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Economic Impact of a Debt Crisis on Harvard University

Posted on February 21, 2009 by Adam

I’ve written in the past on the deleveraging of the debt bubble that has contributed to this financial crisis, but I was reminded of just how bad things are when I read an article in the New York Times talking about how Harvard is managing its endowment portfolio during the downturn.

Like all Universities, Harvard generates a substantial portion of its cash its for operating activities by investing its multibillion dollar endowment. According to the Times article, that portion is about one third. To me, Harvard represents the quintessential institutional investor. During the years leading up to the crisis, Harvard, like most financial institutions, took on an enormous amount of debt and leveraged it in risky assets.

According to the Times,

“The endowment was squeezed partly because it had invested more than its assets, a leveraging strategy that can magnify results, both good and bad. It also had invested heavily in private equity and related deals, which not only lock up existing cash but require investors to put up more capital over time.”

This is a shining example of institutional risk taking gone mad. When Harvard needed to raise cash to pay off the immense bets it made on interest rates, it was forced to sell $1 billion in leveraged equities.

“All went well at first. But in the second half of last year, interest rates plummeted, and Harvard turned to the endowment to meet hefty collateral calls, which could rise to $1 billion if rates remain weak, according to a person with knowledge of the university…. To free up cash, Ms. Mendillo [The endowment director] has had to make some unpleasant choices, selling $1 billion in equities, including some in hedge funds with outstanding performances.”

Keep in mind that this process of deleveraging assets was going on and continues to occur throughout the entire financial industry. It’s impact can be seen in the stock market, which just printed 6 year lows. All because we borrowed too much money. Clearly, this situation needs to be reset. Debt needs to be refinanced and repaid. The sooner we can eliminate the debt, the sooner we can start to recover and rebuild. It is painful, but necessary. That’s why I was alarmed when I read this:

“The school has even added to its debt by issuing $1.5 billion in new bonds, its largest such offering ever…. Like Harvard, many schools are responding by taking on more debt. Princeton sold $1 billion in bonds recently, its first taxable offering since 1994.”

Wait just a second. Did I read that right? We are taking on more debt to repay old debt? Are you SERIOUS?

And don’t think this nonsense is limited to the finance sector. I’ve lost count of how many billions of dollars the government is spending on economic stimulus. Where are we going to get that money? We can print some, yes, but a large portion of the money will have to be borrowed.

Jeez, when will we ever learn.