Regular readers, or simply those with good memories for the jovial Cornell University economist Alfred Kahn, who briefly served as Jimmy Carter’s czar over wage-price controls, as well as the last head of the unlamented Civil Aeronautics Board (where he deregulated the domestic airline industry), will recall that he was strictly instructed by the White House not to utter the "R-word" (recession) in Congressional testimony he was about to give. So, when inevitably asked by the good Representatives whether the economy was in a recession, he replied faithfully that he could not say that, but that it was in his view in "a banana." (Subsequently, following complaints by banana industry lobbyists, he changed the term to "kumquat," presumably a fruit with less vocal representation in Washington.)
So: Are we facing a "banana"? And if so, what should you do about it?
Let’s start with some data points:
- Morgan Stanley, Goldman Sachs and Merrill Lynch have issued "recession warnings."
- The Economist‘s somewhat impish "R-word index," which counts how many times in a quarter the word appears in The New York Times and The Washington Post, and which accurately forecast the 1980, 1991, and 2001 recessions, is nearing a new peak.
- "It is hard to be an optimist," Sullivan & Cromwell Chairman H. Rodgin Cohen said [of the outlook for M&A activity in 2008]. "With the markets where they are, it is going to be a tough year. The markets hate uncertainty, and we are in an uncertain time."
- Gold and oil are both at or near all-time (inflation-adjusted) highs.
- The front page of just one day’s Wall Street Journal lists the following facts:
- American Express drops 10% in one day after announcing increased writeoffs and delinquencies; Capital One, MasterCard, and Discover also drop;
- Retailers ranging from McDonald’s to Tiffany report disappointing same-store sales;
- The stock market has started 2008 with its worst year-opening slide in over 30 years; and
- A Barron’s roundtable questions whether the 25-year bull market is running out of gas.
- The American Lawyer‘s most recent survey of law firm leaders (last month) was appropriately headined "Fog Advisory"—the outlook is unclear.
- And, of course, Cadwalader laid off 35 finance attorneys.
Of the prospects for a recession, the schools of thought are various, ranging from:
- It’s already started, we just don’t know it yet (Goldman Sachs);
- It’s imminent unless we take drastic stimulative steps (all the Presidential candiates, Jim Cramer);
- It’s too early to tell; the data are unclear (evidently, Ben Bernanke);
- It’s probably a long shot (most Fortune 500 CEO’s, most AmLaw 200 MP’s);
- Who, me? What recession?! (no one that I’d consider worth taking seriously).
A salient characteristic of recessions is that, in all too many cases, they can be self-fulfilling prophecies. Once the drumbeat of alarm grows deafening (the Economist‘s "R-word" index), people start to believe what they’re reading and seeing, meaning that consumers dial back spendingto save up for harder anticipated times ahead; business slows or eliminates hiring to batten down the hatches, other businesses cut back on inventories, real estate developers dial back or put off projects, venture capital and private equity pull back hard on the reins, new projects and initiatives across the board are dialed back (IT investments, new offices, geographic expansion, starting new lines of business, launching new products) and before you know it we have an honest-to-God, certified Recession on our hands. Sometimes perception is reality. (Or, as Bernard Berenson famously remarked about the difference between art objects and the historical events they may have sprung from, in the case of actual events, you can never go back and relive them or understand them as those taking part understood them, but with art objects, "the object is the event.")
Saying it can be a self-fulfilling prophecy doesn’t make it any easier to avoid, of course.
This brings us to law-firm land.
Famously, law firms are said to be recession-proof. That’s not true. "Recession-resistant" might be closer, but that’s not quite true either. I prefer to characterize firms as "a-cyclical," meaning not necessarily tied directly to the macroeconomic tides, but still having ups and downs.
What’s going on for 2008, then?
Clearly, some practice areas are suddenly quite out of fashion, including securitization of debt obligations and perhaps structured finance overall. Hedge fund activity appears to be going quieter, as does private equity and, perhaps with them, M&A. (The hope for M&A is that "strategic" M&A will supplant financially-engineered M&A, but I doubt it will be enough to take up the slack since the limit on financially-engineered M&A is the limit on liquidity, until quite recently sky-high, whereas the limit on strategic M&A is always what makes sense in the marketplace, a far lower ceiling.)
Will restructuring and bankruptcy take over where these practices have left off? To a degree, to be sure, but probably not in whole. That leaves us roughly here, as I read it:
- I don’t see a Katie-bar-the-door downturn, but more of an interruption in the post-2001 expansion. Inflation is relatively quiet (although $100/barrel oil makes things look bad, and other commodites are rumbling), which gives the Fed some latitude on rates.
- Inventories are well under control, thanks in part to the supply-chain revolution of the last 10 years.
- Unemployment is at almost historic lows.
- Excesses in the lending sector need to be worked out, to be sure, but we’re already seeing aggressive and accelerating moves in that direction.
What should firms do to prepare and adapt?
First of all, panic not. Temper your partners’ expectations for ever-more-glorious PPP numbers (but you were already doing that, right?–yes, thanks, I thought so). You and your firm are not responsible for the credit crunch, although you’ll be hit glancingly by the consequences.
Second, let the magic of attrition work its powerful wonders. You’d be surprised how quickly payrolls lighten up if you just take your foot off the accelerator for a bit. Of course, they’ll lighten up unevenly and not necessarily where you most wished they would—people are not stupid, and those most at risk are most likely to hang on tight—but you can reallocate and adjust, which is more humane than slashing (and preserves your firm’s reputation for the next up-cycle,when it will matter).
Third, consider a long shot. Rent (occupancy, all-in) is your second greatest expense after people. I’m not counseling or predicting that landlords may suddenly become souls of Christian sweetness and enlightenment, but we also know that unoccupied office space (vacated, perhaps, by a mortgage lender?—just kidding) is anathema because it is, essentially, an irretrievable missed opportunity to collect revenue, not unlike a vacant seat on an airliner about to pull away from the gate. Each month space is empty is a month’s rent that will never be recovered. So, opportunistically and with obvious attention to the peculiarities of your local marketplaces, see if there might not be bargains to be had.
Fourth, and apropos attrition, think about repositioning people. Don’t tell me people get zero cross-training as it is. First, this is an excruciatingly poor use of expensive talent. Who knows at age 26 or 28 whether they’re a litigator or a corporate type at heart? (I surely did not, and making the wrong impulsive choice of litigation was a mistake it took me nearly a decade to recover from and find my home in securities law.) Do not treat $160,000/year talent that shabbily. A second reason to cross-train is if you find yourself in the situation you may find yourself in in 2008. A third reason is the simplest of all: Lawyers with generalist exposure are the best lawyers of all. And isn’t that what it’s all about?
Finally, avoid the defensive crouch.
Be courageous; be brave.
If there is a downturn, seize the opportunity to pick up talent and grow your firm’s capability; some top-quality people may find themselves on the street, or casting about for opportunities, through no fault of their own. Keep your antennae up; let them know you’re answering phone calls and emails.
Regularly, in corporate America, firms that grasp the opportunity to build, inexpensively but strategically, in downturns, emerge into the recovery turbo-charged. You can do the same. Seize the downturn, if downturn it be. It needn’t be a falling knife.
