PRISM Magazine - January 2003
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Shrinking Assets   

With university endowment funds continuing to erode, many colleges and universities will be forced to make deep spending cuts, probably beginning in 2004.

- By Dan McGraw

The stock market goes up, and the stock market goes down. It's pretty basic economic theory, something even a philosophy major in Economics 101 can understand. But in the past decade, some very smart people thought this rule of the stock market had run its course. Some economists, business journalists, and a whole slew of high-tech companies' CEOs proclaimed the new infotech economy recession-proof. This was a "new" economy, they all gushed, and everyone threw their money into dot coms that never made a nickel and into big companies who made that nickel and called it a dime.

Colleges and universities were no different. Throughout the 1990s they saw their endowment funds growing almost exponentially. The normally conservative endowment funds were seeing consistent double-digit returns—an average of 20.4 percent in 1997—unheard of in the slow-and-steady-wins-the-race world of endowment investment. Many school treasurers started overloading their funds with venture capital investments and with high-tech-company stock purchases, foregoing the more conservative bonds, blue-chip stocks, and real-estate funds.

Like the rest of us, many universities got burned. Since March of 2000, about $6 trillion has been lost in the stock market. University endowment funds are now looking at the first two-year consecutive negative earnings since 1974. It is difficult to assess just how serious the losses are and what effect they will have on their educational institutions.

But nearly everyone agrees that after years of spending increases, many colleges and universities are going to see some deep spending cuts starting this year and continuing in 2004. "It's sad, but I think I've built my last campus building," said Wake Forest University's Chief Financial Officer John P. Anderson, who saw the two-year stock market slump drop the school's endowment from $970 million to $780 million.

The damage runs across public and private universities, schools large and small. Rensselaer Polytechnic Institute has seen its endowment drop from $729 million in June of 2000 to $530.9 million in June of 2002, the end of the fiscal year and the last official tally. The Massachusetts Institute of Technology lost $775 million, or 13 percent of its $6.1 billion endowment in 2002. During the past two years, Cornell University has lost about $200 million out of an endowment of about $3 billion; Syracuse University lost about $90 million out of about $1 billion; Ohio State University's endowment has fallen 14.1 percent to $1.1 billion; and Boston University's endowment, now $585 million, lost 27 percent in 2001 and 13 percent more in 2002.

The losses are already being blamed for cost-cutting measures. Stanford University has implemented a hiring freeze as part of a plan to cut 8 percent from its general budget, and has cut its three-year $1.5 billion capital building plan to $1 billion. In addition, Stanford is asking departments to cut back their budget by 5 to 10 percent. MIT halted construction on a new media lab. Duke University plans to layoff 50 faculty members over the next three years.

How the endowment downturn is going to affect engineering departments remains speculative at this point, but many trends indicate that engineering is getting hit harder than other departments and schools. The steeper decline of the high-tech economy—Internet, telecom, and software developers—will no doubt cause a parallel decline of big donors to engineering schools. Engineering departments are also more cost intensive than, say English departments, and they may bear a disproportionate share of cuts. Without endowment funds to pay for million-dollar labs and big compensation packages, engineering schools may have trouble enticing star faculty researchers—and the grants that come with them.

At MIT, the Presidential Fellowships Program—which offers institute-funded graduate fellowships—may have to be reduced because it is tied directly to endowment spending. Graduate fellowships are usually tied to research grants, and students must start their research as soon as they get to campus. But under MIT's Presidential Fellowships Program, the grad students' first year is paid, and they are allowed to take that year to find out what research is of interest to them. MIT used this as a perk to attract some of the best grad students. But by 2004, MIT expects the program to be scaled back, mostly because of the shortfall in endowment income.

Endowments at schools can be large or small, and their influence on the college or university is likewise a big part of the budget or just a small portion. At some schools, investment returns are used to pay for up to 35 percent of the school's budget. Others will be considerably less. But for most schools, the endowment funds are usually about 10 to 15 percent of the operating budget and are used for scholarships, research chairs, capital building projects, and as general revenue.

For some, the amount of endowment money is huge: Harvard has an endowment of nearly $18 billion; Yale University, $10 billion; Stanford, $8 billion; MIT, $6 billion; and the University of California, $5 billion. Endowment managers invest their funds in a variety of ways: stocks, bonds, real estate, private equity (where firms use the funds to buy troubled companies), venture capital (investing in new companies), and others.


After the endowment funds are invested, universities track the return rate. Most schools decide how much to spend after computing the average return for the past three years. The general rule of thumb is to spend 5 to 6 percent of the endowment's return each year, based on the three-year average. This allows the schools to smooth out the effects of short-term market volatility. This three-year average is why spending was still increasing in 2002, even though the market had already been in a two-year slide. In 1999 and 2000, most university endowment funds were still making their double-digit gains. But in 2001, the average university endowment lost 3.6 percent on its investment, the first negative return in 18 years, according to the National Association of College and University Business Officers. In 2002, endowment funds dropped by another 5.4 percent, according to a survey by the Connecticut-based Commonfund Group, which manages investments for 1,400 educational institutions. Most university spending cuts will begin during the next budget deliberations (for the 2003-04 school years), as the average will now be fixed on 2000-2002, which included the two negative years but also includes the positive numbers in 2000. But the big cuts are expected in 2004-05, when all three years figured in the average will be in red numbers.

William Spitz, Vanderbilt University's treasurer, says he expects spending to rise slightly to $102 million in 2003 and then drop by 12 percent in fiscal 2004, with about $12 million cut from the budget. Spitz says many schools may be tempted to alter the formula. "The formula is something you impose upon yourself," he says. "But you can't be tempted to start drawing on the principle. We had an awfully lot of good years. And we'll have more good years. We just have to get through this bump."

But the bump could not come at a worse time. Colleges and universities are bracing for a "baby boomlet" which will steadily increase enrollment during the coming decade. According to the U.S. Department of Education, college enrollment was 15.3 million in 2001 but will increase to more than 17 million by the end of the decade. This will put pressure on schools to build dormitories and classroom buildings, hire more faculty members, and increase services.

While the number of students will be increasing, the amount of money budgeted by state legislatures for public universities is decreasing. Many schools are being hit on both sides: Ohio State is dealing with the 14.1 percent loss in its endowment at the same time the state legislature has cut its budget by 10 percent. The damage is already starting in the form of rising tuition. During the 2002-03 academic year, public colleges and universities have been forced to raise their tuition by an average of 10 percent over the previous year, according to a study by the College Board. The same survey found private-school tuitions rising by 6 percent over 2001-02. Overall, tuition at both public and private institutions has risen 38 percent in the past decade, a decade of minimal inflation.

The third problem is the university donors themselves. Many high-tech moguls had given their alma maters gifts tied to their company stock. Many universities cashed in their stock well past its peak, and they had less money than they had originally thought. And without the millions they once had, donors are postponing their gifts—called "donor dropsy" in the philanthropy business—and schools are scrambling to make their goals in pledge campaigns. Overall, philanthropy was down slightly in 2001, but corporate giving, which is the lifeblood of engineering gifts, was down 14.5 percent, according to the Center for Philanthropy at Indiana University. The final numbers are not available for 2002, but they are expected to be lower than in 2001. "When you put all of theses things together," says Ron Ehrenberg, director of the Cornell University Higher Education Research Institute, and author of Tuition Rising: Why College Costs So Much, "you see that times are going to be tough in the next few years, even if the stock market were to begin a great rally. And when times are bad, institutions turn to tuition."


Ehrenberg believes the coming budget crisis will affect higher education in a number of ways. In addition to higher tuition, schools will trend away from full-time faculty to adjunct faculty, as a way to save money and meet the higher enrollment demands. He also expects more of a reliance on two-year colleges to ease the burden on both students and institutions. And distance learning, long considered part of the realm of discount degree factories, may finally become a substantial part of the university curriculum.

"Schools may not have a choice," says Ehrenberg. "I don't think the resources will be there to handle the downturn in spending and the increased student enrollment at the same time. Some schools may require students to stay home one semester and study from there. It will allow the school to handle the influx of students without building new dorms and classrooms."

Financial aid will be another problem area. Many endowment funds at schools are earmarked by their donors to be used only for financial aid. At MIT, for example, in the 2002-03 school year, $42.8 million is made available for grants and scholarships. Of that amount, $36.8 comes from endowment funds that are earmarked for aid; the other $6 million comes from the general endowment fund. The problem for these schools is that the amount of money in earmarked aid funds will drop; while the general endowment funds, which will drop as well, may be needed to shore up other areas. And the general funds are the ones used to build those new million-dollar labs.

"We intimated clearly to everyone who is dependent on general funds that the growth they've seen in prior years is going to decline," says John Curry, MIT's vice president for administration. In a recent interview, Curry said MIT will try to avert a budget crisis by implementing slightly lower salary increases, less aggressive growth in financial aid awards, and leaving some unfilled positions open or temporarily unfilled.

John Griswold, senior vice president of Commonfund, whose institutions have $30 billion in combined assets, says the problem for most schools will be their mindset. "The difficulty will come from institutions that have been used to spending freely, hiring the star faculty, building the fancy new buildings," Griswold says. "That is hard to pull back from. And for many schools, the only place they have to go is to raise tuition. Most of their other costs—faculty and staff wages and overhead—are fixed."

Griswold says he also expects engineering departments will be pressured to earn more money for their schools through technology transfer and entrepreneurial relationships with the private sector. But University of Kansas engineering dean Stuart R. Bell thinks that any dependence on tech transfer to balance off endowment investment losses will inevitably fall short. "You can't plan for things like that," Bell says. "So much is hit and miss. As an engineering school, we must grow our research programs, support our faculty when they develop relationships with corporations, and do these things over a long period of time. When you do those things, intellectual property rights may be realized."

Bell says that public universities, in particular, will have to work harder to make ends meet. "There are only a handful of states that are not facing a budget crisis for education. We are all going to have to deal with budget shortfalls." But he points out that the KU endowment has been operating since 1891 and has seen several stock market free-falls in its history. "We've weathered the storms of Wall Street in the past, and we'll get through this one," he says.

Which is what they teach in Economics 101. What goes down comes up, eventually. But for many colleges and universities, the heady free-spending days of the 1990s will come to a crashing halt, at least for a few years anyway. Millions of dollars have been lost, and that money has to come out of someone's budget. "The challenge for colleges and universities," says Cornell's Ehrenberg, "is to figure out how to do more with less. You have growing enrollment at a time when state support for public colleges is dropping and at a time when endowments have been hit hard by the stock market. At the same time, the economy is going to make for more students seeking aid."

"Higher education will have to change," Ehrenberg continues. "We can't just keep raising tuition. We have to learn how to become more efficient, how to do things differently."


Dan McGraw is a freelance writer based in Fort Worth, Tex.
He can be reached at

And Now The Good News

The financial health of higher education has been hit hard on two fronts. Many schools—the publics in particular—are suffering from budget woes in their states, and compounding the problem, university endowment funds have declined markedly. But on the positive side, interest rates are at their lowest in almost 40 years, and many colleges and universities are using the cheaper money to finance new capital projects and to refinance outstanding debt.

The timing couldn't be better. Enrollment is surging in some parts of the country and schools must build more classrooms and hire more teachers to meet the demand. In New York, where the economy was badly affected by the September 11 terrorists attacks, Governor George Pataki has asked the two major university systems to restructure their debts whenever it made financial sense.