Monday, October 12, 2009

Buying A Law Degree At The Height Of The Bubble

The past few years have brought us the Tech Stock bubble that crashed the stock market and the housing bubble that almost crashed our entire economic system.  We are still recovering from the housing bubble and are likely to be doing so for the next several years.  Unfortunately, the same principles that led to the tech bubble and the housing bubble are currently at work in the field of law - and may cause the value of your law degree to "crash."  Analysis and what you can do about it after the fold.

At heart, both the tech bubble and the housing bubble were based on the failure of the market to adequately estimate and understand risk and to fail to appreciate supply and demand.

With regard to tech stocks, the prevailing attitude was that the value of the stocks would continue to go up and up forever.  Valuation of the stocks became decoupled from actual economic activity.  For example, investors stopped asking "where are all the people who are supposed to be buying the products and services to support the lofty valuations of the stocks - where are the customers?  Where is the money?"  In the mind of the investors, it was all going to be great - a brand new world where corporate fundamentals no longer chained down the valuations of stocks.

However, despite all of the investor's hopes and dreams (myself included) eventually the companies realized that they can't pay their employees with profits that they were not earning.  To put it another way, no matter how great the investors thought the idea should be, if the customer base was not there, then the business was not sustainable.

Similarly, with the housing bubble, again investors began to believe that the value of housing would continue to go up and up forever.  Again, the valuation of housing became decoupled from all reasonable economic bases, such as the cost of renting and the average income of the housing area.  Again, investors failed to ask themselves "where are all the buyers that are going to buy the house from me at an even more inflated price?"  Again, despite the homebuyer's hopes and dreams, the market eventually realized that the housing values were unsupportable, people stopped buying, valuations fell a little, banks became even more nervous and stopped making loans, and valuations fell a lot.  (I managed to avoid most of this bubble.)

At the institutional level, banks chopped up local real estate portfolios and traded them among themselves in an attempt to diversify away location risk.  Their belief was that any one or two specific cities in the US might be vulnerable to decline, but at the same time some other cities were probably growing.  Consequently, if their risk portfolio of real estate investments was diversified over all locations, then their risk should be greatly reduced.  Sounds like a good plan, but they were faced with a situation wherein substantially ALL regions of the country experienced a decline - so their risk diversification was ineffective.  The banks simply misunderstood the risk.

In summary, in both situations, you have investors or purchasers wrongfully believing that their purchase will always continue to increase in value.  Often this belief was based in part on investors ignoring the fundamental numbers and believing that "for me it will be different."  Also, they believed that because someone bought at 50 and sold at 75, that they should be able to buy at 100 and sell at 150, regardless of whether customers were actually buying the goods.  The failed to understand - or ignored - the risks, they did not do the math of supply and demand, and they ended up much poorer for it.

Let's take a look at law school in this context.  "Everybody knows" that law school is "always a good investment," just like stocks or real estate, right?  (.....  Right???)  No need to calculate the actual numbers, just buy, buy, BUY!  In this regard, law schools are like stock brokers or real estate agents - they make money regardless of whether your investment bankrupts you.

So let's take a look at some real numbers and try to estimate the market opportunity.  It appears that in the glory days of yesteryear, supply and demand were somewhat in equilibrium, possibly with supply somewhat exceeding demand.  This meant that for an average attorney, they could look forward to a starting salary, most likely in the $60K-70K range.  However, about 25%-30% of students ended up unemployed or underemployed.

However, this year has seen massive layoffs - if you want to get a feeling for just how frequent these layoffs are, read Above The LawLaw students competing for half (HALF!) as many job openings as last year in the worst recruiting season IN OVER 50 YEARS!  Even in Intellectual Property, which is commonly regarded as one of the most reliable specialties, there are hiring events where 350 students register and only 9 firms are even interested in seeing anyone.  This would be inconceivable even just one year ago.

Clearly, demand for new layers has fallen off a cliff.  Nor will demand be returning soon because demand tracks the economy and the most recent economic indicators are that we will be in for a jobless recovery and reduced spending.

On the supply side - official overall numbers for 2010 don't seem to be in yet, but individual law school enrollment numbers seem to be way, way up. In some cases to the highest level in 25 years.  This is often what happens when the economy takes a nosedive.  The reflexive response is just to stay in school longer.  However, law students are training for a career with declining demand - and too many students are making the decision to go to law school at the same time.  The increased numbers are going to swamp the available demand.  Also, new law schools continue to open - 16 more law schools  (almost a 10% increase) from 2000-2008 - further exacerbating the oversupply.

Further, when demand does pick up, more experienced lawyers will be preferred over new grads - and there are a lot of lawyers with several years of experience who were laid off and are still looking.  New grads are going to find themselves waiting in line.

Thus, in light of all of the above, I submit that if you were to go to law school now, then you are investing in a law degree during a tremendous bubble.  Supply and demand are very far apart right now - farther than I have ever seen.  This makes it far less likely that you will be able to take the law degree that you will pay $200K for and be able to use it to make a profit.

Flat demand + More Law Schools = Trouble.

So what to do?  Remember that the tech bubble and the housing bubble did not last forever, and after the bubbles burst there was great opportunity to be had.  If you want to use a stock market analogy, then the market for law school is too hot so you should go to cash.  To use a housing analogy, housing valuations are silly, so sell and rent a place until they come down.  More specifically, I am not necessarily saying that you should never go to law school - I am just saying that RIGHT NOW is the worst time in 50 years to do it.  However, it won't be that way forever.  I am not saying that everything will be rosy in a few years, but it is likely to be better than it is now.

Consequently, if you are considering going to law school, I would recommend delaying your entry for at least a couple of years.  If you enroll in the fall of 2011, then you will graduate in the spring of 2014 - and by that time supply and demand should be more in synch.  In the meantime, you will have sat out the worst market in 50 years, and most likely the market will over-correct and law school will become disfavored.  Then, when the supply of law students diminishes, go to law school and take advantage of a favorable supply-demand equation.  Don't bury yourself in the rotten supply-demand equation that exists now.

You may even want to use your time productively by becoming a paralegal, which could give you a leg up in the recruiting process later.

Similarly, if you are currently in law school, finish up the semester, get high grades, and then pause in your legal education until the market improves.  To be blunt, when you find yourself in a hole, stop digging.  Would you rather be $50K in debt with a job that pays $40K-$60K/year (a paralegal, for example) or $200K in debt with a job that only pays $40K-$60K/year - or no job at all.

Just wait a few years - the law schools will still be there - they will still be eager to take your money - and the fundamental economics of the law degree will most likely be much, much better.  The same thing went for buying stocks in 2001 and buying houses in 2007 - people were worried about missing their opportunities and it looked like easy money.  Their greed and desperation caused them to fail to estimate supply/demand and risk correctly.  Unfortunately, they found out too late that the truth was different from their fantasy - don't let the same thing happen to you.


  1. Pause in law school? Oh that'll look good in your transcripts....LOL

  2. 4:13 - I agree, it is not ideal. However, I think that you might agree that shifting your graduation date a few years would greatly helpy your career prospects. Someone else recently mentioned another alternative to me which I think is worth considering - transfer to an evening program (either at your law school or at another). This gives you the benefit of delaying your start date while avoiding the detriment of the "pause." What do you think?

  3. " and the fundamental economics of the law degree will most likely be much, much better."

    I disagree with this because

    (1) it's unlikely that tuition will fall dramatically the way that stock prices do when a bubble bursts. At 200k, a law degree is a big risk even if the job market is good.

    (2) There are lots and lots of kids who want to go to law school and will take any financial risk to do so. These kids will clog up the job market for a long time just through their numbers.

    (3) A lot of legal work is being outsourced to India

    (4) 10 years ago, the ABA opened the door to a flood of new law schools and the floodgates remain open.


    When you consider the economics, opening up a law school is a pretty good idea for any college or university which wants to generate some cash flow as follows:

    1. No matter what they tell you, it doesn't cost more than 3 or 4 thousand dollars a year to provide a legal education.

    2. At the same time, $18,500 per year is available in guaranteed federal loans.

    3. There is a nearly unlimited supply of young people who are all too willing to sign on the dotted line to borrow that money and attend law school.

    Which means that any schmucky little college or university can generate 4 million dollars a year in profit just by opening a law school.

    No wonder so many new law schools are being opened up even in the worst legal job market in 50 years.

    So it seems to me one can expect an oversupply of lawyers to continue flooding the job market for quite a while.

  4. nycsolo - Great comments! First, with regard to the fundamental economics of the law degree, what I forsee is boom and bust with regard to demand. Demand by students for law school education is in a huge boom right now. However, I think that once the word gets back about how bad of an investment it is and the great number of law students that are unable to get a job, then far fewer people will apply to law school. Once going to law school becomes vilified in the press and "everyone knows" that law school is a bad deal, enrollment is likely to be way down and it is most likely going to be the best time to go. I agree that law school tuition is unlikely to fall drastically, but even if tuition remains constant throughout, the average salary that awaits the law students should rise when fewer law students graduate.

    You rightly point out three factors that may operate against this - 1) potential students won't get the message, so there won't be a decline in the number of law students, 2) even if there are fewer students, there will be less work available due to outsourcing to India, which will limit the increases in salary, and 3) more law schools will continue to open which will also act against the decline in law students.

    The factors that you mention are real and will certainly have an impact. They may even swamp the factors that I mention in some scenarios. However, here is why I think that the factors will align the other way:
    1) Right now law school enrollment is benefiting from the "lemming factor" that "everyone knows" that law school is a great investment. This idea is generally put forth by the press. However, the press loves to be contrary in order to "make news." Note the increase in anti-law school stories. I think that we are going to see this increase and that the lemming factor will eventually direct potential students elsewhere.
    2) I have done outsourcing work with India, and frankly - it sucks. Actually, let me clarify - it sucks for anything that requires judgment. If you just need someone to stamp bates numbers, then it is just fine (and cheap). I don't find it to be a substitute for attorneys. I DO find it to be a substitute for the domestic companies that we were using for bates numbering.
    3) It's the profitability factor that is behind the desire to make more law schools. However, once the lemming factor starts steering students away from law schools, the profitability factor declines and new law schools are less likely.

    However, let me again state that although the reality that I describe is what I believe has the greatest likelihood of taking place, it is certainly possible that the reality that you describe takes place instead - I really hope not, though!

  5. "I think that we are going to see this increase and that the lemming factor will eventually direct potential students elsewhere."

    I concede this is possible. But consider the example of grad school in the humanities. It's been known for 20 or 30 years now that grad school in the humanities is a bad investment of time; that you are unlikely to end up with a tenure track position; and so on.

    And yet lots of people apply and go.

    It seems to me there is no shortage of suckers.

  6. Hi nycsolo - Interesting comment! I think that you are right that while there are a few tenure track positions, there are too many candidates for each job. However, humanities grad school is a pretty different financial picture from going to law school.

    For example, I actually have a few friends that went to grad school for the humanities. All of them got TA positions, so they paid no tuition and got a small stipend to live on. That's a pretty differnt picture than paying 200K to go to law school.

    As for why they went? Some thought that they would be the next great author. Some really liked their subject and bought into the "do what you love and the money will follow" BS. Some really did not know what to do as a next step, so grad school was the easiest choice.

    How did they fare? A couple of them stopped their education and got "real jobs" when faced with increased expenses like wife and kids. One wrote his book and is scrapping it out freelance. Several realized that there was not opportunity in their fields and went into elementary and secondary education - they now make lots more then the tenure-track positions they originally thought that they wanted.

    On the other hand, if someone had to take out 40K in loans per year to attend grad school in the humanities, I would agree that the financial choice seems suspect. However, in line with the experiences I mention above, if grad school isn't costing them anything, then I'm not that adverse to it. Also, as long as it isn't costing them anything, I can't bring myself to call them suckers. They may not be as focused as the people that are going to law school, but the law student's focus on a law degree might bring them straight into the trap of $200K in debt - often with a job no better than what they would have had out of undergrad. Comparing these two scenarios, attending grad school seems preferable.

  7. nycsolo - Here's a recent article in the Chronicle of Higher Education that really backs your point about graduate education in the humanities.