Undowments: Higher Education Goes for Broke

Peter Wood

Barron’s cover story this week—festooned with a college grad wearing an academic cap, a barrel, and nothing else—is titled “Crash Course” and examines the sorry state of many college endowments. If you are looking for evidence that someone else’s portfolio is performing worse than your own, perhaps you’ll be cheered by the dizzying losses that appear to have afflicted many college endowments. 

The operative word is “appear.” Since non-profit colleges and universities don’t have to report the performance of their investments except at year end (usually June 30), Barron’s senior editor Andrew Bary had to puzzle out the picture.   Based on the asset allocation formulas that many college fund managers are using, Bary estimates that Harvard, Yale, and Princeton’s endowments are “could be down 25% or more since June 30 if they were to assign realistic values to their illiquid investments.”

Of course, Harvard, Yale, and Princeton are rich enough that even these multi-billion dollar losses won’t be disastrous. The bigger problem in Bary’s view is the many other colleges and universities that, envious of the spectacular growth achieved by the Ivies’ investments in recent years, adopted similar high-risk approaches. They poured money into hedge funds, private equity, and “real” assets (e.g. real estate, timber, oil). 

Many hedge funds are dissolving and others have a sickly pallor. Private equity, which generally means investment in young companies that have yet to prove profitable on the hope of big returns later on, has been spooked by the poor economy. Investors forced to sell their private equity holdings are getting only about half their stated values. Real estate is down 35 percent. 

How much does this matter for higher education? A lot.

Some of this can be measured by the announced cutbacks at many colleges. Bary mentions Wesleyan’s decision to delay the construction of a new science building and a partial freeze on hiring. Cornell has done likewise, as did Boston University a few weeks ago. 

Bary’s analysis is worth reading in full, but we can add some other factors that would seem to make the situation even worse. First, while income from endowment is significantly off, most colleges and universities also look for significant revenue from tuition and fees—and this source is also under pressure.   Loans are becoming harder to get; the demand for government grants is increasing faster than the supply; parents are hard hit by the recession; and colleges and universities are nonetheless increasing tuition. Second, higher education is deeply confused about its purposes and thus seems primed to make mistakes about how it handles the financial crisis it now faces.

Living on Borrowed Funds

The issue of revenue from tuition is, of course, complicated. Colleges charge widely different amounts; some are heavily subsidized by their states; and differences in “price” have an erratic connection with underlying real costs. The more prestigious colleges charge more without necessarily providing more service or a better education.   And almost all colleges practice Robin Hood pricing in which they charge more to the affluent and turn a portion of that revenue into financial aid for the less affluent.   All these factors make it difficult to say straight out what the squeeze on tuition revenue will mean.   But a few basics are clear: colleges will have less money; financial aid will be scarcer; and fewer students will attend the higher priced institutions. 

The higher education “industry” spends $375 billion a year and, as one observer recently put it in The Chronicle of Higher Education, is “anything but a model of efficiency or frugality.”   It has gotten away with gross mismanagement, however, because students have kept on coming, parents have kept on paying, and lenders have kept on lending.   A visitor from far away might ask the question Americans themselves seldom seem to ask: "Why?"  The actual answer is a bit disconcerting if you think it through. It is that large numbers of teenagers and especially their parents are convinced that attending and earning a degree from a four-year college is a necessary prerequisite to having a prosperous career.  

This is, of course, a belief, not an ascertainable fact. It is especially not ascertainable in the case of any individual student. A college education may or may not be part of the recipe for a prosperous life.   We gamble that it is and, in a fair number of cases, the college educated do prosper.   But because it is a long-term gamble, it is next to impossible to hold a college accountable in the here and now for the quality of the education it provides, as measured by the lives of graduates.   The results that matter come perhaps ten, fifteen, or twenty years later, by which time the money was long spent, the other options long foregone, and the college itself likely to have long since moved beyond the curriculum that graduate studied “back then.” 

I doubt there is another “product” or “investment” that people buy with such vague hope. If we buy a house, we get it inspected first, and in any case soon learn what works and what doesn’t. If we buy a car, it comes with a warranty and we know what’s wrong before we’ve driven it far.   If we buy into an investment fund, we watch how it performs. But if we buy education, we buy a tissue of hopes and illusions. Expensive hopes and illusions. 

I don’t say that out of cynicism. I personally believe in the deep intrinsic value of a good education. I am just skeptical of the logic of treating higher education as, primarily, an “investment.” But the higher education industry, led for example by the endless cheerleading of the American Council on Education, has ceaselessly extolled the value of education as a virtual guarantee on a high future income. There is a good deal of deception in this claim. A large portion of students who enroll as freshman and pay their expenses never earn their degrees. And a great many families miscalculate that the more they spend on tuition to attend “better” colleges, the more likely their future college grad will end up affluent.  

Because the imagined pay-off of a college degree lies far off and because it can be imagined to be as large as we wish, colleges have found it fairly easy to convince students to borrow against future earnings. Sixty percent of college graduates now graduate into debt for the funds they borrowed to meet tuition, and the average debt is $22,700. (That’s according to the College Board’s Annual Survey of Colleges.)   To put this another way, colleges operate to a great degree on borrowed funds.   Over $85.9 billion of their income comes from loans ($68,586,000 in federal loans and $17,300,000 in private loans as of 2006, according to the College Board).   That is to say, about 23 percent of total income to colleges depends on convincing students to become long-term debtors for this amount. 

Students seldom seem to resent this. They are instead grateful for the grants that they do not have to repay.   Federal, state, and private grants are another nice source of income to colleges, amounting to another $34.6 billion per year (in 2006): $18.5 billion from federal grants; 6.8 billion from state grants; and $9.3 billion from private sources.   These funds flow, however, only when students enroll, and therefore are also tied up with the capacity of the colleges to entice students into long-term debt.

The numbers I have been citing are a few years old, and the years in between make a difference. The world of student loans has been in turmoil, partly caused by the more general financial crisis and partly by herky-jerky attempts of Congress to deal with widespread fraud in the student loan industry and then by the market’s unforgiving reaction to the Congressional reforms. One result has been a shift away from private loans. As the Chronicle reports (November 7, 2008):

The volume of private loans shrank by $173-million, or about 1 percent, to $19.1-billion in 2007-8. That decline reverses years of double-digit growth and does not reflect the recent credit crunch.  At the same time, the volume of federal loans rose by 6 percent after inflation.

In general, higher education is relying more and more on a model in which the federal government will, in various ways, prop up the student loan system. This includes getting the government to buy more and more student loans from lenders who might otherwise drop out of the market. In October, President Bush signed HR 6889, which extended the Ensuring Continued Access to Student Loans Act, which is essentially a bailout of the student loan industry. Treasury Secretary Henry Paulson and Education Secretary Margaret Spellings issued a joint press release heralding the good news

Today the Department of Education announced still more aid to ailing lenders. As Inside Higher Education reports:

So far… only two lenders have sold $62 million in loans to the department, and four more are expected to sell another $350 million in November, the department reports. But nearly 800 lenders have indicated to the department that they would like to be able to sell loans originated for the 2008-9 academic year.

But DOE is adding to this a provision that will create “a middleman between groups of lenders and outside investors” which would “purchase student loans that were fully disbursed between October 2003 and July 2009.” This sounds as though the government is absorbing the function that used to be performed in the private sector by First Marblehead, before that bank ran onto the financial rocks in late 2007.

A few weeks ago, the National Association of Independent Colleges and Universities released the results of a survey of 500 colleges, in which 57 percent reported that ten or more of their students had been unable to secure a private loan for this semester. And 45.8 percent of the colleges reported that some of their students had dropped out or gone to part-time status as a result of not getting enough financial aid. (See Inside Higher Education, October 22, 2008.)

Most of the talk about the overall student loan situation, however, has not focused on the fragility of this system and its seeming destination in a shrinking pool of dollars available for college loans.   Rather, the talk has been of the likelihood that college will be become less accessible to students who are not affluent, and that higher education will have to endure some belt-tightening. 

These are real enough worries, but in conjunction with the sharp decline in endowments, they seem possibly to understate the magnitude of the problem. Even if the federal government’s attempts to nurse the student loan back to health succeed in some measure, students and their parents will have to be willing to take those loans. And that raises the question of whether higher education will remain in its current form the beneficiary of the kind of blind hope that has sustained the system so far. 

To What End?

In most recessions, higher education thrives. That’s because the opportunity costs of attending college fall. If well-paying work is scarce, many people will take the time to finish degree programs or seek additional education in hope of improving their chances later on. In this sense, higher education is counter-cyclical. When the economy is bad, higher education—especially its vocational side—thrives. Will that be the case this time? 

I expect so, but I wonder whether this trend might work mainly to the advantage of two-year and relatively inexpensive state universities. The more expensive four-year private institutions look to be at an especial disadvantage. They are in the midst of a financial crunch, often accompanied with a sour combination of news in which they admit to freezing projects and hiring while increasing tuition—in most cases by significantly more than the rate of inflation.

These are circumstances that invite students to take a hard look at what higher education really has to offer.  There are some disquieting aspects of the picture. The growing tendency of colleges to spend substantial amounts on therapeutic-minded student affairs programs; the sunk investment that many colleges have made in high-end dorms and recreational facilities at a time when families are forced to retrench on their own domestic budgets; and the ever-more-apparent politicization of the curriculum are the sort of things that eat away at a family’s willingness to trust that “no price is too high” for their children’s future. 

Does it matter that a great many colleges offered college credit for students who went out to campaign for Obama? Does it enter the calculation that tuition dollars at many colleges now cover “service learning,” where the student volunteers in something off-campus? Or likewise, internships, where a student actually pays college tuition and receives academic credit for low-level work in a business or non-profit? 

These little drips don’t by themselves matter. It is always possible to explain away individual inanities—the speech code, the invitation to Ward Churchill, the campus hysteria over what proves a fictional hate crime. It is even possible to turn a blind eye to the college dorm as the place where students are inducted into binge drinking and the STD rate rivals that of Third World brothels.   It is getting less easy, however, to ignore the preoccupation of much of undergraduate education with an estranged view of American life, one that foregrounds our nation’s faults and offers a vague sense of liberation in lieu of an education. 

Will learning the mantras of diversity, world citizenship, and sustainability really carry a young man or woman forward to a prosperous and worthwhile life? No doubt some parents think so, and others think that their son or daughter will be immune to four years of these suasions. But other have doubts and if you add those doubts to the prospect of attending a college in financial disarray, perhaps those doubts will begin to weigh more heavily than they have in the recent past. 

I am not sure how one models the effects of disenchantment with campus ideology in a situation where doubtful management practices, plunging endowments, and budgets strained by the faltering student loan system have begun to converge. But it does appear to me that higher education is entering a period of significant vulnerability.   And to the extent that opens up possibilities for real reform, I welcome it. 


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