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.

If You're So Smart, Why Aren't You Rich?

Actually, the formulation of that headline that I prefer these days is the famous inversion by the Nobel economist Paul Samuelson: "If you're so rich how come you're so dumb?"

And yes, that brings us promptly to the Bernard Madoff scandal.

Among the multitude of "we should have seen it coming" stories:

• the SEC was alerted to irregularities as early as 1994 [by putative competitors, to be sure, but where do you think "competitive intelligence" comes from?],
• the shockingly consistent monthly returns were suspicious on their face,
• Madoff in person was apparently something of a social misfit, whose primary technique for dealing with unwanted questions was to clam up and/or bluster,
• the investment strategy was a black box,
• and the auditing firm was a joke--a three-man firm operating out of a strip-mall office of about 125 square feet, whose principal and senior member was 80 years old and living in Florida.

Nevertheless, there have been surprisingly few first-person accounts of someone who encountered Madoff and said no.

But this week Barron's brings us one: "Living to Tell About Madoff," an interview with James Hedges (not, I assume, a stage name, although in the circumstances it ought to be), "president and founder of LJH Global Investments in Naples, Fla., who has invested billions in hedge funds and private equity since 1990 through relationships with numerous hedge funds."

Eleven years ago, Hedges spent two hours meeting with Madoff in his New York office planning to invest a few billion dollars of his clients' money. He walked out without a deal.

Here are some of the reasons why. If you read to the end, I promise I'll tell you why this is germane to what you do.

• "I was told it was unusual for him to meet with anyone for that length of time, and that he was perturbed with the process. His whole tone during the meeting was curt, truncated, and he volunteered nothing. It was an extraction process to get him to answer anything. He was distracted the whole time, looking at people out on the trading floor through the glass wall of his office. Mind you, I was coming in to potentially invest billions of dollars for prominent families and institutions, representing extraordinarily well-known clientele. I couldn't be more the type of person for whom you would open up the kimono. And what it told me was that it was a fraud, full-stop. It was wildly impressionable on me [I'm just the messenger--that's the word he used. Bruce]. I have said over the years to many people: Do not touch Madoff with a barge pole."
  
  
• "We have a due-diligence questionnaire that we use as a template for any investment. It's substantial, about 40 pages of factors we have to get comfortable with. It covers management's trading strategy, the back office, the pricing mechanism for the portfolio, how the manager is compensated, the checks and balances, and governance issues, and a whole host of other factors. We could barely get past page one with Madoff before alarm bells were going off. On the strategy itself, when I asked him to explain his investing strategy, it didn't line up. His strategy was like [defunct hedge fund] Long Term Capital Management, where you're saying you're going to sweep up pennies and nickels around the globe via arbitrage opportunities. His representation that he was going to get free money gains from the marketplace, without a principal risk, didn't make sense."
  
  
• "I literally remember waving my arms in the meeting and saying -- I'm going to guess -- there were, like, 50 to 75 guys trading [stuff] behind his glass wall, out on the trading floor.
  
  "So what do these guys do? I asked. Because when you're investing with anyone, you want to meet the chef, and the sous chef, see who's preparing the dish. That request was turned down.
  
  "We don't ever allow investors to meet our team, is what Madoff said. I said, Let's go into pricing. Who holds the securities?
  
  "He said, We hold the securities. There was no global custodian, no prime broker. That never happens in a real business.
  
  "I said that what we do is look at three to five years of audited financials on funds.
  
  "He said, We're not going to provide audits. I was there representing a billionaire family, and to be told I couldn't gain access to an absolutely correct and appropriate thing to ask for, was amazing to me.

And now, the "payoff question" from the interview. Hedges is asked how it was possible that "reputable" hedge fund consultants could have placed billions with Madoff? "What could Tremont and others have possibly been thinking?", the Barron's reporter asks (emphasis in what follows mine)

• "I was far from the only person to draw the conclusions that I drew about Madoff. Madoff was the fraud that happened in full view, with lots of complicit partners. This kind of thing requires complicit behavior. I believe the due diligence conducted by investors who were there was faulty, or possibly they were lied to, or it was not even done at all, perhaps put aside in deference to a relationship with a con man. Fairfield Greenwich allegedly derived some $300 million per year from their Madoff product -- that's the rumor. When someone is paying you or me or anybody that much per year to go to polo matches with high-net-worth investors and tell them about their portfolio, or on their boat in the south of France, it's hard to imagine [that] one's vision doesn't get skewed."

Here are the questions the Madoff saga should pose for you, managing your firm:

• What's going on that we're not asking enough questions about? Where are we following the herd because it's socially convenient, socially comfortable, and all of the "in crowd" is doing it (don't kid yourself that the "in crowd" phenomenon expires on high school graduation).
  
  
• Who are the 800# gorillas we're not scrutinizing as we should?
  
  
• Who is getting paid so much, or helping to get you paid so much, that "it's hard to imagine one's vision doesn't get skewed"?
  
  
• Is there a practice group that's throwing its weight around and trying to drive the firm's strategy? Are they getting away with it because they're the most profitable group going? Ask yourself how long that may last, and if you haven't read Clayton Christensen's The Innovator's Dilemma, about how companies at the top of their game can suffer fatal attacks from seemingly unworthy upstarts, it's high time you do. (Andy Grove said of it: "This book addresses a tough problem that most successful companies will face eventually. It's lucid, analytical-and scary.")

The real issue is this: How critical a thinker are you?

This is not a facetious, flip, or insulting question.

The fact is, none of us can rest on our laurels on this score. We can always improve.

I say this from personal experience.

Had you asked me, five years ago as I was about to start "Adam Smith, Esq.," whether I thought I was a critical thinker, I would surely and, resentfully and somewhat with hackles raised, have answered that of course I consider myself so. After all, I can imagine myself saying back then something embarrassing along the lines of, "I've gone to a college and law school you've heard of; I've worked in some fairly demanding environments, and so, yes, I consider myself a 'critical thinker,' thank you very much."

But that was before I started "Adam Smith, Esq."--the single most unexpected and salutary intellectual result of which is that it has made me a much more critical thinker. How so? Today, in a way that wasn't the case five years ago, I can scarcely read anything--from an article in The McKinsey Quarterly to a simple reportial story in The Economist, without asking myself questions like:

• What are the unspoken assumptions behind this piece?;
  
  
• If what the author is saying is correct, what happens next?;
  
  
• Does this align with most things we read in the past few months or is it squarely at odds with the consensus--and then who's right?;
  
  
• What are the author's presumed biases, predilections, and hobbyhorses?; and
  
  
• Last and most important--but hardest!--of all, does it spark any new ideas in your mind? What have you been taking for granted that might be due for a challenge or an update or a revisionist note?

This is all hard intellectual work. The reason most people who invested with Madoff did so is because they avoided the hard intellectual work. They, tragically, relied on friends at the country club, friends at the synagogue, friends in the boardroom, friends in the supposed insiders' group of insiders.

If you are an insider, or if you aspire to be one, don't fall prey to the seductive, salacious, and sleepy temptations of turning off your critical thinking.

Complete with serene, almost beatific smile

Update:  Fri 2 Jan 2009:

A regular reader wrote as follows and, with permission, I have reproduced the remarks verbatim, albeit without attribution.  While the point he makes is inarguable, I avoided it in my initial column both because I wanted to emphasize the "failure of critical thinking" angle to the exclusion of any other potentially distracting dimensions of the fraud and, at least as importantly, because I simply felt as a Scots Presbyterian it was far from my place to note this dimension.

Be that as it may, his remarks:

Bruce,

I love your site.  I've been a bit behind and just read your post of 12/27 about the Madoff scheme, which you attribute to lack of critical thinking.  While that is certainly true, one aspect that warrants further fleshing out (and, to my chagrin as an observant Jew, has been done in the mainstream press) is the fact that a good chunk of this was also a good, old-fashioned affinity fraud.  Too many victims relied on Madoff being a member of boards of Jewish philanthropies, or on the facilitation of Merkin, himself an Orthodox Jew. 

This vouching, almost mafia-like, of "he's a friend of ours" helps explain the lack of critical thinking.  It is simply a larger version of the fraud committed on Jews in Virginia Beach earlier this year.  While clearly many others also lost money, a large portion of the wealth lost (including an estimated $1.5 billion of philanthropic funds) is directly attributable to affinity fraud.

As I recently told a friend, this is a clear sign that we Jews have made it in this country when the biggest financial fraud has been committed by a Jew (Madoff), facilitated by an Orthodox Jew (Merkin), who preyed on wealthy Jews and Jewish philanthropies (Yeshiva U, Orthodox day schools, Jewish Federations, Hadassah, etc), and that the U.S. Attorney General, an observant Jew, had to recuse himself because his synagogue was a victim. 

Regards,

The bad news:  You're out $50-billion.  The good news:  You've made it in this country. 

2008 was indeed one for the record books.

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.

What's Your Attrition Rate Lately?

An unspoken, and certainly uncelebrated, aspect of the law firm associate personnel model is built-in attrition. "Built-in" can have two traditional meanings, and one new one:

• Traditional A: They wash out of their own accord, because of a variety of factors:
  • they've paid off their student loans, and so the music for the dance they signed up for in their own minds has ended;
  • ambitious as they thought they were for partnership, the hours are more than they bargained for (and partnership would only be more of the same--the famous "pie-eating contest where the reward is more pie");
  • they basically like it, but find they don't have true passion for it, and contrasted to those who do, they'll lose;
  • they realize that the years of key family formation coincide with the years to partnership and they choose the family track.
• Traditional B: They're not cutting it and they're excused.
• New Meaning: There has been zero attrition.

Welcome to the new reality of attrition. There isn't any. I was recently talking with the Chair of a firm that would normally experience the departures of 30 or 40 associates over a typical six months. For the past six months? Zero: Not one. The concept of "built-in" attrition is suddenly broken.

So: What to do?

First, one can simply acknowledge, from an economic and a human perspective, that this is entirely understandable.

Warren Buffett likes to say that Aesop was a poor economist because the question of whether a bird in the hand is worth two in the bush depends on when the two will be delivered and what one's discount rate is in the interim. But one thing we can say with certainty today is that a job in the hand is next to priceless. So much for starry-eyed visions of ditching the law firm to join the hedge fund or the private equity firm.

But the question remains: What are you going to do about it?

Logically, you can attack this with how you handle three pools of talent:

• Your investments in summer associate and first-year hiring;
• The level of your interest in the lateral associate market; and
• What you do about your incumbent (and non-attriting) associates.

Easiest is to alter your policy towards lateral associates: Go from choosy to hyper-picky. Only those with spectacular credentials in desperately needed practice areas get even a second look.

The intersection of summer and first-year hiring, and the ranks of your incumbents, is where it gets interesting. A rational view is that your 3rd through 6th years (say) are by and large known quantities, trained and raised in your firm to your standards and liking, and that excusing any of them in order to make room for fresh-faced question marks who are, not incidentally, very difficult to charge out to clients in this environment, is borderline lunatic behavior. You are demonstrating disloyalty to those who have survived at least the first few rounds of their 15-round bout, to make a largely uninformed bet on raw clay.

I beg to differ.

We've all read ad nauseum about the stunning virtues of just-in-time delivery in manufacturing supply-chain land. Our industry is the polar opposite.

Our "supply chain" (associate talent) is three to six to ten years long, depending on where you deem it reasonable to draw the start and finish lines. That is to say, it takes that span of years to take a human being from potential-lawyer-in-essence to actual, performing contributor to clients and the firm.

The relevance of this to today's personnel challenge, I submit, is that you cannot introduce a gap into that supply chain. You need to be in the business of continually recruiting new talent, in order to feed the continually moving production line of senior to mid-level to junior staff needed to manage cases and transactions. You cannot, in other words, inflict on your own firm the equivalent of a "lost generation."

So counter-intuitive as it may seem, I recommend continuing to feed the associate pipeline from the start, summer associates and first-year hires, even at the cost of some mid-year enforced "attrition." Aside from what I believe to be sound long-term reasons to continue investing in the firm's future in this way, there are as well both an abstract and a prudential argument for same.

The "abstract," or logical, reason to keep recruiting new talent is that some of it is bound to be better than your existing talent. It simply has to be the case. (If you think every single lawyer in your associate ranks is the best they could possibly be, stop reading now.) You may be satisfied with Bob 3rd-year or Emily 4th-year right now, but how do you know they're as good as Dave 1st-year or Melanie summer associate will be at their level?

When I spoke about your "supply chain," I wasn't speaking metaphorically. If clients are your demand, talent is your supply. Econ 101. Your "supply" (talent) is what you have to sell. You have few higher priorities than increasing the quality of that supply or, as a friend of mine likes to say, "enhancing the gene pool."

A prudential reason argues for the same continue-to-recruit policy: If your firm shuts down recruiting, be prepared for the market to have a long memory and for it to punish you when the good times return. (If you doubt this, recall that some firms were still suffering reputational dings for having laid off people after the dot-com meltdown half a dozen years later.)

Another reason to continue early-stage recruiting is the positive, optimistic, and confirming message it sends to your firm internally, to the marketplace, and to any other constituencies (potential clients?) whose opinion you value. Loud and clear, it says, "We are investing for the future, confident in the long-term value of our firm and what we provide to our clients."

Make no mistake about the power of this message in today's environment, when century-old firms are imploding and, as Jay Zimmerman, Chair of Bingham, recently put it: "We're starting to see a trend of people [changing] firms because they're not confident in the vision their current firm has of the future."

Now is not the time, in other words, to shut down the processes that feed your talent pool. Now is not the time to act as anything other than a vibrant, going concern. Now is in fact the chance to upgrade the "gene pool."

No voluntary attrition? I'm sorry to report that your business model depends on attrition, and attrition there must be.

Unless you'd prefer to reinvent the model entirely, in which case: We can talk.

In Search of Execution (And, Happy Thanksgiving)

Twenty-six years ago Tom Peters and Robert Waterman published In Search of Excellence, and to some extent the genre of writing for business managers hasn't been the same since.  If for no other reason, it's worth taking a moment to revisit Peters' thoughts on the current state of the art of management, as the FT recently did in its weekly "Lunch with the FT" feature. 

But first, if you haven't read "Search," you might yet give it thought:

"When people think about the great management blockbusters, this is the text they have in mind. Search made the business book news. It has sold more than 10m copies and is still the model to which many business authors – whether they realise it or not – aspire. It also launched Peters on the path to global, jet-setting guru-dom."

Peters himself, however, will have none of his elevation to "guru:"

Few, however, have criticised what he does for a living as ferociously as Peters himself. “I say to people, ‘You got a bad deal, paying money to see me,’” he tells me. “I have utterly nothing new to say. I am simply going to remind you of what you’ve known since the age of 22 and in the heat of battle you forgot. You’d have to be one of those television preachers to believe that you’re going to work with a group of 500 people and change their lives. First of all, most of them agree with you. You’re not going to pay £1,000 [a head] to go and see someone if you think the guy’s a jerk."

Self-effacing as he may be, Peters has some deeply contrarian opinions.  For starters, don't kid yourself that you have it harder than your predecessors or that 21st-Century life is markedly more complex than things were in the past:

Is management getting harder? “No,” he replies firmly – and in defiance of the conventional wisdom. But what about all that new technology, the end of deference, the increased pace of life, and the heightened expectations of employees? Doesn’t that all make management harder?

On the whole, Peters thinks not. We exaggerate the extent of change, he feels. It is the arrogance of modernity to believe that we face unique and unprecedented challenges.   [Putting it in perspective,] my mom died two years ago a month short of her 96th birthday, which means that she lived through the arrival of long-distance telephones, automobiles, airplanes, jet airplanes, a man on the Moon, the great Depression, world war one, world war two, the cold war, Vietnam, Iraq one, Iraq two, [so don't kid yourself].

I beg to differ.  I believe the complexities of the challenges facing law firms today actually are unprecedented.  Here's a very short bill of particulars:

• No longer are all your partners within one timezone, let alone one zipcode. 
• Clients are more sophisticated (read: more demanding). 
• The war for talent, both raw recruits and laterals, has never been more intense. 
• Technology, a major blessing but with a correlative curse, has pushed "work/life balance" to the breaking point for many individuals.
• Transparency of financial performance, and pressure for ever-escalating numbers, seems to reach new annual highs.
• And perhaps putting a nice exclamation point on our landscape, Gary Hamel, merely "the world's most influential business thinker" according to The Wall Street Journal, has pithily described the world today as "less benign" than ever.

But speaking of war, which we were a moment ago, Peters served two tours of duty in Vietnam as a combat engineer building bridges for the Marines, and in a revealing passage, he says that much of what he learned about management came from the diametrically opposed styles of his two commanding officers.

I’m not exaggerating but I really spent the next 40 years of my life writing about Dick Anderson. He was a guy who believed that young men aged 23 needed a chance to express themselves. He believed that [writing] reports was incidental but that building stuff for your customers, typically the Marine Corps, was what you were there for.

“On tour two I had a naval academy graduate who would rather have produced an excellent report about things we hadn’t built than a lousy report about things we had. One guy wanted you to do something, the other guy wanted you to write reports. It was the best management training that one could possibly have had. Do what Dick did and avoid what Dan did – there’s the book ... it’s a very short book!”

What strikes me as most revealing about this remark is that it has nothing to do with strategy, it has entirely to do with execution.  And this from a pair of McKinsey consultants (Waterman, his co-author, being the other).

Peters confirms which side of the strategy/execution chalkline  he's on:

[T]he book did not have an easy birth. Its breezy tone did not play well with earnest colleagues at The Firm, as its authors were to find out. “There’s no way to describe the viciousness with which Bob and I were attacked within McKinsey,” Peters says. “This was not the Holy Writ. It was the intellectual challenge to what McKinsey stood for at the time.

“To some extent what Waterman and I were looking at was the business of ‘execution’, and execution is fundamentally a management thing. We were saying, ‘If you can execute well, it doesn’t matter what the hell the strategy is. The doing is what counts.’ But this was when ‘strategy’ was at its apex. We were pushing back."

Peters subscribes with a vengeance to school of relentless execution, and also to the not-inconsequential  role of luck.  He ironically describes his own good fortune:  “I was born in 1942, in the US. I was protestant. I had relatively intelligent parents and I was white – that’s the first 99.9 per cent of it. Hard work may have done the rest."  And "Search" itself?  "A decent book with perfect timing."

In other words, try hard and then try some more.  Many many things may not be within your control—today seemingly more than ever, Peters' protestations to the contrary notwithstanding—but one thing is within your control:  How hard you work and how much you  get done. 

Having the energy, the imagination, and the sheer intellect to tackle today's escalating challenges—with, I should mention, impeccable integrity—is perhaps the single greatest thing we have to be thankful for today.

"Globalization of the Legal Profession" Conference at Harvard Law

I'll be attending the "Globalization of the Legal Profession" conference at Harvard Law School this Friday (21 November), put on by HLS' Program on the Legal Profession.  Here's the  agenda, with some notables on the program including a keynote by Ben Heineman, and commentary across four panels from many other recognizable names such as:

• Stephen Denyer, International Development Partner of Allen & Overy;
• Prof. Marc Galanter of Wisconsin;
• Dean Elena Kagan of HLS;
• Peter Kalis, Chairman and Global Managing Partner of K&L/Gates;
• Prof. Ashish Nanda of HLS;
• Prof. Carole Silver of Georgetown; and
• Prof. David Wilkins of HLS.

Here's a brief description of the program:

Legal practice historically has been a largely parochial endeavor.  One need look no further than the complex debate within the United States about multi-jurisdictional practice between states (let alone questions of foreign lawyers practicing within the US) to see that the inherent complexities of the emerging global bar extend far beyond fitness and character to practice law.

In an age of rapid globalization, this is no longer merely the academic issue it might have been even a decade ago.  The largest law firms now span the globe, with thousands of lawyers carrying the banner of a single firm, yet residing in geographically diverse offices and practicing law in numerous states. [...]

What can we do - as international scholars, educators, and practitioners - to adapt to the rapidly-changing economic, social and political environment and prepare the next generation of lawyers - domestic and international - to meet the challenges that globalization will continue to present?

I'll be staying Thursday night at the Inn at Harvard.  If any of you will be there and you want to look me up, don't be shy.

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."

Manic-Depressive? Take a Deep Breath

We are surely living in times of manic-depressive equity and fixed-income markets ("We've made the future safe for Western financial institutions!"  "No, we haven't!). New York City itself can seem to be suffering from one gigantic case of whiplash:

Even last month, those of us who don't work in finance took wishful comfort in our Econ 101 understanding of the distinction between the financial crisis--that is, all the accumulated bad debt causing panicky global credit pipelines to tighten all at once, like so many sphincters--and an economic crisis, when people in general stop buying things and companies lay off workers or go out of business. The problem for New Yorkers, however, is that a financial crisis is an economic crisis, since more than a quarter of the wages in the city are paid by the stocks-and-bonds industry. For us, Wall Street is Main Street.

The other night, as I drove down one of New York's more conventional and lovable Main Streets--Bleecker, west of Sixth--looking at the glowing shopfronts and bustling restaurants and strolling pedestrians, I had a sudden elegiac impulse to register the scene and its details. Because, I thought, once a Depression descended, these same blocks would look and feel very different; in 2010 or 2011, I might think back to this particular evening--autumn! Twilight!--and remember how sweet and jolly the city had felt and looked not so long ago.

Alarmist?  Certainly.   A mildly embarrassing and gushy, jejune, home-town lament?  Probably that as well. 

But the insight that the financial crisis is not severable from the potential economic crisis is where attention now focused, and that concerns us all.

So where do we stand?

2008 is to some extent the devil we know.  At least for most firms, the year will be flat to down in the low double digit percentages in revenues and profitability.  But this is also a time when averages may be deceiving.  A small but  nontrivial minority of firms  will actually perform just fine,  thanks to a serendipitous practice mix.   But across all firms people should have a realistic sense at this point of where  they'll end up.  There should be "no surprises" at year-end. 

2009, by contrast, is the devil we  don't know.  From the perspective of today, to imagine it being a strong year risks professional humiliation,  and the key question for most  people is whether  it will be worse than 2008 and, if so,  in precisely what  way will it be worse?

Much as US automakers have found their model  lineups—featuring pickups, SUV's, and large, gas-guzzling  "crossover" models—suddenly and  brutally out of step with market demand, the question for law firms will be whether their practice mix is congruent with the new economic order or orthogonal to it.  Lacking the ability to travel forward in time and report back to you, I can only advise  nimbleness and celerity in adjusting to client demand.

Within reason,  professionals can retool themselves into adjacent practice areas to follow demand.  And to the extent people are under-utilized during a trough, but still  have valuable capabilities to contribute in the future, redeploy them in support of professional development, writing and speaking opportunities (business development), and getting  closer to your clients

What if it's worse, even,  than that?

The 55% unknown in the room  is whether  litigation will rebound to offset the drought  in corporate, transactional, and finance work.   ("55%" because that's approximately litigation's share of all revenue across the AmLaw 200; your firm's mileage may vary.)  What  do the tea leaves say?

Managing partners and senior  partners I talk with say that there is no evidence that litigation is  rebounding as of yet,  and a surprising number of them  doubt that it will.  This dour and gloomy assessment (we know who  we're rooting  for, after all) typically rests on a rather granular analysis of plausible causes  of action stemming from the financial meltdown,  and the view that since it was a systemic crisis, there is no liability for fraud, misrepresentation, or inadequate or misleading disclosure.

Analytically, they may be right. But my faith is unshaken in the creative ability of our plaintiff brethren to point  accusatory fingers  (sufficient so survive motions to  dismiss) when hundreds of billions of dollars  have gone up in smoke.

On another issue, there seems near-universal agreement: We are in for more regulation.  From helping  craft that regulation to explaining and guiding compliance with it, lawyers will be at the fore.

The real V-8 engine of recovery will kick in once the credit crisis has receded into the vanishing point of our rear-view  mirrors,and corporations and institutional investors  have recovered their appetites for risk-taking and deal-making.  At the moment, that  seems a distant day indeed, but our perspective may be warped by the deafening roar of  today's locked-up  markets.  Warren Buffett, after all, is already stirring.

And we know there is no more salubrious time to buy than when all around you think you're  daft to do so.  "Be fearful when others are greedy, and greedy when others  are fearful," spoke the Sage of Omaha on the New York Times's op-ed page last week. 

But back to law-firm land.

Here, the writings and the articles are dire.  Various prognostications promise us that corporations are going to "slash spending on outside counsel," and  that's just for starters.   There are far more apocalyptic predictions afoot, including that:

• As goes executive compensation (down), so goes law firm compensation.
• The recession will throttle demand across all sectors, particularly M&A.
• Financial institutions experiencing the gruesome task of reducing headcounts and budgets "20 to 25% across the board" will grant no immunity to legal spending.

Even worse, did you know that:

• "The key assumptions that underlie the whole legal market" are being undermined?
• We are experiencing the "Wile E. Coyote Effect," running off the cliff into space, powered by sheer inertia, but about to discover that, as the old joke has it, jumping out of a 50-story building is fine for the first 49 stories.
• London will eat New York's lunch, without so much as a "prithee, may I?"
• And lastly that we will be so desperate and delusional that we will engage in fictitious and unsustainable "financial engineering" to keep the numbers looking good for a few more hair-raising quarters before the roof comes inevitably crashing in?

Well, then, that makes two of us.  I wasn't aware of these scenarios of doom, either.

It's time, Dear Reader, to take a deep breath. 

Here are four very concrete things you can do to weather this storm.

Time for a Strategic Re-Think

Why are your practice groups arrayed as they are?  Is it time to invest, or disinvest, in some of them?  What sense does the geographic array of your offices make?  Ought you to be in (just to pick a random place) London in a bigger way than you are?  Does Frankfurt/Miami/Seattle (pick one or three) still make sense?

If you had to reorganize your firm from a clean sheet of paper, would it look the way it looks today?  Well, then, what's stopping you?

Do you have the right people on the bus?  It's entirely possible that some highly talented people might find themselves on the street through no fault of their own.  Even if some of your professionals and staff are "just fine," might now be the time for a little quality upgrade?

Now, in other words, is the ideal time to get back to re-examining some of those "key assumptions that underlie the whole [firm]."  Why now?  Because people's appetite for change, never great, is at a local maximum in the midst of disarray and uncertainty. 

When clients and fees are rolling in, there's no sense of urgency about actually changing anything and, a fortiori, no reason to re-examine whether anything might be suboptimal.  But now is the time when everyone is tempted to ask, "What's wrong?!" and when you can engage them in actually trying to position your firm more soundly.

Go Into 2009 with a Zero-Based Budgeting Mindset

Don't take sacred cows for granted.  Are there things the firm is doing just because..., well, because we always have?

Again, if given a clean sheet of paper, would you recruit the way you do?  Would you spend your marketing dollars the same way?  Your IT investments?  How do you manage cash?

More aggressively, consider bargaining harder with suppliers and vendors, starting, perhaps, with your landlord.  Is the commercial real estate market suddenly softer in your key locations?  Nothing is more deadly to a landlord than vacant space—it's like an empty seat on an airplane leaving the gate.  Perhaps you should have a talk.  Similarly, need new computers?  BlackBerry's?  Servers?  Office suite software?  "Let's Make a Deal."

Get Close To Your Banks

"Keep your friends close, but your enemies closer."  And your banks may not be your best friends at the moment.  (Last week I was at a large gathering where the speaker asked if anyone knew a generous banker these days, to a healthy round of laughter.)

Get out a sharp pencil and take another look at your bank debt covenants.  Are you going to be marching close to the chalk line on any of them any time soon?  Get out in front of it.  Talk to your bankers; let them know your plans.  Let them know what concrete steps you're taking to navigate in this new environment.  Enlist their support and counsel (well, you can at least try).

At the very least, know their  intentions. 

Many many things cause firms to fail, including weak leadership, ill-timed or misguided strategic choices, undiversified practices, extravagant investments in real estate, and weak cultural glue (this one is huge, but that's a topic for another day),  but the proximate cause of failure, if the horrible  horrible  day arrives when the lights  go out and everyone is loosed to the street, is running out  of cash.  Your bank  is your  ultimate cash lifeline.

Communicate, Communicate,  Communicate

You thought nature  abhorred a vacuum?  Well, facts really abhor a vacuum; and in their absence, rumor will rush in to occupy the void.

How is the firm  doing?  Tell people.  And after you tell them, remind them.  Regularly.

What's your debt situation?  Your cash situation?  Your reliance on a few key clients or a few  key practice areas or a few key offices?  If you have good  news to deliver on these  counts, deliver it.  If you don't have good news to deliver, be candid.  Remember, it's not the offense that will get you  (that will sap morale, that will cause people to look at the exits), it's the  cover-up. 

Are we all in this together?  Explain why.  What's  the professional challenge in front of us all, partners, associates, and staff  alike?  Lay it out.  Why should people care about  the place? It's not about how much it  can pay you (best not be, at least), it's about why it matters.

What's the vision for the firm?  Reiterate it—crisply.  At the risk of borrowing language from a no-fly zone in intelligent and sophisticated discourse, don't just reiterate it, preach  it.

After all, you do believe, don't you?

Sand Hill Road Brings You The Head of a Pig

Making the rounds is a  presentation by Sequoia Capital on "startups and the economic downturn," which constitutes a sort of come-to-Jesus meeting for that storied VC firm's portfolio companies.  It tells a tale of radical gloom, with "multiple problems" in the world economy including:

• over-leveraged financials
• falling  asset prices
• frozen credit markets
• weak household balance sheets; and
• global synchronization exacerbating all of the above.

And it gets worse. They point out that bull and bear market cycles are long, and predict we're in a (long) bear market.  They note that consumers have driven the US economy for a decade and more but that they're utterly and completely tapped out.   Assets have become grossly overpriced, while balance sheets have become grossly over-leveraged.  This means massive deleveraging is called for at the same time that asset prices will (so they predict) be plunging, creating a vicious race between the need for increased asset ownership in the midst of decreased asset values.

For housing, the bill of particulars is particularly severe:

• In 2002, less than 5% of mortgages were either subprime or Alt-A (10% in total);
• By 2006, each of those categories accounted for nearly 20% of originations  (40% together);
• Home price inflation was -1.2% annualized from1900--1929, +0.7% annualized from 1930--1997, and +8.0%  annualized  from 1998--2006.

Not done yet, either:

• The notional value of derivatives outstanding is approximately $525-trillion, or 35x US GDP;
• The world has significant excess capacity;
• Consumer spending has gone from 66% of GDP (1987) to 70% (1997) to 73% (2007);
• In the same period, consumer spending as a % of disposable personal income has gone from 88% to 97% to 98+%;
• Consumer savings is, conversely, at an all-time low;
• Real wage growth is stagnant, eroding living standards;
• And not surprisingly, consumer confidence is at a cyclical low, flashing the red light of sustained recession.

They conclude that this will not be a "V" or even a "U" shaped recession, but more like an "L" tilted slightly to the left at the top, with a long  slow slog off the bottom.

Now, for Sequoia portfolio companies, this has implications expressed in VC-speak (such as "$15M raise @ $100M post is gone," which even those of you who can't explain exactly what it means will understand is not whoop-de-do news).  And their diamond-hard-headed advice is to (a) preserve capital; (b) deal only with customers you know can pay; (c) treat cash as king; and (d) avoid the "death spiral" by cutting costs drastically and immediately.  In short:

"Get REAL or Go HOME."

OK, so what about the rest of us?  Is it that bleak?

Your answer to that may depend on whether you think "it's different this time."

Yes, I know, we have all been indoctrinated to instinctively disbelieve (or be skeptical of) that oft delusional mantra. 

The longer answer is that it both is and is not "different this time."  On the down side we have the notable, inarguable, and extraordinary negative differences which Sequoia has just so ably enumerated (not, one might note, without potential ulterior benefit to themselves, at least if they have scared the bejeesus out of one or two of their portfolio companies sufficiently to make the difference between survival and capitulation).

On the positive side we have a number of other considerations, however:

• We have never before witnessed as massive, as coordinated, and, all things considered, as thoughtful and promising a government intervention--wordlwide--as we are now witnessing.
• It is again true that "the only thing we have to fear is fear itself."  The good news embedded within that is that the underlying, functioning economy is not flat on its back and, if credit markets unlock fast enough, need not go there.
• There are signs that the bottom may be in sight, as some savvy and opportunistic investors emerge (Warren Buffett, to name a name).

What then do I counsel for your firm? 

Cash is, indeed, king. 

Bill your work in progress; collect your receivables; don't be shy about client reminders.  And more:  Cut off work for rocky clients who aren't paying.  On the reverse side, hoard the cash you have.  Partner payouts may need to be extended; bonuses delayed; all discretionary spending canceled or deferred.  Watch your net cash like a hawk.

Firms don't fail for metaphysical reasons such as "weak leadership," although defects such as that are not to be gainsaid, and are always telling in the long run.

But when it comes to the hard reality of telling everyone they're out of a job and turning out  the lights, the proximate cause is almost always running out of cash.  And now is not the hour to rely on the kindness of your banker.  Even if your banker is not Sequoia Capital.

"Clients Are Extraordinarily Understanding"

Today's Wall Street Journal profiles H. Rodgin "Rodge" Cohen, Chairman of Sullivan & Cromwell. 

Here at "Adam Smith, Esq.," we're not into gossip and we're not into profiling celebrities (well, celebrities in our world, anyway) for the sake of same—unlike some sites doubtless familiar to you.

However, the roster of high-profile firms Cohen has represented just in the past few weeks is stunning, including AIG, Barclays, Fannie Mae, Goldman Sachs, Lehman Brothers, JP Morgan Chase, and Wachovia.  According to this creative graphic from the NYT's "DealBook," Cohen was tied to more rescues in the past couple of months than anyone else save Hank Paulson, Ben Bernanke, and Tim Geithner, President of the New York Fed.

If you're keeping score at home, Cohen scores connections to six deals; Richard Beattie at Simpson Thacher, Edward Herlihy at Wachtell, and Brad Karp at Paul Weiss tie for second (among lawyers) with three apiece; and Donald Bernstein at Davis Polk and Harvey Miller at Weil Gotshal tie for third with two apiece.

But that's not why I'm writing about Rodge Cohen.

I'm writing about him because of this observation:

Mr. Cohen's immersion in the banking system also has at times put him in a difficult position. As he jumps from one client to the next, it is sometimes hard to tell whom he may be representing at a given moment.

In mid-September, Mr. Cohen represented Wachovia in its preliminary merger talks with Morgan Stanley. Several days later, after those talks faltered, he advised Japanese bank Mitsubishi UFJ Financial Group as it negotiated a 21% stake in Morgan Stanley.

Mr. Cohen was counseling Lehman Brothers until it sought bankruptcy protection Sept. 15, and then pivoted to represent Barclays, which ended up buying the failed investment bank's U.S. operations. Late last month, as banks and private-equity firms rushed to examine WaMu's books, Mr. Cohen had to choose between four clients that wanted to hire him before settling on J.P. Morgan.

This foursquare raises the issue of conflicts, at a level of the game and an intensity of the stakes that we've rarely seen before. And Rodge Cohen's response is simple: While it's certainly true that "Sometimes you just have to pass" on assignments, he says, the far more telling remark is that most of his clients have "extraordinary understanding of the circumstances."

"Conflicts!" has often been raised as an objection to the increasing consolidation of the global legal marketplace. How could it be possible, this line of reasoning goes, that the Global 100 law firms could consolidate to (pick a number) the Global 5, the Global 10, or the Global 25, without running grossly afoul of conflicts?

Rodge Cohen has just given us our answer.

And the answer is slightly more nuanced than that "clients are extraordinarily understanding." It's what Jamie Dimon has to say elsewhere in the same article: "I don't think you can replace judgment and experience and he has both in great quantities."

Now we're getting closer to the issue. By all accounts, Rodge Cohen (and, yes, credit where due, his team at S&C) are the "go-to" people in banking crises like these. Why wouldn't the most sophisticated clients want to hire the most sophisticated team to go to bat for them?

This, by the way, is exactly the same phenomenon expressed with pellucid brevity in my favorite plaque of all of those dedicated to Central Park benches, which appears on one on the east side of the walk just north of the Zoo, donated by an anonymous but clearly once-needy client: "Stanley Arkin, 'The Man to Call.'"

So if Rodge Cohen is "the man to call" if you're AIG, Barclays, JP Morgan Chase, Lehman, etc., in these situations, where exactly is the "conflict?"

Clients don't perceive one, and I would like to ask what cramped, sclerotic, and antiquated view of what "professionalism" means could find one?

Let's go one better: In what other profession would going to the most qualified expert raise the hint of the shadow of the bizarre notion of "conflicts?"

If your firm needs a strategic management consultant, would you deem one who has dealt with similarly situated firms "conflicted?" If you need an orthopedic surgeon, would you go to anyone other than the most highly qualified and experienced in your metropolitan area? Rule out a banker who knows law firms inside out?

You get the point.

Clients are adults, and can by and large be trusted to know their self-interest best.

Are, then, the 19th-Century notions of "conflicts" a barrier to globalizing and consolidating law firms? If you want my view, it's that clients seek concentrated--not dispersed--expertise, and that deep and long-standing industry knowledge is precisely where competitive advantage comes from. This stands "conflicts" on its head, and says that clients seek depth, not shallowness.

Then again, if you don't want to take my word for it, ask AIG, Barclays, JP Morgan, et. al. Or just ask Rodge Cohen.

(New York) City's End?

With all the body blows the New York City financial services industry and its attendant handmaidens (BigLaw, that would be you) have taken in the past couple of months, it may be time to remind ourselves that for the past two centuries or so, ever since New York's emergence as the pre-eminent American city, there has been a vibrant tradition of imagining the Apocalypse descending upon Sin City.

Indeed, one of the earliest published screeds railing against New York came in 1812 when Nicodemus Havens warned (hoped?) that the city would be "consumed by the 'devouring tide' of God's wrath. 'Whole families were enclosed within its horrid grasp,' Havens wrote, 'and whole streets in this flourishing city, swallowed together.'" We learn this through the WSJ's review of Max Page's The City's End.

Just in the past week we have been reminded of how virulent, deep-rooted, and widespread is animus towards Wall Street, which, judging by the rhetorical lightning-bolts flung in its direction from precincts ranging from Alaska to Washington, DC, Paris and Berlin, would be well-advised to dispatch all its inhabitants forthwith to the Trinity Church graveyard which anchors the top end of the Street. Or, as some wits would have it, perhaps Mayor Bloomberg should just rename it "Main Street."  

Many Washington politicians have evidently decided that a ringing denunciation of "Wall Street greed and corruption" (Google results for a search on that phrase:  1,620,000) is an ample substitute for thinking hard and seriously about how to help repair the credit system's meltdown, while Angela Merkel of Germany and Nicolas Sarkozy of France have called for severe retribution against the "excesses" of global capitalism, with, one imagines, no small dose of schadenfreude at the travails of Anglo-American capitalism.

But we digress.

The ways in which New York City has been fictitiously destroyed constitute a tour of the human imagination's ability to contemplate destruction, but underlying them all seems to be a sense of righteous--or at least self-satisfied--indignation that we benighted residents of Gotham are only getting what we have coming to us. Among the animate and inanimate tools of our destruction have been "onslaughts of flood, famine, zombies, plague, conflagration, meteors, earthquakes, cyclones, hostile aliens, thermonuclear bombs, giant insects and King Kong himself." Here's one high point:

In 1886, Joaquin Miller published "Destruction of Gotham," in which the decadent city is consumed by flames: "The very earth was on fire. The oil, the gas, the rum, the thousands of filthy things which man in his drunken greed had allowed to accumulate on the face of the island appealed to heaven for purification."

Ilustrators also got in on the act. Here's one from 1917 advertising Liberty Bonds:

I think the biplanes circling Lady Liberty are a particularly sympathetic touch.

In the 1960's, 1970's, and in the 1980's (as I can personally testify), "Fun City" was anything but. Homelessness and murder rates peaked, police and transit and sanitation workers went on strike, blackouts provoked looting and chaos, Midnight Cowboy symbolized the triumph of grit, lowlifes, and disorder, the City was famously viewed as ungovernable, it went de facto bankrupt and its appeal to the federal government for help fell on deaf ears (the only redeeming value of which was the Daily News' all-time great headline, "Ford to City: Drop Dead"), and "white flight" reached an ugly apogee.

Fast forward to, say, 18 months ago, and we were on top of the world. Times Square had (like it or not) been transformed from XXX Porno Central to DisneyLand East, commercial rents were world-class, foreigners couldn't pay enough for condos in the renovated Plaza Hotel, our murder rate fell to small Midwestern town levels, and, of course, Wall Street revenue and profits were, as they often are, in the stratosphere.

Clearly, we had over-reached.

Thank goodness we don't have that to worry about any more. Our comeuppance is at hand. And about time, say I.

A final word. There's a reason people from all over the world are tempted to pursue their dreams here. And to those who wonder how we'll fare? I say:

We've been here before. We don't, actually, like it. We know how to be innovative, how to re-imagine ourselves, how to re-create for the umpteenth time world-class industries on this slip of an island, and how to fight our way out of a tight fix.

Don't take your eyes off us just because you think we're down.

Heller Ehrman (1890-2008)

It's all over for Heller Ehrman.

One of the best single pieces of coverage comes from The San Francisco Chronicle.

Heller was founded in 1890