UP CLOSE | Funding an uncertain future

budget

In the early- and mid-2000s, Yale’s piggy bank was overflowing.

Administrators responded with zeal, expanding the size of the faculty and staff, dramatically increasing financial aid, constructing new buildings, renovating historic ones, and cultivating Yale’s image as a global educational leader.

“Frankly, it was growing so fast — not only the value of the endowment, but also the income — that we couldn’t expand fast enough, we didn’t have the space,” Deputy Provost Lloyd Suttle said. “We all knew it couldn’t last.”

They were right.

The “boom” years, as Yale administrators like to call them, came to an abrupt end in fiscal year 2009 when the worldwide financial crisis robbed the then-$22.9-billion endowment of nearly a quarter of its value.

Suddenly, the University lacked the funds to cover all its newly acquired costs each year. Facing a $350 million budget deficit immediately after the recession, the University laid off more than 250 staff, stalled capital projects, froze faculty hiring, and imposed across-the-board budget cuts on departments and programs.

Everyone crossed their fingers, hoping the economy would come roaring back to life.

But if administrators expected revenue sources to bounce back quickly, they were sorely mistaken. Almost five years after the start of the recession, experts said, the financial climate for higher education has not recovered: More and more students require financial aid, endowment investment returns are still down, government funding is declining and tuition and fundraising increases are limited by the weak economy.

The spending problem facing Yale today is the opposite of what it was before the crash: Unless Provost Benjamin Polak manages to eliminate a projected $40 million annual budget deficit, Yale’s reserve funds will eventually run dry.

“The money coming in doesn’t cover the expenses going out,” Polak said. “It came from the collapse of the endowment and the fact we haven’t adjusted fully yet.”

University President Richard Levin said he is confident the University will weather the storm, but Polak said changes will be necessary to make that possible — changes that will have negative consequences for Yale. He added that he is not yet sure what those will be. But since part of Yale’s mission is to provide equal or better educational and research opportunities for generations to come, the University has little room to make cuts and must consider long-term finances with every administrative decision.

Sooner rather than later, the University must find a financial model that will support its mission and survive the times.

 

DEPLETED RESERVES

When years of high endowment returns screeched to a halt and the University lost a shocking $6.5 billion with the onset of the recession, the Yale community did not have to suffer the full effects of the crisis. Administrators were able to draw from reserve funds, which are pools of money that the University built up over time as an emergency resource in case of future budget shortfalls.

“We managed for the most part to insulate the core part of Yale College from [the recession],” Polak said. “I think most undergraduates would say their education was completely unscathed.”

Administrators said the use of reserve funds was only intended to be a temporary solution, but when revenue did not rebound fully, the University continued to tap its emergency money to close budget deficits. Every year since the recession, the University has turned to its reserves to balance the budget.

Four years later, the University’s pool of rainy-day funding is coming closer and closer to total depletion. Covering the entirety of next year’s anticipated $40 million budget deficit would consume a third of remaining reserve funds, Polak said.

Experts said a long-term solution to Yale’s budget woes would involve either increasing Yale’s revenue, decreasing Yale’s costs or both. But whittling down expenses is no easy task — especially for a University that has already worked to cut costs for four years now.

“If there was fat to trim, I think we largely trimmed it,” said President-elect Peter Salovey, who served as provost from October 2008 until this January.

If Yale cannot find a permanent solution to bringing its operating expenses in line with its revenue, the reserve funds will soon be too diminished to save the day. Without a sustainable budget, Yale will not be able to offer the same college experience for future generations of students.

“We know we have this hole, and we know the hole is getting worse and not getting better,” said Polak. “Reserve funds can be used, but that’s not fixing the hole, that’s plugging it.”

To fix the problem, Yale will have to examine both its costs and its revenue. But external economic pressures will limit the number of viable strategies for reforming the University’s financial model.

 

EXPENSE AT EVERY TURN

On April 18, students walking into the dining hall for lunch saw a Yale Dining staple: chicken tenders.

Like many of Yale’s expenses, the price of this beloved dish is on the rise, and the University must pay more for the chicken, flour, bread crumbs, oil and other food products than it had to last year.

Polak cited increases in food prices as an example of the kind of rising cost at Yale that “there’s nothing we can do about.” These costs make a sustainable financial model difficult to formulate.

Having purchased its food, Yale must pay for workers to prepare it. Hourly wages, too, become more expensive with every passing year.

Under Yale’s current labor union contracts, which will expire in 2016, salaries for technical, clerical and dining hall employees must increase by 3 percent each year. Excluding benefits, nonfaculty salaries cost Yale $689 million in fiscal year 2012, 25 percent of total operating expenses that year.

And the students who eat at dining halls daily also run up Yale’s balance sheet. Last year, approximately 57 percent of undergraduates received some form of financial aid, but even the 43 percent who paid the full tuition rate of $52,700 only covered a fraction of the amount that Yale actually spends on each student’s education.

Since Yale not only admits undergraduates regardless of their ability to pay the sticker price, but also commits to meeting every admitted student’s full financial need, Yale College’s financial aid costs have quadrupled over the past decade, from about $30 million in 2002 to $120 million in 2012. The University reformed its financial aid policies in early 2008, eliminating the parental contributions of students whose families earn below $60,000 annually and substantially reducing the contributions for other income brackets. Student aid and services for all University students now account for 13 percent of Yale’s total operating expenses.

Experts said eliminating need-blind financial aid for undergraduates could solve many of Yale’s budget woes, but Yale administrators said doing so would contradict the mission of the University. Slashing financial aid, they said, is not on the table.

“We institutionally have made the commitment to the undergraduates in Yale College for full need-based aid,” Suttle said. “We make the cuts elsewhere.”

Once outside the confines of the dining hall, students head to labs, studios, lecture halls and seminar classrooms. There, they are taught by world-renowned professors — professors who expect their salaries to increase year after year.

Combined, faculty and staff salaries and benefits accounted for 60 percent of all operating expenses, or $1.69 billion, in fiscal year 2012 — more than double the $834 million they cost the University a decade prior.

“One of the problems at Yale is that you have a lot of famous faculty,” said Lloyd Armstrong, a professor and former provost at the University of Southern California whose work focuses on financing and improving higher education. “Famous faculty expect that they’re going to make more money next year in real terms than they made this year, otherwise they may go to Harvard or Oxford or somewhere else.”

University budgets are made up of a complicated mix of large expenses, Armstrong said, adding that cutting costs is far from straightforward and always controversial.

Whatever cuts Yale makes will have consequences, Polak said, because the “painless” cuts have already been made.

 

THE STRAIN ON REVENUE

To meet rising costs, Yale’s financial model assumes that revenue will grow each year. But many of the University’s traditional sources of revenue — endowment income, tuition, government funding and alumni gifts — cannot keep up with the rising costs of all components of the Yale experience.

Yale’s endowment posted a return of 4.7 percent last year, which was a far cry from the roughly 20 percent returns that it enjoyed during the mid-2000s. Since the amount the University planned to spend last year was greater than the endowment’s investment income, the total value of the endowment declined from $19.4 billion to $19.3 billion last year despite the positive investment return.

“We can’t just live in hope that the endowment is going to boom up again,” Polak said. “I think it will do better over the next few years — I’m kind of bullish on the American economy. But we shouldn’t be counting on that.”

Levin said the primary issue is adjusting expectations to meet the “new normal.” The growth rate of Yale’s revenue will be moderate, he said, but no longer “explosive.”

Yale Chief Investment Officer David Swensen, who leads the team that manages the University’s endowment, echoed similar sentiments. He told the News last week that he expects Yale’s investments to see relatively good returns in the next few years, but added that he has “abnormally high concern” about the level of risk in the financial world these days.

“There are lots of stresses and imbalances in the global economy that create an unusual level of uncertainty,” he said.

Meanwhile, fundraising efforts have thus far failed to close the budget gap.

Polak said he had hoped Levin would be able to raise enough donations from alumni to reduce the annual budget deficit significantly. Known as “spend-down” gifts, these donations are not specifically designated for the endowment or for capital projects and can be used for deficit relief.

“Rick [Levin] has been raising that kind of gift and has raised a lot,” Polak said. “But not the kind of numbers we’d need to fill the hole, and it’s a hard thing to raise money for.”

Other sources of revenue are not looking promising either.

While tuition increases are limited by political pressure, stagnating American family incomes and increasing demand for financial aid, the federal government is also cutting back on funding for higher education.

“The sequestration situation and more general government situation is putting pressure on the budgets of the agencies that are the main sources for research funds, in particular the [National Institutes of Health],” Salovey said. “Any reduction in grant and contract income is going to primarily hit [researchers], but it also hits the University as a whole.”

Federal grant and contract income accounts for about 20 percent of Yale’s operating revenue, and reductions in federal research funding will require Yale to find the money elsewhere or make cuts to existing programs.

Administrators and higher education economists alike feel Yale and other universities should not have to shoulder such a burden.

“[The American government is] worried about long-run deficits, and we should be, because they have a negative effect on the long-run growth rate,” said Catharine Bond Hill, a higher education economist and president of Vassar College. “But it is crazy to cut back on education to do that because we also think education is really important to long-run growth.”

Sustainable long-term financial strategy for the University depends, at least in part, on the country’s long-term fiscal policies.

 

ITCHING TO GROW

At the corner of Prospect and Sachem streets, a plot of land, bulldozed in preparation for the construction of Yale’s two new residential colleges, now lies barren and abandoned — even though the colleges were initially scheduled to open this coming fall.

To save money, the University put many construction projects on hold during the recession, including the new colleges that had just been approved by the Yale Corporation the summer before the 2008 downturn. Other projects stalled indefinitely included a new biology building, which Deputy Provost for Science and Technology Steven Girvin said is even more “sorely needed” now than when it was promised to faculty over a decade ago.

Sidney Altman, a biology and chemistry professor, said he considers Yale’s refusal to borrow money to finance construction of the biology building a “repeated failure on the part of the administration.”

But Polak said many capital projects cannot go ahead yet because Yale does not want to borrow more money until it can pay back its existing debt and increase the size of the endowment. The debt-to-endowment ratio, Polak said, must be reduced because it has grown to “well above our target” in the years since the crisis.

Though the University’s debt-to-endowment ratio ranged from about 8 percent to 14 percent from 2002 to 2008, the ratio has exceeded 20 percent since fiscal year 2009.

A low debt-to-endowment ratio is critical to maintaining a Aaa credit rating, which Polak said Yale wants to keep so it can borrow money at low interest rates and so the University can have access to liquidity, or readily available funds, if there is another crisis.

Despite the rationale behind stalling capital projects, some construction work cannot wait much longer.

The machinery that closely regulates the temperature, humidity and air circulation in the Beinecke Rare Book and Manuscript Library, for example, is almost 50 years old — and in dire need of renovation. If the University does not approve the project, which will cost between $50 million and $70 million, the library’s collections of medieval manuscripts, personal correspondences and other priceless materials will gradually deteriorate, said E.C. Schroeder, director of the Beinecke.

Though they have yet to review the Beinecke project for final approval, members of the Yale Corporation approved $2.4 million in planned funding for the library’s renovation at its April meeting.

Still, some projects are finally coming close to being realized, such as the $20 million renovation of the exterior of Payne Whitney Gymnasium, which administrators said has become a “safety issue” because the stonework is in danger of falling and injuring passers-by. The Payne Whitney project was approved in April.

Meanwhile, in the realm of academic resources, Polak said many departments have “pent-up demand” to grow their faculties. Currently, most departments are able to hire new professors in order to fill vacated positions but cannot add new positions. Though four searches for new professors are underway this year in the Electrical Engineering Department, department chair Jung Han told the News last fall that his faculty remains “below critical mass.”

Other departments are hoping to add new programs, but there is no room in the budget to allow them to do so.

“In order for the teaching of and study of East Asia as a culture to be complete, we should at the very least add two ladder faculty positions … that would focus on Korea,” Edward Kamens, chair of the Department of East Asian Languages and Literatures, told the News in February. “We currently have none.”

With so many sides of the University in dire need of growth and a budget in need of cutting, administrators need to find a solution.

 

FINDING THE DOUGH

The solution to Yale’s financial woes may lie in a mix of additional fundraising efforts and difficult internal reforms, administrators said.

Levin said securing more gifts will be important in the future because he thinks spending money from the endowment will fund existing University operations but will not finance new projects. If Yale wants to grow, administrators will have to raise the extra money to do so through gifts, Levin said.

He added that this new reality is not so different from the one he faced during his first eight years as president, before the endowment really took off, when Levin said Yale had to rely on donations to meet its expenses more than in the “boom years.”

Throughout his time at Yale, Levin was a successful fundraiser. Between 2006 and 2011, he spearheaded the Yale Tomorrow campaign, which was the most successful fundraising effort in Yale’s history. Despite coinciding with the recession, the campaign raised almost $3.9 billion.

Salovey said the University is also on the lookout for new sources of revenues, but he added that the annual budget deficit “is not going to be solved by selling a few more T-shirts with bulldogs on them.”

Though the University will cover the remainder of next year’s budget deficit with reserve funds, Salovey said difficult decisions lie ahead.

“If we can’t find other sources of revenues, then we’ll have to make expense cuts, and that’s not easy because it comes on the heels of several years in which cuts have been made,” he said. “We may have to particularly focus on units where fewer cuts were made during the recession.”

Polak said he hopes the 14-person Academic Review Committee, which has been meeting since September to discuss how faculty positions are allocated between departments in the Faculty of Arts and Sciences, will be able to help the University distribute resources more effectively in the next few years.

To prevent costs from spiraling out of control, Polak said new initiatives must continue to move more slowly than they ideally would, and departments, already shrunken from the recession, will not be able to hire as many new or replacement professors as they would like. Major capital projects like the new residential colleges must wait for almost full funding from alumni gifts before they can begin, he said.

Still, though Polak said he thinks Yale will find ways to resolve its annual budget deficit within the next three years, experts and administrators said the real hope is that the economy will improve and take some of the pressure off Yale’s budget.

“You can be too conservative or not conservative enough [with spending],” said Hill, the Vassar president. “It’s not good for your mission to do either of those things. … What really matters is the state of the U.S. economy. If real incomes start to pick up, then a lot of the doom and gloom about higher education is not well-founded.”

 

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