The Globe on Harvard
Posted on November 30th, 2009 in Uncategorized | 17 Comments »
At last—the story that everyone’s talking about.
In the Globe, Beth Healy reports on how Larry Summers ignored repeated warnings about the risks of investing operating funds and Harvard wound up losing $1.8 billion at least partly as a result.
Through the first half of this decade, [Jack] Meyer repeatedly warned Summers and other Harvard officials that the school was being too aggressive with billions of dollars in cash, according to people present for the discussions, investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity. Meyer’s successor, Mohamed El-Erian, would later sound the same warnings to Summers, and to Harvard financial staff and board members.
Some key points:
* James Rothenberg speaks to Healy and says, “We all can look back now and say we wish we did something different.”
Drew Faust is quiet as a dormouse.
Rothenberg apparently felt defensive enough to inform the reporter that he had come to Harvard 65 times in the last six years. He does not say, however, whether the number of days he spent at Harvard was greater or fewer than 65.
* Things could have been worse. Summers pushed to invest 100 percent of Harvard’s cash with the endowment and had to be argued down to 80 percent, financial executives say.
* Summers’ defense, articulated by “a friend of his who is familiar with Harvard’s finances ” (lifelong Summers’ apologist Bob Rubin?): Don’t blame me, if I were still there, I would have pulled Harvard’s money from the markets.
Though Summers is speaking to every Washington journalist who wants to puff him up like a balloon at a kids’ birthday party, he would not speak to Healy.
* Turnover —Summers, Mohamed El-Erian, Ann Berman—didn’t help.
* During his year-long stint as substitute president, Derek Bok was understandably clueless about financial issues. “I concentrated on academic issues,’’ he said.
* Harry Lewis reiterates his argument that the Corporation is the real problem here: “The power is just in the hands of too few people with too little accountability.’’
* The overseers are, as per usual, clueless. I don’t mean to be mean, but really…someone in that group needs to grow a pair. What a bunch of invertebrates.
It seems fair to say that while there is some blame to spread around, the bulk of Harvard’s financial disaster can be laid squarely at the feet of Larry Summers.
Good thing he’s not running our national economic policy or anything.
17 Responses
11/30/2009 4:00 pm
“You might as well say,” added the Dormouse, who seemed to be talking in his sleep, “that ‘I breathe when I sleep’ is the same as ‘I sleep when I breathe!'”
“It is the same thing with you,” said the Hatter,
11/30/2009 10:23 pm
nothing of any consequence here. We are all asleep — at the wheel.
12/1/2024 7:59 pm
The last time university professors acted as such was in the 60s. They were emasculated after this. They have no power or interest in anything but themselves.
12/1/2024 8:06 pm
You have it wrong Richard. The corporation was not informed of the investment of the bank in the market. Of course, this is a very grave form of mismanagement. Perhaps this is why Larry was fired?
12/1/2024 9:33 pm
Richard,
Anonymous 8:06 is wrong (and why doesn’t anonymous they us who he/she is?). The Corporation knew about the investments of the bank as far back as the early 1990s, if not before.
1. Believe it or not, in the early 1990s under President Rudenstine, the banks had more than 100% of their equity tied to the endowment (the banks borrowed money).
2. Allen Proctor came in as VP for Finance and cut the position back.
3.In the mid 90s, my wife told Jeremy Knowles that investing the working capital of The FAS in the endowment was dumb and would eventually get Harvard in trouble. The Corporation ignored the warning. She was wrong, because the endowment kept growing and the wroking capital reached levels that would not have been possible had the bank been invested in what it should have been invested in… short term paper.
4. Earlier in this decade Jack Meyer and my wife strenuously argued (once again, sorry to repeat myself) that investing the working capital of the various schools in the endowment was dumb and would eventually get Harvard in trouble. This was in total opposition to Larry’s thoughts. Their argument was a simple one… you do not ever borrow short to lend long. To borrow short to lend long usually leads to fiscal suicide.
The Corporation and Larry ignored the warning. They were right and Jack and my wife were wrong. The endowment kept growing and (once again) reached levels that would not have been possible had the bank been invested in what it should have been invested in… short term paper.
5. The resources produced by banks at the various schools were used to fund all sorts of initiatives that the faculties loved. No faculty, at least that my wife is aware of, said that borrowing short to lend long was a recipe for disaster.
6. The Corporation was aware of this but didn’t change anything (as we have seen). If one argues that The Corporation wasn’t aware of this, then the members of The Corporation (and The Overseers) were not doing their job as fiduciaries. Corporate Board members have an obligation to watch the financial situation of the institution they oversee. Isn’t that taught across the river at HBS?
7. Overall, it was a fine thing, from the standpoint of results, for the University to invest it’s working capital in the endowment. The results, over a long period of time, speak for themselves. However, that was an anomaly. It is financial suicide, 99 out of 100 times, to invest working capital in long term assets. Working capital has a special meaning (i.e. transactions within one year).
8. Larry’s mindset today as a the head of The NEC, is the same as when he was Harvard’s President. The United States is borrowing short to lend long. I hope he’s as lucky today as he was then. I doubt that he will be and if that is so, we, as citizens, will bear the brunt of the mistake.
12/1/2024 9:56 pm
Sam- Glad we have you to set the record straight.
12/2/2024 8:49 am
thanks for your detailed explanation Sam, but your general principles aside the facts speak for themselves here. The 1.8 billion was not lost under Larry Summers watch, but last year, long after Summers had moved on.
If Larry, or Neil, had ignored good advice about how to invest the operating budget they were lucky. Perhaps their luck had to do with the exhuberance of the markets at the time. But over the last two years anyone watching the markets knew we had run out of luck and things were beginning to fall apart. Why did Harvard not immediately move to invest the operating the tank into short term t bills then? and, even more importantly, why isn’t anyone talking about the more recent and PRESENT management failures, and instead go on rehashing the songs of Summers failures? We all know he was a disaster as a President, but at what point does the conversation about accountability begin to focus on those who currently lead the University? Or, should we assume that Harvard is on autopilot and that present leadership is inconsequential?
12/2/2024 9:59 am
Missin’ the point.
My point was no different from yours. I did not say that the 1.8 billion was lost under Larry. In fact, I said that Larry made the university a lot of money and my wife and Jack were wrong (from the standpoint of results, not from the standpoint of logic or fiduciary responsibility) in arguing that the bank should not have been invested in the endowment. So, we are in total agreement or that.
We are also in total agreement that Larry had nothing to do with the banks after he left in June 2006. Unfortunately, many people, on this site and in other media venues, continue to place the blame on him for financial missteps that occurred long after he left. In my mind, that is simply wrong on their part. Someone else was in charge of the bank (and other aspects of Harvard’s financial situation) after Larry left. It was their responsibility.
Furthermore, there have been many charges made against Larry re the swaps that were put on while he was president. I happen to think that at the time they were put on, they were good for the university’s long term financial health. However, once he left, things changed with regard to the progress on Allston. To make an analogy with what Keynes said (” When the facts change, I change my mind. What do you do, Sir?”), if the Allston project changed, someone should have been looking at those swaps. When Larry left in June 2006, the swaps were slightly down (a mere rounding error). Someone other than Larry was responsible for monitoring the position. Even one year later, in June 2007, the swaps position could have been unwound at minor cost. Clearly, that was not Larry’s job to do it; he had been fired. Clearly, that was not Larry’s responsibility. Nonetheless, he has been constantly been blamed for the losses. It is unfair.
On the other hand, even though the bank investments worked out to Harvard’s advantage, I think President Bok and President Rudenstine and Larry and The Corporation were totally derelict in allowing the money to be invested in this way. It was just the wrong thing to do, no matter how well it turned out. It turned out well by pure luck. As I said, 99 out of 100 times it won’t turn out that way.
What was done at Harvard is now being done on a much grander scale in this country. I think Larry and his cohorts in Washington are making a huge mistake. Some of the things they are suggesting and doing are exactly the same things that got the country into the mess it’s been in the last two years (actually five years, but no one in charge was willing to face up to it for the first three). Have we not learned from that experience? Doesn’t look that way to me. Yes, “things” will eventually work out, but at what cost to future generations of Americans.
You can’t borrow short to lend long. Larry got lucky at Harvard but that shouldn’t be mistaken for brilliance. BTW, because there are all these people out there who have excellent knowledge of what goes on at The Corporation level (I’m thinking of you, anonymous 8:06, but there have been many others on this site), what is the bank invested in today? Is the university still rolling the dice or have more sober heads finally prevailed.
12/2/2024 10:13 am
No one I knew on the Faculty had a sense of how the bank was being run, Sam. But by early 2006 the faculty was well aware that we were headed into deficits that required very optimistic fundraising assumptions long into the indefinite future. Caroline Hoxby, reporting for the now-defunct Resources Committee, in January 2006:
To summarize, in the FAS budget for fiscal year 2010 there would be $28.5 million for Faculty growth, $72 million for new buildings, and $29.5 million for programmatic initiatives such as the Center for Brain Science, study abroad, and many others. Although there would be a base margin of -$10 million, there would also be some offsetting new revenue of approximately $61 million, the expected result of some good years for the endowment. Subtracting this amount from the $130 million of new expenses, the resulting $78.7 million represented the additional income needed by fiscal year 2010 to run the FAS. It was clear, Professor Hoxby said, that the FAS would be unable to pay for all of its major strategic investments merely by taking the money from its “checking account,” which had a balance of approximately $72 million. Instead, the costs of major strategic investments would have to be met by sustaining continuing sources of revenue such as fundraising.
Then John Campbell:
In conclusion, Professor Campbell admitted that the $108 to $122 million range was inexact. It would be false precision to claim to know exactly what the Faculty’s financial circumstances would be in 2010. But it was the Committee’s hope that today’s report would offer the Faculty meaningful guidance in thinking about its financial needs and goals during the next four fiscal years.
And then James Engell, in the discussion.
Professor Engell felt indebted to the three members of the Resources Committee for the wonderful job they had done in helping colleagues understand the Faculty’s financial circumstances. He wished to ask about the investment plan for fiscal year 2010. He would wonder if the plan’s figures assumed that a similar amount of money would need to be supplied each year thereafter. It was exhilarating to ski downhill, yet one wanted to be sure that the chair lift worked! A second, more difficult question for the members of the Resources Committee was what they considered the degrees of confidence and of worry in these projections. When one was young, two years seemed such a long way away, four years like an eternity, but in the present context four years seemed very soon. The fundraising assumption of a 9 percent increase per year, year after year, was encouraging, but nonetheless it was an assumption.
Not to worry.
Dean Kirby summarized the Resources Committee presentation, terming it a snapshot, part of a ten-year plan of investment above and beyond the endowment per se and continuing University support. In the long term, one of the large cost drivers was the construction of buildings. The investment could be compared to a home mortgage, a large loan that was paid off at a steady pace over time, while the homeowner’s income went up and the loan’s relative demands on him or her financially became smaller and smaller. He would suggest that this was a time of truly historic investment in this Faculty.
President Summers was presiding at this meeting and offered some encouraging words of his own.
12/2/2024 10:55 am
Harry,
Here was the fatal flaw. Bill said ” a large loan that was paid off at a steady pace over time, while the homeowner’s income went up.”
Why did Bill, Larry and others (so many on the faculty) think that “homeowner’s income” (think endowment) went up at a steady pace? That was sheer folly. Professors Campbell and Hoxby knew that that was not the way things worked in the real world. I said it on this site in 2005 and was loudly lambasted for my views… that markets don’t go up in a steady way and that in Harvard’s case, expenses were too high relative to sustainable income, and the endowment payout formula was broken and made no sense. Annie said the same thing over and over during the previous three years.
As you have said so elequently so many times, where was the governing body of the university? (Good) corporate governance requires that directors (or Fellows) are responsible for seeing that fiscal prudence is maintained. Someone looking at the structure might say that there is little to no accountability.
Where were the other faculties? The Dean of HBS is an expert on investing. He is the longest sitting member of HMC. Did he, and others who are knowledgeable about such matters (I’m think of some HLS professors and some FAS professors) speak up? It doesn’t appear to be the case. Where were The Overseers, some of whom had extensive knowledge of the way things work in the real world?
To get back to January 2006. If Larry left in June of 2006 and someone thought he was wrong in his assumptions and actions, why wasn’t anything changed after his departure? After all, he then had no control over anything at the university and almost all of what he had started could have been undone (similar to the swaps). Why didn’t the faculties speak out?
However, it goes beyond the faculties speaking out (although that would have been critical). It goes back to what you’ve been saying for so many years… where was The Corporation?
To bring it up to the current time, I would bet a lot of money that whatever formula is being used for the payout (and I don’t know what it is), is a broken one and will lead to still more misery for the university in the future.
12/2/2024 10:56 am
That prior post was mine.
12/2/2024 11:16 am
Harry, is the Resources Committee really defunct? Since when?
12/2/2024 11:22 am
If you are correct in your assumptions Sam, Harvard as a University is broken because the way it is governed has proven to be deficient. If this is true, Harvard will go down the drain as the world’s greatest university, much faster than we have to pay the price for Larry’s mistakes in the NEC. What is ironic is that, even today, as so many people can see what is wrong with the way the University is governed, the university seems to be on autopilot towards continuous decline.
12/2/2024 11:25 am
Those consultants who continue to charge hefty fees to advise those running the University might learn something from studying what happens in the airline industry when pilots make mistakes.
http://abcnews.go.com/Travel/northwest-airlines-pilots-miss-airport-150-miles/story?id=8892976
The Business School should undertake the preparation of a case study of the mismanagement of the banks and get to the bottom of how this happened. Harvard could turn the brainpower of its faculty to understanding what is so wrong with current governance, and to trying to fix it before it is too late.
12/2/2024 11:27 am
It is both too late and not late enough. Only after a total collapse of the University will there be the determination to open the black box and understand what was wrong.
12/2/2024 1:11 pm
The Resources Committee was never a Standing Committee of the Faculty-it was not created by vote of the Faculty. It was appointed at the discretion of the dean of FAS. It has not been reappointed recently — not sure exactly how long it lasted, but I suspect that the spring of ’06 was the last time.
12/2/2024 1:19 pm
There is a provocative pertinence to Gladwell’s theories about the reason for air accidents to Harvard’s situation
http://www.worldhum.com/travel-blog/item/malcolm-gladwell-on-aviation-safety-and-security-20090125/
Harvard is an ‘Outlier’ in so many ways. Would Professor Pinker agree?