Harvard datapoint of the day

By Felix Salmon
May 31, 2009

Richard Bradley reports:

Harvard has already halted the hiring of junior faculty and announced an early retirement program for tenured professors, and for the first time ever is considering laying off tenured professors.

And why might Harvard be laying off tenured professors? Because it’s down to its last $25 billion, of course.

Bradley adds a bit to what we know about Harvard’s financial mismanagement:

According to the university’s 2008 financial report, in the next 10 years it must pay various private investors some $11 billion in capital commitments. Where will that money come from if, as seems likely, endowment growth over those years is minimal or nonexistent, and alumni’s own strained budgets limit their generosity?

These are the famous capital calls from Harvard’s private-equity investments, which previous HMC managers assumed could be met out of earlier private-equity payouts. Or something. But now — and for the foreseeable future — Harvard is facing a massive liquidity crunch:

HMC “took the university right to the edge of the abyss,” one alumnus, a financier who is privy to details of the university’s balance sheet, told me. I asked what he meant. “Meaning, you’re out of cash.

“That,” he added, “is the definition of insolvency.”

Er no, actually it’s the definition of illiquidity, but never mind. The point is that Harvard has run out of liquid assets, and that’s going to have huge effects on its institutional psyche — and possibly even on the job security of tenured professors. My guess is though that no one with tenure will be laid off involuntarily.

And maybe Harvard’s alumni might start giving a lot more now than they have in the past. After all, until recently, any giving from alumni was dwarfed by the investment gains of the endowment, and so the incentive to add another drop to the bucket was greatly reduced. Now, by contrast, cash from alumni is desperately needed to meet the university’s annual liquidity requirements. It might even feel better, giving money when you know it’s going to actually be spent, rather than giving money simply to augment some gargantuan endowment.

13 comments

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i’m guessing that this is the school that has turned out many of the guys thats got us in this economic mess we are in to start with. guess no one is safe from stupidity

OT but Felix, you’re one of the folks I rely on for Taleb sightings. Did you not bother with this one? (Maybe I missed it but I do try to keep up.)

Well worth the 30 minutes and brought to mind that essential and timeless issue: Stones v Beatles.

http://www.newyorker.com/video?videoID=2 2785404001

Posted by Alan Murdock | Report as abusive

I think I’ve given them $200 since I graduated, and then stopped, thinking ‘this is nuts, they have $30 billion and I have better charitable targets’

Now they have really pissed it away – they have a bunch of stuff they can hardly sell now, or if they do the prices are fire sale. So should I give them money because they need it? Or withhold because they have been such bad stewards?

I think none of the above: I will give them money if they seem most likely, going forward, to do the best things with it. They’re a very expensive way to get kids educated. The firing of Summers for his ‘women’ remarks did not make me happy (though I think Summers was not a good steward of their money, and the Shleifer business was Not Attractive) and there is a lot of other PC silliness, too. On the other hand, there is useful work going on there, too. Maybe, in a few years. Not yet.

Posted by dave.s. | Report as abusive

I’d like to know Mohamed El-Erian’s role in this situation. He’s all over TV theorizing about “The New Normal” and talking PIMCO’s book. I’ve had quite a bit of respect for him heretofore, but that might change. How come I never hear his name in any of these stories?

Er no, actually, it’s the definition of insolvency. Insolvency is the inability to pay your debts as they come due. In other words, you owe money to creditors but “you’re out of cash.” Your portfolio can be so illiquid that it can’t generate enough cash to pay your debts as they come due, but running out of cash is still fundamentally insolvency. That’s a basic concept that you might want to nail down.

Posted by neil | Report as abusive

Neil is right – there is a dual definition of insolvency for purposes of things like the wrongfully trading while insolvent legislation. If you can’t meet your debts as they fall due, you’re insolvent.

Posted by dsquared | Report as abusive

dsquared mentions a “dual definition” for insolvency, and the law uses both in different contexts. Finance guys pretty much use the “negative net worth” meaning. The simple failure to pay debts — “equitable insolvency” — is grounds for involuntary bankruptcy, for example, while the net worth definition is used in the uniform fraudulent transfer act, and I believe in the requirement that a debtor be “involvent” before filing under chapter 9.

Sad to say Harvard’s Achilles Heel has long been a tendency toward arrogance born of a massive superiority complex. Like the geniuses who gave us the Long Term Capital debacle, Harvard Management managers simply took it for granted that they were smarter and more innovative than most investors. They were confident that they could generate excessive returns (they did) and avoid the consequences of exposure to excessive risk (they didn’t). Many alumni knew better, protested the outsize compensation and called for change – without much effect.

We see today what institutionalized self-satisfied arrogance has done for General Motors. While bankruptcy may be unlikely, Harvard’s future is one of permanently diminished promise and that is a sad prospect indeed.

Posted by H55 | Report as abusive

I hold a lot of my 401K in the S&P 500 (Vanguard). It dropped roughly 38% for the calendar year 2008. IF the Harvard folk were truly making 15% per year for the last 10, then this hit seems perfectly reasonable to me. My “diversified” holdings have not generated anywhere near that type of long term return.

Their mistake in context then, was to not plan for ANY down years, assuming that they could eliminate risk. That would have been the case with “safe” investments like T-bills, but those would have earned less than 5% most years.

But if earlier reports of their past performance are correct, then they still come out ahead in dollar terms with room to charge hefty fees:
Harvard portfolio with fat returns and one year fall: (1*1.15^9)*(1-.30)=2.46

Safe portfolio with consistent 5% annual return: (1*1.05^10)=1.63

Surely the funniest part of the article is when Summers intervened to lock in “low” rates of interest a few years back with some swaps, costing Harvard in the order of half a billion dollars to unwind them last year.

Posted by a | Report as abusive

There are many facets to this story. Two simple ones: the managers at Yale’s endowment – notably Swenson – developed the portfolio models for this diversification into illiquid assets. (I’ve been wondering lately if or when the shoe drops in New Haven.) And the typical finance side: the managers have been paid based on the appreciation, which has been reported each year, in those illiquid assets. Hmmmmm.

Seems to me a problem is right there on its face: that you reward investing in assets which can’t be adequately valued, which can’t be unwind – because they’re illiquid, duh – by paying large amounts of individual compensation in current terms. Again, the risk inherent in illiquid assets compares how to liquid assets?

This then raises a simple question: what would the portfolio allocations have looked like if the managers weren’t paid currently for assets that could not be converted currently? My guess is that Harvard would a) have more liquidity and b) not have lost as much.

Posted by jonathan | Report as abusive

I wish that commentators who wonder about the failure of Yale would look back at Felix’s other Harvard Datapoints– particularly his posts while at the other mag.

I discuss these posts in depth at:
http://ignorancearbitrage.blogspot.com

@jonathan…

First to conflate Yale and Harvard is not thinking properly– different situations since Harvard had a huge change in managers that affected their situation. Second, if Swensen were an awful, greedy s.o.b. like you suggest he would have bailed on Yale along time ago and made a lot more than his current salary. Is his compensation a lot? Yes, and he acknowledges it, but if he were as you suggested (just in it for a buck) he would have left Yale to go into Private Money Management and made a hell of a lot more. Additionally, his pay was significantly less than the pay of his Harvard peers…