For Yale, a $12 billion recession

This article has been corrected. You may view this article’s correction here.

The toll of the financial crisis on Yale’s endowment could total roughly $12 billion over the next decade, according to the University’s most recent budget projections.

That $12 billion represents the difference between what the endowment would have been in 2018 had it stayed on course and what the anticipated value of the endowment in 2018 is now, given this year’s estimated 25 percent drop in value and the expectation of no growth next year.

Vice President for Finance Shauna King discusses Yale’s financial outlook yesterday in the Law School Auditorium. King advised against making rash, unnecessary cuts.
Erica Cooper
Vice President for Finance Shauna King discusses Yale’s financial outlook yesterday in the Law School Auditorium. King advised against making rash, unnecessary cuts.

Instead of standing, a decade from now, at $33.6 billion, the endowment is now on track to be worth $21 billion in 2018, less than it was on June 30, 2008. That gap, based on current projections, could continue to pressure Yale’s budget well into the next decade.

“It is that difference in the endowment, as it gets pulled into the operating budget through the distribution, that is causing the crisis in our budget,” Vice President for Finance and Business Operations Shauna King said in a presentation Monday to about 100 department heads and business managers about the University’s financial status.

At the meeting, King also elaborated on the steps the University is taking to mitigate the long-term budget deficit, which include cutting the operating budget by 5 percent and delaying capital spending projects. She said the University is also modeling a new time frame for construction delays.

The new plan slates the two new residential colleges to break ground in 2013 instead of the original target date of 2011, pending approval by the Yale Corporation in February. But reached Monday night, University President Richard Levin emphasized that the decision to delay construction on the colleges would not be final until the Corporation votes on it.

The endowment is now expected to end the current fiscal year in June with a value of $17 billion. University administrators expect flat growth for the next year, bringing the endowment down to about $16 billion in 2010 after factoring in the endowment’s contribution to Yale’s operating budget.

After 2010, administrators expect the endowment to return to its historical growth rate. University planners use a 9.25 percent growth model, relying on the endowment to grow by at least that much in order to hold its value and cover the target 5.25 percent contribution to the annual budget, as well as 4 percent inflation.

With 16.3 percent average annual growth in the decade ending in June 2008 and four consecutive years of 20 percent growth or better, the endowment easily outpaced both this internal growth model and the industry average.

“That was substantially ahead of model, and contemporaneous spending rates were substantially below target,” Chief Investment Officer David Swensen said in an interview last week. “But we’re looking at a future where I suspect that the spending rates will be above target going forward, and when we incorporate this year’s return, we’ll be moving back to the kind of numbers [used in the University’s model].”

As the endowment’s value wilts, so will the size of its contribution to the operating budget. In the current fiscal year, the endowment provided $1.164 billion, or 45 percent of total income. The original model would have produced a $1.2 billion contribution next year, and almost $1.7 billion by the end of the decade.

But because of the market trauma, next year the contribution to the operating budget will fall about 5 percent to $1.05 billion. Administrators have decided to use reserves to smooth over what otherwise would have been seven straight years of continual decline in the contribution, instead holding the contribution for the next seven years flat at $1.05 billion.

That makes the net loss to the endowment’s contribution to the operating budget $118 million next year and almost $3 billion in lost endowment income cumulatively over the next decade. The deficit worsens over time, King explained, because the original model continues to rise while the new projection stays flat.

In addition to the loss of income from the endowment, King said administrators calculated in December that the combined impact of weak fundraising, higher demand for financial aid and the effects of the current credit crunch would represent $221 million in lost revenue over next 10 years.

The lost income would leave the University with an $85 million gap in the next fiscal year that would grow to a total of almost $2 billion over the course of the decade if no action were taken. To avert this scenario, the University must trim its budget, starting with 5 percent cuts both next year and the year after.

By taking the steps that Levin announced in a memo last month, King said Yale will shrink its projected deficit by between 50 and 75 percent. Those steps include delaying constructions and renovations, cutting personnel and other expenses by 5 percent each, capping salary raises, and slowing spending on major initiatives such as the West Campus and the two new residential colleges.

Although a final decision on the new residential colleges’ time line still has to be made by the Corporation in its meeting next month, the model King presented Monday pushes back the start date for construction from 2011 to 2013. The new School of Management campus and the renovations of the Yale University Art Gallery and Hendrie Hall have all been delayed officially by two years, and construction of the new Yale Biology Building has been pushed back one year.

The delays in capital spending relate to the difficulties of borrowing money to fund construction projects when credit markets are frozen.

“The problem we have right now is we can’t borrow from anyone,” Provost Peter Salovey said in Monday’s presentation. “There’s just nobody who’ll lend us money. They’re not lending anybody any money.”

King stressed the importance of maintaining the highest bond rating to keep the University’s access to credit open. But a critical component of that assessment is the ratio of debt to endowment, so as the endowment falls, so does the amount of debt the University can afford to take on.

Even while adjusting the time frame for the colleges and other projects, the University is continuing with design and other preparations so that if the credit markets free up or if enough donations are raised, construction can commence.

King added that the budget office has run analyses on the point where construction costs might be enough of a bargain to justify moving forward with spending. After all, much of Yale’s campus was built at the height of the Great Depression.

“It is the case with construction costs, if they got low enough, it would be imprudent not to try to build,” Salovey said.

Despite administrators’ self-professed optimism about the University’s financial future, they also acknowledged Monday the striking contrast between the current talk of cuts and the enthusiasm for rapid expansion that prevailed in recent years. In many cases, they are rolling back or delaying expansion plans that were launched within the last year.

“Just a few months ago we were trying to think about how to spend all the new money that was coming in from the endowment,” King said. “Literally overnight, we’re all shifting gears here.”

Salovey said the administration is trying to deal with these new challenges “in a calm and rational way rather than through behavior that looks like panic.” In other words, the University is not trying to recover every dollar that it will no longer receive from the endowment. Instead, current plans aim to recover between one half and two-thirds, leaving room to wait and see how the crisis unfolds.

That approach allows for flexibility in case the markets recover. But if they do not, King said deficit issues would continue into the next decade.

“Who knows what’s going to happen in the markets?” King said. “So rather than cut deeper than we need to cut now, we’re going to wait and watch carefully what’s happening and make a determination if and when we would need to go back for more. Hopefully not.”

For now, the budget office is still in the process of running cost analyses for each unit to see what funds are available and exactly how the cuts with break down. Typically, the budgeting process begins with a guidance memo around Christmas, but this year it is delayed until mid-February.

“It’s better to take a little time to make sure we’re giving you clean targets rather than redoing it later,” King said to the assembled department heads and business managers.

The final budget proposal, usually prepared in April, will not be ready this year until May. Usually, the proposal is presented to the Corporation in April and the final budget is approved in June. But because the complexities of this year’s budget have delayed the process, the Corporation will both consider the proposal and make its final approval in June.

Comments

  • A. Nonny Mouse

    "University planners use a 9.25 percent growth model, relying on the endowment to grow by at least that much …"

    To get some idea of why Yale is in such good shape in this crisis relative to it's peer institutions, one might contemplate that Harvard Business School Dean Light tells its alumns that Harvard planners have for years used a 15 percent growth model, relying on the Harvard endowment to grow by at least that much. This "15 percent assumption" is reported to have been Larry Summers' innovation. Another related element of Summers' legacy is that while he is now gone from Cambridge, and his grand and wildly unafforable vision for a new Alston Campus are now "deader than a doornail" (in Dean Light's words), Harvard is stuck with many burdensome obligations and distortions resulting from that absurd "15% assumption," the ridiculous planning and commitments that assumption led Harvard to make, and from other aspects of from Summers' kooky reign.

  • YaleFan

    Seriously. You have to ask - and be honest and acknowledge the truth. Someone is to blame for this - and it isn't President Bush. Billions of dollars gone like a puff of smoke. Trillions worldwide. It could have been avoided. All because of a political powerplay so the Libs could be in control. Without Truth, Liberty is lost. Liberal fools - this is what you have wrought.