Blockbuster
Posted on April 23rd, 2009 in Uncategorized | 36 Comments »
The Crimson has a helluva piece today on allegations of “pervasive ethical deficiencies” at the Harvard Management Company.
The charges come from Stephen Rose, a former tax director at the firm, who tried to warn Harvard about corruption and cronyism at HMC.
“The general disregard for the rules, procedures and compliance—it was ridiculous,” Rose said in an interview with The Crimson. “You had to be quiet and do it and put blinders on. If you were doing work in other aspects of the company, you could just do your job. But in [my] part of the job, you couldn’t ignore things.”
Harvard Management Company—which oversees Harvard’s multi-billion dollar endowment—was plagued by a culture of ethical laxity, Rose said. Special relationships with funds run by former employees and the use of offshore investment companies—both used to boost HMC’s once-legendary returns—may not be illegal, but are considered to be ethically questionable by some, particularly in light of Harvard’s non-profit status.
Adding to the allegations made by Iris Mack, these new charges are starting to flesh out a picture of a seriously toxic and perhaps deeply corrupt culture at HMC.
Trust me—Harvard will try to cover this up as much as possible, but this is a very big story. The HMC story may be a bigger threat to Harvard’s future than the failed presidency of Lawrence Summers. I’ll go further: Because its financial implications are so profound and long-term, it is a bigger threat.
This is going to get worse before it gets better.
There is one thing that Harvard could do, which it should do…but which it will never do.
It should hire outside counsel—new outside counsel—conduct a full investigation—not like the one they conducted and buried—and then disclose the entire investigation to the public.
This is one story too big and too poisonous to be covered up.
But Harvard will try. Covering up is the default instinct within certain areas of the the Harvard power structure—the corporation, the executive v-ps, some of the public affairs people—and it is the result of a failure to believe in the values of a university and a conviction in the principles [sic] of the money culture.
The battle for the soul of a university, indeed.
36 Responses
4/23/2009 11:41 am
who are these “executive v-ps” of which you speak?
4/23/2009 12:26 pm
The culture of excessive filtering of information released to the public about Harvard’s financial maneuvers is at odds with the values elsewhere promoted within the University. The cause is the desire to avoid embarrassment and responsibility when matters go wrong. The financial leaders of the University, unfortunately, have plenty to hide, especially in the handling of the endowment, the Harvard bank fiasco, the interest rate swap catastrophe and the derivatives mess. The investigation you call for is the correct response, but the approach you advocate is too narrow. The real money is in these areas. The tax issues, while indicative of an rotten culture, are merely the side show.
4/23/2009 2:28 pm
Larry Summers falls asleep at meeting with credit card executives:
http://thinkprogress.org/2009/04/23/summers-sleep/
4/23/2009 2:33 pm
pioneer13
If as you say, “the real money is in these areas” ( I agree with you) tell us what you think the interest rate swap was all about, what went wrong and why you think it was a catastrophe. I don’t agree with you that the swap was a catastrophe and if you tell us the answer to those questions which is easy enough to do, I’ll be happy to tell you why I don’t agree.
4/23/2009 2:54 pm
Anon 2:28
I must disagree with you. Larry is not asleep in that photo.
That is just the pose that he adopts when he is thinking great thoughts. He is probably thinking about how the government can continue to get an overextended consumer to stop paying off debt and step up spending so that he, Larry, can take credit for a revived economy. No, actually that is his pose when he is thinking how the government can use even more of our (taxpayer) money to pay off some more banks and insurance companies. No, the more I look at it, I think that is the posture he uses when thinking about who will be the next head of The Fed.
4/23/2009 3:46 pm
The problem for Larry at those meetings is probably that there’s no Diet Coke anywhere in sight. If he *is* thinking deep thoughts, it’s probably how he can persuade Obama to order in a few crates of the stuff.
4/23/2009 4:10 pm
I dunno, Sam. Looks like he was doing his thing then actually dozed off:
http://www.huffingtonpost.com/2009/04/23/larry-summers-falls-aslee_n_190659.html
From the pool report:
“One thing to note is that Summers appeared to be nodding off near the beginning of Obama’s remarks. And then he DID nod off, doing the head on the hand and then head falling off the hand thing. Photogs seemed to be having a field day. All other officials in the room appeared fully awake.”
4/23/2009 4:38 pm
Of course he was asleep. He did that in Cambridge as well, a number of times, according, “to a source close to the action” ,
and my source is an impeccable source, unlike other “sources close to.”
I think Judith, that while it might be the Diet Coke in most situations, in this one it was probably something different. The President was telling the credit card issuers that there were going to be more onerous rules applied the companies. This means that credit card companies will cut back on issuing cards. Instead of getting twenty unsolicited cards in the mail every day, most people will now only get ten every other day. This will definitely curtail increases in consumer spending (Larry can do the arithmetic regarding maxing out ten cards rather than twenty) which he is (foolishly) championing. So… why should he pay attention… probably thought it was more useful to catch some sleep and what better place to do it than when The President is speaking and cameras are rolling.
4/23/2009 4:50 pm
What better way to get involved in consumer spending than by ordering lots of Diet Coke™ ?
4/23/2009 5:14 pm
Sorry, Sam. I read just your opening and and replied too quickly! And quite so on the more serious points.
4/23/2009 5:27 pm
Sam
An interest rate swap when used for business purposes-as opposed to an interest rate speculation-is a simple swapping of cash flows. In Harvard’s case, the construction was to swap floating for fixed, which is essentially shorting the fixed rate side of the bond market. Now that is fine if the University had an amount of floating rate bonds outstanding equal to the notional amount of the swap or $3.9 billion. Harvard would have been fixing its interest rate exposure to a determined level instead of being exposed to higher costs in the event of a severe inversion of the yield curve or simply higher overall interest rates. But Harvard had very little floating rate debt to hedge. It cocked up a story about issuing floating rate debt in the future to finance the new campus. No such plans were concrete and no consensus existed on the composition of the funding sources for the effort. The one certainty that existed was Summers view that interest rates had peaked and he wanted to express that view. The rest is history. Perhaps it is a bit much to characterize a billion dollar loss as a catastrophe. I apologize.
4/24/2009 6:31 am
Pioneer13
First, I would like to apologize to you for the tone of my response to your blog entry. I thought you were just another person on the site who wanted to blame Larry for all the ills, whatever the nature, of The University. Clearly, I was wrong. An insider? Doesn’t matter. Again, my sincere apologies.
That being said, however, I think Larry is getting a bum rap regarding the interest rate swaps. When I think Larry has made mistakes, I’ve been quite willing to say so on this blog, no matter what the potential personal consequences. On the other hand, I’ve defended him when I thought he needed to be defended from his critics. This is one of those times.
1.Larry was fired and left in mid 2006 and was not engaged (except on other things) for some time before that. It is wrong to blame him for events that took place after June 30, 2006. Here is what I mean. The swaps were put on with the understanding that Allston was going to go ahead and presumably there was a consensus that significant debt would be taken on and rates, over a long period of time would be higher than they were. If Larry was gone, the push to build Allston (and thus take on significant debt) changed, President Bok and The Corporation should have changed the composition of The University’s balance sheet. It is clear that they either planned to go ahead with the project and issue more debt or weren’t paying attention to the fact that this transaction was on the books. Is this Larry’s fault? I think not.
2.The collateral on this transaction was in the footnotes of the 2006 Annual. It was a minor amount. There were very knowledgeable people (regarding this type of transaction) sitting on The Corporation and The HMC Boards. Were they not paying attention to this transaction? If not, why not? After Larry was thrown out, this transaction was their (The Corporation’s) responsibility, not Larry’s. It was easy to get out of the transaction at effectively little or no cost. Clearly, there was some reason they thought they should keep the transaction on the books.
3.Aside from the foregoing, the transaction was most probably thought as a long term one. If it weren’t, then something clearly was wrong. There was no “loss” in it. The additional collateral that had to be put up did not indicate a “loss,” but only a change in mark to market. Looking out over the long term, someone (Larry, The Corporation and other Harvard alums in the business whom I feel certain The University called upon), decided that the rate that was fixed was acceptable. The loss only came when the transaction was unwound recently (was it unwound?; I can’t seem to recall whether in fact it was done; I’ll know for sure after the annual comes out in November or December).
Asides:
I might blame Larry for a lot of things, but not this. I blame him for his (and Secretary Geithner’s) ill thought out plans to bail out the banks. As someone who knows a great deal about banks, this plan (whatever the plan du jour is) may or may not work. What is known, however, is that whatever the plan, it is going to be very costly (hundreds of billions of dollars, if not trillions). There were so many other ways to handle this situation, ways that would not involve a substantial waste of taxpayer money.
You said: “The financial leaders of the University, unfortunately, have plenty to hide, especially in the handling of the endowment…”
Would enjoy hearing your thoughts on the endowment because I, too, have many questions regarding how it was handled beginning in the early 90s.
4/24/2009 7:10 am
that should have been “If after Larry was gone…”
4/24/2009 2:06 pm
You are correct that the Corporation should have addressed the imbalance in the swap upon Summers’ departure. I do not think it is overstating the case to assume the Corporation was negligent in this regard, perhaps even grossly negligent. And I believe it is also true that the Corporation was not paying attention. The same can be said of HMC which had responsibility for the execution of the swap. But this does not absolve the decisionmakers who initiated a swap against no corresponding floating rate liabilities. Sam, you stretch the point about a consensus for utilizing debt and forward movement on Allston. These matters were quite formative when the swaps were booked. From a financial point of view, the mismatch was reckless given the early nature of the project. Summers is not solely to blame for advancing the trade. He had to clear the decision. What is currently not public knowledge is who green lighted the massive bet that Summers pushed so agressively. A portion of the swap remains, which is arguably prudent given the level of floating rate debt. And, importantly, there is not enough cash left at the Center to absorb the additional embedded losses!!
4/25/2009 7:41 am
Thanks, Pioneer 13, though cold comfort it is you bring. I well remember in a 2002 or 2003 faculty meeting asking Summers how he would make sure that the rate of progress in Allston did not do damage to the existing operations of Harvard. This would have been the second or third year in a row the dean of FAS had given the Harvard libraries a zero % increase in the unrestricted portion of its budget (as happened in every year of Summers’ presidency).
Summers replied with a contempt he didn’t bother trying to conceal “Very carefully, Professor T., very carefully”. . .
4/25/2009 12:12 pm
How did we wind up so heavily debt-financed? The debt service we are paying is an important part of the reason for the general contraction. It’s not just the drop in the yield from the shrunken endowment that means we have to freeze hiring and salaries and can’t buy library books and have to cut the House budgets by 25%. Harvard borrowed a lot of money and those interest payments need to be paid first.
Now I am sure that a lot of the pressure to get the buildings started came from my neck of the woods — not the computer scientists but the science community more generally. But it was a new way of doing business when the university started building science buildings on the speculation that donors would come around later to pay for them. For at least 15 years I and my colleagues were begging for a computer science building that wasn’t WWII cinderblocks, and the answer always was, “not a penny until we’ve raised the money.” You can see the results just by walking around — all the science buildings built in the 20th century have donors’ names on them; none of the major science buildings built in the 21st century do. That change of attitude, that borrowing as much as possible to build as much as possible will always pay off in the long run because everything will always go up, arrived at Harvard with the presidency that began in 2001 …
4/25/2009 1:27 pm
This happened at the Medical School as well — I’m not sure any heads rolled after the *New Research Building* failed to find a more illustrious name.
4/25/2009 3:00 pm
1.The life scientists said, “if we don’t get these buildings in Allston, we’re leaving. “X” university (take your pick, Stanford, Yale et al.) will be a very hospitable place.
2.The President before the one who took over in 2001, increased endowment payouts by more than 20%, twice. Until this current year, high watermarks prevailed. Can’t reduce anything, so it’s always more, more, more. Hundreds of millions of dollars in an academic arms race. Few, if any, professors arguing that this arms race was madness. Few if any professors arguing that it should (or would) ever end. Many professors wanting even more. Presidents bringing back professors who had decamped just a few years before, at what can only be imagined were exorbitant prices. Easy money fostering easy spending.
3.Easy to raise relatively small amounts of money for named computer science buildings. Much more difficult to raise 300, 400 or more for life sciences. Very few Jack Whiteheads.
4.Each tub… No coordination in what should be an integrated university. FAS Northwest Science building. Big bucks. No donor name. FAS faculty building. Lots of debt. Big why as to why was this done.
5.Aside from of a few of us (me for example with President Rudenstine), no one seemed to care about the risks with the endowment.
6.Personal vendettas get tiresome after awhile.
4/26/2009 9:17 am
Sam,
A few years ago I wrote, “Summers will be remembered as a weak president, not a strong one.” It has never been my view that everything for which Summers was either credited or blamed was his doing alone. In particular, the extravagance for which we are now paying was no personal innovation of his; his reputation for “boldness” with the Allston plan and so on was over-rated (boy, has that word ever disappeared from the Harvard vocabulary). The Corporation and Summers were always co-dependent; he did the job they hired him to do, and supported him when he did it. The Corporation wanted a new President Eliot, and wanted Harvard at the center of a new medical Silicon Valley. So we are perhaps in agreement more than you realize (including in your #4, where neither of us seems to have an answer to my question). You seem to attribute the building decisions that happened after 2001 to the faculty getting better at blackmail; however that may be, the the buck on the financing model stops with the President and the Corporation; they should have said no at some point, and didn’t.
4/26/2009 11:37 am
“How did we end up so heavily debt-financed?” The debt levels spilled over from corporate finance concepts. Simply, a corporation’s balance sheet was thought to be most efficiently structured if it had the right mix of debt and equity. Too little debt meant that a company’s equity was not efficiently deployed. The concept then migrated to the University where the endowment was equated to a Corporation’s equity. It was thought quite prudent to utilize debt, in moderation, so long as certain rating agency levels could be maintained. In the case of Harvard, 5-10 billion of debt on an equity base (endowment) of 35-40 billion would be very conservative compared to similarly sized industrial corporations. In fact, these levels would even allow for AAA ratings. Hence, the borrowings were considered prudent. That was the logic. However, it was really the need for instant gratification that forced the policy shift to debt. The money was not in hand from gifts—and unlikely to be forthcoming—so the University plunged ahead knowing that it had the borrowing capacity. Now the Corporation is learning that there are no free lunches.
4/26/2009 12:08 pm
Would it be right to surmise that the delay in the start of the planned capital campaign added an extra twist to this situation?
4/26/2009 12:13 pm
No
4/26/2009 12:31 pm
Oh, well.
4/26/2009 12:39 pm
By which I mean that I will just listen and learn when the topic is economics.
4/26/2009 1:27 pm
Pioneer 13: I don’t see the analogy between a corporation increasing its ROE by use of debt, and a university taking on debt, unless the university mind set is that we can earn more on the endowment than our cost of debt. Is that your point?
Harry,
I agree with everything you said.
On the specific topic of the buck stopping with The President and the rest of The Corporation, absolutely so. However, don’t the faculties also have an obligation to speak out when unwise financial policies are taking place. The letter that I referred to (sent to President Rudenstine about the risks of the endowment being run the way it was), I also, two years later when off balance sheet leverage was starting to really scare me, sent an updated version to three professors who knew what endowments were about. Never heard a word. They just didn’t care to kill the golden goose.
4/26/2009 3:50 pm
Interesting New York Review of Books article on universities (http://www.nybooks.com/articles/22673); note the link in that article in footnote number 1: a good review on endowments in InsideHigherEd.com
4/26/2009 4:10 pm
Sam
There has certainly been plenty of discussion about arbitraging the endowment returns by judicious use of debt. Borrow at 4% and earn 15%. The argument was to substitute newly issued debt for withdrawals (also targeted capital campaigns) from the endowment for the building projects. The money would come in eventually from donors so the debt would jump start the construction. Once the donor money arrived the University could pay off the debt or continue the arbitrage. Guess which option was always chosen. The model works beautifully in a rising market, producing a sunny financial picture and a very efficient utilization of the endowment base. But when the cost of debt exceeds the endowment returns the whole process is rather painful. Whether or not this financial model is appropriate for a University time will tell. Should the University look to the simple arbitrage (4% vs.15% or down 30%) to judge the wisdom of its capital structure decision? Or should it take into consideration the benefits and returns from the new buildings in measuring the appropriateness of assuming the debt risks? Should the painful program cuts be part of the analysis?
4/26/2009 4:25 pm
I’ve never thought that professors should have a role in managing the endowment. I know that puts me in a different place than some of my colleagues. To the extent professors feel they should influence investment policy — not to have Harvard invest in companies doing business in country X, for example — I’d agree with you — they should also be watching and complaining when the investments are risky, and might bear some of the blame if they aren’t. In the UK, the professors are completely responsible for the investments of the Oxbridge Colleges, and I suspect that some Harvard faculty don’t realize that constitutionally the system is different here. I, like most professors, have no competence on investments, and nothing in my training or job experience would have given me competence. I feel the same way about negotiating union contracts, buying land, and so on. The Corporation holds all the cards on these things, and the faculty holds the cards on teaching and research (of course, within bounds set by resource constraints, etc.).
Drawing that line between faculty and corporation responsibilities more sharply would have the beneficial effect of making transparency more acceptable. And that would mainly be for the benefit of the alumni, who elect the Overseers (unless they are also faculty — in which case, by design, they don’t get to vote). Of course, when people who are better able to judge come to the conclusion that the people running the place have screwed up, faculty have a right to complain, but by that time they are really complaining about governance failures, not investment policies.
FAS has never known quite how to think about this, and of course in good times no one cares much. For a time after a previous fiscal crisis there was an FAS Resources Committee; when it was working well, it gave the faculty (particularly deans and department heads) a clearer picture of what to expect. I haven’t heard anything about it lately; I think it was moribund and, having never been established as a Standing Committee, it always was appointed only at the discretion of the FAS dean.
4/26/2009 4:53 pm
Should have said that alumni vote for overseers “unless they are university employees, including faculty.”
4/26/2009 4:58 pm
For 90% of faculty the goose was not that golden in the late Rudenstine and Summers years. Most years (with one exception as I recall) faculty salary increases were around inflation, 3-4%, while available research funds have not been increased in about 20 years. There were new ventures afoot of course, with expansion in some areas of the sciences, in administration, and the like, but that is a different matter.
The faculty has absolutely no capacity for influencing the Corporation on financial matters. Even when we were in a full crisis of leadership in 2005-6, it took a great deal of effort to get discussion going, which did finally happen. But finances are another matter altogether, and even the Board of Overseers doesn’t have any real capacity in that regard as I understand.
4/26/2009 8:58 pm
The FAS Resources Committee continues to exist, meet, engage. Why nothing has been heard from them is a mystery. Some recent members: John Campbell, Kay Shelemay, Susan Pharr, Gary King.
4/27/2009 3:15 am
Harry and RT,
I wasn’t suggesting that faculty have any role in managing the endowment. That would be a disaster.
However, “don’t the faculties also have an obligation to speak out when unwise financial policies are taking place.”
These would be but three examples. When knowledgeable people on the faculties see that the leverage of the university’s balance sheet is ballooning year after year (tens of billions of dollars, reaching a peak of almost 80), shouldn’t questions be raised? If endowment payouts are raised significantly, shouldn’t questions be raised as to the sustainability of those payouts? If budgets are done in an ad hoc manner with little or no thought given as to what happens five or ten years from now, shouldn’t questions be raised?
Yes, The Corporation has the final say in the management of The University. However, don’t the faculties have an obligation to speak out on the non academic subject which most directly affects their well being as scholars? The faculties speak out on a lot of other things; why not on this important matter?
It’s clear from what has gone on in the past several years that The Corporation doesn’t have all the answers regarding the financial health of The University… maybe not even most of the answers. It should be rethinking the way “it does business.” The faculties are a vital part of what goes on here. Some time and a lot of hard work on their part will make a difference. Don’t you want to be a constituency that has a vital voice rather than one that merely complains after the fact? I would hope that you would.
4/27/2009 10:40 am
Sam,
When I said the ‘faculty has absolutely no capacity for influencing the Corporation on financial matters’, I meant just that, and was not talking about managing the endowment.
Wanting to have a voice doesn’t come into it. The entire process around the Allston medical-industrial park is a good instance. The faculty was exposed to a certain amount of show and tell, objections about taxation of endowments were aired, questions about the effects on the Cambridge side were posed, but essentially things proceeded on the basis of decisions already made.
The same thing happened in the early Rudenstine period when the decision to reduce contribution to faculty pensions preceded the faculty’s being asked to find that a good and desirable course of action.
The spring of 2006 was an exception, but I imagine it will remain precisely that.
4/27/2009 3:05 pm
Sam,
This is a fiduciary failure, and the solution to a fiduciary failure is not to invite the faculty to be fiduciaries. More transparency would be good for everyone, as it would give the governing boards an incentive to be more critical of their own decisions. Given the current structure, again to quote myself, “The alumni-elected Board of Overseers, the large if marginalized second body of the Harvard governing boards … must not return to functioning as the University’s honorees and cheerleaders rather than governors.”
4/27/2009 4:18 pm
Harry,
I agree with you. It absolutely was a fiduciary failure… and the faculties should not become the fiduciaries.
However, when fiduciaries fail and their failure affects you, the right response, in my mind, is to press the fiduciary to do what will not fail in the future. That’s the real world. Why would someone allow a fiduciary who failed (you)… to do it again!?
Harvard will eventually work its way of this financial catastrophe, although at great cost. If, however, there is no reform, even in an area as mundane as budgeting, then your successor as Gordon McKay Professor of Computer Science, will be facing the same problems twenty years from now, as you face today.
At the next faculty meeting, why don’t you or one of your colleagues say “Your Deanship, this faculty believes it is imperative to have a long term budgeting process so we do not have to live from year to year without knowing what our funds will be. We are involved in a long term educational process and that calls for long term planning.” As I said in an earlier post, you’re not producing steel on order in any one year.
In the meantime take solace in this; we’ve seen the photo before, but the verbiage is quite funny.
http://www.huffingtonpost.com/2009/04/26/summers-on-falling-sleepi_n_191487.html
4/28/2009 12:06 am
I suspect the Dean would respond:
“I agree! I would love to know what three- or five-year payout will be.”