Has the Gravy Train Departed?

Obeying the journalist's trusty adage that one story is an anecdote but two stories are a trend, I'm here to report that today two stories were published, one on each side of the Pond, predicting that the US subprime » US mortgage market » US commercial credit market » global lending market meltdown and ensuing liquidity freeze will stall or even reverse law firms' palmy days of growth.

The shockingly fast freeze-over of these markets reminds me of a maxim of Michael Milken, that once-in-a-generation genius of innovation in fixed income markets, who had this to say about liquidity:   "Liquidity is an illusion.  It's always there when you don't need it, and rarely there when you do."

These make for high-quality headlines, and those who are unprepared may indeed suffer (was the dot-com bust that long ago?),  but for the far-sighted and the nimble, all will be well.  There might even be an opportunity to "buy on the dip."  More in a moment, but first here are the stories, first up "Law firms hit by market turmoil" in the redoubtable FT, and second "With dip in economy, are associate layoffs on the horizon?" in The Legal Intelligencer. 

On our shores, the "associate layoffs" article speculates on whether firms focusing on financings and securitization will find their ranks of associates bloated.  (As an aside, please note the slightly imperious tone, focusing only on associates, and not on such unmentionables as de-equitized partners.)  By and large, firms that are not concentrated in securitization find the layoff predictions eminently plausible, and firms that have active securitization practices point to workouts, bankruptcies, and restructurings.   In what industries?  Why, in industries such as subprime lending whose obligations were securitized, of course!

Pete Kalis, Chairman of K&L/Gates, wisely preaches the virtues of diversified practice:  "Where I came from, you learned at an early age when you buy bar stools, the more legs the better."  And indeed, one of his partners has already been named examiner in the bankruptcy of subprime lender New Century Financial. 

Consultants and recruiters find it equally implausible there will be widespread bloodshed. 

"Firms are at a war for talent and often can't find enough corporate attorneys.

"I can't even imagine a firm laying off an M&A lawyer," [California-based consultant Peter] Zeughauser said. "It's beyond comprehension."

"A mergers and acquisitions practice is the most profitable, the most difficult to build and "you just don't let go of that talent in a downturn," he said.

"Mark Jungers, a recruiter with Major Lindsey & Africa in Chicago, said he has been hearing firms talk about the possibility of layoffs and there is a concern. He hasn't, however, heard any of his large-firm clients seeing a decline in work.

"There still aren't enough corporate associates to satisfy firm needs and transactional practices are still working hard, he said."

Whoever you choose to believe, it's safe to say that the forecast for securitization work is "partly cloudy, with a chance of rain."  Whether you're of a mind to focus on the partly sunny implicit in partly cloudy, or the chance of rain, you probably don't want to go on a structured finance hiring spree right about now. 

But given normal attrition rates (we're talking about associates, by hypothesis), if it takes a year for the unemployment-pig to work its way through the snake of the financial services sector to law firms, you may have little to worry about.  If you find yourself too heavily staffed a year hence, you have both a risk-averse and a more entrepreneurial option.  The risk-averse choice is simply to tighten the screws on performance evaluations and temporarily boost your "attrition" numbers.

The entrepreneurial option is much more fun, as is usually the case, at least if it works out.  That is to "buy on the dip," acquiring talent that may be suddenly on the street through no fault of their own, recognizing that as a financial invention securitization is here to stay in spades, and all that a downturn means is that the market will come back bigger and stronger, and with more investor and lender protections (meaning more clauses and covenants to be written and tested) than ever.

The FT piece is more thoughtful.

It starts with this inarguable proposition:

"The British legal industry's financial success is founded on the soaring international mergers and acquisitions market, although top firms argue that their expertise in areas such as financial restructuring will make them resilient in tougher economic conditions."

Some buyout firms have definitely put out a "gone fishing" sign, as Chris Bown, co-head of the international private equity group at Freshfields, puts it.  But it's worth reminding the hand-wringers that this follows one of the single greatest quarters of LBO and private equity activity in history.  A calmer perspective, which happens to be mine, is offered by Mark Campbell, global head of finance at Clifford Chance, who reports dispassionately:

"The position at the moment is that the froth there has disappeared.  The question is whether that market will return to some semblance of normality in September and October, or whether there will be a longer period of waiting."

Incidentally, Mr. Campbell also echoes my observation that, to the extent the market comes back revivified, albeit with more complex structures (no more "covenant lite" deals), lawyers should thrive.  After all, don't the websites of every self-respecting firm vow that they work only on the most "complex" transactions known to mankind?

Bottom line:   The firms that have actually built many-legged bar stools will do fine, and the adroit and nimble among them will capitalize on the opportunity to do more than fine and to pick up, for example, a 16%+ equity interest in Countrywide Financial at a recent historic low (cf. Bank of America).   Firms overzealous in the pursuit of the latest new new thing will come to a hard stop. 

And maybe, seven or eight years from now, we will have internalized the lessons of the dot-com subprime meltdown and be smarter about our own portfolio of industry-sector bets.