Scarcity amidst wealth: the law, finance, and culture of elite university endowments in financial crisis.

• Author: Conti-Brown, Peter
• Position: NOTE

INTRODUCTION--ENDOWMENTS IN CRISIS? I. THE THEORY OF UNIVERSITY ENDOWMENTS A. Intergenerational Equity B. A "'Rainy Day" Fund. II. UNIVERSITIES AS "DRUNKEN SAILORS"? A. Universities Spent Too Little, Not Too Much B. How Much Is Too Much? III. THE LAW OF UNIVERSITY ENDOWMENTS A. The Development of Law and University Endowments: Trustees, Corporations, and UMIFA B. UMIFA, UPMIFA, and the Financial Crisis C. Charitable Trusts and (the Illusion o39 Donor Restrictions D. Litigation Risks 1. Donor suits: the example of Princeton University 2. UPMIFA and prudential spending E. Conclusion IV. THE FINANCE OF UNIVERSITY ENDOWMENTS A. The Yale Model and the Change to Endowment Management B. The Yale Model and Liquidity Problems C. The Trade-Off Between Forced Sales and Budgetary Disruption D. Other Financial Explanations for University Behavior V. THE CULTURE OF UNIVERSITY ENDOWMENTS A. The Sacred Endowment and the Popular Endowment B. University Administrators and the "Legacy Costs" of Endowment Accumulation C. Endowments and Interuniversity Competition D. Political Cover for Budget Cuts E. Endowment as Core University Mission CONCLUSION: IMPLICATIONS OF THE CULTURAL ENDOWMENT APPENDIX A: EXAMPLES OF BUDGET CUTS AT ELITE UNIVERSITIES A. Harvard B. Yale C. Stanford D. Princeton E. Massachusetts Institute of Technology APPENDIX B: DATA ON THE SCHOOLS' FINANCES INTRODUCTION--ENDOWMENTS IN CRISIS?

In late 2007 and early 2008, Senators Max Baucus (D-Montana) and Chuck Grassley (R-Iowa)---Chairman and Ranking Member, respectively, of the Senate Finance Committee (SFC)--called higher education to attention by opening an inquiry into how elite universities manage their multibillion dollar endowments. (1) Commentators during the previous decade had extolled the genius of elite universities' investment management departments, (2) and now the Senators and others began asking the important question: to what end the accumulation of so much wealth? Indeed, the Senators' own questions carried added bite. They asked universities to provide detailed information regarding endowment restrictions, financial aid policies, student demographics, and the average amount that families must pay for students to attend the universities. (3) Additionally, the Senators and others explicitly challenged one of higher education's sacred cows: its favorable tax treatment under [section] 501(c)(3) of the Internal Revenue Code. (4)

Soon, however, the inquiry skidded to a stop. (5) Along with most other participants in the global financial market, (6) university endowments were severely battered by the financial crisis of 2008. (7) The early estimates predicted an average loss of 23% of endowment value in only five months. (8) The political momentum that had grown around Senators Baucus and Grassley seemed to dissipate while many elite universities scrambled to make sense of budgets that had not anticipated the endowment losses. Roughly a year after the SFC's questionnaire dominated news in higher education, (9) the news shifted to focus on university endowments' increasingly dire financial straits and the university budget cutting that soon followed. Even the most elite universities, with the largest endowments, were not immune. Consider the various responses to the financial crisis from the five private American universities with the largest endowments, measured by absolute dollar value--Harvard, Yale, Stanford, Princeton, and MIT. The schools variously have cut budgets up to 15%, (10) laid off hundreds of employees, (11) frozen salaries, (12) halted or delayed construction projects, (13) issued billions of dollars in debt, (14) canceled or downgraded varsity sports teams, (15) and closed libraries, (16) among many other responses. (17) By every account, universities--including the wealthiest in the country--have made significant cuts to almost every area of their budgets. At first blush, this sudden change has a seductive logic. Yale's President Richard Levin describes the sudden change in attention--from concerns about the ever-growing endowment to concerns that universities cannot finance themselves--in these terms: "We had a run that was historically unprecedented, and at the tail end of that it looked like we were getting too rich.... Well, [that view has] quickly been amended." (18) Excessive wealth, lost quickly, suddenly does not look excessive.

This view, however, leaves many questions unanswered. Even postcrisis, elite universities sat atop multibillion dollar endowments: why, then, did they not spend down more of these cash reserves rather than inflict significant disruption to their operating budgets?

Universities and other commentators, to the extent they have engaged the question at all, have produced roughly three answers: (1) during times of plenty, universities spent at levels that the postcrisis endowment could not sustain; (2) the law prevented universities from spending their endowments however they saw fit, which stood in the way of using endowment funds during times of crisis; and (3) elite endowments were invested in funds and assets that were difficult to access, particularly during times of crisis, making their use for budgetary stability impossible.

This Note argues that these explanations, with respect to elite universities, (19) are wrong: universities did not spend beyond their means during times of plenty, the law does not meaningfully restrict elite universities in endowment spending, and universities could and did access even the most illiquid of investments during the crisis months with relative ease.

Instead, this Note argues, universities have come to view their endowments as having value independent of the financial wealth such funds represent. That is, rather than simply an accumulation of excess capital, an elite university's endowment represents a symbol of status and prestige, similar to the university's libraries, art museums, architecture, faculty, and the prominence of its alumni. And just as an elite university would never sell its libraries, art museums, (20) or architecture, so too will universities reach for any number of alternative funding sources--including their operating budgets--to avoid increased deterioration of their endowments. In that sense, universities' endowments are like cowboys' belt buckles: the bigger the buckle, the more impressive the cowboy. Even though a university's endowment may be adequate for its investment and budgetary funding purposes at one level, the larger the endowment, the more powerful the signal of excellence that the endowment represents.

The Note proceeds in six Parts. Part I discusses the theoretical explanation of university endowments, to the extent that that explanation has been articulated. This theoretical articulation would suggest that universities would spend more heavily from their endowments during times of crisis, not less. Part II introduces data from the top five private universities during the ten years prior to the crisis to explain that the claims that universities overspent during times of plenty does not gel with the data on endowment and budget growth. Part III explains the relevant legal framework for university investment management and articulates why the restrictions that the law imposes on nonprofit investment management are almost certainly inapplicable to large universities with old endowments. Part IV explains why the liquidity crisis explanation, while certainly the most credible of the theories advanced so far, is undermined both by the disclosed composition of university endowments, and by the universities' actual practices during the crisis itself.

Part V introduces the Note's novel explanation for university behavior and articulates a theory of the endowment's cultural significance. Under this theory, a university is reluctant to spend anything but the bare minimum because the endowment itself is a valuable and meaningful signal, particularly as compared to peer institutions. In this sense, a university has strong incentives to grow its endowment beyond any obligation to pay current expenses or support present students. Part VI concludes with a discussion of what the notion of a cultural endowment might mean for universities, and for those who may, in the future, again question whether universities should continue to accumulate wealth for this cultural purpose.

In the months since the worst of the crisis, universities have regrouped, (21) and, in some cases, changed some of their approaches to investment. (22) Nevertheless, future crises will come; these universities will suffer endowment losses again. And when they do, the appeal of endowment retrenchment at the expense of budgetary restructuring may prove more than the various university administrations can resist. This Note is an effort to understand why and how this curious dynamic occurs at all.

1. THE THEORY OF UNIVERSITY ENDOWMENTS

   In order to understand why the conventional explanations of universities' budgetary skittishness in the wake of endowment loss are incomplete, we must first understand the basic theoretical explanation for why universities have endowments in the first place. In a seminal and still insufficiently engaged article, Henry Hansmann provides the most plausible explanations for why universities have endowments, and probes whether those explanations make analytical sense. (23) What follows in this Part is a summary of these arguments, including subsequent scholars' somewhat scattered efforts to build on Hansmann's work, as well as an illustration of how elite university reactions to the financial crisis undermine some theories and bolster others. Ultimately, the conclusion that universities use their endowments as a symbol of prestige and a point of competition supports Professor Hansmann's dissatisfaction with the theories he surveyed.

   It is not obvious why universities maintain large capital reserves at all-particularly in contrast to the...