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Legal Commentary

: Adam Smith, Esq.

Lessons From the Depression


Every day, these days, and more than once, I ask myself, what all this means for our profession and our industry.

By "all this" I refer, of course, to the economic environment. Here are some of the hypotheses I'm putting in front of people I talk with:

  • Will this period embody a "flight to quality" whereby clients decide that if something needs legal attention it needs to be done absolutely positively right, whereas if something is marginally deserving of legal attention it can wait or the client can wing it?
    • Implication: The Magic Circle and the NYC Bulge Bracket firms win.

  • Alternatively, if the overall demand for legal services remains essentially unchanged (admitting that the practice mix emphasis may change), will clients' demand for savings on legal costs drive them away from Super Tier firms?
    • Implication: Second tier firms, with lower rates to start with and perhaps greater "flexibility" on rates, will win.

  • Corporate transactions, M&A, private equity, securitization, structured finance, and even garden-variety asset sales and purchases are, by and large, without a pulse at the moment. Yet we all know (and the original Adam Smith, not to mention John Maynard Keynes and Milton Friedman, would agree) that they will come back. Not, initially, we may surmise, driven by financial engineering, but certainly driven by stategic corporate decisions. At some point in the future, say, 18 months from now, people in corporate-land will begin looking around and saying, "Wow, that company that we've always had our eye on is really cheap."
    • Implication: Everybody hunkers down for the duration and re-emerges in positions essentially unchanged from where we are today.

  • Clients finally get really, truly, serious about alternative and strategically-driven billing in lieu of the billable hour. (I know, obligatory caveat to follow, that we've been talking about this for 20 years, but I think the dirty little secret of that era is that the clients--not the law firms--were always bluffing. They were perfectly satisfied with the billable hour or it never would have maintained the market share it has.)
    • Implication: Any firm that's willing to be creative, agile, and--not least--self-protective in terms of maintaining revenue for services rendered, will thrive. Firms that still think clients are bluffing, that think "alternative fees" is a synonym for "reduced revenue," or that simply lack financial imagination, will suffer.

  • Some firms will bet right and other firms will bet wrong on when demand will resume, in terms of maintaining or cutting staffing.
    • Implication: Firms with the financial wherewithal to carry under-utilized partners and associates for the (unknown) duration of the downturn will be in a stronger position to service demand when it returns. Firms forced by financial exigency or choosing as a strategic option to make deeper cuts will have to hope their bet on the timing of the recovery is right or else that the market for lateral talent will be open and forgiving when the time comes.

  • Although this recession seems to be disproving the tiresome nostrum that law firms are a-cyclical, there's no question that some practice areas are doing better than others, and some types of clients (read: some client industries) are doing better than others. Firms that were already disproportionately engaged with and exposed to those relatively healthy industries and practices will, rather tautologically, perform better.
    • Implication #1, for those who are true agnostics: You can never know or anticipate on which clients or practice areas the sun will shine tomorrow, so a reasonable (not utterly promiscuous, or you lose your reason for being) diversification of practice areas may be a shield against adversity.
    • Implication #2, for those more willing to trust their judgment: Place astute and selective bets on (a) industries, and/or (b) geographies, and/or (c) practice areas, that you think may be up and coming. While this may seem intuitively more appealing and more rational, markets have a way of surprising us all.

I could go on. You get the gist.

Never in my career--or the careers of those I speak with continually--has there been a time of greater uncertainty. The future is as hard to visualize as it is to see the East Side of Manhattan from Central Park West on a deeply foggy morning, or New Jersey from Riverside Park. You know it's there, with definite shape, but you can't see it or draw it or write about it with clarity and conviction.

So let's try to step back and get a bit of perspective.

On that score, the reflections of Ian Davis, the Managing Director of McKinsey, are worth reading:

These are no ordinary times. The venerable independent investment banks Lehman Brothers and Bear Stearns no longer exist. Central bankers and finance ministers are working in concert but struggling to keep up with events. China's government is pumping hundreds of billions of dollars into the country's economy. Chief executives in the US financial-services and automotive sectors have gone to Washington hats in hand.

Along the way, many core assumptions about the merits of globalization, markets, risk, and debt, long taken for granted in business, government, and academia, have come into question. One big shift already under way involves a far larger role for government in the economy, whether through outright ownership of former private-sector assets or tighter regulation. Also inevitable: massive changes in industry structures. Consolidation, effected either by bankruptcies or mergers, is already transforming financial services and seems bound to take place elsewhere as the impact of the credit crisis ripples through the real economy.


Inspired leadership is urgently needed to renew the global financial system and avert a protectionist backlash or excessive regulation that could derail economic progress--especially in countries and regions emerging from poverty--or dampen the entrepreneurial spirit. Strong leadership is equally critical within organizations. Anxious employees, customers, suppliers, and shareholders are looking for a steady hand and clear, candid messages from corporate leaders, not for unrealistic pronouncements that may be overtaken by next week's events. The world is watching.

I would emphasize Mr. Davis' final point: This is a time for leadership. Leadership within your firms, to be sure, but also leadership on the public stage. If any group of managing executives is in a better position than law firm leaders to contribute to the debate on issues such as financial regulation; banking safety and soundness; the integration or severance of investment banking, brokerage, and classical-banking functions; the role of ratings agencies; the utility of global capital flows (just to suggest a few issues), I don't know who they are.

Are you prepared to speak out? If not, why not? If so, shall we try to enlist a leadership council of your peers to do so? If you're interested, "Adam Smith, Esq." is ready, willing, and able to help provide a platform and clearinghouse for ideas, position papers, and fora for discussion.

But back to the economic crisis.

We can also try to suss out some more concrete advice about what we should do now, for example in the popular parlor game of trying to take lessons from the Great Depression. But when it comes from McKinsey, I think there may actually be meat on the bones.

Recent turmoil in global financial markets and its spillover into the real economy have generated considerable interest in the Great Depression. There's much to be fascinated with, both in the parallels (banking failures, a large spike in real-estate foreclosures, and global uncertainty, for example) and the points of contrast (such as the speed and coordination of the response of central banks and finance ministries in 2008).

Can the business practices of the 1930s yield useful lessons for executives setting priorities in today's uncertain and evolving environment? For investments to promote innovation, the answer may be yes.

Using patents as a proxy for investment in the future, McKinsey found a fascinating pattern during the Great Depression: This chart shows change in GDP (green bars) and change in patent applications (yellow bars), lagged by one year, for the Depression era. Note the almost spooky correlation, as if companies could turn innovation on and off depending on which way the economic winds were blowing:


It couldn't be much more dramatically displayed how companies tied their investments in R&D to an almost yearly correlation with GDP growth.

Yet there were some companies that did not. Among them were:

  • DuPont, which invented neoprene (synthetic rubber) in 1931 and nylon in 1934;
  • Polaroid;
  • Hewlett Packard; and
  • RCA, which turned its research from radio to the new market, television, returning to profitability in 1934.

If these names sound like leaders in the WWII era and its aftermath, there's a reason. They leaned against the conventional wisdom and turned against the prevailing economic winds. A lesson for us?

Not only may your competitors be battening down the hatches, but investment assets (talent, primarily) may be cheaper than they have been for a long time.

As I've said before, perhaps a time for us all to read fewer newspapers and more history.

Full post as published by Adam Smith, Esq. on January 12, 2009 (boomark / email).

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