Felix Salmon

How Larry Summers lost Harvard $1.8 billion

Felix Salmon
Nov 29, 2009 22:54 UTC

Most people, if they’ve hired a legendary fund manager on a multi-million-dollar salary to look after investments and liquidity, would listen to the advice of that person. But most people aren’t Larry Summers:

It happened at least once a year, every year. In a roomful of a dozen Harvard University financial officials, Jack Meyer, the hugely successful head of Harvard’s endowment, and Lawrence Summers, then the school’s president, would face off in a heated debate. The topic: cash and how the university was managing – or mismanaging – its basic operating funds.

Through the first half of this decade, Meyer repeatedly warned Summers and other Harvard officials that the school was being too aggressive with billions of dollars in cash, according to people present for the discussions, investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity. Meyer’s successor, Mohamed El-Erian, would later sound the same warnings to Summers, and to Harvard financial staff and board members.

“Mohamed was having a heart attack,’’ said one former financial executive, who spoke on the condition of anonymity for fear of angering Harvard and Summers. He considered the cash investment a “doubling up’’ of the university’s investment risk.

But the warnings fell on deaf ears.

Summers, amazingly, wanted to invest 100% of the university’s cash in the endowment, and had to be talked down to investing a mere 80%. No wonder Meyer and El-Erian tried to talk him out of it: the Harvard endowment was never designed as a place to invest sums of cash which might be needed immediately. Instead, it’s designed to invest for the very long term, taking advantage of the higher returns on illiquid investments.

Summers was playing a high-risk carry-trade game with Harvard’s cash:

The aggressive investment of cash accounts is part of how the university has long run its “central bank,’’ an account that holds funds from its various schools and pays them a modest US Treasury rate of return. The “bank,’’ in turn, has invested the lion’s share of that money with the endowment, generating returns that are used to pay for shared needs, like graduate housing and financial aid.

No one had the stones to stand up to Summers when it came to this high-risk strategy of essentially borrowing at Treasury rates and investing the proceeds in an illiquid long-term endowment — certainly not James Rothenberg, Harvard’s part-time, unpaid, California-based treasurer.

After Summers left, sheer inertia took over, and nothing happened — maybe because El-Erian was soon on his way out as well. The result was that the university ended up losing 27% of its $6 billion in “cash”: a whopping $1.8 billion. There’s no indication, of course, of any kind of apology from Summers.

Update: Brad DeLong, in the comments, does some back-of-the-envelope math and reckons that Harvard came out ahead of the game, on net, even after accounting for that $1.8 billion loss. But that’s exactly the difference between a long-term endowment, on the one hand, and a “cash account”, on the other. If you have money in a cash account, you spend it. And money you’re spending should be liquid, not tied up in an endowment which can drop 27% in one year.

And Viyada York says that Harvard’s investment committee, rather than Summers, should be held responsible for the loss. It’s true that the managers of the endowment are responsible for its performance. But they’re investing for the long term. Summers should absolutely be held responsible for the decision — which was entirely his — to invest the Harvard cash account alongside the endowment, despite the fact that the cash account required much more liquidity than the endowment as a whole.


10 Days later the NY Times reports:
“BOSTON — Harvard announced Thursday that it would indefinitely suspend construction on a high-tech science complex in the Allston neighborhood of Boston because of money problems.”

Regardless of the optimal policy and slight differences between the optimal and good policies, I don’t think anyone can claim that it was a “good” policy covering all economic conditions?

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Hero of the day: Jackie Ramos

Felix Salmon
Nov 29, 2009 18:27 UTC

Jackie Ramos was fired by Bank of America for being too nice to their customers. Of her three commandments — do the right thing for the customer; think of yourself as a customer; and do the right thing for the company — it turns out that only one mattered.

Consumerist has the transcript:

Every day I came to work and did just as I was supposed to: I collected. In fact, I was one of the top performers of my department, even outdoing those who were more tenured than I was. But something was wrong. There was something inherently evil about my job…

All the people that I’ve had to deny [repayment] programs to–they kept me up at night. All the people that I’ve pissed off with a $15 “convenience fee”–they kept me up at night. All the people who were dying, lost a child, husband, mom, dad, all the people who lost their jobs and sat on the phone sobbing to me that if we just gave them a little bit of help, they could make ends meet–they kept me up at night…

As my manager was escorting me outside she told me that if I needed a reference, she would highly recommend me to everyone. I received nothing but accolades while I was at Bank of America. Even while I was getting fired my boss told me that out of anyone she’s ever met I’ve had the highest morals and biggest heart she’s ever seen, and that means more to me than my job.

At the end of the day, I don’t have anything keeping me up at night. I did the right thing in God’s eyes and I’m sure that He’ll bless me. But [boss], can you say the same?

Why was Ramos fired? She stopped denying BofA customers the ability to convert their debit balance into an installment loan, while closing the account. (It’s called Fix Pay.) It doesn’t wipe out the debt, it just stops lots of extra fees being piled on top. One 24-year-old mother had just lost her own mother and her husband in the same week — and found out that she had cancer. According to BofA’s rules, she wasn’t earning enough to qualify for Fix Pay, which meant of course that she had to pay much more in the form of a 30% interest rate and $39 over-the-limit fees.

Let’s hope that John Carney is right and that Ramos becomes a star on next week’s morning-TV shows. Maybe they could invite her ex-boss on at the same time, to explain why Bank of America deliberately makes it as hard as possible to pay off your debts after you rack them up.

Banking shouldn’t be some kind of cat-and-mouse game where the bank tries to squeeze as many fees as possible out of you while you try to avoid them. Banks are treating their customers like the enemy (see Peter Goodman today on Chase, or of course the famous IndyMac case), and that’s not something which goes down well in today’s economy, where banks seem to be the only individuals or businesses making vast amounts of money. And yes, all of those profits were formerly our money.


I hope she does do the morning talk show rounds. Except, I wonder: do any banks advertise on these morning talks shows, or the networks that produce them?

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Mark Pittman was right

Felix Salmon
Nov 28, 2009 21:31 UTC

Bob Ivry has the definitive obituary of Mark Pittman, a giant in the world of financial journalism, who died far too young on Wednesday. Ivry is polite enough not to call me out by name, although I deserve it:

His June 29, 2007, article, headlined “S&P, Moody’s Hide Rising Risk on $200 Billion of Mortgage Bonds,” was excoriated at the time by Portfolio.com for “trying to play ‘gotcha’ with the ratings agencies.”

“And that really isn’t helpful,” said the unsigned posting.

Pittman’s story proved prescient.

I wrote the blog entry in question, and it hasn’t stood the test of time nearly as well as Pittman’s article. At the time — between the collapse of Bear Stearns’s subprime hedge funds and the collapse of the bank itself — I was well aware of subprime alarmism, not only because of the Bear news, but also because I’d spent five months working for Nouriel Roubini. So I concentrated on the way that the story tried to back up its headline, dismissing its damning litany of problems with subprime credit ratings more generally as “2,000 words of throat-clearing”.

Sorry, Mark. In hindsight, your story was indeed prescient, and helpfully aggregated a lot of the well-founded worries that the subprime crisis was going to get much, much worse, and that none of the ratings on subprime CDOs could be trusted. It wasn’t until a good six months after your article was published that I finally understood the importance of what you’d been saying.

Pittman was an aggressive, old-school journalist, who was in his element going after big Wall Street institutions. Like most of the journalists I’ve criticized, he never responded to my blog entry, and I never met or spoke to him. That’s very much my loss: I’m sure I would have learned a lot. But Pittman had bigger fish to catch. His loss to the profession is irreplaceable.


I salute you Felix – its takes a special kind of man to do what you have done

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Against liquidity

Felix Salmon
Nov 27, 2009 17:47 UTC

Paul Krugman today argues in favor of a financial-transactions tax on the grounds that it would discourage over-reliance on ultra-short-term repo markets, among other reasons. In other words, reliance on repos is a bad thing, and it’s a good idea for government policy to “nudge” financial institutions away from it.

That’s something that opponents of the Miller-Moore amendment should bear in mind, when they complain that it could hit the repo market hard. Here’s Agnes Crane:

The repurchase agreement, or repo, market is a critical source of financing for dealers, hedge funds and others who use leverage to finance short-term trading positions. It’s a source of extra income for those holding virtually risk-free securities since they can squeeze out extra return by lending them out.

Such financing makes for a deeper and more liquid market that gives investors confidence that if they buy a Treasury note, for example, they can quickly sell it if they want to.

The problem is that we don’t want to encourage the use of leverage to finance short-term trading positions. Indeed, from a public-policy point of view, we’d ideally want to discourage it.

Would a less liquid repo market mean, in turn, a less liquid Treasury market? I daresay it would. But that’s no bad thing: the more liquid the Treasury market, the more that investors flock to it in times of crisis, exacerbating the systemic downside of the flight-to-quality trade, and reducing the amount of liquidity elsewhere in the markets, especially among credit instruments.

There are serious systemic consequences to living in a world where a Treasury bond — or any asset, for that matter — is considered a safe haven from all possible harm. Investing shouldn’t be about safety: it should be about calculated risk. Excess demand for triple-A-rated risk-free assets, as we’ve seen over the past couple of years, can be much more systemically damaging than excess demand for risky assets like dot-com stocks. So yes, let’s throw some sand into the wheels of the repo market, either through a Tobin tax or through the Miller-Moore amendment or both. Because liquidity is not ever and always a good thing.


I’m not sure why anyone would want to discourage the use of leverage in short-term transactions specifically — that’s the only kind of transaction in which leverage is prudent, after all — it’s ok to buy 10y treasuries at 10-20x leverage, because they can be sold in an instant if necessary. It’s not ok to use leverage in long-term investments that cannot be converted into cash — that’s a sure recipe for bankruptcy, as this crisis has only revealed too well.Further, repos are not just used to lever up treasury holdings — a bank has to park its excess capital somewhere, and the most common and prudent choice is risk-free securities like governments (t-bills, notes or bonds). When some of that needs to be accessed for cashflow, it’s easiest to convert into cash by doing a repo transaction, rather than constantly selling and buying back the securities themselves (which would mean also constantly rehedging interest rate risk).

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Dubai’s disabused creditors

Felix Salmon
Nov 27, 2009 17:03 UTC

The Economist has a good short overview of the situation in Dubai, which includes this interesting take:

Investors had half-expected Dubai World to seek forbearance from its bankers, asking them to extend their loans. But they felt sure the emirate would make good on publicly traded instruments, and in particular Nakheel’s sukuk, rather than suffer further damage to its financial reputation.

I remember the days when investors felt that in the world of emerging markets, publicly-traded bonds were implicitly senior to bank loans. But those days came to an end in the late 1990s with bond defaults in Pakistan, Ukraine, and Ecuador — and they’ve never returned. And it’s not even obvious at this point that restructuring loans is easier than restructuring bonds.

Certainly any entity like Dubai World carrying a large amount of bank debt would be very wary about needlessly infuriating its bankers by defaulting to them while remaining current on its payments to bondholders. If Dubai World’s bondholders really took solace in the fact that they held bonds rather than loans, they thoroughly deserve a large hit in the wallet. And as Willem Buiter says, it’s a good thing too:

Property developers tend to be highly geared and very procyclical in their revenue flows and access to the capital markets. During construction slumps they drop like flies. Because the property sector is risky (ask Donald Trump), its creditors tend to get better interest rates than the sovereign rate. Dubai is no exception to this rule. If you earn a risk premium during good times, you should not moan when the borrower defaults from time to time when the going gets tough…

Property companies don’t fall into the systemically important category. Their collapse is painful for their shareholders, creditors and, if the local labour markets are weak, their employees. They are not, however, systemically important. Their collapse will not threaten the delicate fabric of financial intermediation. They are fit to fail. Creditors beware.


The biggest problem with Roubini’s “W” is the assumption of the fourth leg.As Dr. Black noted, if I’m paying an interest rate that assumes a large chance of default, my willingness to default on that loan sooner than other financing should be assumed. (Brad DeLong keeps trying to argue against this; it’s roughly equivalent to Eugene Fama arguing that his EMH is not to blame for all of the structures that have been built on it [see P. Triana in the FT.)

Cracking down on destructive lenders

Felix Salmon
Nov 27, 2009 16:26 UTC

It’s almost quaint that there are still people out there who believe that all market participants are always rational actors making decisions in their own economic best interest. Take Daniel Indiviglio, who even stands up for IndyMac and its “inequitable, unconscionable, vexatious and opprobrious” regional manager, Karen Dickinson:

I’m a little confused about how Salmon proposes that the bank here wasn’t acting in its own best interest. If he means that its actions led to a judge awarding the home to the borrower, and that screws the bank, well that’s true. But I seriously doubt that the bank believed that its actions would lead to that outcome…

Had the mortgage contract been upheld, then Indymac would have repossessed the home, as planned. Clearly, that’s the outcome it expected its actions to bring. If Salmon means to speculate that the bank would have been better off if it had accepted one of Ms. Yaho-Horoski’s modification alternatives than force her to foreclose, then I’m not sure I can agree…

For whatever reason, it didn’t like the modification options Ms. Yaho-Horoski presented. Maybe it believed that they all had far more risk than just foreclosing and settling for whatever price it could obtain in the battered housing market. So the bank deemed foreclosure its best option.

On the one hand, this is trivially false, since IndyMac rejected a bid at full market price from Yaho-Horoski’s daughter: it’s inconceivable that after going through the expense of foreclosing on and selling the house, IndyMac would net more money than that. After reading judge Jeffrey Spinner’s decision, it’s pretty clear that Dickinson was a malicious liar who was acting not in the best interests of IndyMac but much more simply in the worst interests of the Yaho-Horoskis. If they suggested anything at all — even a desperate offer of simply giving IndyMac the deed to the house, in lieu of foreclosure — Dickinson was predisposed to reject it.

It’s also inconceivable that IndyMac thought it could get a significant amount of money out of Yaho-Horoski over and above the proceeds from a foreclosure sale. Yes, New York is a recourse state. But we’re not talking here about the only kind of situation in which lenders ever go after borrowers after they’ve foreclosed — a case where the borrower is wealthy, clearly has the money to repay the debt, and is simply refusing to do so because the value of the house has fallen. The borrower in this case was Diana Yano-Horoski individually, and all of the proposals she made involved using the combined income of herself, her husband, and her daughter. But Dickinson evinced no interest in maximizing the amount of money being put towards repaying the mortgage: she even “summarily rejected” the offer from Yano-Horoski’s husband and daughter to be added to the loan as obligors.

More generally, it seems that Indiviglio’s fundamentalist beliefs about what banks do are utterly unfalsifiable. This case isn’t a cut-and-dried example of a bank acting against its own best interest, yet he still refuses to accept that’s what was happening. It’s almost as if he doesn’t understand that banks are run by humans, and that humans are fallible, especially in emotionally-fraught circumstances: they get caught up in an us-versus-them mindset which confuses the best outcome for themselves with the worst outcome for their opponents, or they just panic and do something stupid, like lying to a judge or pulling an emergency brake cord on a subway train.

I’m not saying that “Indymac is just pure evil” — the straw man that Indiviglio sets up as the onlypossible alternative to his sunny world where everybody always acts in their own best interest. I’m saying that certain corporate officers, in certain situations, make mistakes — and often make very large mistakes. In the case of the housing market in general, and foreclosure proceedings in particular, those mistakes happen quite often, if not always as egregiously as in this case. Loan servicers are simply overwhelmed by the sheer quantity of mortgages in default, and frequently rush to foreclosure even when there are much better options available.

It’s both in the national interest and in the best interest of the loan servicers collectively to put a brake on such actions: if everybody’s rushing to foreclose at the same time, that just creates a glut of distressed property sales which in turn drives down property prices further and perpetuates the vicious cycle. On the other hand, if everybody else is slowing down, then immoral banks like IndyMac can try to act as free riders and grab all the collateral they can, free-riding on rest of the banking community. Such actions should be opposed by all three branches of government, including the judicial branch. Which is one reason why Jeffrey Spinner is such a hero.


what happen is what needed to happen, the banks and the others want to say homeowners over extended their self in borrowing to much, that may be 1/2 true however let’s not let the banks off the hook. the homeowner could not get a single dime without the bank approval, the homeowner did not create the arm loans, the banks knew exactly what they was during when they gave the homeowners these exotic loans that would mature in 2 or 3 years never qualifying the borrowner on the mature rate or payment, they did not care because before the ink was dry they had already sold their loan on wall streets to investors, they allow borrower to purchase homes on stated income not verifying their income or any other documents that was requested. the bank was paying brokers to give borrowers higher rate on their loans and they did not know it(kickback) to broker, now that it is time to turn the note over to the true investor that bought it at the time the loan was originated they want to foreclose and mislead the public and government that the homeowner are not turning in their paperwork, this is a pack of ties,i have talk to several inside workers at banks and they was told to lose paperwork so the modification could never take place and they would have justification in foreclosing on the homeowner. if the government did not bail the bank out and let them fail and struggle they would be more willing to work with peoples to stay in their home butwhen you have been given billions of dollars to survive at taxpayer expense you can bully the homeowners around and dictate what you will and will not do and lie to the government about who fault it is. if there was a forum or website for each bank for homeowners to discuss with is going on with their bank you will find they are getting the run around,homeowners have been waiting for 6 or month for a decision and some are decline with no reason and those that was given a trial modification never got a pernament modification. the bank are dealing with unclean hands, this was plan and the banks never intended for the homeowners to keep their home. we can write laws for everything but why was their no laws into effects on interest rates and pre-payment penalty. they have some now.investor and banks got us in this mess and they are doing it again. investor are now buying homes at dirt cheap prices because they have cash which allow them to outbid regular first time home buyers and then they put them on the market after 90 days for 40 to 70 more in a 3 more period. this is inflating the market again and the banks that are lending the money to the homeowners to purchase these investors properties are not questioning this high increase in such a short period of time.the american people need to stand up and fight and not let the banks push them around anymore. we need more judges willing to stand up against these banks and hold them accountable for their action.the average homeowners do not have the knowledge and funds to fight corporate america and they know that and they take advantage. enough is enough

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The dollar’s still not safe

Felix Salmon
Nov 27, 2009 15:08 UTC

One quote jumped out at me from the Reuters Dubai round-up this morning:

“We have seen a classic risk aversion reaction in the markets over the past 24 hours. The dollar has slumped, the yen is stronger,” a Societe Generale note said.

Needless to say, this isn’t exactly a classic risk-aversion reaction: when the markets are really scared, they tend to flee to the safety of the dollar, rather than to the Japanese yen. So my feeling is that this — along with the relatively modest stock-market reaction in New York this morning — counts as a sign that Dubai really isn’t all that bad: it shows that markets are trading the news, rather than panicking.

On the other hand, it’s clearly not good news that a severe-if-not-life-threatening shock such as this one sends the dollar down rather than up. The immense fiscal cost of the financial crisis has hurt the dollar’s standing as the global reserve currency, and if I were at Treasury right now I’d be very concerned about this reaction. Not that there’s much Treasury can do about it.


The dollar was down relative to the yen; however, in aggregate, the dollar was up against other world currencies. Essentially what we’re seeing is a flight to safety, combined with the unwind of the Yen carry trade and the U.S. dollar short position (carry trade w/ just about anyone else). Yes the Yen was up, but no the dollar overall was not down.

Dubai World: A great precedent

Felix Salmon
Nov 26, 2009 19:26 UTC

The Dubai World default is big news — big enough that it’s even made it into Gawker. Your one-stop shop for bloggy coverage this Thanksgiving is Alphaville, which features for instance this wonderful chart of the debt structure which is now being crawled over by lawyers around the world.


Personally, I’m quite happy about this default, since it sets another very useful precedent of a state-owned company defaulting on its debt. Historically investors in state-owned companies have perceived an implicit sovereign guarantee — there’s even a German word for it, Anstaltslast. The result is a huge and unhelpful moral-hazard trade.

So it’s great that the government of Dubai has made it clear that Dubai World’s lenders aren’t going to be automatically bailed out by the sovereign, despite the fact that the government has hundreds of billions of dollars in its sovereign wealth fund*. Would that Treasury will follow suit when it comes to the creditors of state-owned companies like AIG.

*Update: As my commenters have pointed out, it’s Abu Dhabi which has hundreds of billions of dollars in its sovereign wealth fund, not Dubai. Some of those dollars might well yet be used fora Dubai bailout, but it won’t be on terms Dubai likes.


I agree. Anyone with a minimum of common sense would have seen that Dubai World’s baroque business plans were doomed. But because the government was supposed to be backing it up, the speculators went for it. It is definitely a healthy precedent that will instill a bit of sanity into the emirate’ future economic planning, and will balance the surreally sugar-coated image that it built through its marketing machinery.


Felix Salmon
Nov 25, 2009 22:17 UTC

Why You Should Support The Lynch Amendment: Don’t let banks own more than 20% of derivatives exchanges! — Rortybomb

A very sad day for the financial blogosphere: the invaluable John Jansen is giving up his blog to move to the sell side — Across the Curve

Hedge fund prospectus says its “Directors will not receive, open, or deal directly with mail addressed to the Fund” — Risk Without Reward

Don’t forget! $50 feeds 8 tomorrow — Robin Hood

The real connection between Arnold Schwarzenegger and Sarah Palin — Sorensen

Debunking the paradox of choice — FT

Pareene unloads on Lou Dobbs. Totally deserved — Gawker

The behavioral economics of Thanksgiving — Bloggingheads

Claims of Thanksgiving Excess Fueled by Feast of Fuzzy Data — WSJ

Greatest Fox News pie chart ever — Fox


Dobbs’ statements about the number of illegal immigrants in the US are correct. If anything, he’s underestimating. It’s much, much higher than the miraculously unchanging “12 million” figure, which was reached back in the early 80′s. (My 1980 edition of the Guinness Book of World Records gives a figure of 10 million in the year of its publication.)The arguments for the accepted figure pretty much all boil down to “everyone responsible is quoting it, so it must be true.” Yeah, I read it in the papers and saw it on TV, so there it is. Absolute stupidity.

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