Why Harvard, Dartmouth, and the University of California Bet Big and Lost

We need a more careful examination of how our most prestigious institutions of higher learning spend their money, and we need to motivate them to move away from their risky investment models.
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According to a new report by the Tellus Institute, Harvard, Dartmouth, MIT, Boston College, Boston University and Brandeis University all embarked on a high-risk investment strategy that has now resulted in reduced endowments, budget cuts, delayed construction projects, and job eliminations. Like other higher education institutions across the nation, these universities all followed Yale University's investment chief, David Swensen's endowment model of relying on alternative assets such as commodities, real estate and private equity.

While this report only looks at the six New England schools, its findings can also be applied to many universities, including the University of California. As I have written, the UC copied Swensen's strategy of moving money from stable securities to high return areas. In fact, the UC is still following this advice, which is evident in the following statement from Moody's regarding the university's investments: ""The long-term targets for the endowment pool would bring alternative assets (including hedge funds, real estate and private equity) to 35% of the total, with domestic and international equity accounting for another 45% of total assets." Instead of shying away from the high-risk Yale investment model, the UC is increasing its exposure to these volatile assets.

Like the UC, one of the driving forces behind these risky investments is the role of trustees and regents with conflicting business interests. According to a Bloomberg Businessweek article, "The investment committee at Dartmouth, in Hanover, New Hampshire, included more than six trustees whose firms oversaw more than $100 million in investments for its fund over the last five years, the report said. Stephen Mandel, who is relinquishing his post as chairman of the school's investment committee to lead the board later this year, originally managed $10 million for the school at his firm Lone Pine Capital LLC. . . . Other trustees who manage money for Dartmouth include Leon Black, with at least $40 million in his private-equity firm Apollo Global Management LLC, and William Helman, a partner at venture capital company Greylock Partners, the report said. Helman, who will take over the committee's helm from Mandel, has received $10 million from the endowment." These types of conflict of interest are also evident in the UC system since many of the regents have major holdings in private equity, real estate, and construction.

Not only are large endowments and pension funds plagued by conflicts of interests, but as the Tellus Institute report explains, these huge pots of money contributed to the global financial meltdown: "By engaging in speculative trading tactics, using exotic derivatives, deploying leverage, and investing in opaque, illiquid, over-crowded asset classes such as commodities, hedge funds and private equity, endowments played a role in magnifying certain systemic risks in the capital markets. Illiquidity in particular forced endowments to sell what few liquid holdings they had into tumbling markets, magnifying volatile price declines even further. The widespread use of borrowed money amplified endowment losses just as it had magnified gains in the past." One reason why these wealthy universities have taken on so much debt is that as they started to lose at the global speculative casino, they decided to double down on their highly leveraged investments.

One might ask why would these universities full of the most brilliant people in the world make such bad financial decisions, and one response that we find in the Tellus study is that "College governing boards have failed to guarantee strong oversight of the Endowment Model by relying heavily upon trustees and committee members drawn from business and financial services, many from the alternative investment industry." Since the people who are charged with overseeing these schools now come from the world of business and high finance, they are willing to involve these institutions in complicated financial transactions that the faculty, students, and employees cannot understand.

It is also important to stress that not only do trustees and regents profit from having universities invest in real estate, derivatives, private equity, hedge funds, and construction, but the people who handle the universities' investments often bring in huge compensation packages: "In 2003, in-house bond traders David Mittelman and Maurice Samuels each earned more than $35 million in compensation, while Meyer himself pulled home a cool $6.9 million. The bonuses drew the ire of alumni and Harvard President Larry Summers, so Meyer reluctantly instituted a cap on bonuses the following year. Nevertheless, even after the cap Mittelman and Samuels again earned bonuses of more than $25 million in 2004, and Meyer's pay increased to more than $7 million" (44). While schools will say that they have to pay these huge compensation packages in order to attract the best and brightest investors, one has to wonder if these traders will have to give back their profits since so many of their deals have now gone bad.

In the tradition of privatizing profits and socializing the losses, Harvard's recent investment history stands out as an extreme case. Not only were traders given hundreds of millions of dollars in bonuses leading up to the financial meltdown, but after the fall, whole communities saw their jobs and tax base disappear. For instance, before it lost so much money in its investments, Harvard was planning an extensive expansion in the Alston area: "The amended "institutional master plan," which Harvard has regularly filed with the city of Boston, projected a 50-year expansion of its physical presence in Allston, unfolding in two phases, each involving the construction of 4 to 5 million square feet of space for the sciences, the arts, several professional schools, including the Harvard School of Public Health, the Graduate School of Education, and the Business School, as well as undergraduate and graduate housing, and other academic uses. At the time the university explained that 'Harvard's Allston Initiative is expected to generate approximately 14,000 to 15,000 jobs over the next 50 years, with about 5,000 jobs created in the first 20-year phase. The construction of academic projects in Allston is expected to generate an average of 500 to 600 construction jobs per year for each of the estimated 50 years of development.'" Of course to help finance this extensive project, Harvard made several risky deals and investments, and when these financial dealings tanked, the university halted its expansion.

According to the Tellus study, the result of Harvard putting the brakes on the Alston project will be devastating: "we estimate that a one-year delay in moving forward with the initial Phase 1A projects would result in lost direct earnings of more than $85 million and a total economic impact for the region of approximately $275 million. A two-year delay would result in lost short-term earnings estimated at more than $170 million, and a total economic impact of approximately $550 million. With a three-year delay, the figures increase to more than $270 million in lost earnings and a total regional economic impact of more than $860 million over the first three years. These impacts are driven solely by the forgone earnings of construction workers and permanent employees; they do not include the impacts of the lost procurement spending for construction materials and equipment that would have occurred in the region. Our estimates are therefore conservative in nature." Since Harvard, like other universities, is now tying its financial fate to volatile investments, its creates a devastating effect on the surrounding communities. When the markets go up, Harvard plans extensive expansion projects, but when the investments go sour, jobs are eliminated and projects are halted.

Perhaps the biggest ways that university investments hurt neighboring communities is through taxes. Since universities have a special tax-exempt status, they undermine the local tax base. For example, the universities examined by the Tellus Institute all have extensive real estate holdings but pay very little property taxes: "The six colleges we have studied are all among the largest land and property owners in their respective communities. MIT occupies 168 acres in the dense city of Cambridge. Even though about 72 percent of its total assessed property value of almost $3.5 billion is tax exempt, MIT has nevertheless been the largest property taxpayer in Cambridge for more than a decade. Harvard also ranks as one of the top five taxpayers to Cambridge, though the vast majority of its holdings are also tax exempt. Among the many tax-exempt educational and medical institutions in Boston, Boston University is the largest property owner with an assessed value of almost $2.4 billion, 89 percent of which, valued at more than $2.1 billion, is tax-exempt. Virtually all of Boston College's $576 million of property in Boston is tax-exempt. And in the rural town of Hanover, New Hampshire, Dartmouth College's tax-exempt property has an assessed value of almost $1.3 billion, which is equivalent to 58 percent of the total assessed value of taxable property in the entire town." Since these schools are paying very little money for their huge property holdings, the local communities are suffering huge tax losses.

While the low rate of property taxes robs towns of their fiscal support, the compensation policies of these universities heightens social inequality: "Even when the Endowment Model "works" best by generating excess returns, the rewards given to top management during the flush years have distorted pay scales on campus and within higher education more broadly. And because these schools are among the very largest employers in their communities, magnification of social inequality in campus pay scales shapes wider increases in social inequality throughout their regional economies. The exorbitant pay these senior administrators have received is passed along in the form of higher prices within their local economies, raising the cost of living in ways that magnify the effects of widening pay differentials even more acutely" (52). As I have shown in my study of how the University of California contributed to the global financial meltdown, universities generate a high level of income inequality, which in turn, drives up housing costs and causes people to turn to risky loans in order to pay for housing needs.

To highlight this connection between income inequality and the risky investment strategies of wealthy universities, the Tellus study examines the growing wage inequality at these institutions: "the average unionized staff member at these schools earned roughly $27,400 in 2000 while the average full professor's salary was about $109,000 (4 times the unionized staff figure), while the average president's salary was $346,000 (more than 12.5 times the figure for union members). Given the effects of compounding of even modest differences in pay increases, the pay gaps widen over the decade. By 2008 the average union staff member earned about $37,000, while the average professor earned $155,000 (more than 4 times the unionized staff figure), and the average president's salary grew to $561,000 (now more than 15 times the union figure)" (51). While we often think that universities are generators of social equality, we see here how these institutions often magnify economic disparities; furthermore, at schools like the University of California, it is the non-unionized employees who are driving up the costs of the institution, and so it is unfair to blame unionization for the financial failures of our public and private institutions.

The solution to this problem is not to close down these prestigious institutions, but we need a more careful examination of these schools spend their money, and we need to motivate them to move away from their risky investment models. One possible solution would be to change the tax-exempt status of these universities. It turns out that because these schools do not pay taxes on their investment gains, they are motivated to over-trade and engage in volatile investment strategies.

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