A leveling recession in higher education

Fri, 12/12/2008 - 2:02pm
The Economist explains why the global recession is killing the budgets of higher education: 
Harvard will have to take a “hard look at hiring, staffing levels and compensation”, wrote Drew Faust, the university president, on December 2nd in a surprise letter to Harvard deans. The Harvard endowment, which was worth $36.9 billion at the end of June, has since lost at least 22%, says Ms Faust. The university should brace itself for losses of 30% in the fiscal year to next June, she adds, although even that may prove far too optimistic. Its ambitious plans for new buildings on the other side of the Charles river seem likely to be scaled back, or at least slowed down. Harvard is not alone. At Stanford University, the president, provost and other senior executives have taken a 10% pay cut. There is speculation that its endowment, which at $17 billion in June was third only to Harvard’s and Yale’s, has performed horribly since then. Many smaller endowments—only six were bigger than the $8 billion that Harvard says it has lost so far—have suffered too. Williams College has seen its endowment plunge by 27%, from $1.8 billion to $1.3 billion, while Wesleyan University’s has tumbled by 24% to $580m.
The scary thing about the article is that these schools did not follow the "Yale model" of portfolio investment -- a model that will sound familiar to those who know anything about sovereign wealth funds: 
The creator of the Yale model is David Swensen, who was persuaded by James Tobin, a Nobel-prize winning economist, to become the university’s chief investment officer in 1985, when the endowment stood at just over $1 billion, and increased it by June of this year to $22 billion. As Mr Swensen explains in his influential book, “Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment”, which was published in 2000, the “permanent” endowments of universities (and of some charitable foundations) meant that they could be the ultimate long-term investors, able to ride out market downturns and liquidity droughts. By investing heavily in illiquid assets, rather than the publicly traded shares and bonds preferred by shorter-term investors, an institution with an unlimited time horizon would earn a substantial illiquidity premium. By 2006, Yale was aiming to invest a staggering 69% of its endowment in illiquid alternative asset classes such as hedge funds, private equity, property and forests. Others followed. According to “Secrets of the Academy: The Drivers of University Endowment Success”, a new study by Josh Lerner, Antoinette Schoar and Jialan Wang in the Journal of Economic Perspectives, Ivy League endowments increased their allocation to illiquid assets from 9.3% to 37.1% between 1993 and 2005. On average, universities raised their allocation from 1.1% to 8.1%. (emphasis added)
This suggest suggests another arena where the state is going to be playing a larger role than it has recently.  Until recently, the standard lament from the "public Ivies" on down had been that the endowment explosion from the elite private schools had opened up an appreciable gap in resourcesbetween public and private schols.  No longer.  The downturn is going to hammer the schools with the biggest endowments.  Those with the smallest -- that would be public schools -- should be better equipped to ride out the downturn. 
Daniel W. Drezner | Permalink | | Comments? Login or register
( filed under: )


Advertisement

 

I think that public schools

by Chris (not verified) on Fri, 12/12/2008 - 3:29pm

I think that public schools are taking it in the teeth too. Aren't public schools suffering greatly from the budget shortfalls of state governments? Anyway, some good may come from these reduced endowments as universities start to rethink their priorities. Less money spent on landscaping, multi-million dollar athletic facilities, and worthless diversity counselors would help schools get back to their core responsibilities - teaching.

Chris, I appreciate your

by Eric (not verified) on Fri, 12/12/2008 - 4:17pm

Chris,

I appreciate your optimism. Not that I want to name names, but a certain private university that I know well is cutting all budgets next year except admissions (defensible) and, wait for it, athletics. At least there are no current salary cuts planned for faculty / staff.

"The scary thing about the

by Soto (not verified) on Sat, 12/13/2008 - 1:18pm

"The scary thing about the article is that these schools did not follow the “Yale model” of portfolio investment . . . By investing heavily in illiquid assets, rather than the publicly traded shares and bonds preferred by shorter-term investors, an institution with an unlimited time horizon would earn a substantial illiquidity premium."

I am not following, probably because I have no background in this type of economics/finance. Should the schools have followed the Yale model? Or would following the Yale model have been an even worse choice? If I understand things correctly, an illiquid asset is one that is difficult to unload quickly. But if chosen correctly and held long enough should produce great gains in value. I imagine that real estate qualifies, especially if held for decades. For example, though here in Los Angeles the home prices have lost a lot of value recently, if you bought your home in 1980, your still way ahead.

But if this is all true, then doesn't the Yale model still work as long as the universities refrain from touching their investments? Hold onto the illiquid assets, ride out the economic downturn, and an 10 or 15 years from now those assets pay out in great value, right? Or is this recession so destructive that even such a long term investment as I have described doesn't survive unscathed?

Or maybe locking up so much wealth in illiquid assets prevents institutions from making needed changes to deal with short term fluctuations?

I am rambling because I am not following the reason for mentioning the Yale model. A little help?

[...] Drezner thinks that

by EphPlanet roundup: 12/13/08 : EphBlog (not verified) on Sat, 12/13/2008 - 9:39pm

[...] Drezner thinks that higher education will be another area where the state will be playing a much larger than it has [...]

How much more of the Harvard

by Pluribus (not verified) on Sun, 12/14/2008 - 12:07pm

How much more of the Harvard endowment will be lost before Harvard gets rid of Drew Faust? Clearly she is not qualified for her position, an affirmative action hire at its worst.

I'm not sure sure it'll be

by anIRprof (not verified) on Sun, 12/14/2008 - 5:31pm

I'm not sure sure it'll be the Harvards hurt the worst either.

Chris is right about public univs being slammed by state budget cuts (my own state is looking to cut spending by about 10-15% across the board).

Plus smaller private universities are far more dependent on tuition. THeir own endowments have taken a hit, just like Harvard. And, they now face a lot of upper-middle class parents who are no longer able to take out home equity loans, no longer able to borrow from 401k account, who don't qualify for supplementary loans under tight new credit rules, or who have lost their jobs entirely.

Their customers are also more price sensitive, since the expected benefits of going to say, Bentley or Bryant over Univ. of Massachussetts are not nearly as large as the difference between Harvard and a state university. Plus, the Ivies are so selective that they can easily keep up their class sizes with only small quality hits if some applicants are now priced out. At lower-tier private schools, just plain filling the seats is going to be a real challenge.

Pluribus-- I realize one

by wugong (not verified) on Sun, 12/14/2008 - 8:14pm

Pluribus-- I realize one should just ignore such stupid comments, but...

How exactly would you pin the blame for Harvard's financial losses on Faust? Do you somehow believe that she makes the investment decisions for the university? I believe it was the previous president who spearheaded a plan for massive growth of the university's physical plant into Alston, a plan that assumed the nation's economy would at least be fairly stable for a prolonged period of time. But hey, why assume he would be qualified to make long term economic projections? It's not like he was an econom....D'oh!

AnIRprof gets it exactly

by Miranda (not verified) on Sun, 12/14/2008 - 9:17pm

AnIRprof gets it exactly right. My private SLAC is getting pummeled. Our endowment has taken a hit and we will probably also lose students to the publics. We are tuition-dependent and it's not a pretty picture. Alas, Chris is also wrong. Athletics and lawn-mowing are not going to get cut--we still need to recruit and athletics provides 40% of our student body. The grounds need to look nice as the competition for students will get even harsher. What is getting cut? Academic budgets, hiring freeze, and then probably staff. Not good news for faculty (or students, probably), but we need to keep our doors open, too.

This accords nicely with an

by King Politics (not verified) on Mon, 12/15/2008 - 2:40pm

This accords nicely with an article I recently read about the University of Texas' endowment. The president, Bill Powers, was relatively optimistic that the University would be able to ride out financial meltdown without significant cuts to operations.