Monthly Archives: May 2013

MAKING MONEY ON OUR KIDS

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Where can an investor earn a 7.9 percent guaranteed annual rate of return? Not 30-year United States Treasury bonds; they pay around 3 percent. Not other countries’ sovereign debt; some of the most economically fragile nations in the Euro zone sell 10-year bonds bearing interest rates of less than 6 percent—and it’s certainly not guaranteed.

Try your kids. The interest rate on subsidized federal student loans is currently 3.4 percent, but it will jump to 6.8 percent on July 1 and covers just a slice of the market anyway. For undergraduates who don’t qualify for the subsidy, it’s already 6.8 percent. For graduate students (including law students), the rate is 7.9 percent.

Big returns with no risk

The program is a moneymaker for the government. According to a February 2013 Congressional Budget Office report, the federal government makes about 36 cents in revenue for every student loan dollar it puts out. Graduate (and law) student loans are especially lucrative — 55 cents on the dollar.

These eye-popping returns are especially juicy because the loans have virtually no risk of non-repayment. If a student defaults, the feds retain a collection agency to pursue the money (total cost of all federally retained debt collectors last year: more than $1 billion). Eventually, they’ll get it because such loans are in that small category of debts that survive a personal bankruptcy filing, along with alimony, child support, certain fines, and taxes. An exception for debtors who can demonstrate “undue hardship” rarely applies.

Bipartisan blame

How did this happen? Good intentions went awry. In the 1960s, Congress followed economist Milton Friedman’s earlier recommendation that the government provide direct loans for higher education. The underlying principle still resonates: a society’s investment in human capital pays long run dividends. The corollary is that those who benefit personally should repay loans for the education that gives them a better life.

Unfortunately, as that better life has become more elusive for so many, the student loan program has converted struggling young people into profit centers for the government. In the trillion-dollar world of educational debt, students entering the professions — including law — are among the most unfortunate victims, in part because both their tuition and their loan interest rates are the highest.

The special plight of young lawyers

Lawyers generate little sympathy from the rest of the population. But 85 percent of today’s law graduates have educational loans exceeding $100,000. The grim market for new attorneys means that only about half of them are finding full-time long-term employment requiring a legal degree. Even fewer earn enough to repay their staggering loans. (Before blaming these young people for their plights, take a close look at the behavior of many law school deans who misled them into the profession with deceptive information about post-graduate employment prospects. Meaningful transparency on that topic is a recent phenomenon.)

As the July 1 deadline nears, proposals that seem to be gaining traction in Washington would preserve all above-market rates and the student loan program’s profitability. They also suggest that we’ve learned little from the subprime mortgage debacle. The House recently passed Rep. John Kline’s (R-MN) bill, resetting the graduate student rate at 4.5 percent above the 10-year Treasury, subject to a 10.5 percent cap.

In the unlikely event that the House bill gets past the Senate, President Obama has threatened to veto it. However, he is willing to have students borrow at a lower variable rate that’s still significantly higher than the 10-year Treasury, but with no cap (although once set, the rate would remain for the life of the loan). Combining the floating rate elements of the House proposal with the president’s plan could produce a truly disastrous compromise. The president also wants income-based repayment and debt forgiveness. Because Republicans with blocking power oppose those partial remedies on the grounds that it will encourage students to take on bigger debt, those proposals seem doomed.

Recently, Sen. Elizabeth Warren (D-MA) offered her first bill. For a year, it would cut the student loan rate to 0.75 percent—the same rate that big banks get on their borrowing from the Fed. Unfortunately, a prospective one-year solution is no solution at all. Sen. Kirsten Gillibrand has the best current plan: set a 4 percent rate for all student loans and allow graduates with existing debt to refinance at that rate. But that won’t happen, either.

Guiding principles

As policymakers grapple with the growing educational debt bubble, they might consider two governing principles.

First, those running institutions of higher education should be held accountable financially for their graduates’ poor employment outcomes. Otherwise, federal dollars will continue to worsen the situation as administrators focus myopically on filling classroom seats to maximize tuition revenues. Allowing the discharge of educational debt in bankruptcy and permitting the federal government to seek recourse from schools that impoverish their graduates with tuition loans might alter some schools’ worst behavior.

A second principle should be even easier to implement. No mechanism for funding higher education should convert our kids into profit centers.

COMMENDABLE CONDUCT AWARD

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Regular readers know that I’m often critical of many law school deans. But when one of them gets it right, let’s give credit where it’s due. As the glut of new attorneys persists, the University of Kansas School of Law Dean Stephen Mazza became the latest dean to announce significant reductions in incoming class size. With that action, he has earned a “Commendable Conduct Award.”

Not the first

The University of Kansas isn’t the first to implement such cuts. Last year, Frank Wu, chancellor and dean of the University of California Hastings School of Law announced a 20 percent reduction in class size for the fall of 2012.

“The critics of legal education are right,” Wu said. “There are far too many law schools and there are too many law students and we need to do something about that.”

George Washington University, Albany Law School, Creighton University School of Law, and Loyola University Chicago School of Law have reduced entering class size, too. In March, Northwestern Law School Dean Daniel Rodriguez said his school would reduce the fall 2013 class by 10 percent. “We can’t ignore the destabilizing forces that the legal industry is facing today,” he said.

KU deserves special praise

All of these efforts to reduce the size of entering classes are commendable. But there are several unique aspects to the University of Kansas announcement that make it especially noteworthy.

First, the reduction as a percentage of enrollment in prior years is large: from 175 students graduating this year to a target of 120 students for the 2013 entering class and for the foreseeable future.

Equally significant, it appears that KU didn’t have to take its laudable step. The dean said that applications were down only about 10 percent — far less than many other schools. Moreover, an impressive 82 percent of 2012 graduates secured long-term jobs where a JD was required or preferred — far above the national average.

As an added bonus, a KU legal education is a relative bargain compared to many other schools: $18,600 tuition for full-time students who are state residents; $31,500 for out-of-state.

Motivations matter; outcomes matter more

Everyone expects that the decline in the number of law school applicants will produce lower average LSATs and GPAs for the entering 1L class. That, in turn, would hit the selectivity component of a school’s overall U.S. News ranking. It’s possible that some deans have reduced entering class size as part of a strategy to protect their rankings. But if the overall net outcome is that law schools as a group produce fewer lawyers three years from now, then the rankings may have helped to mitigate damage that they have caused since their first appearance in 1987.

Ay, there’s the rub. Will there be fewer total law graduates, or will other schools (and new ones in the pipeline) enroll the students that KU and others don’t accept? Indeed, will some schools expand enrollments solely to increase their tuition revenues? Asking those institutions to consider the long-term well being of the marginal students they recruit, or the sad state of the profession itself, would be asking too much, I guess.

One way to counteract the agendas of deans who refuse to do the right thing is to recognize those who do. Even more important is the task of helping prospective law students make informed decisions before they apply to law school. Over time, perhaps more of them will take advantage of increased transparency to assess realistically their own suitability for a satisfying and successful legal career. But at any age, encounters with confirmation bias are never easy.

Meanwhile, kudos to Dean Stephen Mazza and the University of Kansas School of Law. He’s been dean only since April 2011, but he’s already making a profound difference in the way that matters most — one person at a time. (And thanks to one of my regular readers who brought Dean Mazza’s announcement to my attention.)

UPCOMING EVENTS

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Interviews about my new book, THE LAWYER BUBBLE — A Profession in Crisis, continue this week:

WEDNESDAY, MAY 22, 2013, Noon to 1:00 pm (CDT)
“Topical Currents”
WLRN – 91.3 FM (available online at http://wlrn.org/radio/programs/topical-currents)
Miami and South Florida

PBS NEWSHOUR INTERVIEW

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My PBS Newshour interview about THE LAWYER BUBBLE is now available at http://to.pbs.org/143eTTG

UGLINESS INSIDE THE AM LAW 100 – PART 2

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Part I of this series considered the possibility that a key metric — average partner profits — has lost much of its value in describing anything meaningful about big law firms. In eat-what-you-kill firms, the explosive growth of top-to-bottom spreads within equity partnerships has skewed the distribution of income away from the bell-shaped curve that underpins the statistical validity of any average.

Part II considers the implications.

Searching for explanations beyond the obvious

In recent years, equity partners at the top of most big firms have engineered a massive redistribution of incomes in their favor. Why? The next time a senior partner talks about holding the line on equity partner headcount or reducing entry-level partner compensation as a way to strengthen the partnership, consider the source and scrutinize the claim.

One popular assertion is that the high end of the internal equity partner income gap attracts lateral partners. In fact, some firms boast about their large spreads because they hope it will entice laterals. But Professor William Henderson’s recent analysis demonstrates that lateral hiring typically doesn’t enhance a firm’s profits. Sometimes selective lateral hiring works. But infrequent success doesn’t make aggressive and indiscriminate lateral hiring to enhance top line revenues a wise business plan.

According to Citi’s 2012 Law Firm Leaders Survey, even law firm managing partners acknowledge that, financially, almost half of all lateral hires are no better than a break-even proposition. If leaders are willing to admit that an ongoing strategy has a failure rate approaching 50 percent, imagine how bad the reality must actually be. Even worse, the non-financial implications for the acquiring firm’s culture can be devastating — but there’s no metric for assessing those untoward consequences.

A related argument is that without the high end of the range, legacy partners will leave. Firm leaders should consider resisting such threats. Even if such partners aren’t bluffing, it may be wiser to let them go.

“We’re helping young attorneys and building a future”

Other supposed benefits to recruiting rainmakers at the high end of a firm’s internal partner income distribution are the supposedly new opportunities that they can provide to younger attorneys. But the 2013 Client Advisory from Citi Private Bank-Hildebrandt Consulting shows that lateral partner hiring comes at the expense of associate promotions from within. Homegrown talent is losing the equity partner race to outsiders.

In a similar attempt to spin another current trend as beneficial to young lawyers, some managing partners assert that lower equity partner compensation levels lower the bar for admission, making equity status easier to attain. Someone under consideration for promotion can more persuasively make the business case (i.e., that potential partner’s client billings) required for equity participation.

Such sophistry assumes that an economic test makes any sense for most young partners in today’s big firms. In fact, it never did. But now the prevailing model incentivizes senior partners to hoard billings, preserve their own positions, and build client silos — just in case they someday find themselves searching for a better deal elsewhere in the overheated lateral market.

Finally, senior leaders urge that current growth strategies will better position their firms for the future. Such appealing rhetoric is difficult to reconcile with many partners’ contradictory behavior: guarding client silos, pulling up the equity partner ladder, reducing entry level partner compensation, and making it increasingly difficult for home-grown talent ever to reach the rarified profit participation levels of today’s managing partners.

Broader implications of short-term greed

In his latest book, Tomorrow’s Lawyers, Richard Susskind wrote that most law firm leaders he meets “have only a few years left to serve and hope they can hold out until retirement… Operating as managers rather than leaders, they are more focused on short-term profitability than long-term strategic health.”

Viewed through that lens, the annual Am Law 100 rankings make greed respectable while masking insidious internal equity partner compensation gaps that benefit a relatively few. Annual increases in average partner profits imply the presence of sound leadership and a firm’s financial success. But an undisclosed metric — growing internal inequality — may actually portend failure.

Don’t take my word for it. Ask lawyers from what was once Dewey & LeBoeuf and a host of other recent fatalities. Their average partner profits looked pretty good — all the way to the end.

THE LAWYER BUBBLE on C-SPAN2

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On Saturday, May 11 at 4:45 pm (EDT), C-SPAN 2 (Book TV) will broadcast my earlier appearance at The Book Stall in Winnetka, IL.

Time Magazine review of THE LAWYER BUBBLE

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“The legal profession is facing some fundamental changes and Harper deserves credit for sounding the alarm…[His] big-picture argument is undoubtedly correct, and it is a real cause for concern.” — Adam Cohen, Yale Law School, “Is There A Lawyer Bubble?” in Time Magazine 

Additional reviews are collected here.

LAW DEANS SCRAMBLE

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Some law school deans are revealing what they regard as innovation in the face of the legal profession’s continuing crisis. Plummeting law school applications have tested their creativity in selling classroom seats. But recent trends — fewer applications amid a dismal job market for law graduates — haven’t deterred some efforts to preserve an unsustainable business model.

Moving through the five stages of grief

As deans confront declining applicant pools, many are moving through the five stages of grief — denial, anger, bargaining, depression, and acceptance.

Previously, I looked at deans in stage 1 — especially those who took to the editorial pages of major newspapers, touting the inherent value of a $150,000 legal degree for students who couldn’t get jobs practicing law. Apply now, they urged, because declining applications improved prospects for admission. Then you can do lots of great things that don’t require a JD.

Case Western Law School Dean Lawrence Mitchell made himself a poster child for such deans in denial, but he wasn’t alone. Other deans and former deans have similarly offered analyses that miss the mark on the causes of the lawyer bubble and offer proposals that distract attention from their own culpability. Some have advanced to stage 2 — anger over the situation and anyone who publicizes it.

From anger to bargaining

A few deans have reached stage 3 — bargaining. Some schools have reduced tuition and/or guaranteed freezes during a student’s three years. But Touro Law recently announced a special kind of bargain that targets the least informed potential applicants who are most vulnerable to law schools’ superficial sales pitches.

Under a partnership with the University of Central Florida, prospective law students can apply to an accelerated program whereby they attend UCF for three years and then complete their fourth year at Touro Law. They would receive their UCF bachelor’s degree upon completion of their 1L year at Touro.

Quite a deal, right?

Some things you should know

Touro Law inhabits the world of U.S. News and World Report’s unranked nether regions. Readers know that I’m no fan of those rankings, but it’s safe to say that no one would regard Touro as a top law school by any measure. According to U.S. News, it accepted 64 percent of all applicants last year.

Touro’s recent trends are especially revealing. (The following statistics come from the archives of the LSAC “Official Law School Guide.”)

In 2005, the school awarded 158 JD degrees. Tuition was around $26,000 a year.

In 2009, the school awarded 200 JDs. Annual tuition had increased to more than $36,000.

In 2011, the school awarded 221 JDs. Sixty percent found full-time long-term jobs requiring that degree.

In 2012, the school awarded 244 JDs, but only 53 percent had long-term full-time jobs requiring a JD. Tuition is now $43,000 a year.

In other words, as the Great Recession worsened and the demand for lawyers collapsed — especially for graduates of places such as Touro Law — the school increased both tuition and class size, even as its ability to place graduates in legal jobs declined.

The business model at work

Perhaps it’s unfair to single out Touro for behavior that has pervaded legal education: increasing class size and raising tuition as demand for new lawyers declined. But the school’s latest initiative invites close scrutiny of its motives.

According to Touro Law’s new dean, Patricia Salkin, “It’s a financial bargain for the UCF undergraduates and takes some pressure off the law school application process.”

My guess is that it’s a financial bargain for Touro Law, too, especially if it gets to keep most of the tuition that the UCF students pay to attend first year law school classes. (Annual tuition at UCF is $6,200 for residents; $22,300 for non-residents — compared to $43,000 for Touro Law.)

As for relieving the pressure of the law school application process, Touro can claim that benefit for itself, too. There’s nothing like locking in a law student three years before he or she might otherwise apply.

What are we doing to our kids?

It’s bad enough that current UCF undergraduates are eligible for this “fast-track program.” (Even the name implies a selectivity that sounds enticing, doesn’t it?) But encouraging — or even allowing — woefully uninformed high school students to apply to law school as entering UCF freshmen is something else.

The next step for some law schools seems painfully clear: setting up recruiting tables in middle school cafeterias across the country.

FROM THE USA TODAY…

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“THE LAWYER BUBBLE is a must read for managing partners, law school administrators, and most certainly, prospective law students.”

–Former dean of the Georgetown Law Center, Everett Bellamy, from his review of THE LAWYER BUBBLE in today’s USA TODAY.

MORE REVIEWS AND APPEARANCES

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“[Harper has] a complete mastery of his subject matter, both from an economic and legal perspective…. Not only is Harper a gifted lawyer able to marshal facts, but he is an especially deft writer, and he tells his story as only a gifted author can…. Harper does not simply criticize the current state of affairs; he offers solutions, if only we are wise enough either to embrace them, modify them, or come up with additional curatives…. The Lawyer Bubble is a wake up call for those of us who love our profession, and it is a book that all lawyers should read.”
— Hon. Jeffrey Cole (USDC, ND IL) book review in “Circuit Rider,” the official publication of the Seventh Circuit Court of Appeals Bar Association (April 2013)

Bloomberg Business Week recently featured THE LAWYER BUBBLE in two more articles: “The Case Against Law School” and “Howrey’s Bankruptcy and Big Law FIrms’ Small Future.” The latter also appears in the current issue of the print edition.

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On Tuesday, May 7 at 1:00 pm CDT, U.S. News & World Report is hosting a Google-plus Hangout, during which Simon Owens, Assistant Managing Editor of USN&WR, will interview me. Members of the public can RSVP and participate via this link: https://plus.google.com/events/cu2d4q7klmrcts5eb775iv7jkas

UGLINESS INSIDE THE AM LAW 100 — PART I

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Every spring, the eyes of big firm attorneys everywhere turn to the American Lawyer rankings — the Am Law 100 — and the contest surrounding its key metric: average profits per equity partner (PPP). But if the goal is to obtain meaningful insight into a firm’s culture, financial strength or profitability for most of its partners, those focusing on PPP are looking at the wrong ball.

Start with the basics

For years, firms have been increasing their PPP by reducing the number of equity partners. American Lawyer reports that cutbacks in equity partners, when done correctly, are “a solid management technique, not financial chicanery.” But as firms are now executing the strategy, it looks more like throwing furniture into the fireplace to keep the equity house warm.

Since 1985, the average leverage ratio (of all attorneys to equity partners) for the Am Law 50 has doubled from 1.76 to more than 3.5. It’s now twice as difficult to become an equity partner as it was when today’s senior partners entered that club. Between 1999 and 2009, the ranks of Am Law 100 non-equity partners grew threefold; the number of equity partners increased by less than one-third.

Arithmetic did the rest: average partner profits for the Am Law 50 soared from $300,000 in 1985 ($650,000 in today’s dollars) to more than $1.7 million in 2012.

The beat goes on

Perhaps it’s not financial chicanery, but many firms admit that they’re still turning the screws on equity partner head count as a way to increase PPP. According to the American Lawyer’s most recent Law Firm Leaders’ Survey, 45 percent of respondent firms de-equitized partners in 2012 and 46 percent planned to do so in 2013.

But even when year-to-year equity headcount remains flat, as it did this year, that nominal result masks a destabilizing trend: the growing concentration of income and power at the top. In fact, it is undermining the very validity of the PPP metric itself.

An unpublished metric more important than PPP

The internal top-to-bottom spread within the equity ranks of most firms doesn’t appear in the Am Law survey or anywhere else, but it should, along with the distribution of partners at various data points. As meaningful metrics, they’re far more important than PPP.

Even as overall leverage ratios have increased dramatically, the internal gap within equity partnerships has skyrocketed. A few firms adhere to lock-step equity partner compensation within a narrow overall range (3-to-1 or 4-to-1). But most have adopted higher spreads. In its 2012 financial statement, K&L Gates disclosed an 8-to-1 gap — up from 6-to-1 in 2011. Dewey & LeBoeuf’s range exceeded 20-to-1.

This growing internal gap undermines the informational value of PPP. In any statistical analysis, an average is meaningful if the underlying sample is distributed normally (i.e., along a bell-shaped curve where the average is the peak). But the distribution of incomes within most big firm equity partnerships bears no resemblance to such a curve.

Cultural consequences

Rules governing statistical validity have real world implications. Growing internal income spreads render even nominally stable equity partner head counts misleading. Lower minimum profit participation levels make room for more equity partner bodies, but what results over time is Dewey & LeBoeuf’s “barbell” system. A handful of rainmakers dominates one side of the barbell; many more so-called service partners populate the other — and they rarely advance very far.

As Edwin B. Reeser and Patrick J. McKenna wrote last year, in Am Law 200 firms, “Typically, two-thirds of the equity partners earn less, and some perhaps only half, of the average PPP.” Statisticians know that for such a skewed distribution, the arithmetic average conveys little that is useful about the underlying population from which it is drawn.

Why it matters

For firms that don’t have lock-step partner compensation, the PPP metric doesn’t reveal very much. For example, consider a firm with two partners and an 8-to-1 equity partner spread. If Partner A earns $4 million and Partner B earns $500,000, average PPP is $2.25 million — a number that doesn’t describe either partner’s situation or the stability of the firm itself. But the underlying details say quite a bit about the culture of that partnership.

Firms with the courage to do so would follow the lead of K&L Gates and disclose what that firm calls its “compression ratio” and then take it a step farther: reveal their internal income distributions as well. But such revelations might lead to uncomfortable conversations about why, especially during the last decade, managing partners have engineered explosive increases in internal equity partner income gaps.

A future post will consider that topic. It’s not pretty.