Learning From Harvard’s Investment Mistakes
Article: Harvard Swaps Are So Toxic Even Summers Won’t Explain
Financial advisors can learn a lot about what “not to do” by studying this article on Bloomberg today.
I’ll summarize what happened and then provide some commentary along with some choice quotes.
- Harvard planned a major campus expansion and wanted to lock in low interest rates 4 years before they needed the money
- Harvard invested in “forward swaps” to lock in “low interest rates” for the project’s financing.
- These investments bets assumed that interest rates would rise from the existing 2.25% level.
- The Federal Reserve Bank subsequently cut short term rates to .26%.
- The value of the swaps went to a negative $460MM by June 2005 as rates rose. Lesson: Understand your downside risk.
- During the meltdown in 2008, Harvard “cuts its losses” on its swap investments by paying over $1 billion to various banks including JPMorgan, Goldman Sachs, Morgan Stanley, and Bank of America. $500 million up front and the rest paid over 40 years.
- “December 2008 was, by an enormous amount, the worst time in history” to terminate the swaps by borrowing money, said Peter Shapiro, a swap adviser at Swap Financial Group.
- This turned out to be the bottom of the market. Oops. “Concerned that its losses might worsen, the school borrowed money to terminate the swaps at the nadir of their value, only to see the market for such agreements begin to recover weeks later.”
Apparently none of these investment notables had read about Ray Lucia’s “Buckets of Money” strategy:
Making matters worse, Harvard disclosed Oct. 16 that its checkbook fund, the general operating account, lost $1.8 billion in the year ended June 30. Lumping the cash account with the endowment was risky, said Louis Morrell, who managed the endowment for Radcliffe College, which is part of Harvard, until 1990.
“They put the operating funds in the endowment –it’s like the guy who has his retirement income in company stock,” said Morrell, who is also the former treasurer of Wake Forest University in Winston-Salem, North Carolina.
This last move meant that Harvard’s operating account fell by $1.8 billion in just one year. So they had to scramble to raise cash.
As vanishing credit spurred the government-led rescue of dozens of financial institutions, Harvard was so strapped for cash that it asked Massachusetts for fast-track approval to borrow $2.5 billion. Almost $500 million was used within days to exit agreements known as interest-rate swaps that Harvard had entered to finance expansion in Allston, across the Charles River from its main campus in Cambridge, Massachusetts.
Lesson here would be don’t invest cash needed for day-to-day expenses.
Harvard Corp. had a 7-member ruling body approve the transactions. This committee included some well-known figures:
- Lawrence Summers, former Secretary for President Clinton, then Harvard President, now serves as President Obama’s Economic Advisor
- James Rothenberg, his Los Angeles-based company, Capital Group, operates American Funds
- Robert Rubin, former U.S. Treasury Secretary and Summers’s previous boss and predecessor at the U.S. Treasury
- Robert D. Reischauer, former director of the Congressional Budget Office.
Lesson here is don’t be swayed by celebrity endorsements.
Other smaller colleges seem to be learning from Harvard’s mistakes:
Harvard’s woes stemmed from misunderstanding its role, said Leon Botstein, president of Bard College in Annandale-on-Hudson, New York.
“We shouldn’t be in the banking business, we should be in the education business,” Botstein said in a telephone interview.
Another lesson is don’t depend on regulators to protect investors:
Summers, along with Rubin and Greenspan opposed the U.S. Commodity Futures Trading Commission’s attempt in 1998 to regulate so-called over-the- counter derivatives, which included agreements like interest rate swaps. At the time, Summers was Rubin’s deputy secretary.
Now Summers is leading the Obama administration’s effort to write stricter rules for the derivatives market “to protect the American people,” he said in October at a conference in New York sponsored by The Economist magazine.
Better late than never I guess.
The article pointed out Summers was forced to resign as Harvard’s president “after he questioned women’s innate aptitude for math and science.” I bet few American housewives would look to forward swaps when the family plans to build a larger home in 4 years.
In fact, I bet most American housewives would question the wisdom of Harvard borrowing money to build buildings when it had $22.6 billion in its endowment. Some 4-year colleges, like Grove City College, don’t build any buildings until they’ve raised the necessary funds and have the money in the bank. Being debt free, Grove City College has tuition less than half of Harvard University. There’s gotta be a lesson in there someplace.
A final lesson: People shouldn’t invest on the basis of what rich and famous people are doing:
“You can be very big and very rich and very smart and still get things wrong,” Shapiro said.