Harvard Endowment: Punishing the Present to Benefit the Future?

Harvard University has reported that its endowment fell 22% in the four months since June 30.

When I was in college, I would often hear my fellow students complain about how stingy the university was. "We have a multi-billion dollar endowment, why don't we spend more of it?" was the common refrain.

"You idiots don't understand!" I would stew to myself (I never actually argued out loud, especially to a girl. I didn't talk to a girl at all until second semester senior year). "You can't just spend all of the endowment now! Don't think of it as $XX billion you can spend, think of it as an asset that produces an annual cash flow stream that you can spend.

"In a world of perfect foresight, you'd smooth your spending perfectly, spending the same amount on an inflation-adjusted per-student basis every year between now and the end of the world. In the real world you don't have perfect foresight--you don't know how well the endowment will perform or how many students will exist in the future or how available alternative forms of income will be--so you make an educated guess on how much to spend today (at my alma mater it was called the spending rule). When you spend too much today you're taking it away from future students, who have as much right to benefit from the endowment as you do!" I did a lot of stewing in those days, as you can see.

That was then. Today the thing to keep in mind is that it works in reverse too: when you spend too little today, you punish the present to benefit the future. Not only that, but harsh cutbacks in financial aid, staffing, and other spending can do long-term damage to the school's reputation. I don't know all the details, but unless Harvard's President Faust is simply trying to talk down the budget expectations of the various deans, which is the eternal task of a university president, that's the risk Harvard faces.

The $8.2bn decline in the endowment's value looks large and is large, but it's not as large as it looks. First, as Felix Salmon points out, the total value is just back to what it was in 2006--two "lost years" is not a big deal if you're 372 years old and consider yourself immortal. In addition, the pain such a decline will inflict on annual spending, present and future, doesn't have to be that bad:

The endowment's value as of June 30 was $36.9 billion. Suppose the spending rule percentage, absent any market value decline, would have been 4.5%. Therefore the total annual spending would have been $1.66 billion.

Now suppose that come June 30 of next year the endowment declines by the 30% estimate Harvard is assuming, to $25.8 billion. If the spending rule remains constant at 4.5%, then annual spending would decline by an identical 30%, to $1.16 billion. That's $500 milllion less spending. If you've ever tried to cut $500 million from a university's budget you know how miserable life can be. And if you'll permit me to get on my high horse, it's not the tenured professors who will really suffer. It's the secretaries and staff, construction workers, part-time faculty, and others who truly depend on the school for their livelihood. It would be somewhat ironic for an institution that very publicly (and admirably) dedicates itself to the betterment of humanity as a whole to refuse to take care of its own.

But what would happen if instead of maintaining a constant spending rule of 4.5% in the face of the decline--spending $1.16 billion--the university decided instead to maintain the actual dollars spent at $1.66 billion? (On the new lower denominator of $25.8 billion, that would increase the spending rule percentage to 6.43%.) The $500 million in "excess" spending can be thought of as dipping into principal, which in certain old Boston families is worse than adultery, but in this case represents only 1.9% of the new principal amount of the endowment. That would be the penalty imposed on future generations, and that's the number to weigh against the pain current budget cuts would cause.

I suspect that the real problem Harvard faces is a simple cash crunch. It committed to spending a large percentage of its operating budget--i.e. predictable, recurring, difficult-to-take-back obligations--with endowment income, but chose to fund those obligations not with similarly predictable and recurring cash flows but with their polar opposite--hedge fund, PE and VC fund LP interests. This would explain its recent fire sale of PE fund interests, its move to issue new bonds, and its decision to reduce the risk of the endowment portfolio. As David Swensen has shown, embracing volatility and illiquidity in pursuit of superior long-term returns is worth doing. But there is a price.

Comments

[notsosmart:]

among others,a lot of the folks who caused this mess are from harvard & other ivy league schools.our great"mission accomplished" &" im the decider" leader was spit out by yale.none of these places care for the average worker.check out the strike history of the lowest tier worker.mostly self serving elite snobs that are not accountable.instead of ethics,greed 101 is the subject.

2008 Dec 05 12:55 PM

[AlexS:]

Harvard will spend all the money they can get their hands on - and then some. Really there's nothing more to understand than that fact. No wonder so many of them go into politics, to the detriment of taxpayers everywhere.

2008 Dec 05 02:44 PM

[Jon G:]

Time for them to launch a new fundraising campaign!

2008 Dec 05 03:25 PM

[RatWatcher:]

I've read the Harvard story on numerous sites. Nowhere is it presented that Harvard is down *ONLY* 22%. They are weathering the storm better than most of us, no?

2008 Dec 06 02:33 AM

[buyitcheap:]

by not spending the full earnings (after a reasonable return to the corpus for preservation of purchasing power of the underlying principal) they are most definitely robbing the current generation of students.

What one must understand is that internally, on the university budget books, the transfer from the endowment is used to cover shortfalls in funding on the research side. That's all. They already know how much tuition, scholarships, capex etc. will be and they can operate just fine without a transfer, however, they would show a loss by virtue of the under reimbursement on federal research grants (you can only charge 15% of indirect costs to a contract - no school has a 15% indirect cost rate, more like 115% once you figure in all those buildings and research square footage that can't be charged either through depreciation or a per s.f. allocation.

You could take a full 35% of the current endowment and all the universities would have to do is transfer 15% from the corpus until such time as earnings "caught up" to the transfers.

Drastic cuts only occur when administrators are too cowardly to cut or hold faculty salaries, release some of the administrators, and stop taking research grants which generate nothing but losses. This is basic portfolio management at a university level. Nothing more.

Does anyone feel bad that Warren Buffet only has $35 billion, as opposed to his $42? puh-lease.

2008 Dec 06 01:39 PM

[Obama is Bu...:]

Harvard needs to start paying taxes on its endowment earnings (at minimum) and arguably property taxes as well. All the big universities do.

First of all, Harvard earns enough on its endowment that it really doesnt need to charge any tuition.

In spite of enormous endowment earnings, plus an enormous tax advantage, plus the ability to charge different customers different prices to maximize revenue (something that is illegal for most businesses) -- Harvard still has to raise tuition by roughly twice the rate growth rate of GDP, and almost three times the rate of CPI... and it has been raising prices faster than the economy for decades.

Where does this money go? Harvard, like many schools, has literally hundreds of Deans. As you would expect, a Dean of each school and perhaps a Dean of Students. But then they have a Dean of Minority Students, Dean of African American Students, Dean of Asian Students, Dean of Latino Student, Dean of every ethnic group you can think of. Other schools add a Dean of Greek Life (fraternities/sororiti... Every Dean has a staff of several secretaries and a large number of assistants, each of whom also has a secretary. Residential life Directors and assistants, development directors, new facilities directors, existing facilities directors -- all of whom have a support staff.

Not even counting custodians or librarians -- most major universities have "administrative / support staff" that greatly outnumber the professors.

Purchasing? Most universities spend many times what the private sector does for the same goods/services... and that's before you factor in the cost of the staff whose job is supposed to be to rationalize purchasing.

I don't know Harvard's budget, but in a typical "big university", slightly more than half of the schools budget goes to things other than classrooms and professor salaries (the things we think are education). Most of the money we claim to spend on "education" in this country actually goes to something else.

Seniors, about to graduate into the real world with tens of thousands in student loans, would stage a riot if they realized where their money actually goes.

So what? College tuition has already reached a point where upper middle class families cannot afford it. Many marriages are delayed while the happy couple struggles to pay off their student loans before incurring a mortgage debt.

Its one thing to argue that EDUCATION should get a tax subsidy -- but that is not where the majority of the money goes. Academia has become a welfare program for bureaucrats.

And as another poster already commented, Harvard's culture of excessive out of control costs, is where a large number of government bureaucrats originate.

Money doesn't grow on trees-- every dollar spent on welfare / excess administration jobs is a dollar that could have gone toward actual education and/or a lower student debt.

Its high time Americans think about why we should continue to give large bureaucracies tax free existence. Mindlessly crying "education" really isn't going to cut it anymore -- its obvious the taxpayer subsidy is being diverted elsewhere

Whatever your thoughts, no business (not even a "non profit") is viable in the long term if costs grow significantly faster than the economy. Academia is on the verge of pricing itself out of existence.

2008 Dec 06 02:25 PM