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John Harvard's Journal

Fraught Finances

March-April 2006

Amid an historic expansion, the Faculty of Arts and Sciences (FAS) must now come to terms with the costs of its growth. An anticipated deficit of $40 million-plus in the fiscal year ending this June 30 was disclosed at the January 10 faculty meeting; that gap is being filled from reserves on hand.

More daunting challenges loom thereafter. From this year to 2010, the annual cost of building and operating facilities now under construction, hiring more professors (now 700, rising to 750), and funding desired new programs will increase to an estimated $108 million to $122 million. These expenses are in addition to already budgeted costs for continuing operations (College and graduate-school teaching and student life, research, financial aid) and exceed the income projected from the endowment, tuition, research, and gifts. The forecasts follow substantial increases in FAS’s operating budget, from $699 million (fiscal year 2003), to $754 million (2004) and $858 million (2005)—each of which yielded a surplus—to about $970 million currently (with the forecast deficit).

In their January 10 presentations, members of the faculty’s Resources Committee advanced a context for FAS’s financial position, detailed the underlying academic agenda, and outlined the fiscal measures it will pursue to balance its books.

Speaking first, Florence professor of government Gary King said that forecasts of FAS finances always show future deficits due to new projects or emerging fields. Management then must stave off actual budget gaps. In an interview, he said a prospective deficit “means things are going well,” in the sense that FAS is taking intellectual risks. The rest of Harvard, he noted, “has grown spectacularly relative to FAS for a very long time.” Now, increasing the faculty (from about 600 members in 2000; see “Growth Spurt, Growing Pains,” January-February, page 64) and expanding in “areas of science that FAS represents” is exciting and appropriate. The current “investment plan” requires heavy spending on facilities—“the biggest growing period in Harvard’s physical plant in decades” (see "Capital Costs")—to accommodate new professors.

Caroline M. Hoxby, Freed professor of economics, detailed the outlook for the faculty. FAS began this fiscal year with reserves of $72.8 million, she said, and with an endowment of $11.7 billion (of which $1.4 billion is unrestricted—the crucial source of funds for new initiatives). Anticipated faculty hiring from this year forward will add $28.5 million to annual costs by 2010, after accounting for any grants that faculty members receive. Programmatic initiatives—international study, science research centers, dissertation fellowships, expanded arts venues and staffing—require another $29.5 million.

Overshadowing those items are debt service and operating expenses for new buildings, which rise from $11.7 million this year to $72 million in 2010, after accounting for recovery of “indirect costs” for sponsored research conducted there. The driving factor is FAS’s decision to expand its science space 34 percent in a six-year span. All these commitments—particularly the costly faculty growth and expansion in the sciences—are high priorities of both FAS and the University administration.

The aggregate new spending, $130 million per year by 2010, would be reduced by about $61 million, Hoxby explained, through anticipated higher distributions from the endowment authorized by the Corporation (see "Sharing the Wealth"), and an assumed increase in federal reimbursement for those overhead costs. As FAS reserves are spent, by 2008, Hoxby said, sustainable new sources of revenue must be found.

That left it to Olshan professor of economics John Y. Campbell to explain the financing program. Beyond the $69 million net deficit from the items Hoxby outlined, the projected budget assumes a $10-million gap from continuing operations. Campbell cited further factors—inflated utilities costs and a prudent contingency for unforeseen events and additional investments or programs—bringing FAS’s need for extra revenue to a range of $108 million to $122 million in 2010. Campbell then reviewed a four-tier plan to obtain those funds through:

• FAS actions, yielding $15 million to $20 million per year. In a separate conversation, he described such measures as examining restricted funds to see how they could best be used, exploring new fees, or redirecting current revenue streams.

• Increased endowment distributions. Campbell said the Corporation was reassessing whether its payout policies were too conservative, in light of recent investment gains; a liberalized distribution would yield $36 million more annually to FAS, beyond the figure Hoxby described (the 2005 distribution was about $390 million). In addition, the faculty would receive Corporation permission for a discretionary “decapitalization” (spending from appreciation) of its unrestricted endowment, yielding another $24 million per year. Because this reduces future assets and therefore distributable revenue, Campbell said tapping such funds could not be indefinite and would have to be succeeded by gift income.

• Expanded support from the central administration, worth $18 million to $23 million per year. Campbell cited funds for facilities and infrastructure and for graduate-student fellowships. The largess reflects, in part, appreciation in the value of central endowment funds.

• Fundraising, expected to contribute $15 million to $19 million annually. That goal, Campbell said, reflects growth driven by FAS solicitations, in advance of any Harvard capital campaign.

Faculty members questioned several aspects of the plan. In light of Stanford’s recent $1.1-billion campaign for undergraduate education, was FAS fundraising too timid, asked Rabb professor of anthropology Arthur Kleinman. Dean William C. Kirby said the fundraising goal assumed success beyond an already projected 9 percent annual growth in donor support through 2010. President Lawrence H. Summers said the forthcoming campaign would seek more for FAS than Stanford’s effort. The annual goal was the expected income from new endowment gifts of $300 million or more. This is “a period of extraordinary investment” in faculty growth and buildings, he said, justifying expanded central support and extraordinary measures such as the decapitalization.

Gurney professor of English literature and professor of comparative literature James Engell wondered whether the need for new funds in 2010 would persist in following years. When Hoxby said that it would, he asked if the committee members were confident about their assumptions. Hoxby reiterated the need for successful fundraising and recovery of overhead costs. Campbell said capital gifts would yield future income, decreasing the need to draw down endowment. Kirby said the faculty was fortunate to be able to take on its “historic investment” and had a 10-year plan to cover costs and replace and replenish its income.

Separate conversations provided further details about the risks and costs associated with FAS’s plans. One, of course, is “what happens to the endowment and financial markets in general,” according to Campbell, a professor of finance and investments who sits on the Harvard Management Company board. Although the endowment is well diversified, he said, “Bad stuff could happen.” If investment returns are poor or fundraising lags, “The shock absorber is Allston”: the University could slow down development there to cover costs incurred in FAS.

The decapitalization, he acknowledged, would have a “noticeable effect on the unrestricted endowment” of FAS and so must be a transitional measure. (As described, there is no time limit.)

Hoxby quantified the stakes. Even without further expenditure increases after 2010 (an unlikely event), she said, if the projected use of unrestricted capital extends to 2015, the faculty will “run into trouble.” That is, given the “aggressive” decapitalization plan, the unrestricted funds then available for operations would be insufficient to cover those parts of the budget paid for now. Nor are FAS’s current investments in any sense “reversible”: the faculty are hired, steel has been set for the new buildings—ahead of fundraising. In effect, FAS has made “a very large bet on science that will limit our flexibility for years to come.” For instance, it is committed to hiring more science professors to fill the new laboratories, hoping they bring in grants and overhead funds. And beyond some resources for study abroad, FAS has not explicitly reserved funds to pay for reforms from the undergraduate curriculum review (see "Curricular Commitments"). Citing FAS’s circumstances, she said, “Even if you are very, very rich, you can spend more than you have.”

All this puts a premium on execution. Administrators will have to realize anticipated revenues and redeploy funds. (Several observers characterized such steps—for example, charging rent to academic centers and museums which now get free space from FAS—as “politically sensitive” and “difficult.”) The Corporation will have to agree to the increased distribution of endowment funds; according to vice president for finance and chief financial officer Ann E. Berman, its current guidance to the faculties for future distributions accommodates a portion of what FAS is counting on.

And then there is fundraising. “The most important thing,” said Gary King, “is the coordination Harvard does with its alumni.” Having concluded that it would be irresponsible to hoard its wealth, FAS has proceeded with its intellectual agenda. “The more responsible we are, and the more exciting projects we have to invest in,” he said, “the more the alumni rally to our support.” Of the risks overall, he said, “I’m quite confident it’s not going to be an issue.” (That assessment preceded the announcement of Kirby’s forthcoming departure from the deanship, a possible delaying or complicating factor in planning and fundraising; see "Arts and Sciences Dean to Leave Office.")

Kirby, in an interview January 13, reiterated that “none of these costs is a surprise.” The faculty made its academic investments, large as they are, with its eyes open, expecting to use reserves, borrowed money, and endowment funds as needed. Looking ahead, he said, “We won’t spend more money than we have available.”