Lessons from Capital One & North Fork

One of my near-bedrock beliefs is that we're living through a period when the structure of the legal industry is morphing before our eyes, setting up what I believe will be a future pattern that may well endure for decades.   Most recently, I wrote about this in "It's 2015:   Do You Know Where the AmLaw 25 Are?"  (And if you want a far earlier discussion, over a year old, check this out.)

So what, again, is that emerging structure going to look like? 

First, permit me to observe as an economist that the taxonomy of stable, durable industry structures is not infinite—not every structure that can be imagined exists.  Some of the more fascinating industries, from a structural perspective, are:

• airlines, with very high fixed and very low marginal costs, and classically perishable inventory;
• utilities, again with very high fixed generation-and-distribution-infrastructure costs and very low marginal costs of delivering an additional kilowatt or BTU—at least until generating capacity utilization begins to approach its maximum, when the least efficient plants must be brought online, suggesting in the future an increasingly flexible and time-sensitive component to pricing; and
• retailing, dominated both by enormous integrated chains (Wal-Mart, Target, Federated, Safeway, Home Depot, Staples, etc.) and mom & pop's (your drycleaner, deli, coffee shop, shoe repair) with little inbetween.

But we don't work in any of those industries.

The model I want to suggest—and this is entirely by way of "thinking out loud," so I welcome reader feedback even more exceedingly than is the normal case—is that of financial services.

Consider the vast landscape of retail and investment banking, credit cards, securities broker-dealers, mutual fund complexes, and investment managers and hedge funds.  We see essentially clusters of institutions at both ends of the size spectrum:  Goldman Sachs, Citigroup, Bank of America as global, dominant institutions with awesome balance sheets and oceanic cash flows; and Lazard-Freres, JP Morgan private banking, and two guys in Greenwich with a hedge fund at the opposite end, deploying the primary asset of sheer intellectual firepower.

There are many virtues to this industry structure.  On one hand, the Fortune 500 and FTSE 100 can find their "peer group," ready to serve their international needs with apposite financial and human resources; and on the other hand the Park Avenue widow can get her dog walked by her private banker's admin.

The pending acquisition of North Fork Bancorp by Capital One underscores the power of this structure.  To be sure, there were highly deal-specific circumstances powering that agreement, but the trend in financial services across the board is for regional and mid-market players like North Fork to disappear. 

In this case, North Fork had a problem which for Capital One was an opportunity.   The economic model of banking, since the Medici's if not earlier, is the simple one of borrowing cheaply and short-term from depositors and lending dearly and long-term to mortgagors et al. 

As The Wall Street Journal put it:  "Like other regional banks, North Fork has been grappling with a flat or inverted yield curve, resulting in narrower difference between long-term and short-term interest rates. That creates a difficult situation for the banking business, which borrows money at short-term rates and lends it at long-term rates -- typically making a profit on the spread between the two."  And as John Kanas, North Fork's CEO, said:  "In the current economic environment, it is hard to imagine that yield curve will improve any time soon."  In other words, regional banks' basic economic model is broken.

But in the hands of Capital One, North Fork's deposit assets can be lent out not at low long-term mortgage rates but at high credit-card interest rates—and Capital One gets to pay lower interest for those assets than if it had to go to the potentially volatile commercial paper or corporate debt markets.

Back to the analogy for law-firm-land: 

• The Magic Circle, the New York "bulge bracket" firms, and the US' other emerging international powerhouses (Baker & McKenzie, Jones Day, Latham, White & Case, et al.) will have global footprints and scalable teams to serve their corporate peers.
• The Boies-Schiller's and Quinn-Emanuel's of the world will serve their niche, boutique markets.  And:
• The future of regional, mid-size, full-service firms does not seem bright; it's unclear what their natural client base is.

In other words, if you're A Player, why go to North Fork when you could go to BofA.  Likewise, if you're seeking truly personalized, one-on-one counsel, why go to North Fork when you can go to JP Morgan Private Banking.  Even if you're in the middle—say, you or me—why go to North Fork when next week you might be in California or London and wouldn't mind the familiar, fee-free, Citigroup ATM logo on every other corner?

How do you see this playing out?