There are bad news from the financial sector wherever you look these days. Here are just two headlines from the last couple of days:

• Worldwide financial job losses triple in 2007 – Almost 200,000 staff are laid off (FT, 18 January 2008)
• Crisis talks for West LB – about one third of the current staff (of 5,900 in total) to be laid off (FAZ, 21 January 2008)

Well, there we have another fine example of the so called pig cycle: In times of high demand and high profitability, players in an industry tend to extrapolate this trend into the future and thus to extend their production accordingly. In the original example, pig production is finally extended to a point where there is a significant over-supply. Hence, prices are going to fall and profitability is declining too. Again, producers expect this trend to continue on and thus reduce their production. This will finally lead to a supply that does not meet the existing demand. Prices and profitability will rise again, motivating producers to increase their production …
You can easily replace the over-supply with some external event that suddenly reduces demand. The effect will be the same.

In general, there is nothing wrong with a cycle like this. For me this is an excellent proof for one of the basic laws of economics: The levels of supply and demand determine the price and vice versa. In the real world, prices will hardly find their equilibrium and stay there. Rather, supply, demand and prices will fluctuate more or less around this equilibrium. The problem is not this fluctuation, but the exaggeration which leads to unnecessarily extreme peaks. In their excitement over the amazing earning potentials, every farmer extends his pig production to a maximum. All together they reach a level of supply that is far beyond any demand.

It is no rocket science to transfer the pig cycle to what we see in financial services these days.

The industry has had some very good years with several profitable products on the rise: M&A business was growing again, real estate transactions became more M&A-like too, there was the sub-prime mortgage business (Did you notice that there are no more spam mails ‘Your loan request has been approved’) and, of course the wide field of CDO’s, ABS’s, RMBS’s and many more structured products – just to name a few. Profits were rising and banks were desperately looking for experts in these fields in order to exploit these wonderful market potentials. They quickly extended headcounts in the respective desks and departments. I guess, even the other departments which mostly delivered good figures too were allowed to put on some staff after some painful waves of restructuring and redundancies. Now the market for some of these products collapsed, in some cases virtually to zero. The result are headlines like the ones above.

My first reaction was once again to be embarrassed about the exaggeration that comes with a crisis in the financial services industry. It is all too often that we hear about the number of layoffs among the very first measures management takes in a crisis situation. It seems as if they try to get rid of as many people as possible. What a short-sighted strategy. As soon as the crisis is over and there are first signs of recovery, the same banks will again desperately look out for specialists and experts – probably the same kind of people they laid off a year ago.

However, this time, there is hope. It seems as if the industry has learned their lesson from the last cycles of hiring and firing. Here is what I also read when working through the same newspapers:

• A WestLB spokesman denied plans to lay off 2,000 people. He said that they don’t have a clear restructuring plan so far; hence, it would be much too early to determine the number of layoffs.
• There was an interesting article in last Fridays FT (Slowdown could be a moving experience). It says that investment banks currently have difficulties to identify those areas that need more people and those where headcount needs to be reduced. As a result, they are deferring massive layoffs and instead try to move staff around the organisation on an ad hoc basis.
• The same article indicates that banks obviously have recognised that their staff – even in departments like structured products that have been hit hardest – has valuable expertise that they may need elsewhere in the organisation. So they offer them jobs in other business lines or they ask them to relocate to other regions like emerging markets where they need “people on the ground”. I especially liked the approach that “M&A bankers have plenty of transferable skills that make them suitable candidates to advise on structuring companies” (see here why).

It seems as if the industry has learned their lesson from the last cycles of hiring and firing. Companies finally seem to understand that knowledge, expertise and experience are scarce resources which cannot be acquired and divested at will. Of course, it is possible to buy them. The price might be extremely high, depending on the experience those experts have made during the last industry crisis. However, the loyalty of knowledge, expertise and experience can also be earned, also depending on the behaviour of the employers during the last crisis. In the long run, this might be the more worthwhile investment.
Maybe, there will be a bit less exaggeration in this cycle of ups and downs.