October 2008 Archives

In the nearly five-year history of "Adam Smith, Esq.," you could have counted the number of guest columns on one finger.  As of today, make that two.

The following comes from E. Leigh Dance (see immediately below), who has a strong perspective on what globalization means for our industry.  Thanks, Leigh.

E. Leigh Dance
For 15 years E. Leigh Dance has led the global legal services consultancy, ELD International, working with global law firms and corporate law departments around the world.  She is based in Rome and New York and has a London office. 

Earlier this month Thomas Friedman, in his October 5 New York Times column, wrote about the implications of our suddenly new age.  He describes what we're moving into as "globalization and financial integration on steroids." 

"Even though the dollar has strengthened a bit lately," Friedman says, "we are going to need foreigners and sovereign wealth funds from China, Asia, Europe and the Middle East more than ever to survive this crisis...  In the process, we are going to become even more intertwined and dependent on the rest of the world."

While many firms rightly focus on cash flow today, there's also the question of globalization.  American law firms, by and large, have a long way to go.  Adam Smith, Esq. has commented in the past (including in a June 4th column) that New York firms are behind the eight-ball (and behind the Magic Circle) in their international growth.  Whichever side of the proverbial pond, law firms cannot assume they've become global when more than 85% of their fee earners are practicing domestic law and based domestically.  
Of the AmLaw Global 100 (newly released this month), only 38 have more than 15% of their lawyers outside of home country. 

Of the Global 100 firms with offices in at least three countries, a few numbers:

Firm (overall ranking)             % of lawyers outside home country

Kirkland & Ellis (11)                8%
Greenberg Traurig (12)          4%
Morgan Lewis (17)                  7%
Slaughter & May (32)               8%
Bingham McCutchen (39)      4%
Foley & Lardner (41)               <1%
Proskauer Rose (49)              4%
King & Spalding (50)               4%
Holland & Knight (51)             <1%
Pillsbury (57)                            2%

... and at the opposite end of the spectrum:

Firm (overall ranking)             % of lawyers outside home country
Clifford Chance (1)                 65%
Linklaters (2)                           62%
Freshfields (3)                        67%
Baker & McKenzie (4)            82%
Allen & Overy (6)                     59%
White & Case (10)                 66%
DLA Piper Int'l (16)*               51%
Lovells (22)                             76%
Norton Rose (56)                   51%
Simmons & Simmons (59)     60%
*DLA Int'l does not include US - DLA Piper US is separate,only domestic

We know that the UK firms expanded internationally more quickly--the size of their home market dictated it.  Many UK firms are also ahead in fostering the diversity (origin, not race) of their lawyers and the firm's approach to serving clients from many places. 

Of course, UK firms have a glaring gap in their coverage that seriously discounts their lead in other countries:  the US.  The US makes up the lion's share of the world's legal market, and American firms have kept much of their manpower where the money is.  But the make-up of the US market is changing.

As Adam Smith, Esq. wrote in a May 16 article, recent McKinsey research showed that top companies have differentiated themselves through global talent management, including:

• "encouraging people to get experience across multiple locations,
• regarding overseas experience as a prerequisite for promotion, and
• offering managers incentives to move talented employees to other functions or geographies."

Though there are exceptions (Cleary and Latham spring to mind), these sorts of moves have been a relatively low priority for most American law firms.  Even though much growth in work with US multinationals has been outside of the US, now we're talking about a different global equation.

As Friedman comments, the avalanche of incoming foreign capital means that the days of unilateral exercise of American power are pretty much over:  "As the old saying goes:  He who has the gold makes the rules.  Well, we no longer have as much gold, and until we get some, we will have to pay more heed to the rules of those who lend us theirs."

Both firm leadership and partners in their prime have lived through the glory days with their American or English legal systems making the rules and driving the approach to mega transactions, litigation, intellectual property, private equity and regulatory advocacy around the world.   The top Anglo Saxon law firms have excelled at serving global companies primarily run by Anglo Saxon executives according to a predominantly Anglo Saxon approach to international business.  Indeed, I am one of the Anglo-Saxon consultants who has benefitted from these glory days (though I have a few languages and several countries in my portfolio).

Last spring I moderated a roundtable of top global counsel where one General Counsel talked about his big Chinese legal team.  An American, he relayed their viewpoint, which had startled him: "Who says that future global business growth must be centered on American or western legal principles?  Why can't it come from the East-- from the Chinese, for example?"  The counsel around the table were squirming in their seats. 

What, globalization without us as the referees?  That's a whole different ball game. 

New game, new age.  In his article, Friedman quotes Jeffrey Garten, professor of trade and finance at Yale:

"Being a bigger debtor nation means losing even more of our sovereignty.  It means conducting our economic policies with an eye toward whether others approve.  It means bearing the advice and criticism that we have dispensed ad nauseam to other countries for over a half a century." 

Garten suggests that this goes beyond governments into the heart of business.  "Corporate decisions will become more sensitive to international factors, in part because more non-Americans will be on the governing boards."

US law firms with global ambitions need to look at how they can prepare to thrive.  Even if the vast majority of your workforce is here at home, that workforce needs to know lots more about navigating in the world's fastest growing markets, both externally and within the firm.  The vast majority of the lawyers in international offices of US firms tell me that their firm's operating and management style is all American. 

Nothing wrong with that, historically speaking.  But tomorrow, when more of your relationships at your big US multinational client are with non-Americans who may want to see the world and do business their way, you won't necessarily be their first choice advisors.

So what to do?  To succeed in this intertwined world, law firms must go beyond the cliché and foster a truly international mindset.  Just as important but far less tangible than the new Dubai office is changing service delivery to meet demands of non-American and globalized American businesses.  It has to be part of your plan.  Global talent management is just one piece of that profound and demanding strategy, and it goes beyond hiring foreign laterals. 

It's also important to reconsider and adjust your practice growth strategies for the fundamental differences in practice approach and dynamics across geographic markets.  Train lawyers and staff to work effectively in multi-cultural teams.  Hire people at home and abroad that speak several languages and have grown up in more than one country.  Move your institutional assets (of every age) across borders, including into the US.

Building cultural adaptability and capability is not easy.  But from my vantage point, you'll have to take Friedman's (and Darwin's) word for it:  you don't really have a choice.  

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

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

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?

Not every day do we get a new Nobel Prize winner in Economics, not to mention one whose name, Paul Krugman, might actually be familiar to more Americans than the few of us who are poor closet economists. Krugman is of course not only a Princeton professor (we pause to take pride here in the home team), but a regular op-ed columnist in The New York Times where he is known for wielding a hatchet against all things touching or concerning the Bush Administration.

As for his Times op-ed columns, we are, as you know, resolutely apolitical here at "Adam Smith, Esq." Perhaps the best that can be said of those is that we come not to praise but to bury them in the context of his winning the Prize. Or, as was said more pungently in Australia's National Post, "You don't get the Nobel Prize in Economics for writing newspaper columns (as I've been trying to explain to my mother the last couple of days). So the prize awarded Monday to Paul Krugman should not be read as an endorsement of Krugman's uber-Democratic newspapering."

Actually, I'll give the last word on his Times op-eds to his fellow columnist Maureen Dowd:

"I'm not sending Paul Krugman Champagne.

He won the Nobel prize in economics this week, and while I'm sure that's delightful for him, it has raised the bar to an impossible height for his fellow columnists at The Times. We used to strive for Pulitzers, or simply regional awards, or even just try to top each other on the paper's most e-mailed list.

Now we're supposed to compete for Nobels?"

We're here to take a brief interlude, a detour, if you will, into economic theory and into what Krugman's Nobel is all about.

Classic models of trade between countries, stemming from David Ricardo's shockingly brilliant concept of "comparative advantage," predicted, in theory, that trade flows would depend on such things as ratios of capital to labor, with capital-rich countries exporting capital-intensive goods and importing labor-intensive goods from labor-rich countries.

But that's not what the data showed. In reality, most international trade takes place between countries with very similar capital:labor ratios.

Krugman sought to, and succeeded in, explaining this. His explanation was based on economies of scale and on transaction costs across distances. What does this mean?

Economies of scale mean that producer incentives are to concentrate production in a limited number of locations. Too abstract? Let's make it concrete: There's a reason Silicon Valley is a self-reinforcing hub of high technology and innovation in general. An engineering and entrepreneurial culture combined with venture capitalists combined with a world-class research university (Stanford) combined with a very start-up friendly business ecosystem has made it a hotbed for new companies.

Similarly, New York and London are likely to remain global financial centers as far as the eye can see. They both have the infrastructure that sophisticated financial professionals depend on. Permit me to state the obvious ones:

• English
• Entrepreneurial cultures
• The Anglo-Saxon common law tradition, and the rule of law
• An indigenous infrastructure of banks, law firms, marketing professionals, and all the multifarious support professions.

And the less obvious:

• Workable, if not Asian-clean-slate, physical infrastructures
• Terrific international air connections
• Fabulous stores, restaurants, museums, parks, and schools
• Great, and highly diverse, residential and commercial real estate

But back to Krugman.

He described his basic findings in the 1992 "Geography & Trade:"

"Because of economies of scale, producers have an incentive to concentrate production of each good or service in a limited number of locations. Because of the cost of transacting across distance, the preferred locations for each individual producer are those where demand is large or supply of inputs is particularly convenient -- which in general are the locations chosen by other producers. Thus [geographical] concentrations of industry, once established, tend to be self-sustaining."

An example he used was that the auto industry in capital-intensive Sweden exports cars to capital-intensive America while also importing cars from America.  The logic is that both Volvo and GM can reduce costs by producing a relatively large output (sufficient to satisfy worldwide demand) in particular geographic niches where the requisite inputs are concentrated. 

Krugman, of course, was building on the theory of comparative advantage, which he explained perhaps most famously in "Ricardo's Difficult Idea." Comparative advantage is a theory at once powerful and notoriously elusive, which--although beloved by economists, including yours truly--seems to inspire incomprehension even by those who loudly retort that while they subscribe to it, they only happen to see certain exceptions applying, which are only visible to those with a particularly subtle intellect.

At that point you know you're in the company of someone whose fellow intellectual travelers include those who proclaim their belief in evolution while demanding equal time in the schools for "intelligent design." They say they believe, but they don't believe.

Here's where Krugman's brilliant "Ricardo's Difficult Idea" comes into play. Permit me to quote at some length (my own Cliff's Notes version is here at the bottom):

My objective in this essay is to try to explain why intellectuals who are interested in economic issues so consistently balk at the concept of comparative advantage. Why do journalists who have a reputation as deep thinkers about world affairs begin squirming in their seats if you try to explain how trade can lead to mutually beneficial specialization? Why is it virtually impossible to get a discussion of comparative advantage, not only onto newspaper op-ed pages, but even into magazines that cheerfully publish long discussions of the work of Jacques Derrida? Why do policy wonks who will happily watch hundreds of hours of talking heads droning on about the global economy refuse to sit still for the ten minutes or so it takes to explain Ricardo?

[...]

At a deeper level, comparative advantage is a harder concept than it seems, because like any scientific concept it is actually part of a dense web of linked ideas. A trained economist looks at the simple Ricardian model and sees a story that can be told in a few minutes; but in fact to tell that story so quickly one must presume that one's audience understands a number of other stories involving how competitive markets work, what determines wages, how the balance of payments adds up, and so on.

[...]

I believe that much of the ineffectiveness of economists in public debate comes from their false supposition that intelligent people who read and even write about world trade must grasp the idea of comparative advantage. With very few exceptions, they don't -- and they don't even want to hear about it. Why?

[...}

[I]f one tries to explain the basic model to a non-economist, it soon becomes clear that it really isn't that simple after all.

There are, I believe, at least three implicit assumptions that underlie the most basic Ricardian model, assumptions that are justified by the whole fabric of economic understanding but are not at all obvious to non-economists. Here they are:

- Wages are determined in a national labor market: The basic Ricardian model envisages a single factor, labor, which can move freely between industries. When one tries to talk about trade with laymen, however, one at least sometimes realizes that they do not think about things that way at all. They think about steelworkers, textile workers, and so on; there is no such thing as a national labor market. It does not occur to them that the wages earned in one industry are largely determined by the wages similar workers are earning in other industries. This has several consequences. First, unless it is carefully explained, the standard demonstration of the gains from trade in a Ricardian model -- workers can earn more by moving into the industries in which you have a comparative advantage -- simply fails to register with lay intellectuals. Their picture is of aircraft workers gaining and textile workers losing, and the idea that it is useful even for the sake of argument to imagine that workers can move from one industry to the other is foreign to them.

Not is it obvious to non-economists that wages are endogenous. Someone looks at Vietnam and asks, "what would happen if people who work for such low wages manage to achieve Western productivity?" The economist's answer is, "if they achieve Western productivity, they will be paid Western wages" -- as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor plausible.

- Constant employment is a reasonable approximation: The standard textbook version of the Ricardian model assumes full employment in both countries. But in reality unemployment is constantly a concern of economic policy -- so why is this the usual assumption? There are two answers. One -- the answer that Ricardo would have given -- is that international trade is a long-run issue, and that in the long run the economy has a natural self-correcting tendency to return to full employment. The other, more modern answer is that countries have central banks, which try to stabilize employment around the NAIRU ["Non-Accelerating Inflation Rate of Unemployment"--Bruce]; so that it makes sense to think of the Federal Reserve and its counterparts acting in the background to hold employment constant. This is not at all the way that non-economists think about the issue.

- The balance of payments is not a problem: The standard textbook presentation of the Ricardian model assumes balanced trade -- indeed, it is usually a one-period model in which trade must be balanced. Yet the news is full of stories about the balance of payments, of complaints about trade surpluses and deficits. Why are these absent from the story?

Again, economists have good reasons for thinking that it is a good approximation to separate balance of payments from real international trade issues. In Ricardo's case, the essential ingredient was the argument by David Hume that trade imbalances are self-correcting: a surplus country will acquire specie, leading to rising prices that price its goods out of world markets, while a deficit country will correspondingly find its goods increasingly competitively priced. In the modern world, again, the channels involve less Invisible Hand and more government intervention: when monetary policies target the unemployment rate, exchange rates do the adjusting. Economists are also aware that even persistent trade imbalances are not necessarily a problem, and certainly that surpluses are not a sure sign of health or deficits one of weakness.

Permit me to try to summarize the virtues of comparative advantage.

The benefits of trade do not depend on countries' having absolute advantages over other countries, but only on having comparative advantages. This means that a country that is absolutely disadvantaged in producing all relevant goods and services can still benefit from trade. The secret is opportunity costs, not absolute costs.

Consider two hypothetical countries, North and South, which produce only two goods, food and clothes. If each country devoted its entire economy to producing food, North would produce 100 tons and South 200 tons. Similarly, if each devoted everything to clothes production, each would produce 100 tons of clothes. South appears absolutely advantaged, so where's the benefit from trade?

First, let's pretend that each country is equally predisposed to consumption of food and of clothes, so that each devotes 50% of their productive capacity to each. This produces:

Now let's assume trade barriers are lifted and each concentrates entirely on its preferred output in anticipation of being able to trade. This yields:

Of course, this "production" leaves North starving and South naked.

So if we introduce actual trade and imagine some arbitrary preference "price" of one ton of Food for 2/3 ton of Clothes, we get:

Everyone is better off.

Now, if you still don't believe me, consider the famous "attorney/typist" example.

Suppose you're the best lawyer in town and also the fastest typist in town; you have an absolute advantage in both.

Q1: Are you going to go to work as a secretary? Obviously not. You put your absolute advantage as a lawyer to its highest use.

Q2: Are you going to type your own documents? Obviously not. You put your comparative advantage as a lawyer to its highest use.

You are now a subscriber to the doctrine of free trade.

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.

Today's Wall Street Journal profiles H. Rodgin "Rog" 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 Rog 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 Rog 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?

Rog 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, Rog 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 Rog 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 Rog Cohen.

A few weeks ago I posed the question to you all:  Will the realignment of the top financial services institutions fundamentally alter the long-term demand for legal services?

Here's how you voted:

A couple of aspects of these seem worth commentary: 

• There seems near unanimity that, regardless of what happens on Presidential election day in the US this November, we are in for a more regulated world.
• And there is near equal consensus in the short run that it will require more lawyers to sort things out.
• Likewise, the era of 20:1, 30:1, or 40:1 investment bank balance sheets (in terms of assets:equity ratios) seems at an end, perhaps for a long long time.
• And securitization—at least in terms of standard "assembly line" deals—is over.

What can you read between the lines, as it were?

I read massive uncertainty and doubt.

Partly that's from the popularity of the rather cheeky "What do I care?  I'm a litigator!"  After all, when one is nervous, flippancy is a familiar mask to don.

But also I infer it from the lowest-single ranking selection, seeing no fundamental change in demand "because the 'primary' demand" comes from the underlying corporate economy, not Wall Street.  That this option was uniquely unpopular—only 12 votes out of 272, or a mere 4.4%.  In other words, it sure sounds as though the financial services industry is the lifeblood of much of what we've been doing recently.

Which brings to the fore the only question that really matters in terms of getting our financial system back on its feet:  When will "credit" return?  The English word "credit" traces its etymology to the Latin credere, meaning "to believe," and has cognate forms in, among other things, creed, crediblity, credence, and credulity.  Note that neither "assets" nor "liabilities" is a cognate for credit.  Credit is all about belief.

Until fundamental belief in the "credit-worthiness" (for which one could almost substitute "worthiness" without loss of meaning) of financial institutions returns, we will not be able to count ourselves out of the woods. 

At this point the only question is how much more massive the federal government's intervention will have to be.  That, at least, is the question for Presidential candidates, policy-makers, bankers, Wall Street and Main Street, not to mention any corporation that goes to the commercial paper marketplace and any family that's in the market for a mortgage, a car or student loan, or a new credit card.

For you, the question is when your firm can emerge from this, and how best to position it to do so:

• In strategically important and solid relationships with your clients
• With practice groups best aligned to how you see the new emerging landscape
• With expenses under tight control and the opportunity to prune deadwood fully exploited
• And to do all the above with alacrity.

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.

Analogies are imperfect (that's why they're called analogies), but here's an interesting thought experiment tying together the wild rides investment banks have had on Wall Street during the past few weeks and the potential impact of the Legal Services Act in the UK, permitting law firms to go public and to take on public investors.

James Surowiecki, writing in the current New Yorker, talks knowingly about the repercussions of being a public company.

And he was writing before the most recent downward acrobatics occasioned by Congress' incomprehensible, profoundly irresponsible, self-serving, and altogether shocking rejection of the Treasury's rescue plan. Here at Adam Smith, Esq., we don't editorialize, but numerous analyses of the votes have shown that those congressional representatives facing contested elections voted overwhelmingly against while those with safe seats voted overwhelmingly in favor. You are at liberty to draw your own conclusions, but the word "courage" ought to be a part of your reflections.

Back to the repercussions of being public. Here's the intro:

Before the government stepped in last week, the bodies of financial institutions--Lehman Brothers, Merrill Lynch, and A.I.G., with Washington Mutual and even Morgan Stanley threatening to be next--were piling up so fast it seemed possible that Wall Street might simply cease to exist. The list of blunders that led to the carnage is by now familiar: firms succumbed to the frenzy of the housing bubble; relied on dubious mathematical models to manage risk; and leveraged bad bets with suicidal amounts of borrowed money. But the impact of these mistakes was made worse by a seemingly harmless decision that these companies made many years ago: the decision to go public. Doing so put the firms at the mercy of the stock market, and last week that mercy evaporated.

Once upon a time, investment banks were private firms, structured as partnerships, and relying on the capital provided by the partners in order to run their operations.

Sound familiar?

It only gets more so (interpolated text mine):

For Wall Street firms, going public was a deal with the devil, because it meant exposing themselves to what was, in effect, a minute-by-minute referendum, in the form of the stock price, on the health of their operations. This was fine as long as things were going well--the higher the stock price, the richer everyone got--but, once things started to go bad, that market referendum started to look like a vote of no confidence. And that made the problems that the companies were already facing much, much worse.

That's because the entire edifice of Wall Street is built on confidence. Investment banks [law firms] rely on short-term debt [people] to run their businesses, and their businesses consist of activities--trading, dealmaking, money management--that depend on people's faith in their ability to honor their obligations [continue to perform at impeccable levels]. As soon as the customers and creditors of a company like Lehman start to wonder whether it might collapse [the firm will lose top talent], they become less willing to lend or to trade, and more likely to demand their money back [take business away]. The perception of weakness exacerbates the reality of weakness. And although there are myriad measures of a company's health, nothing looks scarier than a stock price that's heading toward zero.

About now you may be arguing that the "stock price" of a law firm should reflect more than the inchoate and indefinable notion of "confidence" in its ongoing power as a magnet for talent, that, after all, the firm has serious clients and a genuine accomplishments and a powerful partnership and a strong pipeline of associates and robust and reinforcing systems of professional development, recruitment, knowledge management, business development, and so forth.

Nice try.

The problem is that if the "stock price" of a law firm drops, it might well signal a drop in confidence in the firm's ongoing viability, whereas the drop in the stock price of most corporations which aren't entirely dependent on confidence per se signals only a drop in expectations for their near-term performance, not an existential questioning of their reason for being.

Thus concludes the article:

The downward spiral can be stunningly fast and near-impossible to escape. Lehman's assets were not significantly more toxic last Monday, when the company filed for bankruptcy protection, than they had been a week earlier. And, technically speaking, the bank may not even have run out of money, since it had access to an emergency liquidity line from the Federal Reserve. What Lehman did run out of was credibility. It couldn't remain a going concern because creditors and customers no longer trusted it. Why would they, when its stock price had fallen nearly eighty per cent in the previous week? The less faith the market had in the possibility of Lehman's survival, the more remote that possibility became.

This doesn't mean that stock prices don't reflect reality--Lehman's business really was in bad shape--or that Lehman would have survived had it been private. But being publicly traded makes it harder to take the long view and survive market storms. [...]

Considering that Wall Street firms spend all day dealing with the market, they have been slow to understand just how vulnerable they were to it. Companies like Lehman and, earlier, Bear Stearns saw going public as an excuse to take on more risk and act more recklessly, when in fact becoming a public company makes caution more important, since the margin for error is smaller, and the punishment for failure swifter. Now that the government has acted, Wall Street (or what remains of it) may yet be able to regain investors' confidence. But long-term survival really depends on remembering the fundamental truth about playing with other people's money: it's a lot of fun until they suddenly decide to ask for it back.

Am I counseling, then, against considering the possibility of going public or taking on material amounts of outside investment? No, I'm only counseling against doing so without considering the long-run repercussions of having to deal with (a) transparency and disclosure that outside investors will demand; and (b) the possibility--and the repercussions--of their yanking their money.

You have tools to fight the reality that being publicly traded makes you "vulnerable" and that it punishes reckless behavior more swiftly. For example?

One thing investors always favor is a stable revenue stream over a variable one. They prefer subscriptions to events, wealth management programs to brokerage commissions, leases to sales, and, in general, ongoing relationships to opportunistic and expedient windfalls.

Let's assume that going public is not within your sights at the moment: What do the preferences of investors have to tell you? Here are a few thoughts:

• Lateral partner acquisitions for revenue bumps are a losing game. This is buying market share, and what you buy is for sale to the highest bidder.
• Lateral partner acquisitions for increasing your firm's capabilities hold, to the contrary, potential promise. Skadden, for example, doesn't even ask lateral partners about their books of business; they only care about what potential partners can add to the firm's capability.
• Thinking of merging? Same analytics apply. Would it add capability or merely revenue?
• Or, approach it from the perspective of client relations: It's amply proven that the more practice groups within your firm a client utilizes, the more loyal that client is. Loyal clients provide more stable revenue streams than one-off clients. So cross-marketing is not just a nice thing, it could be vital to your long-run stability.
• Finally, don't permit partners (senior or otherwise) to hoard clients. Insist that they expose the clients broadly to other members of the team, making the client a client of the firm rather than the individual.

The vast majority of large, profitable, and growing US and global corporations are, of course, publicly held. So there must be something to that model.

But investment banks, and law firms, may be different. Pay attention.