The Financial Times has an ongoing series, The Future of Capitalism (I haven't read it all, but "dubious" would seem to be the most apt one-word review so far),  Knowledge @ Wharton has "revisited" the question whether capitalism is working, and even the normally staid and circumpsect McKinsey Quarterly has The New Normal, positing that "the business landscape has changed fundamentally." 

Meanwhile, the redoubtable Economist has Greed--and fear: a special report on the future of finance (for a taste, try "Financial services are in ruins....") and I will commend to you again Amartya Sen's Capitalism beyond the crisis from The New York Review of Books.

I've written before--but it's worth reprising--that a smart friend of mine observed that today "people are reading too many newspapers and not enough history." So a quick bit of history (Wharton):

The April 21, 1980, cover of Time magazine carried the stark headline: "Is Capitalism Working?" The American economy was in crisis after years of stagflation. The story recounted the ills: Mortgage rates were 17%, business loans carried 20% interest rates and productivity had collapsed. The article quoted Robert Lekachman, a left-leaning City University of New York economist, as saying, "The central economic fact of our day is the declining vitality and élan of capitalism and capitalists." On the opposite side of the political spectrum, Chrysler Chairman Lee Iacocca was quoted as saying, "Free enterprise has gone to hell."

Is the doubt now being sown on the fertile fields of capitalism surprising? Not in the least.

For perspective, we've come off a tremendous 2-1/2 decade bull run favoring capitalism: The Reagan Revolution here, the Thacher Era in the UK, China and India opening up, the fall of the Berlin Wall and the spontaneous resurgence of beaten-down Eastern Europe, even the technology bubble can be seen (charitably) in hindsight as a period of glorious experimentation, with some durable innovators that have changed the daily conversation (Google, Microsoft, Apple, just for starters).

Perhaps, then, we should have been more prepared for a backlash.

But what precisely are the terms of that backlash?

A large part of it, I respectfully submit, stems from the outsized importance that the financial services sector took on (Economist).

For a quarter of a century finance basked in a golden age. Financial globalisation spread capital more widely, markets evolved, businesses were able to finance new ventures and ordinary people had unprecedented access to borrowing and foreign exchange. Modern finance improved countless lives.

But more recently something went awry. Through insurance and saving, financial services are supposed to offer shelter from life's reverses. Instead, financiers grew rich even as their industry put everyone's prosperity in danger. Financial services are supposed to bring together borrowers and savers. But as lending markets have retreated, borrowers have been stranded without credit and savers have seen their pensions and investments melt away. Financial markets are supposed to be a machine for amassing capital and determining who gets to use it and for what. How could they have been so wrong?

The core function of finance, after all, is not complicated. It's to channel capital from investors (be they private equity and hedge funds, university endowments, or CD buyers at your corner Bank of America) to productive users of capital. And to reallocate risk in the process from those less willing or able to be exposed to it to those more willing and able.

This is where financial services failed us in the past several years. And in the process, or as the result, of that failure, they have betrayed our trust. Again, to the Economist:

Financial transactions are a series of promises. You hand your money to a bank, which promises to pay it back when you ask; you invest in a company, which promises you a share of its future profits. Money itself is just a collective agreement that a piece of paper can always be exchanged for goods or services.

Imagine, for a second, how finance began, with small loans within families and between trusted friends.... Trust in a modern economy has evolved to the miraculous point where people give complete strangers sums of money they would not dream of entrusting to their next-door neighbours. From that a further miracle follows, for trust is what raises the billions of dollars that fund modern industry.

Trust's slow accumulation pushes financial markets forward; its shattering betrayal batters them back.

A new era of financial regulation is, to be sure, called for (and more work for us, not incidentally). Our patchwork of largely Depression-era regulators, supplemented by rudely bolted-on encrustations designed in haste and for which we can only repent at leisure (see: Sarbanes Oxley), could stand a blank-sheet-of-paper rethink.

After all, were we to task ourselves with the challenge of designing a 21st-Century financial services regulatory structure for the world's leading economy, what are the odds that it would bear any resemblance to what we have today?

But we have strayed a bit from the initial question.

To answer it, I can only recur to first principles, and to do that, I submit to the wisdom of the masters.

First, of course, is the intellectual namesake and virtual godfather of the publication you're reading, Adam Smith himself.

I honestly believe--without meaning to slide into exaggeration or aggrandisement--that Adam Smith did more to improve the lives of more people than anyone in human history who is not reputedly a deity.

His wisdom is too overwhelming to abandon. So I hope.

Second, Joseph Schumpeter. I hope that Wharton is right when they write that:

Stripped down to its core and at its best, American capitalism is ideologically close to the theories espoused by Joseph Schumpeter.... The centerpiece of his thinking is the concept of "creative destruction..."

Creative destruction means that old established companies under capitalism tend to lose their dynamism with time and atrophy under a layer of corporate bureaucracy and complacency. Then entrepreneurs, who usually have few links to the past, introduce bold and fresh ideas for new products, manufacturing techniques, or distribution and displace the old order. The process is often destructive, but also creative. This corporate lifecycle has repeated itself again and again in numerous fields.

The moral here is both harsh and liberating.

Harsh because it involves destruction. Liberating because it involves creativity.

Permit me to make this less abstract. We have traded:

• Howard Johnson's for Starbucks;
• American Motors for Lexus;
• Faxes for emails;
• Trunk-size "mobile" phones for BlackBerry's; and
• Google for almost everything.

Is capitalism, then, done?

As has often been said about America (but not often enough, of late) and has equally often been said about New York City (same), "nobody ever won by betting against them." The same, I devoutly believe, goes for capitalism--although it will surely have a longer reign in the history of the human race than, as passionately as I love both, either America or New York City.

And what has this to do with Law Land?

We're about to experience an unprecedented multiplication of business models in our industry, an exhilarating and tragic journey through what works and what doesn't, an effervescence of creativity and a mournful descent into destruction, all carried out in accelerated time.

Global law firms are not "over" unless you believe that globalization is over. Wall Street law firms are not over unless you believe that Wall Street is history. Boutiques are not over unless you believe we will never see visionary iconoclasts again. Regional firms are not over unless you believe in the brotherhood of man.

The only future that's certain is one of an efflorescence of creativity, right in front of our eyes.

Hold on to your hats.

• David Warsh's Economic Principals is perhaps the single most studious, well-written, thoughtful, and occasionally (but not doctrinally) contrarian site I know of. David publishes on a faithful, if quaint, once-a-week schedule, just like the print journalist he was, with provocative pieces such as "More than two aspirin," and "What comes after a golden age?."
• Truth on the Market bills itself as 'academic commentary on law, business, economics, and more," and it's surely worth checking out for that promise alone. While uneven at times, at its best it can be great fun.
• Matrix (on interpreting the real estate economy, with a focus on New York City) is a remarkably wide-ranging and thoughtful site covering the industry that's arguably at the root of all our evil woes, written by Jonathan Miller, who is the gold standard of appraisers in the New York City market.
• Academic Earth bills itself as "thousands of video lectures from the world's top scholars."  And it is.  Origins of the Financial Mess (Alan Blinder, Princeton) is a good place to start.
• Marginal Revolution talks about a wide variety of topics in an often irreverent tone. A current post about the AIG bonus PR nightmare consists in its entirety of:
  

  Outrage, outrage, blah, blah, blah, etc. Often I feel that some topics are too obvious to blog.
  The real lesson is that this is another reason not to nationalize banks. It means politicizing every decision which ends up in the newspaper.
  Here is a good post on why the bonuses should be paid.
  Outrage, outrage, blah, blah, blah, etc.

But forthwith to the book review.

Animal Spirits, by George Akerloff (Nobel Prize Winner in Economics) and Robert Shiller, father of the famous Case-Shiller real estate index, was reviewed in the Financial Times:

[The authors] argue that the key is to recover Keynes's insight about 'animal spirits'--the attitudes and ideas that guide economic action. The orthodoxy needs to be rebuilt, and bringing these psychological factors into the core of economics is the way to do it. . . . The connections between their thinking on the limits to conventional economics and the issues thrown up by the breakdown are plain, even if they were unable to make every link explicit. Even more than Akerlof and Shiller could have hoped, therefore, it is a fine book at exactly the right time. . . . Animal Spirits carries its ambition lightly--but is ambitious nonetheless. Economists will see it as a kind of manifesto.

What are "animal spirits," again?  The most concise explanation was actually provided by a reviewer on Amazon:

In his epoch-making General Theory of Employment, Interest, and Money (1936), John Maynard Keynes noted that concerning investment decisions, "most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits--a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." Because of this propensity of investors to base decisions on variables other than "market fundamentals," the aggregate investment function of an economy will tend to be highly variable and erratic. Indeed, even today, it is virtually impossible to predict aggregate investment successfully, although the other sources of aggregate demand and supply are relatively well understood.

The book explores, in its Part I, five different dimensions of animal spirits and how they affect the economy: 

• Confidence
• Corruption
• The "money illusion" (basically, people's propensity to ignore modest levels of inflation and deflation and to believe in a constant value of money)
• "Stories" which can mislead (for example, "the Internet will revolutionize everything..."); and
• Lack of perceived fairness (for example, AIG bonuses).

Part II, in turn, looks at some consequences of animal spirits' role in economic decision-making, and how they can help explain the answers to such questions as:

• Why do economies suffer depressions?
• What's to be done about the current financial crisis?  (Caveat:  Events are moving so quickly on this front that the authors' discussion is already looking quite dated.)
• Why can some people not find a job?
• Why is saving for the future so arbitrary?
• Why are financial prices and corporate investments so volatile?

The most valuable aspect of the book is that the authors show how human decisionmaking—as it's really performed, animal spirits and all—violates the classic notion of purely rational homo economicus.  Consider this thought experiment they offer:

Of course, neoclassical economic theory essentially addresses only the top left cell, whereas animal spirits help inform our understanding of the other three cells.  Actually, I would argue that we can ignore the entire right hand column for present purposes, since it's by hypothesis in the realm of the "non-economic," but even if you wipe that from the attention of your cortex, the bottom left quadrant is clearly where a lot of the fascinating debate today around "fairness" (AIG bonuses again), "moral hazard," "fragility," "systemic risk," and so forth revolves.

Indeed, our again-helpful Amazon reviewer, who has simulated the behavior of individuals in markets, reports:

There is nothing in economic theory that says that rational individuals interacting on markets will produce stable, efficient outcomes. The Walrasian general equilibrium model says that if there are no market externalities, there are market-clearing equilibria that are Pareto-efficient, but this model has absolutely NO attractive dynamical properties. When I subjected this model to an agent based simulation (Herbert Gintis, "The Dynamics of General Equilibrium", Economic Journal 117 2007:1289-1309), I found that there is a robust tendency towards market clearing equilibrium, but this is always offset by highly volatile stochastic movements in prices, wages, capital demand, and other macroeconomic variables. This stochasticity is due to the fact that the macroeconomy is a complex, nonlinear, dynamical system, not because of "animal spirits."

Jargon patrol:  A "Walrasian equilibrium" essentially means a competitive environment and not one populated by players with market power.  "Externalities" are costs imposed upon, or benefits enjoyed by, actors not participating in the market in question.  "Pareto-efficient" means that there is no possible change which would leave every player no worse off and at least one player better off.

The fascinating point here is that a core result is "always" "highly volatile stochastic [random] movements in [key] macroeconomic variables." 

And isn't that just what we've seen in the subprime meltdown and its aftermath?

The really stunning fact about the current macroeconomy is that disequilibrium in the home mortgage market could so seriously compromise the American financial system. Even those who foresaw the housing crisis did not predict so massive and credit collapse, leading to levels of government intervention that would have been inconceivable in the past.

Animal Spirits is without doubt an intriguing, thoughtful, and timely book (and a quick read as well at 264 pages including notes and index), but I fear that its very focus on the quirkiness of human decision-making might serve as a pleasant distraction from the core and unavoidable truth that under- or improperly regulated markets cannot be counted upon to produce economically or socially desirable results.

Given the general level of surprise and intellectual shock that have accompanied this global meltdown,, it has become increasingly common to hear calls for a "new capitalism" or for some inchoate reworking of the received canon of wisdom in economics to help us navigate these seemingly unprecedented times.

If you're tempted, as I admit I occasionally have been, to pursue this path, I commend to you Amartya Sen's Capitalism Beyond the Crisis in the March 26,2009 issue of The New York Review of Books.  Sen was the 1998 Nobelist in economics for his contributions to "welfare economics,"  ("Welfare economics," roughly speaking, is the branch that concerns allocative efficiency within a society, income distribution, and—you guessed it—achieving Pareto-optimal results.)

Sen's article is, by and large, an effective effort to debunk the mythologies that have been attributed, for motives base and innocent alike, to the Big Thinkers in economics including Adam Smith and John Maynard Keynes.  Perhaps we should not be surprised that the imprimatur of these legendary names would be appropriated for ideological or expedient means, but it's worth going back to what they actually said, as Sen does, to realize that we may have the blueprint for recovery in front of us if only we choose to see it. 

Here is Sen on the "public/private mix" that undergirds all of today's First World economics.  Forgive the somewhat lengthy excerpts, but Sen's argument is subtle and his prose pleasant:

What are the special characteristics that make a system indubitably capitalist--old or new? If the present capitalist economic system is to be reformed, what would make the end result a new capitalism, rather than something else? It seems to be generally assumed that relying on markets for economic transactions is a necessary condition for an economy to be identified as capitalist. In a similar way, dependence on the profit motive and on individual rewards based on private ownership are seen as archetypal features of capitalism. However, if these are necessary requirements, are the economic systems we currently have, for example, in Europe and America, genuinely capitalist?

All affluent countries in the world--those in Europe, as well as the US, Canada, Japan, Singapore, South Korea, Australia, and others--have, for quite some time now, depended partly on transactions and other payments that occur largely outside markets. These include unemployment benefits, public pensions, other features of social security, and the provision of education, health care, and a variety of other services distributed through nonmarket arrangements. The economic entitlements connected with such services are not based on private ownership and property rights.

[...]

[T]he pioneering works of Adam Smith in the eighteenth century showed the usefulness and dynamism of the market economy, and why--and particularly how--that dynamism worked. Smith's investigation provided an illuminating diagnosis of the workings of the market just when that dynamism was powerfully emerging. The contribution that The Wealth of Nations, published in 1776, made to the understanding of what came to be called capitalism was monumental. Smith showed how the freeing of trade can very often be extremely helpful in generating economic prosperity through specialization in production and division of labor and in making good use of economies of large scale.

Those lessons remain deeply relevant even today (it is interesting that the impressive and highly sophisticated analytical work on international trade for which Paul Krugman received the latest Nobel award in economics was closely linked to Smith's far-reaching insights of more than 230 years ago).

[...]

Even though people seek trade because of self-interest (nothing more than self-interest is needed, as Smith famously put it, in explaining why bakers, brewers, butchers, and consumers seek trade), nevertheless an economy can operate effectively only on the basis of trust among different parties. When business activities, including those of banks and other financial institutions, generate the confidence that they can and will do the things they pledge, then relations among lenders and borrowers can go smoothly in a mutually supportive way. As Adam Smith wrote:

When the people of any particular country have such confidence in the fortune, probity, and prudence of a particular banker, as to believe that he is always ready to pay upon demand such of his promissory notes as are likely to be at any time presented to him; those notes come to have the same currency as gold and silver money, from the confidence that such money can at any time be had for them.[1]

Smith explained why sometimes this did not happen, and he would not have found anything particularly puzzling, I would suggest, in the difficulties faced today by businesses and banks thanks to the widespread fear and mistrust that is keeping credit markets frozen and preventing a coordinated expansion of credit.

It is also worth mentioning in this context, especially since the "welfare state" emerged long after Smith's own time, that in his various writings, his overwhelming concern--and worry--about the fate of the poor and the disadvantaged are strikingly prominent. The most immediate failure of the market mechanism lies in the things that the market leaves undone.

And here, if you will, is the punch line:

Smith called the promoters of excessive risk in search of profits "prodigals and projectors"--which is quite a good description of issuers of subprime mortgages over the past few years. Discussing laws against usury, for example, Smith wanted state regulation to protect citizens from the "prodigals and projectors" who promoted unsound loans:

A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into those which were most likely to waste and destroy it.[4]

The implicit faith in the ability of the market economy to correct itself, which is largely responsible for the removal of established regulations in the United States, tended to ignore the activities of prodigals and projectors in a way that would have shocked Adam Smith.

The present economic crisis is partly generated by a huge overestimation of the wisdom of market processes, and the crisis is now being exacerbated by anxiety and lack of trust in the financial market and in businesses in general.

Sen also writes that unappreciated in the current crisis is the relevance of Arthur Cecil Pigou (a contemporary of Keynes, also at Cambridge and also in fact at King's College).  Whereas Keynes viewed the economy primarily through a mechanistic and hydraulic lens (the value of the famous "multiplier" being a primary example), Pigou put his focus on psychology, where Sen (and yours truly) believe it belongs.  At the root of economic fluctuations, Pigou wrote, were "psychological causes," namely "variations in the tone of mind of persons whose action controls industry, emerging in errors of undue optimism or undue pessimism in their business forecasts.[5]"  Sen goes as far as to say that "the real crisis...has become many times magnified by a psychological collapse," and he scarcely overstates the case.

Perhaps we should conclude with the culminating irony of this short tour of the landscape of Fabled Economists:  It is that while Smith and Pigou are traditionally seen as "conservative," and Keynes as something of a rebel, the first pair were far more outspoken, insightful, and insistent upon the importance of non-market institutions and non-profit values.

What else am I reading? Alpha by author:

• Geoff Colvin's Talent is Overrated:  What Really Separates World-Class Performers from Everybody Else.  This book, based soundly in empirical research, delivers the hard message that true excellence depends upon hours and hours (10,000 hours, to be precise) of "deliberate practice"—be it the young Mozart composing, the young Tiger Woods practicing, or any aspiring concert violinist.  The same, by extension, is true of surgeons, mathematicians, CFO's—and lawyers and writers.  As Colvin puts it, this is good news and bad news:
  
  "What would cause you to do the enormous work necessary to be a top-performing CEO, Wall Street trader, jazz, pianist, courtroom lawyer, or anything else? Would anything? The answer depends on your answers to two basic questions: What do you really want? And what do you really believe? What you want - really want - is fundamental because deliberate practice is a heavy investment."
  
  
• Jerry Coyne's Why Evolution Is True.  Demolishes creationism and "intelligent design"—and then intellectually carpet-bombs them again, to make sure "the rubble bounces," as Churchill described the goal of a particular bombing campaign in WWII—but does so with respect and patience.  I can do no better than to repeat the aphorism that "Nothing in biology makes sense except in the light of evolution."  Coyne explains why, and brings you up to date on recent developments in this endlessly fascinating science in the bargain.
  
  
• Niall Ferguson's The Ascent of Money: A Financial History of the World:  Ferguson recapitulates the history of money from the pre-Christian era through today's subprime meltdown and global credit freeze, noting that bubbles are as much a part of economic history as are booms and concluding with a warning that excessively precautionary regulation  cannot and should not remove the possibility of extinction for institutions which are weak.  That is to say, financial crises should and must result in casualties.  Or, as Joseph Schumpeter put it in The Theory of Economic Development (1934):  "This economic system cannot do without the ultima ratio of hte complete destruction of those existences which are irretrievably associated with the hopelessly unadapted."
  
  
• Dexter Filkins' The Forever War  A harrowing account of the "war on terror" from the rise of the Taliban in the 1990's through virtually today in Iraq and Afghanistan, by one of the New York Times' star reporters.
  
  
• Michael Lewis' Panic:  The Story of Modern Financial Insanity, a tour de horizon of recent financial embarrassments, using the tool of reproducing contemporaneous (and a few subsequent) accounts and analyses, and covering the collapse of Long Term Capital Management, the Asian financial crisis of the 1990's, the dotcom meltdown, and early warning signals of our present distress.  Plus c'est change.
  
  
• Jessica Livingston's Founders at Work:  Stories of Startups' Early Days.  The stories of mostly legendary (and a few relatively obscure) entrepreneurs, told in their own words through extensive interviews, about the early days at their would-be companies, including:  Max Levchin/PayPal, Steve Wozniak/Apple, Mike Lazaridis/Research in Motion, Mike Ramsay/Tivo, Charles Geschke/Adobe, and Ron Gruner/Alliant Computer.  Utterly charming.  And the moral?  (1)  Expect the unexpected.  (2) And meet it with persistence. 
  
  
• Daniel Pink's A Whole New Mind:  Why Right-Brainers Will Rule the Future.  Pink's thesis, fairly widely adopted today, is that human economic organization has moved from the agricultural to the industrial to the information and now to the conceptual age, where the value is on those individuals and firms capable of integrating empathy, meaning, design, and a narrative (a/k/a "story") to their products and services.  If you or your firm can't master those skills, beware of "Asia, Abundance, and Automation."
  
  
• Robert Samuelson's The Great Inflation and Its Aftermath:  The Past and Future of American Affluance.  An economic and political history of what is now a curiously forgotten period, the "great inflation" of the 1970's and early 1980's, famously cut off at the knees, along with much economic activity, by Paul Volcker and Ronald Reagan in the 1981-'82 recession.  Not, perhaps, a deep or subtle read, but a fascinating and thorough portrayal of, as I say, an oddly invisible era.
  

Enjoy.

The news out of Dewey & LeBoeuf--that 66 partners, or about one in five of their 350 partners, have seen their compensation cut over the past 15 months by up to 80%--begs for an explanation, or at least some commmentary. First, what's going on in the firm's own words:

The reductions are meant to weed out less-productive partners, firm Chairman Steven Davis tells The Am Law Daily.

Those affected by the "substantial performance-related reductions to their compensation" represent a wide range of practices, Davis says. The partners include some who have been practicing for 25 or more years.

Of the 66, the more fortunate are now taking home $25,000/month, the standard draw for partners. Lower-tier partners have faced more drastic reductions, with monthly draws of as little as $10,000, or an annual total of $120,000 -- $40,000 less than the starting salary for a 2008 incoming first-year.

Both Davis and executive director Stephen DiCarmine characterize the recent actions as an intensification of the firm's long-term strategy of replacing poor performers with higher-producing laterals. "We have a merit-based compensation system," Davis says. "There are a variety of outcomes that people have experienced. It probably occurred to a greater and enhanced extent due to the merger."

Paying partners less than first-year's? What on earth, you may be asking yourself, is going on here?

To begin with, I have nothing to say about the selection criteria for who's taking these hits and who isn't (or, as the firm puts it, who is "experiencing which outcomes"). I can only take the firm at its word that they are intended to be performance-related and to alter the mix of partners over time.

The point I'm interested in is a larger one. Why would a firm feel compelled to take such drastic measures in order to--at least partially--protect the very high incomes of its other partners?

This brings us to what I call the "profit imperative."

First, required is a small digression into the wonderland that is law firm accounting. Partners (we're talking equity partners) actually wear three different and distinguishable hats, in terms of their economic participation in the firm:

• Workers/producers, in which role their job is to actually bill hours and perform client work. In this role, their appropriate compensation is what the firm would have to pay a non-equity partner to perform the same work.
• Managers/administrators, in which role they help run their practice groups or departments, manage staff, mentor associates, participate in firm committees, and so forth. In this role, their appropriate compensation is what the firm would have to pay nonlawyer executives to perform the same work.
• And last and only last, equity partners, which is to say, owners with a residual claim on the profits of the enterprise after all other expenses and claims have been satisfied--including, if you want to be rigorous about it (and some of us do), paying the first two sums listed above out of operating income.

But of course, in wonderland, partners view themselves as wearing one and only one hat, namely the last one. This means they view their compensation as coming entirely from their role as equity owners. And given the current realities of law firm organization, finance, and accounting, they are entirely right to see it that way, however economically irrational that might be in the abstract.

Why does this matter? Only because, as we're about to see, "profits" in law firm land have a special meaning, and that's why they're imperative.

If equity partners across BigLaw had been raised from 3L status on to understand, internalize, comprehend, and expect that their compensation would consist of those three different components, the last of which is highly variable, profits would not be as imperative as they are. But that's not the world we live in.

So now that we're all agreed on the financial irrationality of partners' compensation being paid entirely out of "profits," and are equally agreed that this is culturally embedded and not about to change in your lifetime or mine, it's a baby step to seeing why profits in a law firm cannot fall precipitously and expect the firm to remain in equilibrium. It comes down to expectations.

Perhaps the simplest way to explain this is to contrast it to a normal company, say, Toyota or GM.

As is exhaustively known, GM has been bleeding cash and losing money hand over fist for most of this young Century, yet it continues to exist. The fact that it may not continue for too much longer, and that its pleas for help from Washington may be rewarded, only speaks more strongly of its durability. As for Toyota, it's been coining money during the same period and, even though it may suffer its first loss in its 70 years of operations, there is absolutely zero doubt about its continued viability as a global industry leader.

And the point would be?

• Law firms cannot survive a single year with zero profits.
• That, as we know, is all that partners have to take home.
• If partners have nothing to take home, they will be gone.
• And the firm will be no more.

This may provide perspective on the drastic measures Dewey has taken. There are, of course, other examples of unprecedented Hail Mary's techniques being employed:

• Norton Rose is floating the notion of a four-day work week;
• CMS Cameron McKenna is asking partners to "volunteer for de-equitization" (no, I'm not making this up);
• 92% (92%!) of City of London partners recently polled by Legal Week predicted a drop in profits of more than 15%;
  • 65% predicted it would be more than 20%;
  • 47% predicted it would be more than 25%; and
  • 17% predicted more than 30%.
• And the drastic cuts being implemented far and wide are, at the moment, unavoidable:  "Tony Williams, former managing partner of Clifford Chance and the co-founder of Jomati consultancy [and a good friend of mine—Bruce], said: "You always have to look forward. Cutting people has not just been a knee-jerk reaction [to falling profits]. You have to take the appropriate decision at the appropriate time.""

The point?

Simply that noisy protestations about how firms are cutting people loose in wholesale numbers—be those protests boisterous and cynical or heartfelt and agonized—miss the point that a reasonable level of profitability for a law firm is not a luxury and not an option.  It is as required for survival as oxygen is to us.

In all the obsessiveness and compulsiveness about the impact that this little economic interregnum we're gamely marching through is having on our firms, our P&L's, and even our personal balance sheets, let us pause for a moment to consider the genuine human toll of layoffs.  The National Law Journal recently put it nicely:

Situation wanted: High-performance type with dashed hopes, loads of law school debt and mortgage acquired at peak of housing boom seeking self-esteem and lost identity following recent layoff from law firm. Willing to adjust once-lofty career aspirations in exchange for doing anything remotely related to the practice of law.

The ad may be fiction, but the scenario has become a reality for hundreds of attorneys who started law school just a few years ago with prospects of six-figure salaries and their pick of where to practice.

Nor should it surprise you to hear that lawyers are especially poor at dealing with layoffs—particularly the "Millenials" who have been raised on a non-stop diet of affirmation and positive reinforcement.  Lawyers' inherent traits work against them following a layoff, no matter how often they're told that it was not "performance" related:

• As Type A personalities, they're not used to anything short of excelling; a layoff comes as a complete shock and takes time to assimilate psychologically.
• This is probably the first time in their lives they've been forced to deal with feeilngs of failure.
• The loss of direction and purpose is profound.
• Classic lawyers traits—risk aversion, impatience, skepticism—work against a speedy recovery from the body blow of a layoff.
• Lawyers also are introverts and the enormous insult of a layoff tends to make them even more withdrawn and isolated.

What's going on at a psychological and physical level is the classic "fight or flight" response that kicks in whenever one feels in danger.  While this was a beneficial and even life-saving adaptation on the African savannah, study after study has shown it to be profoundly counterproductive and self-defeating in the canyons of our cities.  The continual low-level anxiety tempts people to make rash decisions, view the world in Manichean terms, and blame themselves for their fate, regardless of their actual responsibility for finding themselves on the street.

What's less widely recognized is the negative impact on those lawyers and staff who remain employed.  As noted in the LA Times in "Layoffs take toll even on survivors:"

"None of the effects are good," said Frank Landy, author of "Work in the 21st Century." An organizational psychologist, Landy specializes in understanding the emotions of work. "Layoffs clearly have emotional and practical consequences for companies and workers."Those consequences are, unfortunately, long-term.

The psychological fallout of surviving a layoff lasts six years, according to the study published by the Institute of Behavioral Science. And the effects of surviving multiple layoffs are cumulative. They add up rather than dissipate.

"It only takes one action of distrust to lose basic confidence in the employer. It's like a romantic relationship. Once the trust has been undermined, it's very, very difficult to recover," Landy said. "There's no data that suggests workers become more resilient. 'I'm a survivor, hear me shout'? It doesn't happen."

The problem, of course, is that even the "survivors" feel their situation is precarious.  They also feel—rightly or wrongly—that their firm has broken a covenant of faith with them.

Lingering distrust is one of the final stops on the emotional misery tour taken by most surviving employees. First, there's the disbelief, anxiety and desperation resulting from the initial layoff announcement. Then comes the sweeping sense of relief when one's job is spared, followed, in rapid succession, by guilt, fear and stress.

In a volatile labor climate that's rapidly shedding existing jobs across all sectors of the economy, and during which any available employment may be likely to bring less pay, that emotional trajectory is only amplified.

The risk is that the survivors are tempted to descend into cynicism.  (If you doubt me, spend not more than 30 seconds [please!] reading comments on "Above The Law.")  The temptations for the cast-off and the survivors alike are all self-destructive:

• Withdrawal (as noted).
• Increased alcohol use or drug abuse, especially of painkillers or sleep aids.
• Shockingly negative thoughts, including suicidal ones.
• A pessimistic outlook, which in turn engenders negative interactions, which lower expectations, which encourages pessimism.
• Sloppy and compulsive eating habits, with concomitant weight gain.
• Neglecting exercise.
• Sleeping poorly.

And it would be folly to predict anything other than that it will get worse before it gets better.  If you doubt me, just extrapolate the last few months from this chart, courtesy of Above The Law's "Layoff Tracker."  Since the image is small, here are the numbers:

As of March 6, 2009, there have been over 7,241 layoffs (3,045 lawyers / 4,196 staff) since January 1, 2008. There have been 5,408 (2,149 / 3,259) in calendar 2009 - 1,132 (337 / 795) in March.

Update: Andrew of LawShucks wrote to correct my reference to Above The Law, which merely republishes (with permission) the LawShucks tracking info. We stand corrected. Thanks, Andrew.

A healthy, useful, and enriching option is to volunteer—and anyone reading this page surely has a multitude of skills to offer.  In fact, if you believe From Ranks of Jobless, a Flood of Volunteers, here in New York, at least, nonprofits are enjoying almost an embarrassment of riches:

Many who run nonprofits have marveled at the sudden flood of bankers, advertising copywriters, marketing managers, accountants and other professionals eager to lend their formidable but dormant skills.

Volunteer for what?  Well, the truth is it hardly matters. The point is to get up and get out and feel you're making a contribution:

God's Love We Deliver, which provides food to the severely ill in their homes across New York City, has seen a record number of the recently laid-off among its 1,400-member volunteer corps, according to Karen Pearl, the organization's president and chief executive. Among them is Eryka Teisch, who saw her job disappear when her financial technology firm downsized in September. God's Love initially asked her for two hours a week.

"I laughed," said Ms. Teisch, 39. "I just said, 'That's great, but I kind of want to add a zero to that number.' "

Ms. Teisch said the experience -- she works in the kitchen, the office, wherever she is needed -- has been a therapeutic tonic for her workaholic, Type-A personality. A bonus is the chance to bond with her fellow unemployed volunteers.

"You try not to focus on the bitter side -- you know, 'I hated my company and I can't believe what they did to me,' " Ms. Teisch said. "At least we have something to wake up to in the morning, rather than focusing on getting another job in this very difficult economy."

If you happen to be in the New York area, VolunteerNYC is an on-line clearinghouse, funded in part by the United Way, that helps match people with nonprofits.

You should also be prepared to take advantage of the professional resources that are available to help.

The only good news may be that there are professional resources available to help.

Primary among them is the ABA's "Commission on Lawyer Assistance Programs," which describes the background to its mission as follows:

During this time of career and financial uncertainty, lawyers are experiencing new stress and trauma as a result of the recession and national belt-tightening in the profession. Law firms are finding it necessary to reduce their lawyer and support staff numbers and are in some instances closing firms. The states that have staffed lawyer assistance programs (LAPs) can provide peer support for individuals and referrals to counseling--career, mental, and financial. The lawyers helping lawyers component of LAPs has existed from the beginning and continues to be of critical assistance in times of relapse, stress, and trauma. These volunteers can share a special bond and understanding, which has been found to be true in other professional peer support programs as well.

During an extended recession in the 1980s, researchers at Johns Hopkins University were able to correlate a statistical significance between economic factors, such as joblessness and social harms, with alcoholism and suicide. The data showed that for each one percent rise in unemployment, suicides increased 4.1 percent; homicides, 5.7 percent; deaths from heart disease, cirrhosis of the liver, and stress-related disorders, 1.9 percent; and admissions to mental hospitals, 2.3 percent for women and 4.3 percent for men. Although data and intuition imply that unemployment and lack of hope, both common in recession, are correlated to addictive behavior, a cause and effect relationship cannot be automatically implied. The legal profession has previously reached number one in another Johns Hopkins study that ranks professionals in rate of depression and suicide. We are seriously concerned that these numbers will continue to increase.

If you personally have been side-swiped by this unprecedented period, you should know these resources exist and take advantage of them.  If you have escaped the scythe but know someone who hasn't, reach out to them.  They're not lepers.  Time for us to band together as best we can.  This cannot—this will not—go on forever.  Be sure you're battle-ready when the clouds finally begin to part.

• Prof. Larry Ribstein on "the over-leveraging and over-regulation of the legal profession:"
  

  In the longer run, we now see very clearly that running law firms as thinly capitalized worker cooperatives is not an equilibrium solution in this market.

  The answer, as I've said many times before, is dropping regulatory restrictions on law firm structure and letting them be run like real businesses. This particularly includes permitting non-lawyer capitalization and perhaps even public ownership, as well as enabling firms to hold onto their intellectual property through non-competition agreements.

• A piece in, of all places, The Atlantic's blog called "There's leverage everywhere!" with this pregnant introduction to our system:
  

  But let's work the argument a little further. It surely is true that unlike their current incarnations, the old Wall Street partnerships did not destroy the world with excessive leverage. But in the pre-credit-boom era, no one else was incurring much leverage either. It might be worth considering whether there are entities that are structurally similar to the old Wall Street firms (i.e., partnerships in which a substantial portion of the partners' net worth was tied up in their employer, and could not easily be removed from same) and see whether they have taken on significant leverage in the modern age of easy credit.

  As it turns out, there are such entities. We call them "big law firms." And their example is instructive.

  and
  
  
• More than one of these new pieces has referenced something that ours truly wrote about "Leverage:  Friend or Foe? (Or Noncombatant?)" back in December 2005, where I said:
  
  Common sense would tell you that in a labor-intensive service industry, where revenue is driven primarily by sheer tonnage of hours worked, the higher the ratio of associates (and non-equity partners) to (full equity) partners, the higher the revenues and thus the profits per partner. Right? It turns out this is one of those cases where it's not as simple as it seems.
  
  [...]  Then there's the evil twin of high leverage: Low utilization. It doesn't help that your leverage ratio is through the roof if nobody's busy; indeed, welcome to the worst of both worlds.

What has changed?

For starters, the whole world is now aware of the perils of leverage.  Let me throw a few charts into the discussion for starters.  By and large, I would like to believe, they speak for themselves.

Finally, here's one that leaves you wondering whether to laugh or cry—and it's seriously out of date at this point.

It's a chart showing the large global banks' market capitalization as of the 2nd quarter of 2007 (large blue-grey circles) and then as of October 20, 2008 (small green circles). 

In order, left to right and top row to bottom, they are:  Morgan Stanley, RBS, Deutsche Bank, Credit Agricole, Societe Generale, Barclays, Unicredit, UBS, Credit Suisse, Goldman Sachs, BNP Paribas, Santander, Citigroup, JP Morgan, and HSBC:

Update (8 March 2009):  A very helpful reader, who chooses anonymity, pointed out within hours of my publishing this that the chart above is seriously misleading.  Why?  Because the circles, being two-dimensional, invite us to visually compare their areas rather than their diameters—and the latter is what the chart-drawer actually chose to represent. 

Take Citigroup:  Its market cap went from $255B to $82B in the period in question.  Now that you look at it closely, you can see that's how the chart was drawn.  But were the circles drawn to scale appropriately in terms of their area, it's clear that it would take only 3.11 of the small green circles to fill the large blue circle (since 255/82 = 3.11).  Your eyes tell you in a flash that the green circle as drawn is far too small, in fact.  (Full explanation here.)

While I apologize for this mental and visual hiccup, all I can offer in defense is that I'm not the only one:

Pretty scary, eh?  It's a chart showing the deterioration of major bank market caps since 2007.  Prepared by someone at JP Morgan based on data from Bloomberg, this chart flashed across Wall Street and the financial world a few days ago, filling thousands of e-mail in boxes.  Putting a face on the current banking crisis it really brought home to many people on Wall Street the critical position the financial industry finds itself in.

Too bad the chart is wrong.

[...] So it's a typo: no big deal, right?  Yeah, but what a typo!  It got past Bloomberg and JP Morgan and pretty much all of Wall Street before someone said, "Hey, this makes no sense!"

Here's a proper chart.  While the players are somewhat different, that's more than made up for by the fact that it's far more current:  Comparing the market cap as of March 30, 2007, with the market cap as of February 20, 2009—barely two weeks ago:

Still not great performance, to be sure, but if there are degrees of horrendous-ness, this is at least less so.  Plus truthfully representative.

Thank you, Dear Reader.  Thus concludes the update.

While there are many reasons for these breathtaking declines, surely a proximate cause was the sky-high assets to equity ratios of many of these institutions.  20 to 1, 35 to 1, and even 50 to 1 were not unheard of in the palmy days.  Suffice to say that business model is, as I heard someone remark recently here in New York, "so last August."

So other parts of the economy (shockingly large parts!) may have gone crazy.  What does this have to do with us, necessarily?

If there are analogies to be drawn across professional service sectors, leverage is out for the investment banks and leverage is out for us as well.  For the I-banks, as noted, it was (in retrospect and even, to some more astute observers at the time) outrageous ratios of assets to equity, and for us it may be the high ratio of lawyer leverage.

I said at the outset that there are different definitions of "leverage" in our world, and I want to take some time and spend a little bit of effort breaking them out, because I believe the subtle differences matter.

Courtesy of The American Lawyer, here are the top 25 most leveraged firms from the AmLaw 100 and the bottom 25 least leveraged firms.

Top:

And bottom:

These figures are calculated by dividing the total number of lawyers at the firm (full time equivalent) by the number of equity partners.  For example, using firm #100 here, Faegre & Benson has 424 total lawyers and 255 equity partners, so 424/255 = 1.89.

Again, we can debate whether this is the ideal measure of leverage or not; my own preference is to divide all lawyers who are not equity partners by equity partners, but the results would be directionally similar. (Using Faegre & Benson as an example, again, the number of "lawyers who are not equity partners" would be 424-255 = 169, and dividing that by the number of equity partners yields 169/255 = 0.66.)

Why does leverage matter? For starters, as I noted in my 2005 column I quoted at the outset, leverage is your best friend in good times and your worst enemy in bad times. While we've heard the drumbeat of client complaints about paying for useless junior associates for years, this is suddenly the kind of environment where it will grow sharp teeth and bite hard. Either: (a) massive litigations will not be pursued because they're too complicated, uncertain, protracted, and expensive; and/or (b) if they must be pursued, contract attorneys, staff attorneys, and outsourcers will provide the human throw-weight needed for massive document review; and/or (c) corporations will simply insist that document review be completed for flat fees of $X/unit [$1.00/page? $0.50/page?]. In any event, no one I talk to--absolutely no one--believes that the litigation "factory" model with one partner overseeing half a dozen or more associates who are billing 'til the cows come home will be a predominant source of revenue going forward.

All well and good, but I think a more interesting calculation compares the ratio of non-equity partners to equity partners.  The charts and calculations that follow are premised on The American Lawyer's conventions, which denote someone an equity partner if they receive a K-1 and a non-equity partner if more than half of their income is guaranteed.  This is not the place to debate that methodology; the point for present purposes is that all firms are hewing to the same metric. While the raw data is courtesy of The American Lawyer, the calculations and the sorting are my own.

Here are the firms where the non-equity to equity partner ratio is greater than 1.00:

And here are the firms where that ratio is less than 0.25:

Note that I've drawn lines segregating the 11 firms with a non-equity to equity ratio between 0.00 and 0.25, simply because—depending on what may be special circumstances unique to each firm—arguments could probably be made that they don't "really" have non-equity partners as they see it; they just have to report this way based on The American Lawyer definitions.   Also note that I alphabetized the listing, by firm name, of all those reporting 0.00 ratios.

Why does this matter?  Aren't all the firms reporting layoffs reporting exclusively layoffs of associates and staff, not partners.

Yes, but those reports reflect actions taken to date, and I want to essay a little vision into what we may be seeing in the future, and to set the stage I think the two charts above are most informative.

First, why have no firms announced partner layoffs?  Isn't this the worst kind of cronyism, safeguarding one's peers, taking it all out on the "little people," and demonstrating lousy business judgment to boot, when the cost savings realized by offing (say) 10 associates could probably be realized by tossing a single partner overboard.  (Such, to paraphrase, is how it has recently been expressed to me, in tones ranging from outrage to derision to glum resignation.)

The issue, as so often is the case, is more complex than that.

Simply put, it takes time to get rid of partners.  They are not employees at will, as associates and staff.  They must be cajoled, "spoken to," almost certainly offered incentives to walk gently towards the door.  Note, importantly, that this is almost universally true of non-equity as well as equity partners.  (Off the top of my head, essentially every partnership agreement I've seen that addresses the issue at all treats non-equity and equity partners alike on the topic of termination—that is to say, it's hard to accomplish without cause.)

And there's more.  More and more non-equity partners, that is.  This chart shows the percentage of all lawyers at AmLaw firms who are not equity partners, from 2000 through 2006.  The big red bars are of course associates, ranging from 82% of the total in 2000 to 75% in 2006.  The light grey slices are "income" partners, growing from 9% to 13%, and the darker grey slice at the very top, growing from 9% to 12%, are "other non-equity lawyer" (don't ask me about the terminology; I'm just the reporter here). The chart is courtesy of last year's Citibank/Hildebrandt Client Advisory.

Now—bear with me—one more data point. 

Here's the "productivity," measured by annual hours billed, of (a) equity partners; (b) income partners; (c) associates; and (d) other non-equity lawyers, at "higher profit" and at "lower profit" firms:

What it shows with conspicuous graphic clarity is that income partners and other non-equity lawyers are systematically the least productive lawyers in these firms.  Associates work the hardest, but equity partners work almost as hard.  (At higher profit firms, the associates record a negligible 2.5% more hours than equity partners.)

From both a human and an economic perspective, this is all perfectly logical. Non-equity lawyers don't have to beat their brains out.  So they don't.  Their deal—again, a perfectly rational one, to them—is that, premised on good behavior, they have a job essentially for life at, say, $350,000 to $450,000/year, adjusted for inflation.  If you think that's not an attractive deal, I suggest you immediately take the elevator down to the street and ask the first ten people you encounter if they'd like such a job.

What else do we know about non-equity lawyers?

They are the most expensive form of leverage.  They make more than associates, to state the obvious, and have also "maxed out" on any variable benefits one needs a certain period of tenure to earn, such as 401(k) matches, etc.

This, frankly, is the least of it. The real issue is cultural.

Go back and take a look at the firms with non-equity to equity partner ratios < 0.25. Better yet, focus on those where the non-equity tier is either nonexistent (0.00) or de minimis and probably only an artifact of The American Lawyer's reporting system.

What do they have in common?

Indeed: An unusually high combination of cultural cohesion and readily articulable strategy. Just a sampling proves the point:

• Cleary, Cravath, Davis Polk, Debevoise, Paul Weiss, Simpson Thacher, Skadden, Sullivan & Cromwell, Wachtell.

Like them or not, you can say of each of those firms that they stand for something, and that achieving partnership there is dependent on several dimensions beyond that of being a mighty rainmaker.

Vs. those with the non-equity to equity ratio > 1.00: Without (re-)naming names, it must be said of that group that their strategies are extremely diverse and, in some cases, as yet unproven. Additionally, many of the firms in that group have high proportions of relatively new lateral partners.

But back to culture. I submit that firms with high proportions of non-equity partners have changed their culture. They may not have intended to, they may not have foreseen it, but change it they have.

Thirty or twenty years ago and even pretty much today, at least in New York-based firms, the reality is truly up or out. This attracts a certain cohort of hard core Type A people who (as I felt at that time) have never been anywhere other than at the top of their classes and who don't intend to be anywhere else now. As a managing partner said to me last week, "We've all heard the statistics that only one in 25--or whatever--starting associates at Cravath will make partner. But you know what? All the Cravath on-campus interviews are hugely oversubscribed! Everybody thinks they're going to be the one in the 25."

He has a point.

So how does the introduction, and more importantly the perpetuation, of a material cohort of non-equity partners change the culture of a firm?

Let me editorialize about a few consequences:

• The culture shifts from "excellence or else" to "good enough."
  • I don't think that "good enough" is sustainable in this environment.
    
    
• In the palmy days of 2001--2007, having a flexibly extensible non-equity tier served as a crutch for firms that wanted to avoid making difficult decisions about people or having awkward conversations with them.
  • I don't think that those difficult decisions and awkward conversations can be postponed in this environment.
    
    
• One of the reasons we're seeing widespread associate layoffs--apart from the pure economic imperative to cut costs in order to match revenues to capacity--has to do with morale. It's dreadful to morale to walk the halls seeing a bunch of your colleagues with too little to do, who are then guiltily sneaking out at 5:30.
  • The non-equity tier, with nothing to aspire to and perhaps (psychological speculation on my part, which I am shockingly unqualified to offer) feeling themselves ever so slightly "damaged goods" only exacerbate this.
  • None of us, none of our firms, have room for morale-busting zombies in this environment.
    
    
• The ranks of the non-equities grew not by design but by happenstance and, frankly, inattentiveness. While it may be true, as Oliver Wendell Holmes famously remarked, that "the life of the law has not been logic, it has been experience," it's time to apply some analytic logic, some serious and rigorous strategic evaluation, to the weed on steroids that has been the growth of the non-equity tier in too many firms over the past palmy period.
  • And no, we cannot afford to do otherwise in this environment.

We read, finally, that firms are drastically cutting back their summer programs and dialing back first-year offers, postponing start dates, offering semi-paid sabbaticals, and so forth. All well and good and relatively innovative examples of rising to this dismal occasion.

The pipeline of new talent must be kept as full as anticipated demand warrants. Law firms live and die on their talent, and they cannot short-change their investment in it based on next quarter's or next year's depressing projections, although they can certainly try to size it to better approximate the new reality.

But the talent that may not be carrying its weight, that needs profound re-examination, is that of the non-equity tier.

If you were starting your law firm today, would it look as it does in terms of non-equity partners?

Better yet, or more realistically yet, perform Andy Grove's famous thought (and reality) experiment when Intel was a low-end maker of commodity DRAM chips, having their lunch eaten in the late 1970's by the voracious and talented Japanese, threatening Intel's very existence.

I paraphrase: Grove said to his top management team, "If we don't turn things around in a very serious way, the Board will fire us. So why don't we 'fire' ourselves. Let's march out of this conference room and march back in assuming we're the new team the Board has hired. What would we do then?"

They performed the exercise, decided to abandon DRAM's and invest in microprocessors. The rest is history, and it's history residing under your desk or in your lap.

I'm suggesting you perform a "Grove Intervention" on your firm. And if you've read this far, you know where I think you might start.

More info here.

Admission is free but registration is required.

It would be great to see you there, and it promises to be an interesting panel.