Drew Gilpin Faust and the Incredible Shrinking Harvard

The roots of Harvard’s fiscal crisis go all the way back to 1990, when money manager Jack Meyer left the Rockefeller Foundation and assumed the reins at the Harvard Management Company (HMC). Breaking with the traditionally conservative approach, Meyer was in the forefront of university portfolio managers who integrated complicated financial instruments into endowment investments. He reduced the amount of stocks and bonds in Harvard’s portfolio to less than 30 percent and diversified into illiquid assets such as commodities, real estate, timber, hedge funds, and private equity. He also ventured into financial tools such as derivatives and emerging market debt that carried more risk than stocks and bonds but promised much larger returns. “There’s not much plain vanilla in our portfolio,” Meyer told BusinessWeek in late 2004.

When Meyer came to Harvard, the endowment stood at $4.7 billion. When he left 15 years later, that number was $22.6 billion. From 1995 to 2005, the endowment averaged a nearly 16 percent annual return, beating the benchmark for peer universities by more than 50 percent. During that run, Harvard’s financial success became a source of fascination for the nation’s business press, generating countless articles with titles such as “How to Invest Like Harvard.” Harvard may or may not have been the world’s best university—there were nagging questions about the commitment to teaching and the coherence of the undergraduate curriculum. But those concerns were always eclipsed by the fact that Harvard was the world’s richest university. The wealth glossed over its imperfections like fresh paint on an old house.

Meyer left in 2005 amid controversy over the multimillion-dollar bonuses paid to some of his money managers. Rumors also swirled that he had clashed with Larry Summers over control of HMC. It’s hard to know: Neither man is talking. Still, there is no question that Summers took a much more active role in Harvard’s money management than his predecessors.

After Meyer stepped down, he was replaced by Mohamed El-Erian, a managing director at the bond giant Pimco, who lasted just under two years in the post. He was followed by Jane Mendillo, who had been managing Wellesley College’s endowment, and whose assumption of the job last July would become the very definition of bad timing.

The turnover may have hurt, because last fall’s stock market meltdown seemed to catch HMC asleep at the wheel. As of June 30, 2008, the Harvard endowment was 105 percent invested: HMC had borrowed above the endowment’s value in order to make additional bets. With the vast majority of its money tied up in holdings from which it could not easily be extracted, the university was ill prepared when the tanking Dow spurred anxious counterparties to call in their chits. Those margin calls forced Harvard to put up collateral—cash that it did not have. And it couldn’t unload its illiquid investments to come up with that money, because their value had fallen so precipitously that no one had any idea what they were really worth.

Further squeezing Harvard was a transaction Summers had pushed it into in 2004, when he successfully argued that the university should engage in a multibillion-dollar interest rate swap with Goldman Sachs and other large banks. Under the terms of the deal, Harvard would pay Goldman a long-term fixed rate while Goldman paid Harvard the Federal Reserve rate. The main goal was to lock in a low rate for future debt, and if the Fed had raised rates, Harvard would have made hundreds of millions. But when the Fed slashed rates to historic lows to try to goose stalled credit markets, the deal turned equally sour for Harvard: By last November, the value of the swaps had fallen to negative $570 million. The university found itself needing to post more collateral to guarantee those swaps, and would ultimately buy its way out of them at an undisclosed cost.

HMC “took the university right to the edge of the abyss,” one alumnus, a financier who is privy to details of the university’s balance sheet, told me. I asked what he meant. “Meaning, you’re out of cash.

“That,” he added, “is the definition of insolvency.”

And so last fall HMC had no choice but to sell some $2 billion worth of stock into a plunging market. Harvard also raised an additional $2.5 billion by selling bonds on which—again because of the awful timing—it will pay interest at a significantly greater rate than identically rated corporate debt. As Bloomberg News has reported, the terms of Harvard’s bond sale mean that its interest costs will mushroom to as much as $550 million over three decades. In February, HMC, suddenly not looking so smart anymore, started laying off about a quarter of its staff.

On campus, there has been widespread denial about the severity of this crisis, a deep reluctance to admit that the endowment losses are going to have profound long-term ramifications. And many Harvardians still don’t know or understand exactly what happened, because the people who do know don’t want to talk about it. Some of Faust’s closest advisers actually opposed her initial letter to the Harvard community last November regarding the endowment plunge, essentially saying they could tough it out until the year-end financial report, by which time the markets might have risen.

Though the stock market hemorrhaging appears to be over, Harvard isn’t out of trouble. According to the university’s 2008 financial report, in the next 10 years it must pay various private investors some $11 billion in capital commitments. Where will that money come from if, as seems likely, endowment growth over those years is minimal or nonexistent, and alumni’s own strained budgets limit their generosity?

“If you can’t afford to lose the money”—and a university that depends on its endowment to defray operating costs can’t—”don’t play the game,” says one Harvard grad, an investor who was once involved in the university’s finances.

“You had very smart people [at HMC] who never had a real answer to the question ‘What would happen if this doesn’t work out your way? What if what the black box is predicting doesn’t occur?’

“The answer would always be ‘That’s impossible,’ or ‘You don’t understand.’

“The arrogance,” says this alum, “was palpable.”

To get a sense of how Faust is selling the changes Harvard must undergo, I crashed an April question-and-answer session she gave at Dudley House, the grad student center in Harvard Yard. About 50 students, mostly doctoral candidates, had turned out. Faust arrived promptly, but most of the people in the room didn’t notice; she does not compel attention. A tall, angular woman, Faust can look stern when she is not smiling, and despite her southern roots (she’s from Virginia) she projects a Puritan austerity. She was wearing dark slacks, a black blouse, and a gray jacket. A publicity shot of Faust while Radcliffe dean showed her decked out in funky, oversize hoop earrings. Now she was uniformed in discreet gold hoops, a gold necklace, and gold wire-rimmed glasses.

She began by speaking for a few minutes without notes, indulging in the kind of boilerplate into which university presidents too often lapse and on which Faust too often relies. “You represent the future of higher education,” she told the students. “I am depending on all of you to keep the flame of commitment alive….”

Barack Obama could pull this off, but Faust is not Barack Obama. She is adept at communicating small truths, but her sweeping statements tend to feel forced. Things picked up when she told the graduate students, “I’m not allowed to say that I favor one school or another, but a lot of my heart is with you.” For about an hour, they asked Faust questions, mostly about the scholarly life. Perhaps because she felt at home among this group, Faust’s answers were, for her, unusually personal, touching upon an awkward theme: At virtually every point in her career, she has been promoted not only because of her merits, which are considerable, but also because of gender. While her gender has helped her get ahead, it has also left her, fairly or not, hampered by the perception that she is a beneficiary of affirmative action.

Faust told the students how, after earning her Ph.D. in American studies at UPenn, she was hired there as a lecturer and, ultimately, a tenured professor of history. “To be quite honest,” Faust said, “the department thought, We’re going to have to hire a woman—better to hire a woman we know and trust than to hire a strange and unknown one.

“This [pattern] happened over and over,” Faust said. As she went on to become Penn’s first female department head and win appointments to committees dealing with everything from tenure recommendations to athletic policy, “people were looking for women to do administrative jobs, and I seemed to be more or less sane.” She was the woman university officials turned to when they needed a woman. It was the same at Harvard, where President Rudenstine convinced her to become Radcliffe dean in 2001. “Harvard was slightly retrograde, so I had to come here and do a lot of that over,” she said.

Her honesty was self-effacing and likable—but as one graduate student who’s known Faust for years told me afterward, Faust has been dispensing bits and pieces of this autobiography since before she became president. It’s getting old, this student said. Where was the Faust who could command respect as she confronted Harvard’s economic woes?

Drew Faust would love to spend her tenure teaching graduate students, promoting the arts and the environment, ribbon-cutting at new dance and theater spaces—an NPR presidency, you might say. Which is why the current economic crisis seems so deeply ironic: Just as Harvard prepared to refocus on its core mission of teaching and scholarship, led by a passionate champion of those pursuits, the one thing no one ever expected to get in the way is suddenly making that harder.

Faust has groused to associates that she is not happy about the amount of time she must now devote to financial matters. Even though she is said to have delegated most of the economic oversight to executive vice president for finance Ed Forst, she has been meeting with deans and department heads to discuss their new budgets, instructing them to plan for 15 percent cuts. And however diligently she ducks the media, she is inevitably the public face of the university’s hardships. Sometimes, it seems as if she’s straining to change the subject. Recently Faust sent a mass e-mail to alums in praise of some students who spent their spring break volunteering, not usually the type of thing meriting a presidential missive. “It’s been tough on her,” says one
colleague. “She’s been beaten up a lot.”

This spring Harvard offered early retirement to some 500 FAS staffers. Only about 150 accepted, which means the university will likely have to fire people—probably in the summer, to minimize bad press and potential commencement protests. A campus group calling itself the Student Labor Action Movement (S.L.A.M.) has taken to parodying a pro-environment slogan Faust has been pushing: The president’s “Green is the new Crimson” has become “Greed is the new Crimson.” In April members of S.L.A.M. loudly interrupted Faust’s lunch in a house dining hall and presented her with a T-shirt bearing their mantra. She’s not unsympathetic to such passions; as an undergraduate herself at Bryn Mawr, Faust traveled to Alabama on a civil rights protest. But it was the latest sign that her honeymoon is over.

Increasingly, money dominates the Harvard conversation. On April 14, FAS dean Mike Smith, a Faust appointee, held an open meeting in a packed Sanders auditorium. Sitting on a stool and occasionally tapping on a laptop, he delivered alarming news: Despite efforts to close the budget gap, FAS was facing an ongoing annual $220 million deficit. And by the 2011 fiscal year, the university would be cutting FAS’s annual infusion of endowment cash by $125 million.

There were no more inefficiencies, Smith said, no loose dollars here and there. “It is extremely important for us to think deeply about how we not only resize our activities…[but] to really start thinking about reshaping these activities.”
The “reshaping” is already more dramatic than the word suggests. The career services office is talking about closing for a month in the summer; other offices are expected to take similar furloughs. The library system, its budget pared by 31 percent, is cutting back on hours and book purchases, and the Quad Library is closing altogether. The college’s “January term,” part of a much-ballyhooed new curriculum, is now dead. Harvard has already halted the hiring of junior faculty and announced an early retirement program for tenured professors, and for the first time ever is considering laying off tenured professors. Funds for housemasters are being slashed by one-fourth, and even the hot breakfasts the houses served on weekdays are out. Meanwhile, idled cranes bow over the pit in Allston, as if in mourning.

“The grumbling” of faculty discontent “is growing louder, no longer whispered but said in front of strangers,” one professor e-mailed me. The faculty worries that the low-key style that was once seen as a welcome change is actually a sign that Faust was unprepared for the job and is now in over her head.

“Everybody says they like her,” this professor wrote, “but she doesn’t know anything.”

[sidebar]In the midst of its economic pain lies an opportunity for Harvard. It can reconsider itself, restate its core values. It can conduct the kind of soul-searching that should have been sparked by Larry Summers—intentionally or not—but was lost in the mad rush to oust him.

“If Harvard is honest,” says one high-powered alum active in university affairs, “we’ll say, ‘We want a sustainable, long-term, top-notch university. And we can’t be all things to all people. What we can do is excel, and that means we have to live within our means.'”

Drew Faust just might be an ideal president to steer that university, a president comfortable with humility, one whose professional ambitions have always been tempered by intractable circumstance. A chastened Harvard could be well led by a woman who has never allowed herself to indulge in illusions of grandeur. But first, she will have to provide that clear leadership.

At Dudley House that day, one of the graduate students asked Faust a question about the impact of budget cuts. He prefaced it by thanking her, saying, “We all know you didn’t sign up for this.”

Her face carefully expressionless, Faust didn’t acknowledge the sentiment. Nor, particularly, did she answer the question.

Richard Bradley is editor in chief of Worth and the author of Harvard Rules: The Struggle for the Soul of the World’s Most Powerful University.