<p>I know there is another, now closed thread, but I wanted to emphasize this:</p>
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<p>Harvard used margin. $34 billion in assets and the school used margin and bought illiquid assets.</p>
<p>The school didn't match its cash flow needs with expenses.</p>
<p>Pretty amazing.</p>
<p>And one of the great leaders in this mess ends up with a great job at Pimco where he can pontificate his bs ideas in the media.</p>
<p>If finance was taught in high school, society would know these finance guys made their returns by gambling and with a bull market at their back.</p>
<p>They didn't make money by using their brains.</p>
<p>And if finance was taught in high school, finance wouldn't be a big deal and people in the financial industry would be paid about the same as cab drivers. (No offense to cab drivers. My grandfather was a cab driver).</p>
<p>Interesting. So in addition to the cash calls from private equity funds, Harvard was also getting cash calls on interest rate swaps. This would explain the $300 million from the $1.5 billion bond issue that was used to terminate interest rate swaps.</p>
<p>Can anyone explain the swap described in the article: paying fixed rate interest for a swap that returns floating payments based on equity indexes? Was this used as a way of "locking in" interest rates for the Allston project? Or simply as a way of leveraging control of larger equity investments? In effect, this swap is "borrowing" a fictional portfolio to pocket the returns.</p>
<p>Or simply as a way of leveraging control of larger equity investments?</p>
<p>Yes. A way of leveraging to make money based on stock market returns.</p>
<p>I don't know the details of Harvard's swaps.</p>
<p>It would work something like this.....</p>
<p>I borrow at a certain rate. In return, I get some percentage of stock market returns.</p>
<p>Might limit my upside to 80% of stock market returns. Might limit my downside.</p>
<p>Many ways to do this. Maybe, I get close to 100% of the returns.</p>
<p>Kind of like borrowing money and getting a variable annuity in return.</p>
<p>Since stocks have historically returned about 10%, if you can borrow at a much lower rate, and you get close to historical stock market returns, it can be a super investment.</p>
<p>But... historical returns and future returns may not be similar.</p>
<p>You can end up with cash flow problems if the timing of expenses and the returns don't match.</p>
<p>And if stock prices go down, you can lose on stocks and lose paying the interest...a double whammy.</p>
<p>And doing this with commodities is a super gamble. Anybody can partake in this strategy. Doesn't take brains.</p>
<p>I read the NYT article, but am confused about the following section. Could anyone explain it for me?</p>
<p>"One she might not have anticipated was the intense pressure caused by the Allston expansion, according to one person with knowledge of the endowment. Several years ago, the university had envisioned an ambitious capital expansion program stretching for more than a decade. Lawrence H. Summers, then Harvard’s president, had raised the possibility of locking in interest rates that appeared to be at historic lows, a plan the university adopted, said several people familiar with the endowment. </p>
<p>All went well at first. But in the second half of last year, interest rates plummeted, and Harvard turned to the endowment to meet hefty collateral calls, which could rise to $1 billion if rates remain weak, according to a person with knowledge of the university."</p>
<p>By Harvard locking in the low rates, I am assuming that it is the borrower (and not the lender). How does interest rate falling force H to have collateral calls? If the debt has fixed rates, then it just pays the same monthly amount, right?</p>
<p>“All went well at first. But in the second half of last year, interest rates plummeted, and Harvard turned to the endowment to meet hefty collateral calls, which could rise to $1 billion if rates remain weak, according to a person with knowledge of the university.”</p>
<p>By Harvard locking in the low rates, I am assuming that it is the borrower (and not the lender). How does interest rate falling force H to have collateral calls? If the debt has fixed rates, then it just pays the same monthly amount, right?"</p>
<p>This didn’t make much sense.</p>
<p>So I ignored it. :)</p>
<p>Harvard may have bought interest rate swaps or other products that decrease in value as rates plummet. So Harvard locked in interest rates, but not necessarily "low " interest rates.</p>
<p>Now I’m guessing…</p>
<p>Why would Harvard do this?
My guess is because Harvard would not have to put up much capital unless things went wrong. Less capital than if they issued bonds in the first place.</p>
<p>So Harvard made a big bet on interest rates using margin or leverage.</p>
<p>Just a guess.</p>
<p>Harvard, under the “leadership” of Larry Summers locked in what are now very HIGH interest rates. They apparently have huge commitments to interest rate swaps that are highly unattractive. Beyond that, I couldn’t suss many details out of the article.</p>
<p>Plus, Harvard invested money locking in high rates for building projects that are obviously not going to happen at anywhere near the anticipated timelines.</p>
<p>Kind of scary that the person who lost billions for Harvard by locking in high interest rates, the person who was in charge when Harvard went so heavily into alternative investments that are blowing up is now the person who seems to be in charge of our Countries economy.</p>
<p>people on this blog appear to know a lot about the private college endowment situation. I don’t believe the top elite schools are being transparent about the situation (which I can agree they need to be secretive about this, because this could make it difficult to unwind postions they have taken).</p>
<p>But some of the private schools like Brown, Georgetown, Williams, etc…seem to be in worse position.</p>
<p>But what are the “indicators” if a school is running short of cash or an endowment crash?</p>
<p>Examples being:</p>
<p>-expanded enrollement?
-putting more kids on waitlist (can colleges that are “need blind”, not then be “need blind” if they take kids off of a wait list?, thus selecting kids that will pay the full amount?)
-bonds (as Harvard did and ND did for $150 million)
-freezing or cutting back of the fully funded PhD programs
-???</p>
<p>My son has applied to some of these schools and I just want to be able to watch this situation.</p>
<p>Also, these elite private schools really won’t understand their enrollments until the last minute of the start of the academic year, a lot partents are going to send $ to the public “safety” and then to a private school, but not make the decision till late summer.</p>
<p>What I heard from someone “in the know” at Harvard was that, to fund a raft of new buildings (and not just the Allston expansion), it was decided to borrow the money rather than to use endowment income because, at the time, the endowment was doing extremely well, and it seemed wise to plow back some of the profit to help the endowment grow faster–and it did, for a while.
The problem Harvard has now is one of cash flow. Of course the endowment has been hit badly, but it is still large. Harvard could probably solve its problem (but drive endowment lower) by making a larger “payout.” Despite a lot of hand-wringing, it’s not about to fold. There are, however, some colleges that have taken huge losses (see Brandeis, for instance).
State universities are by no means immune. In fact, state budgets shortfalls are forcing some universities to adopt really drastic measures that will have a direct impact on students.</p>
<p>MiPerson80, many colleges mismanaged their endowments. So many of us complain…</p>
<p>“But some of the private schools like Brown, Georgetown, Williams, etc…seem to be in worse position.”</p>
<p>But as far as a student going to one of the schools you mentioned or similar schools, I wouldn’t worry about it.</p>
<p>Marite:</p>
<p>None of these colleges pay cash for new buildings. They all finance them over 30 years with tax-exempt bonds. Harvard is no different.</p>
<p>Harvard’s problems right now aren’t limited to loss of endowment or issues that could be solved by increasing the endowment spending rate. For a variety of issues related to aggressive investment positions, Harvard has signficant cash-flow problems. The size of the endowment is somewhat irrelevant because they don’t have sufficient assets they can turn into cash money tp cover their obligations (especially the obligations regarding cash calls.)</p>
<p>They’ll work it out. They have the financial foundation to do things like borrow $1.5 billion for operating cash.</p>
<p>For an applicant, Harvard and the other elites aren’t going anywhere. The promises of enhanced financial aid were so public and so financially modest a drain (in the overall scheme of things), that the commitments will not be reneged upon for most.
But the specter of the best and the brightest scrambling to pay their bills is some sight to see. I don’t know whether I’m more proud to know I can cover my commitments this month and next, or worried for all of us.</p>
<p>I do not believe that Harvard pays cash on any of the buildings, nor did I suggest so. What I heard is that Harvard decided to borrow money in order to fund these buildings rather than drawing on its endowment income. At the time, it made sense since investment income was far higher than the interest on the borrowed money. Its problem is that the buildings are not yet paid for, so it has to continue to pay, like any homeowner.
I don’t know that the size of the endowment is irrelevant. Surely, it’s up to the Harvard Corporation to decide on the amount of the payout. Wasn’t it recently–and on CC, nacht-- that people were complaining that private universities were not using more of their endowment income? Well, I have a strong suspicion that Harvard and other universities will be using more of their endowment in the next few years.</p>
<p>
</p>
<p>I haven’t seen anything in Williams’ financials that looks like they have gotten bit worse than the average bear. The only place where their situation really stood out was a high percentage of their debt in variable rate demand bonds. But, their high credit rating kept demand for those bonds up, they were never forced to rebuy any of them, and that particular threat appears to have eased overall for now. As for ultimate losses, President Schapiro has suggested they could be 30%. That’s about average according to Moodys. Schools that are tossing around numbers less than that are mostly lyin… er, shading the truth. It’s all relative, but Williams looks OK. Swarthmore looks OK. (Keep in mind that “OK” in this context still means significant budget cuts over the next three years). Amherst has some serious issues that are going to “leave a mark”.</p>
<p>“I do not believe that Harvard pays cash on any of the buildings, nor did I suggest so. What I heard is that Harvard decided to borrow money in order to fund these buildings rather than drawing on its endowment income. At the time, it made sense since investment income was far higher than the interest on the borrowed money. Its problem is that the buildings are not yet paid for, so it has to continue to pay, like any homeowner.”</p>
<p>Marite, I think it’s a little more than that.</p>
<p>Because Harvard had collateral calls.</p>
<p>I’m sure Harvard will be ok.</p>
<p>
</p>
<p>All colleges have done this for all buildings at least going back several decades. It’s standard operating procedure. Tax-free bond issues to pay for the buildings. Pay off the bonds over thirty years as an operating expense.</p>
<p>Of course the size of the endowment is not “irrelevant” in the grand scheme of things, but it is when the limiting factor is cash flow. Say you had a million dollars worth of stock, but your stockbrocker says that he can’t sell enough for you to pay for the car you want to buy because nobody wants your stock. The size of your nest egg is irrelevant to the car purchase, if you can’t turn any of it into cash to pay for the new car. That’s what Harvard is bumping into because their endowment is so heavily committed to non-liquid investments.</p>
<p>Changing the policy to increase the endowment payout is irrelevant until you actually have the cash to spend. It’s not like Harvard can’t find ways to raise cash – like selling good performing investments and/or borrowing $1.5 billion. These aren’t steps Harvard wants to be taking. They are painful.</p>
<p>Well, I’ll admit I have not followed all the discussions about Harvard’s financial problems closely, nor am I knowledgeable about finances. But I have not heard that Harvard cannot raise cash. All I have heard about is the size of the payout as well as belt-tightening all around (though not in the area of financial aid).
I once heard a Yale faculty member say that the amount of free food available at Harvard compared to Yale is astonishing. In Cambridge, people have been joking that when Harvard decides to tighten its belt (no more free lunches at seminars and meetings, fewer lectures, take guest speakers to cheaper restaurants and so on), the many merchants around feel the impact.</p>
<p>Marite:</p>
<p>The belt-tightening due to decreased endowment payout, greater financial aid discounting, and so forth is universal. All colleges and universities – from Harvard to Bunker Hill Community College – are going through that process.</p>
<p>This cash flow thing is a different issue. The big endowments all invested in private equity, leveraged buyout, and timber/oil/gas partnerships. These are not investments that are traded on a stock exchange. There’s little or no market for selling them and there’s no easy way to price the value of these investments. Most of these investments are structured with cash calls. In other words, you sign a legally binding agreement to invest $500 million with Bain Capital over the next three years. Bain takes $100 million now and buys some company to plunder, strip of its assets, load up with debt, and sell to some larger fool in an ever increasing bubble market. They can come back at any time and make you pony up the additional $400 million cash money. The colleges thought they were safe because they used the profits from the last Bain Capital deal to cover the following year’s cash calls. As long as the bubble market kept every deal profitable, no sweat. For some astonishing reason, none of the brilliant investment managers ever considered that the market would collapse and, therefore, never worried about where they could get the cash to meet these cash call obligations.</p>
<p>But, guess what happened on the way to the forum? The market crashed. All of Bain’s deals for the last three years are now worth ZERO. They aren’t returning any profit to Harvard. And, they are all coming demaning cash on the outstanding cash calls. Harvard can’t raise the kind of cash we are talking about. They are so heavily invested in these kinds of investments that they have relatively little left in traditional stocks and bonds that can actually be sold. They tried to sell $1.5 billion of their positions in Bain and similar private partnerships and couldn’t find any buyers in a small secondary market except for pennies on the dollar. Finding the prices being offered unacceptable, Harvard gave up and started borrowing money to fund the various cash calls.</p>
<p>I haven’t studied Harvard’s financials so let me give you a simllar, but smaller example. Amherst’s endowment is now worth somewhere between $1.0 billion and $1.2 billion. Less than 40% ($400,000) of it is in liquid investments like stocks and bonds that can be sold. $600,000 is in these private partnerships that can’t be sold.</p>
<p>Guess how much their outstanding cash call commitments are? $503 million dollars! In other words, they could cash out everything they could possibly sell at firesale prices and still maybe not have enough cash to cover the cash call commitments. And, even if they cover them, they end up with an endowment that is so high risk, it’s off the charts. And that’s before we even talk about the cash for next year’s endowment spending. It is really ugly. That’s why, like Harvard, Amherst just borrowed (taxable bonds) for operating cash. The only difference is the size. Amherst borrowed $100 million, Harvard borrowed $1.5 billion.</p>
<p>What really should happen is that Harvard should tell Bain to go pound sand and refuse to pour more cash down the black hole. But, because these schools endowments are so large, they wag the market. If Harvard did this, it would instantly make all such private equity investments worth zero, including their own. I figure they are going to have to quietly work a deal with the Bain Capitals where the cash calls just stop coming.</p>
<p>Thanks for the explanation, Idad. It makes a lot of sense.</p>