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The Impending Bubble Bursting of Harvard, Yale and possibly Stanford Universities

May 26, 2013

In the housing bubble that burst, many financial institutions carried what are known as Tier 3 assets. These are assets whose value was no more than hypothetical–mortgages, for example. Their market value was “marked to a model.” If your computer program said a particular piece of paper was worth 96, you wrote down 96. Moody’s and Standard & Poor’s said the paper was AAA and therefore worth 96. But we know now that most of that stuff was garbage. And it is that kind of stuff that makes up a very large share of the endowments in question.

Harvard University and most other elite schools do not manage a lot of their own money. A hotshot private equity guy comes in and says invest in our fund, and Harvard gives him $100 million. He goes out and invests in new ventures or buys companies; wherever he does, he marks it to model and Harvard accepts his numbers. Now the fund manager has every incentive to jack up valuations, just as Fannie Mae and Citibank did, and just as everybody else who was using mark-to-model did. And Harvard loves to accept the numbers with pride.

So they spent money and gave everybody raises. Harvard went out and bought huge amounts of acreage in Boston. Yale bought a lot of acreage. They thought: We have all this money; it is time to expand; we can be generous. So did the non-profit organization I was fired from called Liberty Resources, then a year later they had to lay off half their personnel. Harvard, however, began borrowing. They began selling bonds to the public, based on their respectable names and their AAA credit, and the market bought into it.

Harvard, Yale, Stanford and other universities for the first time in history now have debt on their balance sheets. They have bonds they have to pay off. At the same time, many of the portfolio managers have leveraged the portfolios. They have bought things on margin. It is a classic case of how companies and institutions get into trouble. They borrow money, being told there is no problem. Things go bad, then things get worse, and they realize that this is a permanent state, that they have a serious problem. It is especially a problem in academia because they cannot cut their expenses. They have unions, tenured professors. A professor at Salem State College in Massachusetts once told my class that he got into teaching because he saw that during the Great Depression his parents didnt lose their jobs because they were tenured professors. Think about that, he basically said he got into teaching for job security and not because he has a passion for teaching or because he is even good at what he does.

Then there are the many off-the-balance-sheet obligations. One of the more absurd requires the school to pay for the college education of the children of any parent–not just a professor–who has been employed by the university for ten years. An employee with three or four children represents over $1 million of future obligations.

Some of the people running these university financial departments are not terribly clever. The same is true of many pension plans. Many state and city pension plans are bankrupt. In the next bear market, whenever it comes (and it will probably hit pretty soon), you are going to see more of the same. It will come as a huge shock to the world when Harvard University or Princeton or Stanford goes bankrupt, when these institutions that have been around for decades, for centuries in some cases, understand how bad their finances are. But it will not come as a surprise to my readers, will it?

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From → Economics

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