Did Big Endowments Worsen the Crisis?

Posted by: Louis Lavelle on May 20, 2010

It’s no secret, at least in higher education circles, that in recent years a lot of the biggest endowments have pursued an aggressive investment model that for a while brought them out-sized returns. When the crash came, those same endowments were hit hard. They couldn’t get out of their high-risk investments, which turned out to be surprising illiquid, and ended up taking big losses—the biggest since the Great Depression.

Now a new report is out that suggests that’s not the half of it.

The report, by the Center for Social Philanthropy at Tellus Institute, paints a grim picture of how a small handful of economic actors can, in the pursuit of profit, inadvertently do a lot of damage. You can read the report here and the Bloomberg report on it here. The report profiles the six privately endowed New England colleges and universities: Boston College, Boston University, Brandeis University, Dartmouth College, Harvard University, and MIT—all of which come in for some withering criticism.

Here are some of the findings:

The endowments helped enable the crisis. By being so successful initially, the big boys encouraged smaller players to follow similar high-risk strategies, and when the riskiest investments went bad, they were all forced to sell equities and other investments into a tumbling market, making the whole mess a lot messier.

The governing boards have conflicts of interest. Many rely on trustees or committee members for oversight, but in some cases those individuals are drawn from the financial services industry, people whose firms manage some of the endowments’ funds. Technically, that’s called the fox guarding the hen house.

The economic impact of the endowments’ big gamble is spreading. When the endowments plunged, many had to make smaller withdrawals, which meant layoffs, hiring and pay freezes, and program cuts. But it didn’t stop there. Planned construction projects were put on hold, resulting in lost jobs and an economic ripple effect on surrounding communities. In Boston alone, the report says that the endowment losses and subsequent cuts were responsible for $130 million in lost economic activity annually.

The endowments’ tax-exempt status leaves taxpayers footing the bill. The six schools featured in the report own $10.6 billion in tax-exempt real estate. Without the tax-exempt status they’d owe $235 million in taxes, but they actually pay less than 5 percent of that in payments in lieu of taxes. That tax-exempt status also lets the schools borrow at very low interest rates, and keep most of their endowment cash invested in the risky financial instruments that got them into trouble.

So, to sum up: “The Endowment Model of Investing is broken. Whatever long-term gains it may have produced for colleges and universities in the past must now be weighed more fully against its costs—to campuses, to communities, and to the wider financial system that has come under such severe stress. The financial crisis has revealed that the risks of the Endowment Model of Investing—of volatility and illiquidity—are much higher than previously understood, particularly when amplified by the use of leverage.”

As one of the schools criticized in the report, Havard was contacted by Bloomberg for comment. John Longbrake, a Harvard spokesman, said “virtually every issue raised by this report about endowment management practices has been addressed and continues to be addressed by the current leadership team” at Harvard Management, which oversees the university’s endowment. The university’s “large and positive economic impact to the region is well documented, and we consider it an important outcome of fulfilling our teaching and research mission,” he said.

In journalism, this report is what’s known as a “conceptual scoop”—no real new information, but a new way of looking at the information we already have. As conceptual scoops go it’s an interesting one, and it raises some really interesting questions. Did the endowments act recklessly? (I’ll point out that nobody was complaining when the endowments were reporting double-digit returns.) Should the government be in the business of subsidizing endowments if they’re going to use their tax-exempt status to make reckless gambles? Should endowments be allowed to invest in a way that imperils more than just their account balances? What responsibility do schools have to the communities in which they exist?

Reader Comments


May 21, 2010 9:28 AM

The report brings up a good point about endowment governance, but the rest of the study simply highlights the authors lack of understanding about investment management and the role of endowments within a university's budget process. I'll make two points. First, what do they recommend as an alternative to the "endowment model"? A 70/30 mix of stocks and bonds would have lost more money in 2008 than a portfolio that included alternative assets! Second, are the authors aware that endowment distributions only make up 10% of the operating revenues at some of the schools in their study? The problem at many universities was in the budget office, not the endowment. Layoffs and other belt tightening at universities were a result of budget deficits, which were caused by many other factors (large capital projects, debt service, poor planning, failing to consider how operating revenues are correlated) other than a decline in the endowment value.

Ann Goldman

May 22, 2010 11:12 AM

What is your opinion of the endowment model for large foundations -- Gates, Kellogg, Carnegie, etc. -- and whether it, too, is "broken"?

BW's Louis Lavelle

May 27, 2010 10:13 AM

I may be wrong about this Ann (large foundations aren't my area of expertise), but my sense is that the big foundations were never as gung ho about "alternative" investments as the big endowments were. In the view of this report's authors, that's what really caused the problems: the hedge fund and other investments they adopted in search of ever higher returns. Maybe there's someone out there who's more familiar with foundations than I am...

Louis Lavelle
Associate Editor
Bloomberg Businessweek

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