodbye:

• The Dow ended the year down 33.8%, its worst annual showing since 1931--and 28 of the 30 stocks (all but Wal-Mart and McDonalds) were down by more than 10%;
• The more representative S&P 500 was down 38.5%;
• The famously tech-centric NASDAQ was down 40.5%;
• The small-stock Russell 2000 was down 34.8%;
• The FTSE 100 declined 30.9% on the year, its worst annual drop since it was created nearly 25 years ago;
• Nearly $7-trillion in US wealth has been wiped out, erasing all the stock market gains of the past six years;
• There was no place to hide abroad either, with the "BRIC" stock markets down from 55% to 72%;
• Commodities such as oil and copper have crashed, and the Reuters-Jefferies CRB index, which first began tracking a basket of commodity prices in 1956, will be down nearly 40%, an all-time record annual decline, while the S&P FSCI index, another benchmark for commodity investors, was down over 50%;
• And of course the US housing market is in a famous and now nearly theatrical swoon, with median prices (there is of course no such thing as a "median" housing market) down by about 14%, by all accounts the largest decline nationwide since the Great Depression;
• Wall Street as we knew it (Bear Stearns, Lehman Brothers, Merrill Lynch, and Morgan Stanley and Goldman Sachs in their own ways) went away;
• Not to mention Heller Ehrman, Thacher Proffitt, and Thelen Reid, plus countless layoffs and pay and bonus freezes in our little corner of the world.

What, then, are my wishes for you for 2009?

As I've written fairly consistently this year, try to put these events all in perspective.  You are not your net worth or your income, and if both have returned to 2002 or 2003 levels, the world has not, actually, come to an end.

Nevertheless, an array of forces that have heretofore seemed rather randomly aligned, disconnected from one another, and more imaginary than real, may—emphasis on may—be assembling for the first time into something recognizable and coherent, although still, at the moment, of little real impact.  I don't know if this is, or will be, true, and I don't know of any way of thinking about it harder or looking for more data to tell if it will be true.

I can promise to you, however, Dear Reader, that in 2009 my fervent hope and commitment will be to continuing to make "Adam Smith, Esq." a place where everyone who cares so deeply about our industry and our profession can assemble to help figure these things out—and change them for the better.

Happy Big Bad Bright 2009.

Perspective

Perspective.

It's time for some.

A friend of mine who's the lead financial reporter for one of the original three networks prompts these thoughts. Not that he/she subscribes to the view that it's time for some "perspective"--au contraire. To paraphrase their view: "We're in a severe recession. This is not the time to be sanguine, it's the time to be alarmist. [And] In terms of investments, it's time to go to CD's; if you've already lost 40% in equities, you want to get out; you don't want the 40% to become 60%."

Now, we all react in our individual ways to once-in-a-career times like these, and if my job were to report on deadline every weeknight to a national television audience about the state of the economy and the financial system, I'd probably not be writing this piece. I'd be writing about how this time is different, and not for the better: That this time is more akin to the Great Depression than to the 70's staglation and OPEC oil price spike, the 80's Volcker-induced shock therapy to stamp out inflation, or the 90's dotcom meltdown. I would, in other words, be writing alarming things.

Since we're still in the middle (the beginning?) of this economic episode, we of course can't know. My call for "perspective" may be delusional and this may be one of those pieces ruefully quoted back to me months or years hence. But I'll go out on a limb.

This chart shows the US per capita GDP in 2000 dollars from 1870 to 2004 (ratio scale), and comes from the new textbook Macroeconomics by Charles Jones:

The trendline is 2%/year growth, and the only real deviation visible to the naked eye is the 1929-1933 Great Depression--and even after that, the trendline quickly returned to normal. Every other recession appears as little more than a blip or a rounding error.

What does this tell us?

It scarcely "proves" that this time is nothing to worry about, but it does suggest that, my friend the financial reporter's views to the contrary notwithstanding, the "animal spirits" of capitalism (John Maynard Keynes' felicitous phrase) will arise again. Assets will be bought and sold. Companies will be started, grow, and decline. Capital will flow from country to country and industry to industry. New financial instruments will be created. New regulatory structures will govern. Globalization will not cease.

In all of these activities, lawyers and law firms will be enablers, facilitators, innovators, brokers, handmaidens, and creators.

I'm not gainsaying the challenges, and for those of you in leadership positions in firms these days, this is surely the time you'll earn your keep. What I'm saying is:

• Be not apocalyptic.
  
  
• Manage your partners' expectations. If next year is tantamount to a return to 2003, we'll all live.
  
  
• Recruit carefully, prudently, assiduously, but keep recruiting. Talent is your lifeblood. Do not shut if off.
  
  
• Communicate, communicate, communicate, to your partners, associates, and staff, about how the firm is doing. (Yes, some of it will hit "Above The Law" in a nanosecond, but that's a topic for another day.)
  
  
• Communicate with your clients. They're anxious as well; let them know you're in the same boat. A little bit of sympathy about cost-cutting pressures wouldn't hurt as well.

It all depends, perhaps, on your perspective. If it's the nightly news, it's one thing. If it's the arc of a career, it's another. Stay true to which is yours.

Beyond continuing to hypothesize duelling views of future realities, let's look at the historical record (with help from McKinsey).

Financial crises, to begin with, are not that rare:  On average, they occur every decade to one major economy or another.  And while this promises to be among the more severe, a lesson from the 20th Century is that how bad things will get depends largely on the governmental response. 

At this point (December 2008), according to Bloomberg, US financial instiutions have taken total credit-crisis related write-offs of almost $1-trillion.  McKinsey estimates the total required amount of writeoffs will be between $1.4 and $2.2 trillion, or 10—15% of US GDP.  Historically, in the past century that level of writeoffs was exceeded only three times:

• During the early 1990's banking crisis in Japan that initiated its "lost decade;"
• In the Asian financial crisis of the late 1990's;
• And of course in the Great Depression.

In the first two, writeoffs in the affected banking sectors were 15 and 35% of GDP respectively; in the Great Depression, about 20%.

But from the perspective of the functioning economy, the real question for companies is not what's happening in the banking sector but what's happening to the availability of credit:

How long it takes an economy to emerge from a downturn depends heavily on what kind of cleanup and stimulus package governments employ--especially in repairing the banking system's ability to provide credit efficiently and restoring confidence among companies and consumers. On average, countries have needed two years to emerge from past recessions after major banking crises and up to twice as long to return to trend growth. Only in two cases did a downturn last substantially longer: in Japan during the lost decade, as a result of counterproductive government policies, and in the Great Depression, when the government was far less able to mount a coordinated response than it is today.

And with respect to stock markets—the high-profile indicator that everyone including our financial reporter friend pays attention to—we are also, apparently, in a quite well-precedented downturn:

Equity markets are the most visible and dramatic indicators as crises unfold. At the end of October 2008, the S&P 500 index had fallen by 46 percent from its peak a year before (October 9, 2007, to October 27, 2008). By late November 2008, the US equity market had given up almost all of its gains since the 2001-02 dot-com bust. Although nobody knows if the market has reached bottom, the fall so far isn't unusual by historical standards. Japan's Nikkei 225 fell by 48 percent from peak to trough (December 29, 1989, to October 1, 1990) during the banking crisis, though the market has subsequently fallen still further; at the end of October 2008, it retained less than 20 percent of the peak value reached in 1999. During the Asian financial crisis, the equity markets of Indonesia, South Korea, and Thailand fell by 65, 72, and 85 percent, respectively, in local-currency terms. In the United States, the S&P 500 index fell by 49 percent from March 24, 2000, to October 9, 2002, after the tech bubble burst.

Here, as well, are some fascinating and troubling statistics on the housing market.

But reasons for hope still remain, and they're all tied to how theunderlying economy is—or isn't—isolated from the financial services sector blow-up.  For example, in the early 1980's S&L crisis, 258 US banks failed or required FDIC assistance and during the entire decade of the 1980's 750 failed and more than 1,500 required assistance (vs. 35 during the entire decade of the 1970's), yet corporate investment continued to increase at an annual rate of 4.5% in the 1980's. How well prepared are we today?  Surprisingly well:  US industrial companies have higher interest coverage and lower leverage than they did going into the dot-com bust or the S&L crisis.

By contrast, one reason the Depression was Great was that business investment fell by more than 75% from 1929 to 1933 because capital had almost nonexistent cross-border mobility and even the soundest of corporate credits couldn't obtain long-term debt financing.  That happening again today appears exceedingly unlikely.

So where does this leave us? 

As we've just all learned, the famous PG Wodehouse character had it right when he said, "never confuse the unlikely with the impossible."  Now that we've all seen shockingly unlikely events unfold, including the end of Wall Street as we knew it, what should we actually be doing?

Your answer depends on how uncertain you feel about the future.

If you feel that what we're going through is a "normal," albeit severe and protracted, recession, we know how to deal with that. Pull in your horns, sit tight, control costs rigorously, and wait for the legal industry (a lagging industry) to pull out after the real economy does.

If on the other hand you feel that we're experiencing a generational or once-in-a-career change in the way high-end legal services are bought and sold, then you need to stand on tiptoes, rather like a sprinter entering the blocks at the starting line of a race, prepared to bolt forward as soon as there's clarity enough (in your mind) to think the starter's pistol has fired. This does not mean you need to be inattentive to costs, any more than sprinters are inattentive to weight, or complacent about your current exalted standings. At the starting line, you have no standing; all are equal, at 0:00.

This is where I actually think we are. We are all about to begin running a new race, one where incumbency will count for far less than it used to, and where a premium will be put on agility, speed, and foresight. Because this race, once the starter's pistol fires, will be run in heavy fog, with visibility just yards down the track and the positions of your competitors, be they ahead of or behind you, difficult to discern moment to moment. But the time to start training, to make your firm more agile and alert and responsive, is now.

Thacher, Proffitt & Wood LLP: 1848 - 2008

A Merry Christmas, Happy Holidays story of the first order:

As noted this morning by The New York Times, Above The Law, and The WSJ Law Blog, Sonnenschein is acquiring about 100 lawyers, including 40 partners, from 160-year-old Thacher Proffitt & Wood—technically, not a merger of the firms but a large lateral group acquisition.  The lawyers come from Thacher's four main practice areas, including Structured Finance, Corporate and Financial Institutions, Real Estate, and Litigation, and include the chairs of each group.. 

The sad news is that this represents the end of the road for Thacher as a firm, but the reason to celebrate is that this extremely talented group of lawyers will have the opportunity to remain together, serving their clients from a broader, more diversified, and financially strengthened platform.

Are there larger lessons in this deal for our industry?  I believe so, but for now I'll leave those for another day.  (Hint:  They have to do with heavy concentration on specific practice areas.) 

For the moment, it's a much-needed vote of confidence in the ultimate recovery of the financial services sector:  Thacher's core clientele included all the biggest banks and investment banks and today a marquee client is the US Treasury Department itself, under the TARP program.  The sector will regain a pulse eventually, and this is a sign that I'm not alone in that faith.

Sad as it is to see a storied firm, bombed out of the World Trade Center twice and still resilient, reach the end of its road, what really matters is not the name of a brand, but the individual lawyers and professionals. No one at Thacher died during the two WTC attacks, and none will "die" professionally today. That's why it's a good news holiday story. They are living to fight another day, and (disclosure) from personal experience and acquaintance, I can testify that they're fighters.

Rumors of Its Demise

"Reports of my death have been greatly exaggerated."
—Mark Twain, in a cable from London to US publishers, who had mistakenly printed his obituary.

And so, for the entirety of my career, has it been the case with predictions of the demise of the billable hour.  If the best predictor of what will happen is what just has happened, then the billable hour is here for keeps.  But I wonder.

If you can say nothing else about what's going on now, you can say that the volume of the dialogue about alternatives to the billable hour has never been higher.

Last month the Association of Corporate Counsel announced their "Value Challenge," through, among other venues, an interview with Susan Hackett, their GC. Some of her comments included:

Value from the corporate perspective means receiving a solution that addresses the client's problem-for an appropriate cost. [...] Take a look at the cost of legal services and the fact that they've been rising 6, 7, 8 percent a year, for as long as anyone can remember. But the services remain pretty much the same. And at the same time that outside firms' costs are rising, the in-house law departments are getting better at their efficiencies and at lowering their costs. [...]

We also want to measure whether people are starting to do more of their work on a non-hourly basis. It¹s one metric. I¹m not saying billable hours is the entire project, but it¹s one good way to look at this. [...] You would see a lot less work done on the billable-hour basis, but I don¹t know what alternative billing will look like.

I don't know about you, but it sounds like "billable hours is the entire project."

Consider another perspective: The dehumanization that comes with the billable hour. And dehumanization it is, is it not? Doesn't it tell people that they're fungible commodities? To be sure, their hourly rates vary, but they're all and every reducible to cogs in the machine. No rewards for specific insight, no discounts for slogging through it, no premiums for remarkable efficiencies. You are your watch.

Or consider the perspective of the intersection of the core years to partnership tournament with the key family formation and child-bearing years. At the moment, these two critical life trajectories tend to overlap in people's lives. Both are intensely time-consuming. Their intersection is, for many people, unsustainable; they are forced to choose one or the other.

Don't misunderstand; I'm not suggesting that the pressures of the path to partnership years--and the partnership years themselves--can be substantially ameliorated, minimized, or underestimated. There is no substitute for hard work if one wants to achieve professional performance at the level partnership entails. But what I am suggesting is that the billable hour model exacerbates the tension between familly and work precisely at the time it matters most. Without it, contributions could be more readily recognized "on the merits," without the quota of hours in the office or on the BlackBerry.

Two other perspectives are, I believe, more important and will be more consequential. One results from the tsunami of changes in the complexion of the financial services industry in the last year and the other results from an inherent structural problem with the billable hour model for firms themselves.

Financial Services

The industry is unrecognizable from its form a year ago. Bear Stearns, Lehman, Merrill Lynch, gone, and Morgan Stanley and Goldman Sachs essentially far different from what they were. Balance sheet leverage ratios of 30:1 or 40:1 are ancient history. New regulations, of forms we can't yet predict, are certain. Old forms of regulation may go by the wayside, but the net result, to be sure, will be an overall increase in oversight.

Which brings me back to the billable hour: If financial services comprise a substantial part of your clientele, look forward to their being more heavily regulated than before. With congressional oversight. Care to explain to, say, Barney Frank, why $1,000/hour is a fair and economically justified rate? Wouldn't you far prefer to explain why (say) $750,000 as a flat fee on a $50-million transaction is reasonable?

Also, Bank of America buys legal services very differently than did Merrill Lynch. RFP's, beauty contests, bakeoffs, diversity quotas, expectations about first and second year associates (don't bother putting them on the bill), and so forth: It will be a new world.

Structural Issues

I have long predicted that the demise of the billable hour will only come about when law firms find it in their own self-interest to call a halt, and perhaps at last the stars are beginning to align. Consider the four variables that determine your firm's revenue and profitability under the billable hour model:

• Rates;
• Hours;
• Realization; and
• Leverage

Faithful readers will know that I've pointed out that all four of these variables have intrinsic limits:

• Rates: $1,000/hour? £1,000/hour? At some point there is a limit to clients' stomach for it.
• Hours: 2,200/year, 2,600. 3,000? At some point the body rebels, and the talent pool capable of sustaining these super-human schedules thins out.
• Realization: >100%? I think not.
• Leverage: At what point do associatesl look at the odds and simply check out?

But on the profitability side of the ledger, there are no intrinsic limits.  How high is "too high" for PPP?  Sarah Palin Joe Six-pack probably thinks $2-4-million/year would do just nicely, but when you're a partner at BigLaw regularly rubbing shoulders with hedge fund managers and private equity folks—or plain old Fortune 500 CEOs—you're a piker by comparison. Consider also the baffling silence over the fact that corporate execs get equity in the form of stock, restricted stock, or options.  Lawyers, even the best of them, toil for ordinary income.  Yes, you can make a very respectable income and if you sock it away prudently (we Scotch Presbyterians can give you advice on this if you'd like), you'll end up with a very comfortable nest egg.  But it will have been gained by the sweat of your brow and not the true alchemy of returns on capital.  So we have, under the billable hour model, inherent constraints on revenue but no inherent constraints on the desire for ever-increasing profits.

This brings me to the point: Won't firms find it in their own self-interest to get beyond the billable hour in the pretty darned near future?

Do not, I hasten to add, be afraid. "Alternative billing" is not code for "reduced revenue."

Indeed, we have every reason to expect that getting away from the billable hour will lead to less micro-management of billing, fewer he-said/she-said spats about whether this, that, or the other micro-activity was justified, and less general embarrassment over tiny charges for faxes, messengers, and other costs of doing business.

I'll suggest another reason more potent than "embarrassment" for ditching the billable hour:  Doesn't it fundamentally reflect a lack of trust between your firm and your clients?  Rather than being able to say "For professional services rendered...." and have confidence that hte client will trust you to have put a fair price on things, the billable hour reflects a green eye-shade mentality, notoriously subject to auditing (now, even by bespoke software programs designed to ferret out inconsistencies and discrepancies of the most minute and trivial nature).  The billable hour, I believe, starts from a relationship of mistrust:  "See, we can prove we actually did the work!"  And the GC or other inhouse counsel can, in turn, tell their finance department, "Yes, see, they really did the work." 

This is not the premise from which mature relationships of trust and confidence arise. 

At the risk of piling on, I'll suggest yet another reason the billable hour disserves our profession:  Economically, it begins life with "cost of production" rather than "value to client."  Except for the rawest and most basic of commodities, "cost of production" should have virtually nothing to do with price.  (OK, before the microeconomists in the audience start piling on, permit me to issue the immediate caveat that, in a  perfectly competitive marketplace, price will equal marginal cost of production, but I stoutly question the assumption that the marketplace for services of BigLaw is remotely "perfectly competitive.")

To be sure, firms need to meet their costs and then some to make a profit, permit reinvestment in their businesses, and appropriately reward their owners and investors.  In this technical sense, then, "cost of production" is clearly a relevant variable when determining price.  Price best exceed cost of production by a reasonable margin if the firm is to survive as a going economic entity.  But for price to be mathematically determined to the second decimal place by "cost of production" is flatly irrational.  Worse, it ignores (again) what the perceived value of the services is to the client.

Now, don't pretend you can't put a value on those services.  We value complex baskets of goods and services all the time, and markets for those goods are highly liquid.  Why is a haircut at "Frederic Fekkai" on East 57th Street worth hundreds and hundreds of dollars while one with Sal the barber on Upper Broadway is worth $30 including a hefty tip? 

Finally, a failure to bill "for professional services rendered" represents, I must believe in my heart of hearts, a failure of courage.  Do you mistrust what your services are worth?  Do you mistrust whether your client agrees with your perception of their value?

If that is the root cause of the continued dominance of the billable hour, then we have far more work to do than turning off "timeslips elite."  But for the health of our profession, for our self-respect, and for the benefit of clients, turn it off we ultimately must.

Lessons From Citi

Consider a nonrandom selection of headlines from The New York Times, The Financial Times, andThe Wall Street Journal:

• Citigroup Pays for a Rush to Risk
• Citigroup Tries to Steady Stock
• Turmoil Continues in Banking Sector
• Citigroup: You Can't Step Into the Same Crisis Twice, Right?
• Citi crisis deepens as shares fall further
• Pandit denies break-up as Citi tumbles

Aside from the obvious, that these articles all revolve around Citi, they have, I suggest, one core theme in common: An erosion of trust in Citi. Theobvious question is whether this skepticism is warranted. Some think not:

"The earnings power is there," said Charles Peabody, a financial services analyst at Portales Partners. "It's a question of getting through the credit issues."

But is that the right question? Trust may be intangible, but it's an intangible with extraordinarily powerful repercussions. Trust is granted by grace, not demanded or usurped by fiat, can only be cultivated over an extended period of time, and can be forfeited in a heartbeat (Exhibit A: Eliot Spitzer).

Now,this may seen an exercise in rehearsing the obvious, but at times a return to first principles is in order.

We sit astride or at least within firms which may have hundreds of thousands of dollars of debt per partner, and extensive long-term lease obligations, often in far-flung networks of offices, yet whose assets voluntarilly choose each morning which building to enter and which elevator bank to go to.

As Citi's recent experience deonstrates, these are not abstract issues.

How, then, can you reinforce the cultural glue that brings people back to your offices every day?

I submit you have two tools at your disposal: (1) Communication; and (2) Behavioral Incentives.

Communication means constantly telllingpeople how the firm is doing and reinforcing that message at every opportunity you have.

Be candid, or don't bother. People have shockingly acute sensitivity to insincerity, and an incomplete or half-hearted effort will do more harm than good.

If there are challenges facing the firm, explan them. Call for collaborative action and, if necessary, shared sacrifice. You'd be amazed at people's ability and willingness to rise to the occasion when hard times are at hand.

How will you know if your message is getting through? Ask them. Ask your partners, associages, and staff if they feel they understand the firm's situation, meaning the external threats and opportunities, and the internal strengths and weaknesses. And, of course, your plans for addressing those threats and weaknesses.

Afraid that if you communicate it will appear on Above The Law in no time?

Get over it.

We live in the YouTube/Above The Law era, but that does not relieve you of your obligation and your duty to lead. It makes it more challenging and more risky, but if anything even more necessary. I've written that information abhors a vacuum, and the unprecedented availability of channels for near-instantaneous distribution of rumors or innuendo increases, not decreases, the burden on you to tell the firm's story. If you're clear, consistent, candid, and direct, Above The Law won't be able to lay a glove on you. (If you disagree, permit me to ask you whether your time-frame is that of months and years, appropriate to managing a firm, or that of Above The Law itself, which is hours or minutes.)

Second, Behavioral Incentives: Reward (read: pay for) the behavior you want.

As an economist, I can't help but reflect the reality that I'm ingrained with the power of incentives. This brings us back to Citigroup:

To some, the misery at Citigroup is no surprise. Lynn Turner, a former chief accountant with the Securities and Exchange Commission, said the bank's balkanized culture and pell-mell management made problems inevitable.

"If you're an entity of this size," he said, "if you don't have controls, if you don't have the right culture and you don't have people accountable for the risks that they are taking, you're Citigroup."

A more serious problem was whether the bank, assembled from a potpourri of financial services firms by Sandy Weill, ever came together as one coherent entity:

Even as Citigroup's C.D.O. stake was expanding, its top executives wanted more profits from that business. Yet they were not running a bank that was up to all the challenges it faced, including properly overseeing billions of dollars' worth of exotic products, according to Citigroup insiders and regulators who later criticized the bank.

When Mr. Prince was put in charge in 2003, he presided over a mess of warring business units and operational holes, particularly in critical areas like risk-management and controls.

"He inherited a gobbledygook of companies that were never integrated, and it was never a priority of the company to invest," said Meredith A. Whitney, a banking analyst who was one of the company's early critics. "The businesses didn't communicate with each other. There were dozens of technology systems and dozens of financial ledgers."

As an example of how "Citi" never integrated, it's been reported that in China the mortgage unit and the credit card unit couldn't even agree on a common consumer-fronting language: One used Mandarin and the other Cantonese.

This brings us back to law firms.

Are your firm's incentives aligned to encourage people to collaborate, or to give them reason to hoard business? Do you keep track of partners who "give away" business they've originated to other partners/offices/practice areas to handle? Do you reward them for doing so? Or, contrariwise, to you have perpetual origination credits, rewarding partners or heirs of partners in perpetuity for entrepreneurial achievements now lost in the sands of time?

I suggest now is not the time to indulge in such hereditary droits du seigneur. If the unfolding lesson of Citi is anything, it's that unclear and blinkered management, perverse incentives, and a failure to enforce and communicate a firm-wide vision can catch up with you in sour times.

Care to guess how fast the sour times are going to end?

BigLaw & The Big Three

Consider Detroit's Big Three.

Having made what  turned  out to be bad bets on  over-investing in now shunned product lines, they've been  conspicuously laying people off, downsizing, attempting to  renegotiate credit lines, and furiously trying to revamp their product offerings to align to and conform with the world's new reality. 

Sound familiar?

It should because the same description, with variants in emphasis, could apply to our industry.

So I have a modest proposal:  Let's put all our lawyer  brethren in Congress—surely we should at least get some good out of the vast over-representation our colleagues enjoy in poliitics—working on a bailout bill for BigLaw.

I owe the genesis of this insight to a faithful reader, Brent Jeffcoat, of McGuire Woods' Charlotte office.  He frames the key argument nicely:

When do law firms start seeking federal assistance?  After all, think of all the people we affect: our young associates marry and live in condominiums in urban centers.  We probably support Starbucks.  Allen Edmonds is toast.  Many high-end automobile dealerships will suffer mightily without the patronage of lawyers.  I mean, the list goes on.  Think of all those poor guys in Scotland who will not be able to sell their single malt whiskeys.  It would be a global crisis of unimaginable proportions if one or two of the AmLaw 100 were to fail.  The Federal government has got to step in and lend a hand.  Before year-end or else the distributions will be hit.  Heck, many people in the medical industry are dependent upon elective cosmetic procedures scheduled just after year-end distributions.  America needs us to survive.  Who will keep the kept women?

This is firmly in keeping with the evident economic philosophy of our times.  Who needs Microsoft, Intel, Starbucks, or, for that matter, Target?  Wouldn't we all be  better off in a world dominated by Wang, DEC, Howard Johnson's, and Nash Rambler?  And isn't your dream  for your kids that they can grow up and join the UAW?  Don't you wish you could, to paraphrase William F. Bucklkey, stand astride the tide of history and cry, "Stop!"?

Joseph Schumpeter (Mr. "Creative Destruction"), and Adam Smith himself, would be outraged and appalled.  And  rightly so. 

Permit  me  to remind our colleagues in Congress what happens when a company declares the dreaded "bankruptcy:"  Its workers are not taken out and shot, its factories and offices are not incinerated, and its customers' demand does  not evaporate.  Rather, all those assets  and market forces are  reallocated elsewhere.  If the Big Three have demonstrated anything  over the past 30 years, it is their unrivalled  managerial genius at misallocating productive  assets and falling ever further behind their rivals.  Time, one might  think, to give someone else a chance to deploy those assets.

Sympathetic as I am to law firms struggling with yesterday'spractice areas, and to lawyers rudely discovering the urgency of reinventing themselves, the dynamism of the  market will not abate. 

That is something devoutly to be celebrated.

New York Today and Tomorrow

Our texts for today come from (in inappropriate order) the New Testament, as it were, and Peter Kalis, the chairman of K&L Gates:

"The metaphysical question is whether you can have bulge-bracket Wall Street firms without Wall Street," says Kalis. "The capital markets, when they rebound, will no longer have the margins they once did. Like night follows day, they won't be willing to pay premium rates."

And from the Old Testament, Simpson Thacher's Chairman Richard Beattie:

"I strongly suspect we've got a rough period of time ahead". He sees the markets turning around within a year or two, and doesn't expect big changes ahead for his firm and its closest competitors. "I don't think [the market changes] will impact fees," he says. "The M&A work will come back, and Goldman Sachs and Morgan Stanley will be advising the companies doing M&A, and I don't see the fees being different. . . . The private equity firms will be back. They're sitting there with huge piles of money."

In my conversations with managing partners in New York and elsewhere, they segregate their worries into the (relatively) pedestrian and the existential. The low-level worry is one of duration: How long will this recession last? If it's of "ordinary" duration, say about a year, and of "ordinary" depth, with unemployment staying below 8%, we know how to deal with that: Be prudent about costs, manage your partners' expectations, and stay the course.

But there's another possibility, the one Pete Kalis fingers: Are we facing an existential challenge?

If the US Treasury is a major stockholder in major financial institutions, how will that change the dynamic of how premium-level legal services are bought and sold? Not to be facetious about it, but how would you feel to be called before Barney Frank to justify your $950/hour rates?

Short of being hauled before the television cameras of Congressional hearings, contemplate the implications of the changes in ownership of major financial institutions simply on the private side. If you think that Bank of America hires lawyers as Merrill Lynch hired lawyers, guess again. Here are a few examples from their website (warning: they run 69 pages):

• Extraordinarily explicit diversity requirements;
• Refusal to pay for first year and junior associates;
• No payment for time spent on conflict checks;
• Automatic "most favored nation" status on rates;
• Staffing demands enforced at a task-level basis;
• Highly stylized and formatted billing submission requirements, failure to adhere to which spurs immediate rejection of the entire bill; and
• You get the picture.

But back to the issue of New York. To what extent will it remain a financial powerhouse for investment banks and, by analogy, law firms?

At the risk of offending both Pete Kalis and Richard Beattie, I don't think New York will become Just Another Big City, nor do I think its pride of place at the pinnacle of the food chain is guaranteed. Instead, I want to offer an analogy between law-firm land and corporate land.

The common perception is that Fortune 500 companies have been abandoning New York for their headquarters in a steadily departing stream for the past 40 years or so. The reality is quite different. (Not so incidentally, there are a multitude of studies showing that firms that relocated outside New York have underperformed the S&P 500 whereas those that stayed here have outperformed--but that's a debate for another day).

Here are the numbers on Fortune 500 headquarters in New York over time; the exodus  actually ceased over 20 years ago:

• 1965:  128 of the F500
• 1976:   84
• 1986:   53
• 2007:   53

And just for reference, here are the top five states by Fortune 500 headquarters as of 2007:

• New York:  57
• Texas:  56
• California:  52
• Illinois:  33
• Ohio:  28

Even companies that have formally relocated their headquarters, with all the ancillary staff that usually implies, more often than not keep a core group of finance, design, marketing, and other professionals in New York, and you can be sure their key executives fly through regularly. (Even the Sage of Omaha almost invariably announces his big deals in New York.)

Similarly, as recently as 10 years ago, New York was where essentially all new significant company listings occurred. Since then, for a variety of reasons including Sarbanes-Oxley, the "Spitzer Effect," and even (I say this speculatively) America's relative fall from international grace, new listings on London's AIM, in Hong Kong, and even in Beijing are now substantial.

But New York remains the financial capital of the Americas and, I will confidently wager, will remain so as far as the eye can see.

Is its international importance diminished? To be sure. Is it at threat of becoming marginalized? Not a chance.

To some extent, the  erosion in New York's pre-eminence is an ironic reflection on how all-important it had become—and on how that importance can only decline, in a relative fashion, as Brazil,  Russia, India, China, and the Mideast grow in global importance.  But surely Orrick's Ralph Baxter has it right when he says:

"There will be some adjustment.  But there's really no way to be an American-origin firm that has anything to do with capital markets and finance without being in New York in a serious way."

On this view, New York will remain one of a handful of global financial centers, along with London, Hong Kong (or its possible Asian successor, such as Shanghai), and perhaps Dubai or another Mideast center of gravity. 

Recent months have brought a surfeit of announcements by firms of expanding finance practices in the Middle East and Asia.

Even before the financial crisis, Jay  Zimmerman, CEO of Bingham, said his firm had broadened its approach, continuing to seeek opportunity in New York but also expanding abroad, especially in Asia.

"There have been shifts in the global economy," he said. "Demographics are clearly pointing to a shift ininfluence and financial strength to Asia."

But Mr. Zimmerman added that it would be quite some time before such new markets could supplant New York, either as a financial center or a source of firm revenue.  He said that New York would remain Bingham's number-one priority for growth.

Let's not be seduced into thinking this is an all or nothing, Manichean proposition:  "New York will forever be King of the Hill or it will become irrelevant."

Consider that New York has so many established assets which are all part of the lush and verdant ecosystem sophisticated law firms needing to attract world-class talent have to have, and it's not all about stock exchanges, banks, and capital markets.  Hubs of top-end global commerce need to provide the environment to attract, please, and win the affection and allegiance of the Type A, discriminating, demanding professionals from all walks of life who together produce the pulse, the vibrancy, and yes, the romance, of a global capital:  Museums, theater, opera, restaurants, sports, universities, stores and boutiques,  a reasonably salubrious climate, great housing stock, and abundant international  air connections. These aren't built in a day.

And unless you really know New York, it may be hard to appreciate how profoundly woven into the City's warp they are.

It's not that you can find a dozen great restaurants or a spectacular concert or a wonderful theater troupe or the "nowhere else" boutique, because you can find those in a hundred or more cities worldwide.  No:  It's the depth of New York's "bench."  By which I mean:  Not only are the top 10 [pick your favorite category] institutions great, but so are the 50th, the 250th, and the 500th. I would pit a "neighborhood" New York restaurant against a top restaurant in many other cities, the chorus line at an off-Broadway show against lead dancers in other shows, and so forth.  You are welcome to call  this chauvinism or provincialism, and I'm an increasingly appreciative consumer of culture and the "urban experience" around the globe, but it's a difficult base of expertise  to replicate in short order.

Think this is a bit touchy-feely?  Think again. Studies of why corporations tend to favor large metropolitan areas for headquarters reach a common conclusion: 

"What exactly are the competitive advantages of large cities?  The central function of corporate headquarters is the acquiring and disssemination of information.  [...More specifically,] concentrations of business service firms in large cities, such as medial, law, accounting, and consulting, may enable firms to achieve cost and price advantages."

If acquiring and  disseminating information doesn't sound to you like what law firms do, what would?

But don't just take my word for it. 

Professor Bill Henderson of Indiana University School of  Law—Bloomington just published "The Changing Economic Geography of  Large US Law Firms," which analyzes the geographic  migration of lawyers in the AmLaw 200 over the past 20 years and concludes (emphasis supplied):

Our preliminary findings suggest that over the last twenty years, New York City has supplanted Washington, DC as the more interconnected market, particularly for law firms with international offices in Europe and Asia. Although profitability and revenues per lawyer appear intimately tied to presence in large global cities, particularly New York City and London, the network analysis reveals several firms that are following successful niche strategies.

Bill also produced this fabulous graphic showing the change in headcount of lawyers in AmLaw 50 firms from 1984 to 2006, by region of the US:

This shows how uneven lawyer  headcount growth has been.  In absolute numbers the growth occurred:

• Abroad: +8,012 lawyers
• New York: 7,315
• Washington, DC:  4,908
• Los Angeles:  2,453
• San Francisco:  2,430
• Chicago: 2,130
• Everywhere else (domestic): 7,372

The short story this tells is that, if you're a lawyer in BigLaw, being in a major metropolitan center is more important than ever, not less.

If you're asking yourself right about now whether this distribution mirrors that of corporate America,  the answer is not in the least. 

To dimensionalize that asymmetry, Bill undertook an ingenious analysis,  namely comparing  the percentage of Fortune 500 revenue attributable to each city to the percentage of AmLaw 200 lawyers in each city.  (Actually, it's next to impossible to determine the percentage of Fortune 500 revenue actually  "attributable" to each city, so as a proxy Bill assigned all revenue to the headquarters city.  I'm not a statistician but this  strikes me as a fair approximation.)

At one extreme, take the Midwest region (ex-Chicago), which accounts for 25.2% of Fortune 500 revenue (2004) but only 10.1% of AmLaw 200 lawyers.  The ratio of lawyers to revenue is then 0.40.  At the other extreme we have Washington, DC, with 14.7% of lawyers but only 3.4% of Fortune 500 revenue, for a ratio of 4.33.  Here are the other figures:

In macroeconomic terms, this means that New York is a net exporter of legal services (and,with more AmLaw 200 lawyers than LA, San Francisco, and Chicago combined, a huge exporter). 

The question remains—and a fair one it is—whether New York's past pride of place is prologue to future pride of place.  The answer will emerge from whether New York can continue to generate innovations—in finance, in transactions, and in capitalizing  upon changes in the regulatory environment.  And the answer to that, in turn, depends on continuing to attract the premier, take-no-prisoners, absolute best of breed talent.  So far as I can see, nothing that has happened in the last year has changed that dynamic.  Nothing.

The challenge is famously laid down in the sappy but still resonant chorus to "New York, New York:"  "If I can make it there, I can make it anywhere."  Those of us who have lived through this City's re-inventing itself roughly every decade for the past 40 years will give the last word to Jay Zimmerman: 

"I wouldn't want to bet  against New York."

New Industry Economic Indicator

I am happy to re-publish the press release issued this morning by ThomsonReuters reporting on a new alliance we have struck.

For my purposes, the value of this will be being able to offer you, my readers, an additional perspective on legal industry market conditions at a time when they might be of particular interest.