Debt is not bad. Issuing debt is not “the logic of the condo flipper.” I mean who writes this stuff? Debt issuance has many associated costs and benefits, including but not limited to taxes, financial distress, and is the solution for many investment distortions related to agency conflicts.

I agree. The issue is what is the appropriate amount of debt. The problem that condo-flippers face is not that they used debt (everyone with a mortgage is in debt) but that they used too much debt and, therefore, were excessively exposed when the value of their assets (the condos) dropped but the value of their debts did not.

I really can’t believe that I have to defend borrowing, but I guess it’s come to this.

Indeed. I agree that all the great and good think that Williams should borrow $250 million to fund its building projects instead of spending money in the bank. The main/only reason for doing so is the belief that leaving that $250 million in the endowment earns more money (either ex ante in expectation or ex post in fact) than the cost of borrowing the money.

This is exactly the (correct!) logic that made many condo-flippers in Florida rich through 2006. The value of their assets (condos) went up more than enough to pay off their debts.

And, as long as the Williams endowment goes up by 10%, the deal is a no brainer! (And thanks to Jeff S for explaining how the law limits the amount that Williams can borrow.)

But was it reasonable to expect, in 2006, that the Williams endowment would make 10% per year on average for the next decade? (Use whatever time horizon and hurdle rate you like.) Perhaps. Was it reasonable to expect that condo prices in Florida would keep going up? Perhaps.

But the dangers in both cases are obvious. We have just enjoyed 25 years of amazing bull market returns. Might the Williams endowment be flat for the next ten years? Sure. If so, those bonds will have proven to be an expensive gamble. How certain are you that the endowment will earn more than the interest rates in the bonds over the next 5 years? 80% sure? 99% sure?

Again, I am not certain that this is the wrong decision. I doubt that I would have voted against it were I a new member of the investment committee at Williams. But borrowing money to, more or less, invest in stocks does not strike me as obviously the world’s greatest investment strategy.

The growth of a college endowment is the beginning amount plus investment return plus endowment gifts minus endowment spending.

I haven’t seen a full list, but I believe that Amherst moved just ahead of Swarthmore for third on the LAC list in per student endowment for June 2007 behind Grinnell and Pomona.

I believe the top five on June 2007 were:

Grinnell
Pomona
Amherst
Swarthmore
Williams

http://amherststudent.amherst.edu/current/news/view.php?year=2008-2009&issue=05&section=News&article=01

Doubly concerning is that Williams is in the middle of a fund raising drive right now, unlike Amherst (although unlike Williams, Amherst is not in the middle of a massive spending spree to totally reinvent its center of campus). Seems like Amherst money managers are doing a better job, as they are outperforming Williams in BOTH bear and bull markets …

After seeing a generation of finance executives line their own pockets with obscene bonuses while running pillars of finance like Lehman Brothers and Wachovia into extinction on pyramid scheme investments, I think anyone associated with “finance education” for the last thiry years really ought to slink off in disgrace.

Harvard Business School should be bought at pennies on the dollar by the US taxpaper.

Debt is not bad. Issuing debt is not “the logic of the condo flipper.” I mean who writes this stuff? Debt issuance has many associated costs and benefits, including but not limited to taxes, financial distress, and is the solution for many investment distortions related to agency conflicts. There is a lot of research on this. It’s called the theory of capital structure and is an essential ingredient of any finance degree at any level, so don’t start this “if you’d had a year or two of finance” canard. If you’re interested, which somehow I suspect you are not, I’d start with the Harris & Raviv survey article in 1991. Yes, 17 years ago. Since then there has likely been about 10,000 articles on this, with the most relevant that I could find in the about 10 minutes I can bear to devote to this:

“Tax-Exempt Debt and the Capital Structure of Non-Profit Institutions: An Application to Hospitals” by Wedig, Hassan & Morrisey in the September, 1996 issue of the Journal of Finance. I’m too lazy to summarize it here, but it’s pretty easy reading. If you don’t have access to JSTOR I can send it to you.

I really can’t believe that I have to defend borrowing, but I guess it’s come to this. Lastly, I can’t even address the “loss” that you calculated for the university on its endowment. I’ll just point out two things:

1) Lots of firms with cash borrow. Sometimes equity markets go up, sometimes they go down. In 2003, the S&P went up 26.39%., Exxon had approximately 10B in cash and about 5B in debt. Let’s assume that with tax benefits and all, Exxon paid 6.39% as an interest rate. You’ll see that this makes the calculation easy. Using your logic, issuing debt made Exxon 1B dollars in 2003.

2) Everything you read in the previous paragraph is wrong, at least after the words “interest rate.” Why? Because finance is about EXPECTED returns, and not REALIZED returns.

Now I think my head is about to explode. I get so tired of explaining this to people who wait for an event to rehash some comment that stuck in the craw 2 years ago. Really, if we have to start here, financial literacy in this country is at an alltime low.

Now can we please discuss something like what financial education is being provided at Williams, what professors are saying about the crisis, whether special events surrounding it are being scheduled, lectures given, knowledge imparted? I might even re-engage for such a discussion. This, not so much.

First, cash is king. The college has healthy and strong revenue streams, but cash and marketable securities are another reason the college has such a strong credit rating and low cost of capital.

Second, the college is a high quality credit that can borrow cheaply. This will bear our over time. Paying off bonds b/c of current negative returns in endowment is unwarranted given long term trends. Buy and hold with strategic adjustments.

Third, debt can serve as an inflation hedge. Inflation reduces the real amount of debt outstanding just as it reduces the real value of the endowment. Assuming some of these securities are fixed rate with a long maturity, such borrowing is one hedge against inflation.

Fourth, it is completely appropriate for the college to issue debt even with its huge endowment. Borrowing allows the college to pursue an investment strategy that does not have to be interrupted or adjusted due to each capital project. Borrowing for these projects allows the college’s investment strategy to be executed independent of short term cash requirements of capital investment.

There may be other better reasons, but these are the ones I would advocate.

Debt is good for Eph given the tremendous fund balance (shareholder’s equity in the taxable world) on Eph’s balance sheet.

So the college can only issue tax exempt bonds (at the attractive rates that a tax exempt AA rated bond receives) if it can spend the money within a couple of years on a suitable project.

I would actually be very interested in whether the college had auction rate bonds secured by bond insurance prior to the meltdown in that market. When this market “failed” it resulted in thousands of failed auctions that forced obligor’s to pay rates 3x and 4x the prior interest rates to holders of these securities.

The auctions failed b/c the assumed liquidity of these investments was in question due to bond insuror credit quality concerns (CDOs anyone?). As a result, the auctions could not “clear” and the underwriters were overwhelmed and unable to buy the securities that could not find buyers.

I have hospital clients that were caught in this completely unanticipated vice. This was a very expensive failure of a huge segment of the tax exempt bond market.

There is also detailed information on interest rates and maturity on each Series of Bonds. The College fairly routinely pays off a series of bonds and issues a new series, when rates and yields make that attractive.

At least for the colleges I follow, debt is only issued to finance long term capital construction, like the Paresky Center or a new dorm.

The debt as a percentage of endowment for the two colleges I looked at this morning is nearly identical (right around 13%), thus suggesting an accepted amount of debt. One of the schools has the highest Moody’s rating AAA, the other the next highest AA1, so both are considered financially well managed.

You can’t just look at the returns for one year. The question is whether the interest over the term of the bonds is less than the investment return over the same thirty year period. You can argue that holding the debt resulted in an imputed loss last year, but it resulted in an imputed gain the year before when borrowing cost 4% and investment return was 20%.