The current wipe-out in mortgage securities is having a similar impact on a band of highly specialised New York law firms as the tech slump had on West Coast practices. Susan Beck looks for lessons from the last crunch

Remember 2000? Remember when the technology bubble burst? Law firms that had placed heavy bets on that sector reeled. Revenues and profits dropped, associates were shed, and partners were quietly shown the door. California-based firms suffered the most, and their competitors in New York smugly shook their heads at that West Coast foolishness.

In hindsight, the folly of it all seems obvious. But here we are again.

Eight years later, another bubble has burst. The market for mortgage-backed securities and other collateralised public offerings has nearly evaporated. And as in 2000, a handful of firms are staggered and dazed. Only this time around, it is mainly New York firms that succumbed to the irrational exuberance.

What can Cadwalader Wickersham & Taft and others expect in the coming months and years? Looking at the experience of firms from the tech-frenzy era, here is the good news: a well-managed, stable firm that corrects its overreliance on one practice area can rebound. Here's the bad news: large associate lay-offs may lead to significant forced partner departures. And here is the worst news: a firm that lacks a cohesive culture can collapse under these market stresses.

The firm that arguably did the best job of dusting itself off after the tech crash and remaking itself is Cooley Godward Kronish. During the boom, premerger Cooley bulked up on lawyers as fast as it could find desks and phones for them. "In 1998-99
we grew unbelievably fast," recalls Stephen Neal, who has been Cooley's chairman since early 2001. "The numbers were pretty staggering. We added 300 lawyers in a 12 to 18-month period."

Similar stories filled Silicon Valley. Brobeck Phleger & Harrison grew from 540 lawyers to 724 from 1999 to 2000, a pace outdone by Wilson Sonsini Goodrich & Rosati, which ballooned in that time from 550 to 812 lawyers. Says Neal: "In retrospect you might say [the growth] was a mistake, but we did not know at the time how long this market would last. At the time it was almost irresistible."

Indeed. Cooley's profits per equity partner exploded in that hot market, rising 60% in two years, from $565,000 (£315,000) in 1998 to $905,000 (£505,000) in 2000. At Wilson, profits rose 50% in that period, to $930,000 (£519,000); at Brobeck, profits almost doubled. And these numbers do not include money partners made from investing in start-up clients.

The market was insatiable, remember some partners. "We turned away nine out of 10 pieces of business – maybe more," said Mark Tanoury, who then headed Cooley's business group, in 2000. "There was talk of just shutting the doors completely for six months and putting a moratorium on new business."

These firms, and others that poured money into this sector, thought this was just the beginning. "This is a shift in the economy," said Wilson Sonsini's much-lauded chairman Larry Sonsini in 2000. "The globalisation of technology is just in its infancy. We are in the top half of the first inning."

But then the game was rained off. The tech market tanked, and Cooley's profits per partner fell by 21% in 2001. It took another year for the firm to accept that the market wasn't returning, and in November 2002 the firm announced that it was cutting more than 80 associates.

From the start of its shock therapy strategy, Cooley firm leaders knew that partners would have to be cut, but they kept that news to themselves. "At the very first meeting where we discussed [associate] lay-offs, we talked about implications for the partnership," Neal recalls. "We had to make sure the partnership was the right size and make sure we had room to move associates into the partnership [down the road]."

Quietly, Cooley eased out partners over the next four years. Neal declined to say how many, but it appears from Cooley's head counts that roughly 45 departed.

Neal insists that forgoing lay-offs by slashing partner profits wasn't an option, nor could other practice groups absorb such a big influx of bodies. "We would still have 80-100 young lawyers at the early stage of their career with no work to do," he says.

Lay-offs were not the only remedy. Cooley closed an office in Kirkland, Washington, and after a long search, diversified by merging in 2006 with New York's Kronish Lieb Weiner & Hellman, known for its bankruptcy and litigation work. Cooley's chief executive officer, Joe Conroy, says the firm still has a strong base of technology clients, but is now balanced about 50/50 between corporate and litigation; before, the corporate group dominated. "We absolutely have been more careful how we have grown," he says. Last year, Cooley reported its highest profits per partner of $1.4m (£780,000).

Wilson Sonsini never admitted that it laid off lawyers, although its head count plunged from 812 in 2000 to 540 in 2004. The firm still has fewer lawyers (623, according to the most recent Am Law 100 data) than it did at the height of the tech boom, and its equity partnership has contracted from 151 in 2004 to 119 last year. Unlike Cooley, the firm has not diversified much, and is still closely identified with Silicon Valley. Last year, it reported the same profits per equity partner as Cooley.

Cooley's story may be reassuring to lawyers at Cadwalader, McKee Nelson and Thacher Proffitt & Wood, all of which bet heavily on securitisation and all of which cut their associate ranks this year. But hovering nearby is the spectre of Brobeck.

Lots of factors led to the implosion of that iconoclastic firm in 2003, including management turmoil and excessive debt. But the beginning of the end came when former chairman Tower Snow refused to lay off associates, defying the wishes of many partners. Brobeck's partners – who included a large contingent of laterals – rebelled and toppled Snow, who was, himself, a lateral. That does not mean that firms that want to avoid lay-offs are doomed. But it does illustrate how destabilising lay-off decisions can be if they are not widely supported.

This time around, firms at the centre of the storm have taken the scythe to associates more quickly than their California counterparts. Publicly, their leaders speak optimistically about the future. Reed Auerbach at McKee Nelson stresses that his firm diversified before this crash. Auerbach, a member of the firm's executive committee, notes the firm added a business litigation practice last year that has grown to 32 lawyers, and they are also focusing more on white-collar matters. Their public offerings have plunged, he acknowledges, but they have picked up major private deals.

At Cadwalader, firm chairman Christopher White expresses no regrets. "There was a bubble, we rode that bubble, it contracted, and we adjusted. Even knowing what I know now, I wouldn't have changed a thing," he told The Wall Street Journal in August.

Confidence is good. But as Cooley's experience shows, a little humility can help as well. In the ironically fateful words of Brobeck's Snow: "History shows that those who are overconfident or arrogant tend not to do well when the environment changes." That is an inconvenient truth.

A version of this article also appeared in the September edition of The American Lawyer, Legal Week's US sister title.