Did University Endowments Contribute to the Financial Crisis?


Big banks and private investors aren't the only ones who got caught up in the latest financial bubble. A new report by the Tellus Institute shows that higher education needs to take its share of the blame. The report notes that wealthy colleges and universities have been making increasingly risky investments with their endowments over the past two decades. Called the 'Endowment Model of Investing,' this practice generated high returns during financial boom times. But when the financial crisis hit, tens of billions of endowed dollars were lost - up to 30% of the value of the endowments at some of the wealthier institutions.

These financial challenges aren't just harming schools. Most postsecondary institutions play a significant role in their local economies through employment and relationships with local businesses. When schools responded to endowment losses by slashing budgets, laying off staff and reducing force and benefits, local communities suffered.

College Intertwined with the Financial Industry

In Too Deep: Colleges Get Cozy with Investment Banking

The Tellus Institute set out to explore the relationship between educational endowments and their impact on schools, local communities and the economy. They select six privately endowed New England colleges and universities as case studies: Boston College, Boston University, Brandeis University, Dartmouth College, Harvard University and the Massachusetts Institute of Technology (MIT). These institutions are some of the largest employers in their areas, and still control a significant amount of wealth even after the crash - the Institute reports that together they control almost $40 billion in endowment assets, which is over 12% of the approximately $310 billion held in college and university endowments across the country at the end of fiscal year 2009.

The Institute's examination found that the 'Endowment Model of Investing' relied on diversifying endowment portfolios into illiquid and high-risk asset classes such as hedge funds, private equity and 'real assets' like private real estate, timberland and oil, gas and other commodities. These risky investments generated high returns, but also subjected college finances to the 'rampant volatility of the global capital markets.'

These practices both made institutions more vulnerable to the crash and helped make it happen. Both through the amount of capital at the disposal of college endowments and the credibility the institutions lend to high-risk investment strategies, colleges and universities exert a considerable influence on financial markets. They engaged in speculative trading tactics from derivatives to hedge funds, relied on borrowed money and led other institutions into following their investment practices. The result was a major influx of assets in the 'shadow banking system' that is largely being blamed for the economic crisis.

What may have led to these risky behaviors? The temptation of high returns and a cozy relationship with financial institutions. Or, as the Institute's report phrases it, 'Wall Street's influence undermined endowment stewardship.' College boards are full of trustees with professional connections to the banking industry and rife with potential conflicts of interest - Dartmouth's board alone has included over half a dozen trustees who also run firms that managed over $100 million in endowment investments. And many schools have started wooing CIOs away from investment banks and consulting firms to manage the complex Endowment Model. Not only do these professionals also have a tight relationship with the banking industry and a predilection for risk, they also tend to be the highest paid individuals in the nonprofit sector.

Harvard University

Financial Hardships Ripple Out to the Community

The Tellus Institute's report points out that the people who feel the biggest consequences from major endowment losses are not the people responsible for mismanagement. Faculty and staff suffer from layoffs, reduced hours, salary and benefit cuts and hiring and pay freezes. Students are stuck with tuition hikes, program cuts and reduced student services. And the damage radiates out from the ivory tower - the Institute reports that nearly $135 million has been lost in annual economic activity in the Boston metro region, and over $30 was lost in annual economic activity in the Upper Valley of western New Hampshire and eastern Vermont.

Because these institutions are some of the largest employers in their areas, local communities also felt the sting of job loss. Furthermore, many institutions abruptly postponed planned construction projects, which led to a huge loss of potential earnings, more job losses and reduced opportunities for local economic development. The report 'conservatively estimates' that the delay of Harvard's Allston Initiative alone will lead to a loss of over $860 million in expected economic activity over the next three years.

The Institute points out that colleges' tax-exempt status also has a detrimental effect on their surrounding communities. City, state and federal governments forgo considerable tax revenue from colleges and universities in exchange for the public benefit of employment and engagement with local businesses. The report estimates that the six schools in the study hold tax-exempt real estate worth over $10.6 billion, which would mean $235 million in taxes. Collectively they paid less than 5% of that amount through negotiated 'payments in lieu of taxes' (PILOTs).

Colleges also benefit from tax-exempt status in other ways. Gifts to endowments are tax-deductible to donors and investment gains and income earned by endowments are tax-exempt, making it easy for endowment managers to trade rapidly without considering tax consequences. Colleges also hold tax-exempt bonds that allow them to borrow at low interest rates while their endowment assets are fully invested. They keep the difference in yields tax-free. This indirect tax arbitrage has even led the Congressional Budget Office to investigate college finances.

Postsecondary institutions continue to enjoy all of these tax benefits even as their contributions to the public good are significantly hampered.


The Tellus Institute concludes their analysis with the blunt assessment that 'the Endowment Model of Investing is broken.' The costs both to schools, their communities and the broader financial system have far outweighed their gains. High-risk investing is exceptionally irresponsible from colleges and universities who are long-term investors with a major stake in the sustainability of the economy. The report urges postsecondary institutions to stop contributing to systemic risk and 'embrace their role as nonprofit stewards of sustainability' through greater accountability, transparency and investor responsibility.

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