How Much Is Enough?

Colleges are still being too cautious about using their endowments, write Burton A. Weisbrod and Evelyn D. Asch.

February 22, 2010

The cost of a college education is soaring. Meanwhile, colleges and universities with stratospheric endowments are husbanding their wealth. Why?

Endowments provide income for important spending each year. But they also are a college’s savings -- their insurance for a rainy-day loss in revenue. With insurance, a college can sustain its programs even when bad times cause donations, tuition revenue, or government grants to shrink. Clearly, we have been having a very rainy day. Yet colleges and universities with the largest rainy day funds have been cutting expenditures rather than drawing down their endowments to continue their activities and fulfill their mission until the economy improves. To be sure, even the wealthiest universities can benefit from scrutinizing their budgets for waste, duplication or programs that didn’t work out, but the cuts we are seeing extend to limiting admission to doctoral programs, eliminating valuable education programs and laying off long-time, valued employees.

Many colleges, private and public, have little or no savings. A third of community colleges and 11 percent of four-year nonprofit and public colleges and universities, attended by 2.4 million students, have no endowment. When revenue falls, these schools have little alternative but to cut faculty, eliminate programs, furlough staff, shrink financial aid to needy students, and in other ways try to live within their means. But since those colleges never counted on their endowments for much revenue, they are not suffering as much from the lower endowment values.

But why are Harvard, Stanford, and other universities with multi-billion dollar endowments crying that they are forced to cut expenditures? Their wealth is certainly down -- 25-30 percent -- but from all-time record highs, and they are back to where they were just four years ago, when spending was full speed ahead. Now is exactly the time when the rainy day insurance funds should be tapped -- not the time to decimate programs to maintain endowments.

Universities often say that they would run through their funds if they just started spending them. But how quickly would that really happen? We are not talking about using the endowments to bankroll their whole budgets, only a portion. Further, the economic conditions today aren’t normal and can easily be distinguished from the need every year to balance budgets and set priorities.

Consider the case of Tulane University. After Hurricane Katrina struck in 2005, its revenues fell 10 percent — from $710.5 million in 2005 to $637 million in 2006. So the shortfall it had to make up was 10 percent of its budget. That becomes a useful yardstick for thinking about how many years a college could maintain its pre-disaster expenditures out of its endowment.

Tulane had a pre-Katrina endowment of $780 million. But Harvard, Yale, Stanford, and Princeton have endowments over $10 billion, even after the massive investment losses they experienced last year.

A year ago, Yale had an endowment that would have permitted it to offset a 10-percent revenue loss for 92 years of rainy days. Should Yale be cutting spending, as it is, in order to prevent further erosion of the endowment? A 25-percent loss from investments would still leave a 69-year rainy-day fund, more than any imaginable sustained loss of revenue and sure to increase as the economy recovers.

Harvard’s rainy-day fund was bigger still. Before the market plunge, it could have covered a 10 percent budget shortfall for 96 years. Even after its endowment lost over 25 percent of its value, Harvard had enough wealth to make up for 72 years of a 10 percent shortfall. For Princeton, those numbers are 141 years and 106 years.

Some smaller colleges are even better protected. Although their endowments are smaller than those of Harvard or Yale, they also have fewer students and smaller budgets. Grinnell College, with 1,600 students, had an endowment so large relative to its annual budget that it could withstand 191 years of rainy days, making up a sustained 10-percent revenue loss for almost two centuries. Even with a 25-percent loss of endowment value, Grinnell still could outlast 143 years of rainy days!

Universities with large endowments often remind us that they are not free to spend their endowments — that the money is restricted by the donors’ wishes. According to NACUBO, only about half of the funds in the wealthiest institutions’ endowments (those over $1 billion) are “true” or “permanently restricted.” Furthermore, recent legal decisions and state legislation have given colleges increasing freedom to spend even restricted funds when they are needed to sustain the organization.

How much is enough? Colleges and universities do not truly need endowments that would last even 50 rainy-day years. At some point, their burgeoning endowments should be considered so large that there should be less reliance on revenue from tuition, and more expenditure on educational programs. Endowments should exist to support the educational mission; the college’s mission is not to increase the endowment.

To be sure, colleges will argue that there is another reason for holding an endowment: to permit greater spending in future years even when there is no rainy day. A few wealthy colleges and universities finance as much as 30 to 40 percent of their budgets from returns on their endowments. But remember that spending less on the current generation to put money aside for future generations means leaving more for later students who, because of economic growth, will generally be richer than today’s students. Intergenerational equity should not mean massive transfers from current students, many struggling to pay their tuition, to those of the future on the scale that many colleges and universities are practicing.

It is time to rethink college endowments, both on campuses and in Washington. While the timing of rainy days cannot be predicted, they can be planned for. When they come, colleges should use the savings they have accumulated to sustain programs. Now that the stock market is rising, the first priority should not be taking the endowment to the top of the rankings, but spending until the rainy day is over.


Burton A. Weisbrod is John Evans Professor of Economics at Northwestern University. Evelyn D. Asch is a researcher at the Institute for Policy Research at Northwestern University. Weisbrod, Jeffrey P. Ballou, and Asch are coauthors of Mission and Money: Understanding the University (Cambridge University Press, 2008), which examines endowment issues more expansively.


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