Crisis on Campus_ A Bold Plan for Reforming Our Colleges and Universities - Mark C. Taylor [32]
When, in a networked economy, virtual assets disappear into thin air in an instant, as they can on a massive scale, the entire global economy is at risk. As networks expand and more people and institutions are connected, everything speeds up and the stakes grow higher. As we have seen, in complex networks like financial markets, effects can be disproportionate to their causes. In 2008, the collapse of the housing market in the United States quickly set off ripples through world financial networks and triggered a catastrophic collapse of banks and other financial institutions in England, Russia, China, even Iceland. The problem was not simply that individuals had purchased houses that they could not afford but that so-called financial engineers had created derivatives known as mortgage-backed securities and credit default swaps whose risks most investors did not understand. These investments bundled and securitized thousands of individual home mortgages, divided them according to their supposed risk and then sold them on global markets. Mortgage-backed securities were sold and resold to other speculators so many times that they seemed to lose any relation to the actual assets that were supposed to serve as collateral. When the bubble burst, real estate brought virtual assets crashing back to earth.
This financial meltdown has been devastating for college and university endowments and is wreaking havoc with their budgets. The schools had irrational dreams of huge payoffs just like everyone else. The magnitude of the losses and the scale of the problems they engendered will force a rethinking of the entire financial structure of higher education and will require cutbacks and new efficiencies that will bring major organizational changes. Meanwhile, some facts and figures about what has been going on for the past several decades should shed considerable light on the difficulties higher education is facing.
Until recently, colleges and universities followed very conservative investment policies. Many schools managed their endowments in-house with the guidance of a small group of trustees. Through the 1950s, most institutions restricted endowments to cash and fixed-income assets. During the 1960s institutions gradually began to invest some of their endowments in conservative securities. Not until the 1970s and 1980s did they begin to invest significant sums in stocks, and at first they did so cautiously; even the most venturesome portfolios were split into roughly 60 percent securities and 40 percent bonds. Spending policies were also conservative—the widely accepted practice was to spend no more than 5 percent of endowment income and keep everything else as principal as a hedge against inflation. That meant that every dollar spent required twenty to remain in the endowment.
All of this changed dramatically in the 1990s. Many colleges and universities, led by the wealthiest institutions in the country, shifted away from securities and fixed income and moved toward hedge funds and private equity firms, which were profiting from heavy investments in the new financial instruments that had been introduced since the mid-1980s.
Yale’s David Swensen led the way. By 2000 he had published Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, which quickly became the bible for advisors charged with investing university endowments. Though he urged caution for less wealthy institutions, he nonetheless concluded, “These findings suggest1 that long-term investors maximize wealth by investing in high-return, high-risk equity rather than buying debt instruments of governments and corporations.” By 2008, Swensen had invested an astonishing 80