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 the underlying
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.