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University finances - Barokong

Colleges and universities are being badly hit by the Covid-19 virus. The spring and summer were pretty bad.  If, as likely, it extends into the fall things will be much worse. The tragedy of all this, for large private colleges, is that our administrations apparently learned nothing from 2009, and set themselves up for exactly the same (if not worse) financial crisis.

The exposure

It's hard to think of a business model more susceptible to pandemics. Students come to universities from all over the country, and all over the world. Many US colleges are highly dependent on full-tuition revenue from overseas, especially China. College education was a big export industry for the US, which travel and visa restrictions are likely to kill.

Many state schools depend on people paying full tuition from out of state. Lots of people are not likely to want to pay for online classes, and they certainly don't want to pay more quarters of room and board while living at home in another state. (This might be good for some flexible state schools or community colleges that can let people pick up some transferable credits).

Classes are really not the problem.  Undergraduates barely go to classes anyway, and, as reviewed in previous super-spreader posts, we have not seen classrooms as a site of such events. It seems like if people don't talk loudly, they don't spread the virus. The main problem is that the college experience in most of the US centers on a loosely supervised alcohol-fueled bacchanalia. As Stanford's president put it delicately in a recent email to faculty and staff,

A key challenge is the highly communal nature of our undergraduate living, dining and learning settings, which are not conducive to the physical distancing that has been a key means of controlling the pandemic...

How to spread Covid-19? Nursing home. Aircraft Carrier. Cruise Ship. Jail. College dorm or fraternity.

A single “Beer Pong” party where participants shared drink glasses at an Austrian ski resort is credited with producing hundreds of infections in Denmark, Germany, and Norway (Hruby, 2020)

reports the excellentNBER working paper on Covid-19 models by Christopher Avery, William Bossert, Adam Clark, Glenn Ellison and Sara Fisher Ellison. Judging by the remains on my daily run past the frats at Stanford, normal life here consists of a lot of beer pong.

(Digression. This is really a great paper. If you think "science" has anything on economics when it comes to forecasting models, you will see we are in the same boat. One of the best and most subtle points comes in discussing standard errors starting on the bottom of p. 25. The models all miss their 95% confidence intervals all the time. That tells you something about the confidence intervals. Delicious quote from Jonathan Dushoff:

“Retrospectively, the most successful looking model is also likely to be a model with narrow confidence intervals, where there was some luck involved in making the model forecasts look good. In cases where there's a lot of models, and not so many realizations, this is very likely to happen.

Welcome to finance everybody. End of digression.)

There is also a population of students who have nowhere to go, who remain on campus, on financial aid.  Many universities depend on their hospitals for a steady flow of cash. The Covid wards are busy, but with many medicaid and uninsured patients, while everything else is empty. Hospitals are draining money right now.

The money

The president's email gave us a suggestion of the situation at Stanford (also reported in theStanford Daily)

For the current 2020 fiscal year, which ends in August, we are estimating a $200 million reversal in the consolidated budget of the university, leaving an anticipated $100 million deficit at fiscal year-end. The challenge is likely to grow in the 2021 fiscal year, when we expect to see reduced operating revenues in a number of areas as well as a potentially significant decline in endowment payout based on losses in the financial markets.
$200 million from March to August alone is real money. And students had paid tuition, room and board for spring. (I don't think they were refunded anything. Were they?)

Douglas Belkin and Melissa Korn write in WSJ that our nemesis to the north (on big game day) has the same loss

The University of California, Berkeley,..So far, the school has had a $200 million hit from lost revenue and additional expenses. The university’s annual operating budget is $3 billion.

Ted Mitchell, president of the American Council on Education..estimates the number of students on campus will decline by 15%, leading to $23 billion in lost revenue
At Brown,

$22 million in lost revenue and additional costs. Dr. Paxson anticipates that will rise to between $80 million and $90 million next fall.
(The article also mentions the delicate question of Rhode Islands requirement that anyone coming in to the state quarantine for 14 days. Again, a business model dependent on students flying back and forth 4 times a year from out of state or out of the country is really susceptible to travel bans.)

State colleges and universities depend on state budgets. State budgets are cratering. Melissa Korn, writing in WSJ reports

Montclair State University, in New Jersey, said it has been told not to expect $12.3 million of state funding it had been counting on for the rest of the current fiscal year, after Gov. Phil Murphy slashed funding in light of the coronavirus’s toll on the local economy. That’s about 25% of the university’s annual state appropriation.  ..
If fall is virtual, the financial carnage will be huge.

Budget cuts

The budget cuts are coming.  At Stanford

the provost has asked units across the university to develop budget plans for a scenario that includes a 15 percent reduction in endowment payout and a 10 percent reduction in general funds for the 2021 fiscal year.
Budget cuts, hiring freezes, pay freezes and pay reductions are already under way at colleges across the country. The University of Arizona already announced furloughs and wage cuts up to 20%. So much for sticky wages. From the earlier WSJ, at Montclair state

.To make up for the unexpected loss of funds, the university instituted a hiring freeze, eliminated temporary and contingent positions including non-tenure-track instructors, deferred capital projects and is planning to offer fewer, larger classes come fall, she said
One might say that universities have an over-bloated staff and a lot of deadwood so this might not be a terrible thing. But that requires an administration ready to impose pain on entrenched constituencies. Not hiring promising new researchers is a lot easier.

The 2008-9 recession led to exactly the same responses.


Well, if you're a business phenomenally exposed to a pandemic, and, as we learned in 2009, exposed to financial crises and recessions too, my wouldn't it be handy to have, say $30 billion in assets lying around (Stanford). Or $40 billion (Harvard). Every other business in the country is counting how many days they can last until the cash and borrowed money runs out. Wouldn't it be great to have enough assets for four years worth of expenses ($6.8 billion budget). You could keep your faculty and staff, you could go out and hire all the best young people in next years' carnage of a job market, you could go poach the best senior faculty.

Wait a minute, we have cuts and freezes too -- just like 2009 (and just as Harvard, Chicago, and all the other big private universities did in 2009). What the heck is going on? How can you have $30 billion in the bank and budget cuts and salary freezes?

Well, that's not now it works. The endowments of major private universities have next to no cash. Actually they have next to no liquid assets. Here's as much as I could find on the Stanford management company website

Right away you can tell that the private equity and real estate is completely illiquid. My understanding from other sources is that the rest of it is all actively managed and highly illiquid. The Stanford management company (for a fee) sends its investments to managers who, for a fee, buy the actual investments, which are mostly illiquid. A colleague guesstimates the fees at $700 million dollars.

So, bottom line, private universities can't sell the assets if they wanted to. (We also don't want to. Universities hold to payout rules and do not use endowments as a rainy day fund. They don't even borrow against endowments. Long story, but one that could have been changed between 2008 and now.)

Moreover, we're leveraged. Large private universities are allowed to borrow money tax-free. I couldn't find the total, but I did find one issue for Stanford at $500 million.  When I looked, Chicago had several billion in debt.

Everyone wants to be a hedge fund. Borrow short and cheap, invest in illiquid, high-fee, actively managed, cyclically sensitive securities. Report great returns. And, in the downturn, carnage ensues.

I would be kinder about this if we had not gone through this a mere 12 years ago. In 2009, all the major universities faced financial carnage. Despite pleasant disclaimers about being "long run investors" who could "wait out market downturns" (Chicago's website in 2008), in the crisis it turned out universities had to roll over debts at high interest rates, and tried to sell in a crisis. Harvard tried to sell its portfolio of private equity in .. December 2008! It was only saved by a complete absence of buyers. It had a hiring freeze while the endowment was supposedly $45 billion dollars. Chicago did manage to sell most of its equity just about exactly at the bottom.

Well, once burned twice shy they say? No. Like everyone else in America, universities went right back to the hedge fund with a football team model. And here we are again. Budgets evaporating. And firing people, cutting wages, and missing opportunities.


University endowment practices are quite a puzzle. Why do universities invest in assets rather than people? When huge corporations sit on cash, we assume they have no good investment projects. Why do they follow a fixed payout policy rather than, as above, use them as a buffer stock? Why are they invested in obscure, illiquid, hard to value, assets, with at least two layers of high fees (university management + asset managers) rather than, say, have one part-time employee and put the whole business into Vanguard total market for about 10 basis points? Why do they leverage with short-term municipal debt which must be rolled over at the most inconvenient times? Why do university preseidents seem to glory in great endowment returns in good times, but these occasional liquidity crunches are seen simply as acts of nature, not preventable with a nice pile of liquid assets?  Why do donors put up with this -- why do donors give money that will be managed in obscure high fee investments, rather than demand low-fee transparent investment, or even set up separate trusts, transparently managed, to benefit their alma maters?

Thomas Gilbert and  Christopher Hrdlicka have a nice paper on some of these issues, "Why Are University Endowments Large and Risky?" in the Review of Financial Studies. As they document, the practice of paying out a fraction of value, but in the old parlance never touching the "principal," is due to regulation in the Uniform Prudent Management of Institutional Funds Act (UPMIFA), and like all regulations has unintended consequences. They

seek to explain why universities (and nonprofits more generally) that have productive internal projects sufficient to motivate their high donation rates tolerate the opportunity cost of building large and risky endowments.
They construct a nice economic model to try to understand this behavior and see what levers might result in a more efficient outcome. In their model, the payout constraint

prevents the endowment's use as an effective buffer stock, thereby increasing the volatility of production, and it slows the growth of the most productive universities.
It's surely worth more economic investigation.

The other salient feature of universities is that they are non-profits. This doesn't mean they don't make profits. This means they don't have shareholders and so are insulated from the market for corporate control. If you think a company is badly managed, you can buy up the shares, take over the company, and set things right. You can't do that with a university, hospital, or other "non-profit," which naturally leads to high staff and expense levels.

More updates:

This post seems to inspire my email correspondents. It's probably easier to keep updating here than to add posts.

Where are the trustees? Well, I speculated to one correspondent, there is a natural selection bias. How do you get to be a university trustee? 1) Make a ton of money as a (lucky) active asset manager, especially on trades and investments that come from college contacts;  2) Collect a lot of fees;  3) Persuade yourself how smart you are and how easy the alpha game is 4) Desire to socialize with the people who run universities. This is hardly likely to produce contrarians, fans of scientifically validated, quantiative, low-fee investment strategies.

My correspondent did the leg work for Stanford, and adds up our trustees thus:

32 Stanford Trustees

18 investment banking and hedge funds.  (2 indirect as wives)

9 tech.  1 of them a wife

2 manufacturing. (1 GM, 1 housing)

1 retail.

2 law (1 wife)

Wives typically run foundations related to education. "Wife" rather than the usually appropriate gender-neutral "spouse" is technically correct.


A second correspondent found Stanford's actual debt. Roughly speaking it's $2.5 billion total outstanding. Why borrow and invest at the same time? Because we borrow at tax free rates and don't pay taxes on investment returns. By hedge fund standards it's not a lot of debt though. When I left Chicago was a lot more leveraged. (Chicago was making huge investments in plant and faculty however, exactly the lack of which I was criticizing above. Though it was contentious, I agreed with President Zimmer's view that Chicago had one chance to invest in human and physical capital to stay on top.) I note with pleasure that Stanford's debt is almost all long term. Unless there are swap contracts I don't know about (that's what got Harvard into trouble in 2009), this is praiseworthy. I wish the US were funding itself so long term. It means if (when) interest rates rise, Stanford won't be hit by big interest costs, or rollover crises.

My correspondent also found Stanford's 2019 financial report.

Tuition is not a big deal -- unlike the case at most universities. In part, Stanford like other large private universities runs one of the biggest price discrimination games in the country,

48% of undergraduates were awarded need-based financial aid from Stanford while 81% of graduate students received some form of financial support.
Imagine how happy United Airlines would be if they could ask for your 1040 and a statement off assets before quoting you the price of a ticket to New York.

Most of the money comes from "sponsored support,"

Sponsored support is the largest source of operating revenue, representing 27% of total revenues. The majority of the University’s sponsored support is received directly or indirectly from the federal government. The Department of Health and Human Services (DHHS) and the U.S. Department of Energy (DOE) are the two largest federal sponsors.
and 20% comes from running a hospital. (One look at the bills they send tells you a lot about that, and its durability. Most recently, 10 minute telemedicine video chat about a hand injury cost $680 after "insurance discount." When Stanford gets the medicare for all that most of its faculty vote for, watch out.)

This provides an interesting look at the real risks to the budget. That so much Stanford research ends up cheering the federal government is at best a noteworthy coincidence.


Melissa Korn, Douglas Belkin and Juliet Chung have a long update on colleges and universities in WSJ. As you would imagine, small tuition dependent liberal arts colleges are most heavily hit. They were already in trouble.  Recessions do wipe out marginal businesses.

Even before the virus hit, many colleges and universities were running on razor-thin margins, with 30% of those rated by Moody’s Investors Service showing operating deficits.
Published tuition rates had skyrocketed, but few students actually paid full price. That left schools fighting over a limited pool of wealthy prospects. Some schools had turned to international students to bolster revenue—a strategy that may now prove to be a liability....
Before the pandemic, about 100 of the nation’s 1,000 private, liberal-arts colleges were likely to close over the next five years,
But trouble is brewing at the top too.

Princeton University, one of the wealthiest in the country, with an endowment valued at $26 billion last year, announced a salary and hiring freeze. It is cutting back on all nonessential spending and won’t renew employment deals with some contract workers...
Johns Hopkins University went from projecting a $72 million surplus this fiscal year to expecting a net loss of more than $100 million. ...
One major factor: revenues have plummeted as the Johns Hopkins Health System abandoned most elective procedures in response to the pandemic, illustrating a particular vulnerability for universities with major medical centers.
Mr. Daniels [President] has detailed plans to cut salaries and suspend retirement contributions and capital projects.

The Stanford Daily reports

When asked if it was possible to address the deficit by decreasing the endowment principal — the core invested portion — Drell responded that “options are open,” but only 20 to 25% of the endowment can be used, without legal restriction, for the University as need may be.
“There is a real caution that needs to be applied in using long-term funds for short-term needs,” she said.
One can also borrow using securities as collateral.


Disclaimer: This is not about Stanford, nor is it a complaint about any individual. The general character of the endowment was similar when I was at Chicago, and my understanding of Harvard, Yale, Princeton, Columbia, etc. is that it's broadly the same everywhere, as it is at major nonprofits. As Gilbert and  Hrdlicka point out, economists should regard any behavior this uniform as an inevitable and rational response to some screwed up incentive.

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