Saturday, December 06, 2008

Financial brilliance?

About five years ago, as I recall, I had an interesting conversation with my friend and Harvard classmate Bill Strauss, who had heard some interesting gossip about our alma mater. It concerned the management of the Harvard endowment. Because the endowment managers--most of them, anyway--were employees of a non-profit, Harvard had to disclose their compensation. Their compensation, like that of most fund managers, was based upon the performance of the part of the multi-billion dollar endowment which they controlled. Putting all that together with the easy money of the first half of this decade had produced striking results. Inidividual managers were receiving bonuses of up to $30 million in a single year. Bill Straus, who sadly died of cancer about a year ago, had an odd mixture of views: he was a social conservative but an economic liberal who believed that the endowment of a university was supposed to benefit the university community, not the men and women who managed it. He was particularly outraged because these bonuses--which, he calculated, would have paid the tuition and fees of an entire Harvard class for one year--were being paid while tuition consistently increased an annual 3-4%. He suggested that we start a protest, and we did. Initially a total of seven classmates joined in: a writer and entertainer (Strauss) two attorneys (both of whom worked thousands of miles from Wall Street), a journalist, a freelance writer who was in the process of becoming a clergyman, and two academics (including myself.) In a series of letters addressed to Harvard President Larry Sumemrs, we made a number of suggestions: that the compensation of any Harvard employee be limited to what the President of the University made (about $750,000); that tuition be frozen and eventually cut back, so that today's students (who were paying more than three times as much for their education, adjusted for inflation, as we did) would not have to begin their careers with a large burden of debt; and that Harvard establish a program of loan forgiveness for students who went into some form of public service. Our campaign immediately attracted significant publicity, and the reaction we received was quite revealing.
President Summers, an economist and former Treasury Secretary, never signed his name to a reply to any of our letters, but he spoke to use directly at our 35th reunion in 2004 and told us that we were "deeply misguided." The performance of the endowment managers had been spectacular, he said, and they deserved every bit of their reward. I heard equally patronizing reactions from every financial professional with whom I discussed the issue over the coming months. "Those guys are oustanding," I remember an investment banker telling me in the gondola at Stowe, "and they should get every penny they want." Michael Lewis, the author of Lia'rs Poker, wrote an extremely patronizing column about us when Summers began to show some signs of taking us seriously, arguing that our dubious moral outrage was having an influence even on those who actually "understand how the money game is played." I heard however that at least one of Summers' associates in the financial world--a veteran of one of New York's leading investment banks--had expressed private agreement with us that the fund managers were being exhorbitantly compensated, and eventually some action was taken. Jack Meyer, the chief endowment manager, and several of his colleagues left the employ of Harvard to start their own hedge funds. They apparently remained the managers of a good deal of the endowment, however, under financial terms which no longer had to be disclosed. Meanwhile, in the last three years (during which Summers also stepped down for a variety of accumulated reasons), some real steps were taken. A new manager was appointed at a much lower salary (but continued to show excellent results through 2007), and Harvard announced a new financial aid policy designed to reduce tuition and fees to a much more reasonable proportion of family income. We were very pleased by that.
All the while, however, I personally had been troubled by another aspect of the situation. While not a financial professional, I had done what I could to study the publicly available financial accounts of Harvard to try to estimate the benefits that the university was reaping from the reported enormous increases in the endowment. Without being able to review the data now, I can report that I could not find commensurate benefits in the figures. The endowment was said to be growing by leaps and bounds, but from what I could tell the proportion of the university budget which income from it was funding was not increasing nearly as much. I tried to get more of an explanation from Harvard financial officers but never succeeded (at one point I received a set of figures that did not seem to be consistent with the official published documents.)
What I was wondering was whether the gains would in the long run turn out to be genuine. As was frequently explained to us, the managers were running the endowment like a hedge fund, leveraging its substantial cash with other people's money to buy some highly speculative assets. The compensation for the managers, moreover, depended on the annual increase in the estimated value of those assets, not, apparently, on the amount of increased income they provided in the short term. That seemed to me to be an invitation to value assets as highly as possible, and to put short-term growth ahead of long-term income--exactly the opposite, one should think, of a strategy more appropriate to a university. I suggested to my co-protesters that we raise these issues as well but I never could persuade them to do so. I did read in the last two years, however, that two of the hedge funds started by former endowment managers had now collapsed.
On Thursday, walking through the Providence airport, I noticed the front page of the Wall Street Journal and saw that the other shoe had dropped. The Harvard endowment had lost at least 22% of its value during the first four months of 2008. That loss amounted to $8 billion, dropping the total to $36.9 bilion. "Harvard," the story continued, "said that the actual loss could be even higher, once it factors in declines in hard-to-value assets such as real estate and private equity--investments that have been increasingly popular colleges. [Harvard's new, aggressive endowment management strategy, the article indicated, had been widely imitated.]" The University anticipated a 30% decline for the fiscal year ending in July 2009. That means that the gains of 2005-7 would be completely wiped out, and I frankly doubt that the hemmorhage will stop there. The story added that Harvard has been trying to sell $1.5 billion in private equity holdings but that it had received bids amounting to only $.50 on the dollar. Eventually even those might look pretty good.
It was in the early 1990s that my contemporary Camille Paglia wrote a brilliant essay, "Junk Bonds and Corporate Raiders: Academia in the Hour of the Wolf." She used those words as a metaphor, to describe the takeover of university humanities departments by postmodernists selling increasingly popular intellectual snake oil. Now, however, the same title could be applied to what has happened to the financial resources of our greatest universities. Like their counterparts in the academic departments, the (mostly Boomer) managers of the endowment showed extraordinary cleverless, but an utter absence of wisdom. They turn out not to be the financial geniuses that so many people assured me that they were, but rather the modern equivalent of what Keynes called "sound bankers"--not bankers who were never ruined, but bankers who were ruined along with all the others. The increasingly popular financial practices of the last 35 years have now brought down the American economy--and have brought down the financial health of most American universities along with it.
I can't help expressing a little pride in my own very modest contribution to the economic health of my alma mater. I am not referring to contributions--I gave token ones in the past but stopped doing so in response to the current controversy. What I have done is to publish three successful books for the Harvard University Press. They were not the literary equivalent of sub-prime derivatives or private equity funds--those would be the celebirty-authored books that fill the best-seller lists, and which are bought far more often than they are actually read. They were, I like to think, carefully crafted products of some general interest for which I was modestly compensated, and which made modest, real sums of money for the press through sales to people who wanted to read them. It is now the task of the younger generation to put real money into investments like that--and to create new economic insitutions, I suspect, that will make more investments like that possible, and make stocks and bonds issued by productive corporations, rather than mysterious financial instruments, the investments of choice once again.


Anonymous said...

I don't see too many financial geniuses lauding Harvard's hedge fund strategy now. Frankly, it is disgusting how common sense got thrown out the window by the boomer generation in the face of any "get rich quick" scheme.

When 40% of the S&P500 profits were from "financial services" (and twice as many Harvard graduates joined Wall Street than the previous generation) you know you have a problem in the "real" economy.

HoosierDaddy said...

Like their counterparts in the academic departments, the (mostly Boomer) managers of the endowment showed extraordinary cleverless, but an utter absence of wisdom.

Did you mean cleverness?

I think the real issue is the whole financial industry is so overcapacity that there just aren't a lot of opportunities left. El-Arian and Swenson may have had a good idea but now everyone went to that fishing spot and there's nothing there but empty beer cans and muddy water. The self dealing of financial advisors has been an issue for government entities around the country, from Florida's money market fund to Transit authorities to Jefferson County Alabama to school districts in Wisconsin.

Anonymous said...

Hi David

why are people like you (intelligent, sober, community-minded, etc) always the ones petitioning the dickheads that seem to run everything in your country, to consider doing the right thing? How come the genuinely best and brightest never get within a bull's roar of real power in the USA, so that the right thing gets done from the get-go? The dickheads running Harvard are just a small subsection of a whole class of dickheads, hunnerds and thousands of them, running the finance sector, the national security state, Enron and the utilities, etc. And the there's the govt itself...

Rant over. I wanted to do two things - one, do you know whether Road to Dallas book will be available here in Australia? I could order it via Amazon but the shipping makes it expensive. I couldn't ascertain this from the book's site (by the way, it would be good if that site had a link to this blog...)

Also, I wanted to thank you for your efforts on this blog, which is now one of my regular drop-in websites. I don't always agree with your emphases but I am very often made to think bout things in a different way by what you write - so thanks, and have a good festive season and a great 2009.

Glenn Condell