Last September, two influential congressmen, worried about the size of the largest U.S. university endowments, called on schools to start spending more. They needn't have worried: eight days later, Lehman Brothers collapsed, markets plunged, and within six weeks the endowments of America's top schools lost roughly 25 percent of their value.
Although most private endowment-dependent schools were able to hold tuition hikes to the 3 to 4 percent range and protect financial aid, they quickly cut other costs: freezing salaries, slowing or freezing hiring, and reducing staff. Most schools reduced budgets by 5 to 10 percent, but a few, such as Stanford and Harvard's Faculty of Arts and Sciences, announced deeper cuts.
Such reductions aren't easy for institutions with lifetime tenure and other high fixed costs. Universities are complex organizations that include hundreds of distinct operations: academic departments, libraries, research centers, athletic teams, and so on. Cutting one can feel like closing a military base: what's good for the whole is not often seen as such by affected constituencies. But this is not the first time we've had to trim expenses, and in the long run, it makes universities even more fertile ground for innovation. Cutting the least-essential positions and programs allows us to add more important ones when the economy recovers.
Another positive outcome of the crisis is increased federal support for scientific research. The U.S. stimulus package has injected billions for health, science, and energy, with more to come. This will boost U.S. competitiveness. But it won't close universities' budget gaps.
For private endowment-dependent schools, two questions loom large: Did we spend too much during the good years? And did our unconventional investment model expose us to too much risk? The answer to each question is no.
Endowments are not meant to be hoarded; they are meant to ensure steady support for university operations. All leading private schools have rules that buffer them from fluctuations in endowment values. Thus, as endowments grew rapidly from 2003 to 2008, schools spent less than they might have. Still, spending increased rapidly—at Yale, it doubled in four years.
Was the money used wisely? I believe so. We held tuition and fee increases to 4 percent per year in the past decade, just one point ahead of inflation. And Yale's financial aid tripled, with the fraction of first-year students receiving grants rising from 40 to 56 percent. Families earning less than $60,000 now pay nothing. After inflation, the cost of attending Yale for a family at the median U.S. income level is now 40 percent of what it was 10 years ago.
Some have claimed that the much--celebrated and widely imitated investment strategy developed at Yale by David Swensen has served universities poorly during the downturn. Rather than investing in a simple mix of U.S. stocks and bonds, the Swensen strategy involves diversification into foreign stocks, hedge funds, private equity, real estate, oil and gas, and timber. The critics argue that during the past year, a traditional portfolio of 60 percent stocks and 40 percent bonds would have lost only 13 percent of its value, rather than the 25 percent lost by the diversified portfolios of the largest endowments.
This argument is astonishingly shortsighted. Over the past 10 years, Yale's endowment realized average annual returns of 11.7 percent to reach its current value of $16 billion; a 60–40 portfolio would have earned 2.1 percent, resulting in an endowment of only $4.4 billion. The moral of the story is that universities should stick with the Swensen strategy, not abandon it now.
That doesn't mean coping with the crisis won't be painful. But if U.S. universities take the long view, they will emerge leaner and stronger, better prepared to retain their leadership, to advance science and technology, and to help the next generation take on the challenges facing humanity. Should that result, the pain will have been well worth it.