Harvard Magazine
|
|
view allAlumni WritersBreaking NewsCommencementHarvard in the NewsWeb ExtrasAlumni in the NewsCryptic PuzzlesSolve the March-April 2008 puzzle! Hints available soon. |
Breaking NewsOctober 9, 2008FAS Dean Outlines PrioritiesMichael D. Smith, dean of the Faculty of Arts and Sciences (FAS), outlined his priorities for the academic year in his first forward-looking annual letter, published on October 9. Among the highlights: • Fiscal concern. Smith cautioned about the possible effects of the current financial situation, increased public scrutiny of universities (resulting in “increased demands to quantify the benefits of programs, justify costs, and demonstrate compliance with state and federal regulations”), and cost pressures (for energy, food, and construction)—all at a time when FAS faces “a structural deficit in unrestricted income created primarily by building projects and faculty growth. This deficit, if not addressed, will limit our ability to undertake new initiatives, will hamper campus renewal, and will stifle educational innovation.” • Administrative change. As in his message to faculty colleagues last spring, Smith emphasized what he now calls “an empowered academic leadership supported by better administrative structures and processes.” New details include devolution of budgetary authority to academic deans (Harvard College, the Graduate School of Arts and Sciences, the School of Engineering and Applied Sciences, and the divisional deans within FAS) to seed new programs and speed faculty recruitment, and the bolstering of the administrative staff for each such dean. Smith also outlined a new FAS budget process and a process for vetting curricular needs and targets for future intellectual and programmatic growth—the aim being to coordinate priorities in an “annual budget that is clearly aligned with our academic programs and new initiatives.” (In his remarks last spring, Smith made it clear that he intends to “pause” from further faculty growth this year, in order to consolidate recent additions, to come to terms with the resulting pressures on the FAS budget, and, likely, to align future hiring with academic plans which seem certain to place greater emphasis on expertise in the sciences, where FAS has made enormous investments in new facilities.) • Campaign planning. Longer term, Smith wrote, these annual processes will also underpin decisions about FAS goals for a University capital campaign, whenever that is launched. His initial goals include funding the recent increases in undergraduate financial aid; expanding the ranks of, and funding for, graduate students, commensurate with the recent growth in the size of the faculty; and funding improvements in undergraduate education—ranging from the new general-education curriculum and integration of classroom work with enhanced international and laboratory experiences, to “renewal” of the Houses (which is shaping up to be huge, expensive construction project). Smith also mentioned FAS participation in Allston planning, looking toward a future where “FAS remains one campus—that campus just has a beautiful river running through it,” and the challenges of switching to the new academic calendar, less than a year from now. He also outlined faculty-led reviews of the non-ladder faculty (those outside the tenure track), hiring practices, and FAS’s own rules of procedure. Once two more appointments are made—of a new dean for the School of Engineering and Applied Sciences, and of a new special adviser on faculty development and diversity—Smith’s academic leadership team will be complete. With them, and colleagues, he looks forward to joint efforts to “improve academic planning, right our finances, prepare for a capital campaign, and empower our Academic Deans,” thus providing “a solid foundation for the exciting and important work that each of us came to Harvard to pursue.” October 8, 2008Martin Chalfie ’69, Ph.D. ’77, and Roger Y. Tsien ’72 Share Chemistry Nobel PrizeMartin Chalfie ’69, Ph.D. ’77, now Kenan professor of biological sciences at Columbia University, and Roger Y. Tsien ’72, now professor of pharmacology at the University of California, San Diego, School of Medicine, and professor of chemistry and biochemistry at UCSD, are two of the three scientists awarded the Nobel Prize in Chemistry, for fundamental work on the green fluorescent protein, isolated from jellyfish, now a basic tool used to study biological processes within cells. The prize announcement and accompanying explanatory information for the public are available at the Nobel website. Chalfie’s home page and Tsien’s laboratory website provide further information on their current work. Writing in his twenty-fifth anniversary report, Chalfie noted that after three years of “odd” jobs following his graduation, “I started what has turned into a real job: biological research.” He saluted his doctoral adviser, Bob Perlman, and especially his postdoctoral colleagues in Cambridge, England, “who by their example and enthusiasm made me strive to do significant research and to try to avoid any self-imposed barriers. They also taught me that sharing, not hoarding, information was the most satisfying way of operating in this business.” Speaking of his love for genetics and his work with the roundworm, C. elegans, Chalfie said he was trying to understand “the molecular mechanisms underlying cell differentiation (how different types of cells, in my case a specific set of nerve cells that act as touch receptors, arise), inherited nerve-cell degeneration…and early events in the sensing of mechanical stimuli (which are the bases of our senses of touch, position, and hearing).” Ten years later, he wrote, “Life and lab continue to be pretty enjoyable (especially this year, since I am on sabbatical).…” Tsien, who is a Howard Hughes Medical Institute investigator, wrote in his twentieth class report of his 1989 move from the Bay Area to San Diego, and of working with colleagues “to design and use new molecules to probe intracellular signal transduction. The move brought major improvements in research environment at the price of some sacrifices in local climate and scenery. Still, we can’t complain.” October 7, 2008$125-Million Gift for BioengineeringHansjörg Wyss, M.B.A. ’65, who became president of the U.S. division of Synthes in 1977 and drove the company to global leadership as a manufacturer of medical devices during the ensuing 30 years (he stepped down as CEO in 2007), has given the University $125 million—the largest donation in its history—to create a research institute for biologically inspired engineering; it will be named in his honor. The University’s official announcement of the gift says it is intended to “uncover the engineering principles that govern living things, and use this knowledge to develop technology solutions for the most pressing healthcare and environmental issues facing humanity.” President Drew Faust hailed it as “a transformational investment in powerful, collaborative science.” Background on Wyss can be found in the Harvard Business School announcement conferring its alumni achievement award in 2007 (Wyss previously gave the school $25 million to support its doctoral program). For background on Synthes, which specializes in orthopedic instruments and surgical implants, read here. The interdisciplinary research program (according to the news release, it will involve “experimentalists, theoreticians, and clinicians with expertise in engineering, biology, chemistry, physics, mathematics, computer science, robotics, medicine, and surgery from Harvard’s Schools and affiliated hospitals, as well as from neighboring universities”) will be directed by Donald Ingber, Folkman professor of vascular biology in the department of pathology at Harvard Medical School and Children’s Hospital. According to his webpage, Ingber is “interested in how cell structure and mechanics impact cellular biochemistry and tissue development. His research approach has combined techniques from various fields, including molecular cell biology, engineering, chemistry, physics, and computer science.” In focusing on how blood vessels form, he has “made pioneering contributions to the fields of angiogenesis, tissue engineering, mechanobiology, and systems biology,” and he is “credited on over 20 patents which cover technologies ranging from new cancer drugs and drug-screening assays to medical devices, micromanufacturing techniques, and computer software.” His laboratory work is described as “driven by our hypothesis that the process of tissue construction may be regulated mechanically. We introduced the concept that living cells stabilize their internal cytoskeleton, and control their shape and mechanics, using an architectural system first described by Buckminster Fuller ['17], known as ‘tensegrity.’ To approach questions relating to how mechanical distortion of the cell and cytoskeleton influence intracellular biochemistry and pattern formation, we have combined the use of techniques from various fields, including molecular cell biology, mechanical engineering, physics, chemistry, and computer science.” (There are visualizations of the processes at work at Ingber’s laboratory website.) The University has shown increasing interest in bioengineering, most recently in the form of “Engineering Biology for the 21st Century: A Plan for Bioengineering at Harvard,” a strategy paper prepared for the School of Engineering and Applied Sciences (SEAS) and Harvard Medical School (HMS) by a committee under the direction of Joanna Aizenberg, McKay professor of materials science, professor of chemistry and chemical biology, and Wallach professor at Radcliffe, and Pamela Silver, professor of systems biology. (For an earlier report on the committee’s work, see here; for a report on Silver’s work on systems biology, see here. See also the links to the work of Aizenberg’s lab on “biomineralization and biomimetics” and Silver’s lab site.) That report envisioned “a focal point of pedagogy and collaborative and translational research of life scientists and engineers working together”—involving the schools of engineering, medicine, law, business, and public health—and engaging problems such as bioenergy (using photosynthesis to capture and store energy); water purification; food supply; and healthcare. Thus, it is more broadly conceived than most bioengineering programs, which focus principally on biomedical research per se. This Harvard University Bioengineering (HUB) program, its authors hoped, would have a minimum of 20 new faculty positions. Importantly, the initiative embraces both research and education—with both an undergraduate concentration and a graduate curriculum—much as the systems biology program has evolved in recent years. Full implementation of the recommendations awaits, among other things, the appointment of a permanent SEAS dean; in the meantime, the University has provided seed funding for the Harvard Institute for Biologically Inspired Engineering (HIBIE). Its initial focus is on synthetic biology, living materials, and biological control. The Wyss Institute appears to be an element in this broader bioengineering initiative: it is focused on research and faculty recruiting and development (the gift will endow seven new positions), with Harvard responsible for administrative and facility costs. The educational component envisioned in the HMS-SEAS report is apparently not a principal focus of the Wyss gift. Its initial research aims, including a core of instruments and facilities for a variety of experiments, will be aligned with those described for HIBIE; as such, it is meant to support basic science, clinical research, and collaborations with industry to commercialize products. According to the University release, the Wyss Institute’s mission is “to discover the engineering principles that nature uses to build living things, and to harness these insights to create biologically inspired materials, devices, and control technologies to address unmet medical needs worldwide and bring about a more sustainable world”—in other words, the biomedical and perhaps other parts of the broader bioengineering agenda. The release went on to say that in the recent past, “engineering, biology, medicine, and the physical sciences have increasingly converged. Through revolutionary advances in nanotechnology, genetics, and cell engineering, it is now possible to manipulate individual atoms, genes, molecules, and cells one at a time, and to create artificial biological systems. Simultaneous progress in materials science, molecular biology, and tissue engineering has enabled scientists to develop synthetic materials, microdevices, and computational strategies to manipulate cell function, guide tissue formation, and control complex organ physiology. As a result of these developments, the boundary between living and nonliving systems is beginning to break down. The Wyss Institute will leverage these advances and facilitate new breakthroughs by advancing the science and engineering necessary to develop biomimetic materials, microdevices, microrobots, and innovative disease-reprogramming technologies that emulate how living cells and tissues self-organize and naturally regulate themselves,” as well as addressing broader questions of energy and the environment. See the January-February 2009 Harvard Magazine for a full-length feature on bioengineering at the University. September 26, 2008Financial Crisis, Faculty Perspectives: Part 2On the afternoon of September 25, President Drew Faust hosted a discussion on “Understanding the Crisis in the Markets: A Panel of Harvard Experts,” before a full house in Sanders Theatre and a webcast audience. (An archive of the webcast is available here.) Faust noted the “unsettling news” of disappearing financial institutions and the assumption of huge new responsibilities by the federal government, and introduced the panelists. The first and last, Harvard Business School (HBS) dean Jay Light and McArthur University Professor Robert Merton, played the same bookending roles in the business school’s similar panel two days earlier (for a full account, “Financial Crisis, Faculty Perspectives: Part 1,” see here). Between them, new panelists offered sharp perspectives on the weakened condition of the American middle class, a blistering critique of unregulated financial products such as the subprime mortgage loans that are now defaulting at unprecedented rates, and warnings about the interdependence of the United States economy with (and dependence on) the larger global economy. After summarizing the current situation, Light characterized the proposed $700-billion injection of federal funds into the market for financial institutions’ damaged assets not as a “bailout” but as an auction mechanism to make now-frozen credit markets functional again—perhaps an even more alarming way of looking at the problem. The short-term goal, he said, was to “allow price discovery to work,” implying that at present, the market mechanism is completely inoperable, or nearly so, given fears about further loan losses, the incomprehensibility of some of the complex investments, and financial institutions’ impaired capital cushions. HBS professor of management practice Robert Kaplan—a Goldman Sachs alumnus who on June 30 completed eight months of service overseeing the University endowment as interim head of Harvard Management Company, on whose board he now serves—agreed that there is a financial crisis. But, he said, it is only symptomatic of a “severely weakened middle class in the United States.” Citing wage stagnation and the rising costs of essentials—food, energy, education, healthcare [and of course, during the housing bubble, shelter itself]—he said middle-class Americans had rationally sought the most available source of funds: the rising value of their largest asset, their houses. Serial refinancings tapped equity and enabled families to make ends meet, he said. They are fundamentally unable to do so at prevailing wage levels, he argued—and now, of course, the support provided by rising house values has been kicked away. Consumer “deleveraging” is now an institutional imperative, too, prompting the rounds of asset write-offs, efforts to raise capital, and bank and investment bank failures. The proposed $700-billion federal financing, he said, is “unfortunately necessary”—but not sufficient to get institutions to lend again, nor to “rebuild the middle class,” the engine for the economy as a whole. To that end, he said, although the injection of funds into financial institutions will end up costing only “a fraction of the headline cost,” the country faces hard choices and expensive investments—for which it will need reserve financial capacity—to address necessary changes in tax policy, energy, healthcare, deteriorating infrastructure, fiscal discipline more broadly, and incentives for savings. In the long run, he said, such steps are essential for any shorter-term financial fix ultimately to work. Gottlieb professor of law Elizabeth Warren in a sense took Kaplan’s stance as a starting point. “The middle class is in big trouble,” she said, and has been for a generation or more. The housing crisis is merely symptomatic of “the effects of beating up someone who is already sick.” Overall, she argued, the $700-billion federal financing plan addressed the back end of the nation’s economic problems; the solutions, she maintained, lie in addressing the front end: the restoration of the middle-class core of the economy. Housing, Warren said, has traditionally been the way middle-class people accumulate wealth. Local lenders evaluated their borrowers, made loans, and held the risk in their own portfolios; if a repayment problem arose, the local lenders knew how to work with their debtor-customers to resolve the issues most effectively, minimizing foreclosures and all their attendant ill-effects on the homeowners and their neighbors. In the new, broker-driven environment that Dean Light outlined, Warren said, financial institutions took advantage of their unregulated status to market higher-priced mortgage products with misleading teaser rates and terms that made comparison shopping difficult—in effect foisting loans that were “from day one” unsustainable onto the public. The widespread use of subprime loans, beginning in 2000, she said, was not an accommodation to make housing available to the poor; just two years later, in fact, 80 percent of subprime loans were used in brokered refinancings of existing mortgages, “ripping out” equity and putting borrowers into expensive, unsuitable loans under the cloak of 24-month teaser rates. She characterized the entire market as a “Ponzi scheme.” (Warren spelled out these arguments in detail in “Making Credit Safer,” published in the May-June Harvard Magazine; there, she called for a Financial Products Safety Commission that would review loans, credit cards, insurance, and related services much as physical products, such as toasters or cribs, are now vetted.) Given the need to work out millions of inherently failed home loans, Warren said, the proposed federal financing addresses “the wrong end of the dog.” With the loans themselves deconstructed into “zillions of fractionalized shares” of mortgage-backed securities and other derivative instruments, she said, merely assuming ownership of such assets represented no progress toward the essential task of working with families, sorting out those mortgages that had to be foreclosed from those that could be revised, with the goal of keeping the maximum number of householders in their homes. In her view, some sort of bankruptcy reform, aimed at the individual loans, affording a neutral forum for working the problems out, is the key. There is not enough money to support the whole market for the financial assets held by weakened institutions, she said, nor could the country afford to do so “because you can’t throw that many people under the bus.” The problem, she repeated, “began with a dirty product” sold knowingly by its creators, who took advantage of a deregulated environment. Avoiding such problems in the future, she suggested, would depend on addressing such abuse at the outset. Beren professor of economics N. Gregory Mankiw, who teaches the perennially popular Economics 10 introductory course and and is the author of the core introductory textbook in the field, said that “the basic problem facing the financial system is that lots of people made very big bets that housing prices could not fall 20 percent,” despite evidence to the contrary in the Great Depression and more recently in Japan. The resulting losses wouldn’t matter in classical economic theory, he said—taking risk entails absorbing loss—except that the simultaneous large bets undercut much of the financial system all at once, and that system, as readers of his textbook know, is vital for the economy as a whole. Federal Reserve chairman Ben S. Bernanke ’75 (access his June Commencement address here) focused on just this problem in his examination of the role of bank failures in worsening the Great Depression, Mankiw noted. How should one view the proposed $700-billion federal financing initiative, Mankiw asked. One theory, advanced by President George W. Bush the night before, was that financial institutions’ damaged assets have value greater than their current price, and only the federal government has the resources to buy and hold them to maturity. Wall Street economists, Mankiw said, like that interpretation. Their (tenured) academic counterparts are skeptical: the Treasury, they say, will overpay, thus bailing out failed managers who don’t deserve it; and/or the funds will be insufficient to recapitalize banks, given the real magnitude of the losses they face. Academic economists’ alternatives are three: let the market handle the situation (as hedge funds and private-equity funds step forward where they see attractive opportunities to invest fresh capital); have the government somehow take equity positions in troubled banks and other institutions, directly infusing them with capital but benefiting as they recover (much as investor Warren Buffett put $5 billion into Goldman Sachs, with the right to invest $5 billion more on favorable terms); or force banks to raise capital, no matter what (in the friendly manner, Mankiw suggested, of a Mafia enforcer dropping by for a chat with management). As for the presidential candidates, Mankiw said, Barack Obama, J.D. ’91, seemed to be saying that the market had run wild, inflicting on the public the downside of unfettered capitalism. Recalling his service from 2003 to 2005 as chair of the president’s Council of Economic Advisers, Mankiw said that he had tried to rein in the government-sponsored Fannie Mae and Freddie Mac. Predecessors in the Clinton administration, he said, found the task impossible, too. This was a known “time bomb,” he said, not a market problem. Nor was it simply a problem of lax underwriting standards for loans. Of John McCain’s emphasis on Wall Street “greed” and “corruption,” Mankiw said, there was scant evidence that corruption was the problem. Many people made ill-advised bets, he said, but that was not criminal. And he suspected that greed would be a factor in the markets that any future administration would encounter. Cabot professor of public policy Kenneth Rogoff, former chief economist and director of research for the International Monetary Fund, tried to put the “truly incredible” recent developments in some larger context. The financial sector of the economy, he said, had become “bloated”—accounting for 7 to 8 percent of jobs (including insurance employees), but capturing 10 percent of wages and 30 percent of profits. Such evidently huge returns naturally attracted torrents of new investment, making the financial sector as a whole a bubble: “It is too big, it is not sustainable, it has to shrink” even beyond its already depleting ranks. The problem, he said, is not merely bad debts held by institutions, but “bad banks” themselves: the whole sector of financial enterprises begs to be restructured. (Rogoff noted that he had for several months forecast the collapse of at least one large investment bank, but even he was surprised at the near-collapse of nearly all the principal investment banks virtually overnight.) Much as auto makers or steel companies in the past argued that they were basic to the economy and therefore required federal support, he said, today the “country is being ransomed by the financial sector” in the demand for the $700-billion bailout, which would have the effect of maintaining management salaries, bidding up the prices of stock and bond holdings in their companies’ portfolios, and so on. Today, unlike during the Great Depression, Rogoff argued, the shrinkage of such institutions would be “not unproductive” for the economy as a whole. (As an aside, he noted that all those Harvard students who marched off to investment banking “will be freed to go into other activities.”) Given the difficulties of conducting auctions to buy distressed assets with the government’s largess without letting excess funds leak back into the financial sector, Rogoff was sympathetic with Warren’s argument for focusing on the needs of homeowners. In international perspective, he said, the United States “has been running spectacular deficits” for 15 years or more. The availability of foreign funds has enabled the country to keep interest rates low—maintaining abundant liquidity—but has exposed the fragility of the system if federal budget deficits balloon. In the present instance, he said, the issue becomes a question of whether Beijing wishes to lend the United States $700 billion to repair American financial institutions. Americans aren’t immediately going to be the source of those funds, he noted: “We’re supposed to keep consuming.” In other words, the country is saying, “We borrowed too much, we screwed up, so we’re going to fix it by borrowing more.” He said a better strategy was required—but not at the expense of excessive regulation that would choke off innovation, one of the few flagships of American economic growth and strength in recent decades (a point also made by Merton at HBS on September 23, and again after Rogoff’s presentation). After the dot.com bust of 2000-2001, Rogoff said, the technology sector regained its footing. Today, it is equally important not to overreact, so that a dynamic financial sector, corrected by “tough love,” can resume its proper and important role in the economy and in future growth. September 26, 2008Financial Crisis, Faculty Perspectives: Part 1Harvard faculty members participated in two panel discussions this week focused on the roiling crisis in the nation’s financial markets, the proposal to inject up to $700 billion of public funding to strengthen weakened institutions, and the wider implications for the economy. They concurred that regulation of financial institutions will be changed significantly; worried that the proposed intervention and forthcoming regulatory changes could themselves have unintended and adverse consequences; and pointed to even more severe underlying problems in the “real” economy—a worry described most vividly by Harvard Business School (HBS) professor of management practice Robert Kaplan when he told a Sanders Theatre crowd on September 25 that the current market turmoil is merely symptomatic of a “severely weakened middle class in the United States.” (The account of the September 25 forum is available here.) At a September 23 forum in HBS’s Burden Auditorium, a standing-room-only crowd of M.B.A. students—many of them suddenly concerned about their prospects for employment, in finance or indeed any sector, as their questions indicated—heard first from Dean Jay Light, who spoke of “an anxious time, an historic time, even a dangerous time,” as the “slow-motion train wreck” among financial institutions during the past 18 months accelerated into a fast-moving collision. He traced the collapse of the housing bubble; its intersection with a largely “new but untested financial system” (as mortgage lending evolved from local savings institutions that made loans to nearby homeowners and held those loans in their portfolios, to a transactional system of nationwide brokers who collected commissions as they made loans, sold them off, and the assets were in turn turned into complex securities and peddled to investors worldwide); and limned the dangers of sharply rising leverage among homeowners, investment banks, Fannie Mae and Freddie Mac, and investors in an era of reduced transparency and of reliance on highly liquid sources of capital (indeed, of using overnight loans to finance portfolios of mortgage and other securities). Under the circumstances, Light—who is a director of Harvard Management Company, which oversees the University endowment, and of Blackstone Group, the large private-equity firm—prescribed a three-step course of action. First, as in a medical crisis, the patient has to be stabilized, the bleeding stopped—as in the form of the proposed $700-billion federal liquidity facility for frozen credit institutions. Second, the problem has to be diagnosed and repaired. And third, the wider financial system has to be rehabilitated and put back on its feet, not least in the form of changes in regulatory oversight and standards for leverage, transparency, and liquidity. The latter task, he thought, would be the work of several years. HBS lecturer Nicolas P. Retsinas, director of the Joint Center for Housing Studies, described the dimensions of the housing-price bubble and current crash, given the excess inventory of housing units for sale—he suggested a million units at least—and the turmoil in lending. Ironically, he said, in current conditions, only borrowers with excellent credit ratings and substantial downpayments can purchase houses: the conditions that prevailed a few decades ago, before mortgage lending became the national, brokered business Light described. But of course there are too few buyers in those circumstances, and too few willing lenders, to clear the current inventory from the market. HBS senior lecturer Clayton Rose, former vice chair and chief operating officer of J.P. Morgan Chase, and of investment banking there, summarized 20 years of deregulation of Wall Street that was unaccompanied by any changes in the prior oversight structure. In an atmosphere of intense business competition, he said, investment banks employed unprecedented levels of leverage (30 times their capital, in the case of many leading firms) to boost returns from their investments, at the same time that the value of those increasingly complex investments—mortgage-backed securities, derivatives, private equity holdings—became much harder to determine. He cited Goldman Sachs, a J.P. Morgan competitor, as an example: it boosted profits fivefold from 2002 to 2007 by assuming much more risk. While banks and bank holding companies remained under strict capital standards, and were overseen, variously, by four or five federal agencies and the Federal Reserve Board, investment banks escaped such capital limits, and were principally overseen by the Securities and Exchange Commission. But all the competitors, he said, placed heavy bets on the value of mortgage securities—the biggest pool of such financial assets—and all made faulty assumptions about default rates, the national prevalence of market weakness, the value of their securities, and the availability of liquid funds on demand. Now, the contagion has spread to all classes of assets, and lenders, frightened by losses and the looming unknowns, have shut off the credit that the economy needs to operate. Banks, with less leverage, more capital, and access to the Federal Reserve for backup funding, are less threatened than investment banks, he said—witness the forced merger of Bear Stearns into J.P. Morgan Chase; the bankruptcy of Lehman Brothers; the hasty merger of Merrill Lynch into Bank of America; and the involuntary conversion, as he described it, of Morgan Stanley and Goldman Sachs into bank holding companies, under Federal Reserve supervision, on Sunday night, September 21. In the long term, he said, the investment banks’ returns will decline, and their cultures and management will change from the style that has prevailed until recently. McLean professor of business administration David Moss, author of When All Else Fails: Government as the Ultimate Risk Manager, agreed that the housing crisis underpinned all of the current problems, and that the resulting weakness in the financial architecture—excessive leverage, distorted compensation incentives, conflicts of interest on the part of credit-rating agencies, and the sheer complexity of current financial instruments—had created a genuine crisis of confidence, nearly to the point of precipitating a twenty-first-century run on banks last week as funds were pulled from the multitrillion-dollar money-market-fund industry. Moss’s greatest concern, however, is that whatever steps the public sector takes to ameliorate the risks must also be accompanied by parallel measures to control the resulting “moral hazard.” Thus, he explained, federal insurance of bank deposits could encourage banks to engage in more risky lending—but generally does not if coupled with appropriate regulation; workers’ compensation might encourage malingering—but it is also tied to compensating steps [no one wants to be injured, replacement income is limited, the business is regulated]. Federal disaster relief, he said, has the opposite effect when it encourages rebuilding of hurricane-damaged communities in precisely the most hurricane- or flood-prone locations. Thus Moss defined the problem as successful versus unsuccessful government management of risk. So far, he said he saw in the rapid movement toward the $700-billion federal financing plan no offsetting steps to apply appropriate oversight and other measures that would discourage future, inappropriate risk-taking by the institutions which would be resuscitated as they sell damaged assets to the government. McArthur University Professor Robert Merton, a 1997 Nobel laureate in economics for his work on options pricing and risk analysis, advanced the importance of “functional analysis of the financial system.” (His experience with the system is both theoretical and actual; he was a principal in Long Term Capital Management, the extraordinarily leveraged investment firm whose collapse in 1998 nearly precipitated a world financial crisis and necessitated a bailout negotiated by the Federal Reserve; see a review of books on that precursor of the current situation here). Although current concerns focus on liquidity and the credit markets, Merton said, it was essential to note that as too-high housing prices deflated, perhaps $3 trillion to $4 trillion of actual wealth had been lost in the last year alone—and was unlikely to return. With each successive decline in the value of an asset held on a leveraged basis, he said, an owner’s effective risk and effective leverage ramped up at an accelerating rate, underlining the destruction of the financial institutions that held the underlying failed mortgage loans and securities based on them. In addition, such deterioration prompts “feedback”: for instance, banks and thrift institutions held Fannie Mae and Freddie Mac preferred stock as part of their presumably safest, most reliable capital; when the government took control of those institutions, the banks’ and thrifts’ capital absorbed immediate, large losses—instantly increasing their own leverage and decreasing their ability to make loans, worsening the underlying housing crisis. Financial innovation and “engineering” are widely blamed for causing, or worsening, the current crisis, and in a sense, they have, Merton said. Innovations inherently involve the risk that some ideas will fail, and inherently outrun existing regulatory structures. But rather than clamping down so severely that financial innovation is choked off, he argued that regulation must allow for further, future innovation as an engine of growth, because the functional needs—consumers’ need to finance their retirements, developing nations’ ability to fund economic development—remain intact. Thus, he urged that the focus remain on the necessary financial functions, and not on saving any particular form of institution that currently meets those needs, or did until recently. Jobs in finance, he told the anxious M.B.A.s, would be “tough” to come by. But the solution for society would not be to rid financial institutions of highly trained, innovation-oriented financial engineers. Rather, he insisted, management teams, boards of directors, and regulators needed much more such expertise in their own ranks so they could understand the products they were offering and acquiring—as they so apparently did not in the recent past. Part 2, on the University forum held on September 25, is now available here. September 24, 2008Gore to Speak at Sustainability CelebrationFormer vice president Al Gore ’69, LL.D. ’94, will be at Harvard on October 22 for a University-wide celebration of sustainability. The event will celebrate Harvard’s past achievements, present efforts, and future goals, including President Drew Faust’s commitment to cut greenhouse-gas emissions 30 percent by 2016 (read more about that in the current issue of Harvard Magazine). Gore, who drew attention to climate change with his 2006 film An Inconvenient Truth, is scheduled to speak at 4:15 p.m. in Tercentenary Theatre. More information is available at the event website. Below, the full text of the news release from Faust’s office:
September 12, 2008Harvard Endowment Rises 5.7 Percent to $36.9 BillionHarvard Management Company (HMC) reported on September 12 that the University’s endowment had increased by $2.0 billion, or 5.7 percent, during the fiscal year ended June 30. The new total of $36.9 billion represents an 8.6 percent investment return on endowment assets after expenses and fees; plus endowment gifts received during the year; minus the $1.6-billion distribution of funds to support University operations and—according to the news release—substantial capital outlays (see discussion below). Jane L. Mendillo, HMC’s president and chief executive officer since July 1, said, “Results for HMC for fiscal year 2008 were very solid” in light of “pretty turbulent market conditions.” She said that Robert S. Kaplan, who served as acting president and CEO from last November through June 30, had done a “fantastic job” managing the organization during a time of senior management transition and very challenging market circumstances. Kaplan, who has now joined HMC’s board, cited the work of the “great team here” in the investment organization. The 8.6 percent return on investments follows a stellar 23 percent return in the prior fiscal year, which ended June 30, 2007 (see “The Endowment: Up, and Upheaval,” November-December 2007). That returns in fiscal year 2008 were less robust is hardly surprising, given the adverse conditions in world financial markets during fiscal year 2008. The endowment assets are diversified among many categories of investments (domestic, foreign, and emerging-market equities, private equities, commodities, real estate, various kinds of bonds, etc.), but HMC noted, as it does traditionally, that popular market measures such as Standard & Poor’s 500 index (of large U.S. stocks) had declined 13.1 percent during the fiscal year, while the Lehman Aggregate Index (a broad proxy for the bond market) gained 7.1 percent. In seven investment classes, HMC results exceeded those for the appropriate market benchmarks: domestic, emerging-market, and private equities; real assets (including all three subcategories of commodities, timber and agricultural land, and real estate); and domestic, foreign, and inflation-indexed bonds. In three classes, HMC performance fell short of market benchmarks: foreign equities, absolute-return funds, and high-yield assets. In the aggregate, HMC’s 8.6 percent investment return exceeded its market benchmarks’ 6.9 percent return, providing a “value-added” margin of investment performance of 170 basis points, worth some $600 million-plus in extra endowment return. (The median return of a group of large institutional investors, aggregated by the Trust Universe Comparison Service was negative 4.4 percent. Peer universities such as Princeton, Stanford, Yale, and others, whose investment strategies are similar to Harvard’s in several respects, have yet to report results individually.) The star performers in HMC’s portfolio were the three components of “real assets,” which in the aggregate produced a 35.8 percent investment return for fiscal year 2008, slightly ahead of the 33.0 percent benchmark return in those classes. Real assets comprise “liquid commodities” (oil and gas, agricultural goods, metals, and so on), which soared in value during the year, driven by strong demand from developing nations and from investors’ perception of rising inflation; timber and agricultural land, an inflation hedge for which values fluctuate on a different cycle, but where results were apparently also good; and real estate, both commercial (offices, warehouses, retail facilities, and so on) and residential (apartment and condominium buildings, for instance)—where results in the recent fiscal year appear to have been least favorable. As might be expected, all of the fixed-income asset classes performed strongly during the year, with domestic bonds up 16.1 percent, foreign bonds up 21.3 percent, and inflation-indexed bonds up 20.3 percent. In total, the real assets account for about one-quarter of endowment holdings, and the bond portfolios another 15 percent; the gains there offset the negative returns in the large domestic and foreign equity portfolios (12.7 percent and 12.1 percent, respectively)—about another quarter of total assets. In their written narrative on the year’s results, Kaplan and Mendillo cited “periods of intense market turmoil highlighted by liquidity disruptions, severe dislocations in various financial markets (examples include residential mortgages, commercial paper, consumer loan markets, leveraged loan markets, and municipal auction rate preferred markets), and emergency policy responses.” (Those “responses” ranged from sharp cuts in U.S. interest rates by the Federal Reserve Board to the supervised takeover of the Bear Stearns investment bank, and continued in late summer with the government assumption of control over the Fannie Mae and Freddie Mac housing-finance enterprises.) The result, Kaplan and Mendillo wrote, was “the early to middle stages of a fundamental financial market de-leveraging”—as banks, other institutions, and investors shed assets and pared down debt, often leading to the distressed sale of assets, sharp volatility in investment markets, and unusual movements in the prices of commodities such as oil, all prompting concerns about slower economic growth and, simultaneously, rising inflation worldwide. In the immediate future, they wrote, “[W]e expect to see a continuation of the process of financial market de-leveraging. This process will likely create periods of disruption and market volatility.” In this context, HMC did not itself need internal instability. The unexpected resignation of HMC president and CEO Mohamed El-Erian in the fall of 2007 (see “An Unexpected Risk Factor,” November-December 2007) raised the specter of just such disruptions, given that he had only recently put in place a new operating structure and the personnel—several of them new to the management company—to staff it. But the indications are that such fears were not realized. Noting superior relative investment returns in certain of HMC’s assets, Kaplan and Mendillo cited “the outperformance of our internal portfolio management group”; successful execution of midyear adjustments to respond to market risks, and of “overlay strategies” to insure the endowment portfolios; and “strong results delivered by a number of our longstanding and recently added external managers.” (As Kaplan pointed out, HMC’s hybrid structure, with internal and external money management, may yield dividends in turbulent years like the past one. Because HMC manages some funds in-house, the senior management team can have immediate, direct insights into market conditions from their colleagues; such information would be less readily available and timely were they relying solely on third-party firms to invest endowment funds.) Reflecting on the transitional year, Kaplan and Mendillo cited further recruiting of investment personnel who complement “our existing strengths”; further steps to encourage investigation of new investment ideas and themes; continuing work on asset allocation in a changing world, and on the evolving dynamics of the private-equity and hedge-fund industries (which have been important sources of superior investment performance for Harvard and other diversified endowments); and appropriate responses in light of the rising risks of inflation. The fiscal year 2008 results and the accompanying commentary bear importantly on the two topics most pressing for the University itself: the availability of funds from the endowment to support Harvard’s academic mission; and the investment environment in the near and intermediate future. As noted, the HMC release put at $1.6 billion the distributions of funds in support of the University’s operating budget and capital spending. Details of that distribution will be forthcoming in the next few weeks, when Harvard’s annual financial report is published—and will be carefully scrutinized, in light of Congressional interest in private universities’ use of their tax-exempt investment returns on their growing endowments (see “Endowments—Under a Tax?” July-August; the most recent hearing on the issue took place in the U.S. Senate on September 8). It is reasonable to assume that this total combines three kinds of outlays, in a manner first used in the fiscal year 2007 report (see “Getting and Spending,” November-December 2007). In that year, endowment income distributed for operations—the conventional measure of distributions—totaled $1.04 billion, up just less than 12 percent from fiscal year 2006; the “strategic infrastructure fund” assessment for Allston campus development totaled $140.5 million; and a $100-million “decapitalization” was made for Faculty of Arts and Sciences construction programs. The sum of those figures totaled about $1.3 billion. Rough estimates for the fiscal 2008 distribution would be operating funds of $1.2 billion, in part reflecting increases in financial aid across the University; an Allston fund assessment of perhaps $180 million or so; and further decapitalizations, to be specified, of roughly a quarter-billion dollars. As to the investment environment, Kaplan and Mendillo sounded unusually wary. “During these challenging times,” they wrote, “we continue to emphasize the importance of HMC’s hedging and risk management strategies. We are quite cognizant of the near-term risk of subpar investment returns from many of the asset classes in which we and other investors participate. We are closely monitoring the deterioration in certain underlying debt and equity markets and the potential impact of these declines on the ultimate realizable value of investments in our private equity portfolio and on certain of the investments held by our hedge fund managers.” Citing what Kaplan calls “very successful” past performance—five-year annualized returns of 17.6 percent, and 10-year annualized returns of 13.8 percent, with very large margins of performance in excess of the market benchmarks and the median returns of large institutions—they were “keenly aware that returns produced in the next few years may fall well short of these robust historical levels. We will continue to aggressively pursue our key investment strategies, as well as appropriate risk management, in order to help the endowment navigate these challenging market conditions. Even with this said, our expectations for the endowment’s returns in fiscal year 2009 and over the next several years are very cautious.” The positioning of HMC’s model portfolios and its management strategies suggest confidence in long-term performance for the endowment—Mendillo describes “the great talent working at Harvard Management Company” now, and Kaplan foresees “strong prospects” in the future—but with the real likelihood of a much rougher ride in the next few years than in the comparatively tranquil decade and more that preceded fiscal year 2008. September 3, 2008Harvard Basketball Program ExoneratedAn inquiry by the Ivy League into allegations of improper recruiting and lowering of academic standards by the Harvard men’s basketball program has determined that no violations of either NCAA or Ivy League rules occurred. More >> August 27, 2008A Startling Achievement in Regenerative MedicineDouglas Melton, co-director of the Harvard Stem Cell Institute, has figured out how to transform one type of cell in a living animal into another, using a new process his research team has dubbed “direct reprogramming.” More >> August 15, 2008SEAS Interim Dean AppointedMaterials scientist Frans Spaepen will serve as interim dean of the School of Engineering and Applied Sciences (SEAS) starting September 15, Michael J. Smith, dean of the Faculty of Arts and Sciences, announced today. More >> |
RSS FEEDadvertisements