Here We Are… Yet Again

The American university is once more in financial crisis, writes Nicholas S. Zeppos, and he cites five lessons from the past to help deal with it this time around.

March 31, 2020
 
 
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Those who cannot remember the past are condemned to repeat it.

-- George Santayana

Insanity is doing the same thing over and over again and expecting different results.

-- Albert Einstein

It’s like déjà vu all over again.

-- Yogi Berra

Perhaps only one of these epigrams would have sufficed. But I couldn’t resist. The existential crisis of 2008 revealed a number of financial blunders by our nation’s colleges and universities, including some of the very wealthiest. Today, as higher education institutions face the financial fallout from the COVID-19 pandemic, we will be asked whether we learned our lessons from 2008. We have no excuses for repeating them. The wisdom of the ages was easily available, whether the warning came from the Institute for Advanced Studies in Princeton or the New York Yankees' clubhouse.

I learned, in painful ways, these lessons in 2008. I was a new chancellor at Vanderbilt University, and as we managed through the financial crisis and its aftermath, I vowed never to be as vulnerable financially as we were then. The subsequent conservatism might have led to spending and borrowing less and saving more. But then again, it forced a discipline that allowed us to strategically prioritize what was important, such as eliminating student debt through our Opportunity Vanderbilt program.

As higher education now grapples with the ongoing effects of this pandemic, boards and institutional leaders are going to have to chart a path forward. All constituencies will be affected, and they will expect transparency, clear communication and a partnership in identifying the challenges faced and solutions offered. Some could be unprecedented and enormously painful.

No college or university will be immune to these financial challenges. But whether an institution learned the lessons of 2008 will have profound effects on not only the short-term pain it experiences, but also its ability to weather yet another “once in a generation” storm without a permanent and material impairment of its ability to be accessible, diverse and distinguished.

What are these lessons?

First, keep a lot of cash on hand. When things go bad quickly, cash is king. It doesn’t matter how big your endowment is if you are forced to sell liquid assets -- stocks and bonds -- at fire-sale prices to pay bills or keep paying faculty and staff members.

Don’t count on access to hedge funds. Even when redemptions are provided for in written documents, they can become impossible to obtain. (You will learn about “gates” or “side pockets,” and I urge you to look for the word “hypothecation” in documents.)

Don’t count on asking your private equity or venture capital managers for a break, either. They may be calling you for more capital to try to make it through the day! Yes, it is fun to spend all of your free cash and load up on debt when things are good. But when things get bad, you’ll wish you had done otherwise.

Second, a plain vanilla debt portfolio is perfect. A good old-fashioned long-term fixed-rate portfolio with orderly payment of principal is boring but prudent. The minute you start doing complex financial engineering with your debt portfolio, you are proceeding down a dangerous path. Stay away from large “bullet payments” due on debt. You don’t want your debt payments over time to look like the spiky spine of a stegosaurus. (Go to the dictionary and look up “kurtosis,” or read this link. You may have it!)

Stay away, as well, from fancy short-term notes to bring down interest payments. Those “deals” sound great when they are sold: “If you issue these variable-rate demand notes (VRDBs), you’ll only pay 1 percent interest …” But beware of the not-so-fine print. The interest rates on these can be reset daily or weekly and have to be resold every week -- sometimes for 30 years. In a financial panic, what could possibly go wrong? We don’t have to ask what could go wrong because it happened in 2008, and it’s happening now. Rates skyrocket, and you can’t sell the notes. Three weeks ago, the interest rates on such short-term notes were hovering around 1 percent. As the crisis hit, they increased dramatically. And why? Because they have to be sold every week. There are no buyers. When the panic hits, nobody wants to tie money up in anything but … cash. See point one above.

The Federal Reserve has now this week -- similar to 2008 -- come to the rescue with a credit facility for these short-term notes and commercial paper, bringing rates down for now. But who knows what lies ahead, and it is beyond expectation to structure a debt portfolio assuming that the sovereign will come in to bail you out. Or if for some reason you did, that’s moral hazard in action.

Third, get rid of your derivatives/swaps. Most college and university leaders, and even many board members, don’t even understand them. They exist, supposedly, to “hedge” your short-term debt if rates spike. See point two above. But if rates plummet, they quickly go underwater. (I could explain how, but it’s too complicated.) And there are various flavors of these derivatives where you can get whipsawed no matter what rates do.

In short, be aware that complexity is your flashing red: anything that requires such a complex explanation is not worth the risk. I’ll simply say that if rates plummet, it will hit your bottom line and could require a lot of collateral posting on short notice. Where is that cash going to come from for your collateral posting? Did you follow point one above?

Fourth, recognize that your outside financial partners are sometimes there with you until they aren’t. You may have a line of credit to buy your short-term notes if needed in a failed remarketing. (See point two above.) That, however, is a short-term solution and can be expensive. Worse, what if you already have been leaning on this credit line because you don’t like to keep around a lot of cash? (See point one above.) Or what if you’ve violated one of the terms of the credit lines, and the bank won’t allow you to use it or wants to renegotiate the rate and duration?

Fortunately, our banks seem to be much stronger than they were in 2008. But what if the credit line dries up? In 2008, our credit line effectively disappeared when the bank decided to close up shop and then was “merged out of existence.” Sometimes those lines are called “hybrid lines.” But hybrids can be chimerical. Don’t count on your broker who markets these notes to buy them to help you out. They can’t afford to do it in a crisis, and regulatory policies may bar them from doing so. (If you ask your CFO about this possibility, and she mentions the Basel III Accord, you are in trouble.)

Finally, know that following these lessons promotes the best governance when you need it most. If you don’t follow them, you and your board will be spending the bulk of your time on financial engineering. I remember having to call what seemed like daily meetings of the executive committee of our board in December 2008. All we discussed was our financials -- nothing about education or research. Is that what you want to do?

Sure, every board needs to be deeply engaged in managing through this crisis, particularly given what could be some tough decisions ahead. But our major concern must be our students, faculty, staff, local communities and somehow trying to keep our mission going. We do a tremendous amount of good. Even in a partial shutdown, we can contribute to the betterment of society, and we surely need to do so now -- especially in finding treatments and vaccines and caring for patients and families.

I had a wonderful mentor at our university. He was retired and in failing health but wise and experienced, with much scar tissue. I remember a meeting where I asked him, “How do you manage to learn and keep straight all of the technical financial information in a university and its academic medical center?” He looked at me and without hesitation said, “Run it like your family household. Imagine you and your spouse are sitting around and thinking about buying a new house or a new car. You still need to be able to buy groceries for you and your children and take care of basics like education and health care. What about your rainy-day fund? Do you even have one? And what if you need to help your elderly parents? Can you handle all of these things?”

He taught me that the university is a big family (which means we also argue and fight) that does important work and in which people care for each other. And that we should manage our institutions just as a good family would manage itself.

As we all made our way through the collapse of 2008, I learned these lessons and remembered the advice from my mentor. I realized that I would never sit down at my family table and say, “Well, we are going to buy a new house, and to afford it, we are going to get a really low-rate mortgage that resets interest rates daily, and we have to requalify for it every week. And then we’ll buy interest-rate protection against skyrocketing rates, and I don’t think rates are going down, so we don’t need to worry about any savings to post collateral …” If I did, I think my family would have said, “Sounds complicated. We like this house just fine!”

Our colleges and universities are among America’s greatest institutions. We heal the mind and soul and nourish with knowledge. There are hard times ahead. But those who learned the lessons of 2008 will experience less pain. As Warren Buffett says, “Only when the tide goes out do you see who is swimming naked.” The tide is out … yet again.

Bio

Nicholas S. Zeppos is chancellor emeritus and Cornelius Vanderbilt Distinguished Professor of Law and Political Science at Vanderbilt University. He served as chancellor of the university from 2008 to 2019.

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