Trickle-Down Economic Duress

Months of national fiscal strain have had little direct impact on most colleges so far. As liquidity crisis intensifies, a few signs of actual distress begin to emerge in higher education.
October 2, 2008

The financial headlines out of Washington and Wall Street could not be scarier, with words like "collapse" and "crisis" and "failure" spilling out of news reports to an extent not seen in decades. (Analysts are expressing widespread hope, if not exactly confidence, that the U.S. Senate's passage Wednesday of a federal rescue plan for the financial markets, if followed by House passage Friday, will put out the raging fire.)

But as talk of pending national economic doom has reverberated for much of this year, though, predictions of blunt force impact on higher education -- in terms of evaporating student loans, families unable to pay for college -- have largely failed to materialize.

This week saw some of the first tangible signs that the broader turmoil in the financial credit markets is having a direct effect on colleges and universities, notably the restrictions placed on the availability of money from the Common Fund for Short Term Investments, in which about 900 colleges store some of their financial assets. As of Wednesday, Commonfund, which manages the fund, had ensured that colleges would have access to about a third of their money, and relatively few institutions are so dependent on the money they have invested in the short-term fund that the restrictions on it will dramatically hurt them.

But the fact that officials at hundreds of colleges could wake up on a Monday morning and find that they had been directly affected by the virtual disappearance of a national financial institution (in this case Wachovia, which controlled the short-term fund but is selling its banking operations to Citigroup) was a stark reminder, if anyone needed it, that no aspect of American society is inoculated from the turmoil roiling the larger credit markets.

Such reminders have been relatively few and far between for colleges and universities. Despite many dire predictions through the winter and spring that the seizing of the credit markets and the apparent beginnings of an economic downturn would result in a major shortfall in student loan availability and potentially leave colleges with many students and families unable to pay their tuition bills (because of a loan shortage, an inability to borrow against home equity lines, and/or lost jobs), colleges have seen relatively little of that. And while some institutions have seen the cost of borrowing rise because of upturns in the price of bond insurance, campus officials have not reported any widespread need to defer building projects or otherwise curtail major initiatives. The biggest impact has been in a relatively small number of states that have seen significant financial shortfalls, at least some of which can be attributed to the larger financial picture.

Might that change because of the stunning developments of the last two weeks, which have seen major national financial institutions fail and confidence in the U.S. economy collapse to levels that have international implications?

Boston University, for one, isn't taking any chances. The university's president, Robert A. Brown, announced in a letter to employees and students Tuesday that because of the "uncertainties created by the upheavals in the financial markets and the nation’s poor economic outlook," the university would immediately freeze hiring of all new employees that are not "absolutely critical," and freeze "commitments to all new capital projects for which construction contracts are not already in place, irrespective of the source of funding."

The dramatic nature of that action would suggest an institution in financial peril, but BU is far from that, Joe Mercurio, the university's executive vice president, said in an interview Wednesday. The university has just finished two consecutive years of "record breaking financial operating performance," its 2009 budget is fully balanced, and its reserves are flush, Mercurio said. "We are not in any kind of financial difficulty."

But when Brown and his cabinet met Tuesday for their weekly meeting, they concluded that the "prudent" thing to do, given the prevailing economic climate, was to take preemptive steps to avert a potential meltdown.

"We're monitoring, on a daily basis, economic factors such as the interest rates on bonds, the unemployment rate and the impact it may have on the financial needs of our students, and the price of heating oil and other utilities," Mercurio said. "We just decided that with everything that's so uncertain right now and the economy in such dramatic turmoil, it was time for us to pull back before we have a crisis. We're trying to husband all our resources today in case something happens three months down the road."

The steps BU is taking are "not really as dramatic" as they sound, he said. Faculty hiring for the current year is largely done, and the university has not discontinued the searches that are just getting under way for faculty appointments for 2009-10. Officials have taken 250 staff and other positions off the university's recruiting Web site and will repost any jobs that involve security or are otherwise deemed "mission critical," he said. And the university hasn't stopped putting money aside for its future expansion; because of the good financial year it just concluded, Mercurio said, it has set aside an $8 million endowment to create four professorships as part of its 10-year strategic plan.

The Outlook for Various Types of Colleges

Although Boston U. depends on tuition for about half of its revenue, it is far from the most financially vulnerable colleges and universities in the country, given its $1.1 billion endowment. By contrast, some of the 900 institutions that store their funds in the Common Fund for Short Term Investments that Wachovia plans to liquidate by year's end are much smaller and poorer, which is why the situation involving the fund reverberated as it did.

The situation is already quite a bit less dire than it was Monday, when Wachovia revealed that it would limit each investor to 10 percent of its account as of the close of business Friday, apparently to avoid a potential run on the funds. That proportion had grown to 26 percent by Tuesday, and to 32.6 percent by Wednesday, said John S. Griswold, executive director of the Commonfund Institute. Although some of the institutions whose funds are held in the Common Fund are dependent enough on them that they could face a short-term squeeze, Griswold said, "most schools, when they sit down with their various options, probably will be able to muddle through this."

The longer-term outlook is highly uncertain, and higher education finance experts offer differing assessments about how bleak or blurry it is (few if any see it as bright). One caveat they all offer was summed up by Russell K. Osgood, president of Grinnell College: "The situation is unsettled and remains turbulent. Anything I say today could be nullified tomorrow."

Osgood is among the bears. He anticipates that even if Congress acts to resolve the immediate crisis of confidence that has the financial markets in a tailspin, the country is facing a "significant downturn" that will undoubtedly affect colleges and universities. No matter what else happens, Osgood said -- even if the worst does not happen and there is no second wave of failures of banks and financial institutions -- "everybody's endowment is going to go down."

Who gets affected most by that may not be entirely predictable, he and others warned; institutions that have invested conservatively might have shown the biggest losses to date, but larger universities whose investments may be tied up in private equity, real estate, or other illiquid investments may pay a bigger price in the coming year. "Endowments that are invested conventionally tend to show losses earlier, but then they don't have the catastrophic unraveling" that some fund with riskier investments face. Small private colleges that have few reserves and are highly dependent on tuition revenue remain vulnerable to major economic downturns, too, of course.

The results of a significant downturn, Osgood said in an interview Wednesday, could lead colleges to "put a break on tuition and other fee increases," produce a "significant pullback in future capital expenditures," and "the first significant period of cost containment in higher education." "I think people will say, 'Do we really need all this?' "

Donald E. Heller, director of the Center for the Study of Higher Education at Pennsylvania State University, said that the outlook for public colleges and universities was also highly uncertain. Disruptions in the bond markets, particularly in the last two weeks, have made it more difficult for some states and localities to raise money for facilities and other services, and The New York Times reported Wednesday that significant numbers of government entities are cutting back plans for projects.

While a small number of state institutions have announced cutbacks of various types, the financial situations of public colleges tend to lag behind those of private institutions: many state colleges are now operating off of budgets set last spring, before the latest downturn really took hold. Officials in some states have begun talking about midyear rescissions in the 2008-9 budget, but the larger questions will be how far tax revenues fall by the time legislatures convene early next year to begin work on the 2009-10 budgets, Heller said. "There is a lot of uncertainty about what's going to happen to appropriations to public institutions in the next year."

More generally, "I'm sensing a fair amount of anxiety and concern about what the future is going to hold, and a lot of waiting and watching on the part of administrators," Heller said. "Right now it doesn't seem that there is any large-scale trend of major financial problems going on yet.

"But it may be," he said, "that we are just six months early."


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