Citing Recession, Yale Makes Deeper Cuts

Yale has announced a second, deep set of austerity measures; its reasons for doing so may cast light on the financial choices confronting Harvard.

In a letter disseminated to Yale faculty and staff members on February 24, that university's president, Richard C. Levin, outlined "a more aggressive approach to budget reductions for the coming fiscal year" than he disclosed last December 16, when he estimated that Yale's endowment would decline 25 percent in value during the current year. With "diminished" prospects for an early economic recovery compared to the outlook only a couple of months ago--and more rapidly growing unemployment, worsening credit markets, and the spread of recession around the world--Levin said that the endowment's performance had not deteriorated from the earlier projection. But, "[I]t will likely be some time before the endowment resumes its normal growth." Accordingly, Yale has taken the following steps, several of which may shed light on Harvard's situation:

Slashed its capital spending plans. New buildings and renovation projects under way will continue (in contrast to Harvard's decision to slow construction on, and perhaps halt or redesign, the flagship Allston science laboratories), as will the renovation of two residential colleges ("Houses" in Harvard terminology). But all other projects will be postponed, as will design work, unless gift funding is secured or credit-market conditions improve significantly. This puts on hold Levin's highest-profile, flagship project: the construction of two new residential colleges, and expansion of the Yale undergraduate body, for which site work was scheduled to begin imminently. (See the Yale Daily News postings here and here for details.) In all, some $2 billion of work planned for the next five years is on hold.

The implications for Harvard: Starting significant new construction, or major renovation projects such as the renewal of the undergraduate Houses, will require changed circumstances. The extraordinary decision to incur the costs of slowing construction in Allston--finding alternate space for the laboratories that were intended to be based in that science complex, and perhaps even redesigning the buildings after construction has started--are an indication of the pressures on costly building projects. The renovation of the Fogg Art Museum, being designed by Renzo Piano, has not yet begun--but the building has been closed and is being prepared for construction by 2010. Watching what happens there will be significant, as the facility cannot now be used, the art collections are being made inaccessible for years, and significant gifts have been made toward the renovation (from David Rockefeller and Emily Rauh Pulitzer)--but not all of the funding for the multi-hundred-million-dollar project is thought to be in place.

Cut its operating budget further. Yale had planned a reduction in its 2009-2010 budget of 5 percent of the salaries and benefits of all nonfaculty staff; now that has been raised to 7.5 percent. It aims to achieve the reduction through attrition, but for the first time, the specter of layoffs is being raised. In addition, non-salary expenses, intended to be cut 5 percent in each of the next two fiscal years, are now to be reduced 7.5 percent for 2009-2010 and 5 percent in the succeeding year. And salaries are being reined in, too: employees who earn less than $75,000 will be eligible for 2 percent merit increases, but those with higher incomes now will have salaries frozen (previously, they were to be eligible for increases of up to $1,500). The extra savings may forestall the disappearance of still more jobs. Those cuts are intended to save $37 million in the next fiscal year, in addition to the $50 million to $70 million in savings anticipated in the December announcement.

The implications for Harvard: Yale derives more of its operating revenue from endowment distributions than does Harvard as a whole (about 44 percent versus 35 percent), but significant parts of Harvard are more endowment-dependent than Yale—notably the Faculty of Arts and Sciences (FAS), which now receives considerably more than half its revenue from endowment distributions. Yale's aggregate cutbacks for next year now approximate those being planned for FAS alone, although Yale as a whole is more than twice the size of FAS. The differing financial pressures reflect, at least in part, FAS's decision during the past four years to expand the faculty significantly and to use debt to pay for the construction of about $800 million worth of new laboratories and other buildings, the financing and operating costs of which are now being borne. In addition, if the estimates hold true, Yale is expecting slightly better endowment performance during the current fiscal year than Harvard  projects (a decline of 25 percent in New Haven, versus 30 percent in Boston).

Layoffs, borrowing, and gifts. The Daily News articles point to three other factors.

First, as noted, Yale now anticipates layoffs; the university's vice president for human resources and administration, Michael Peel, is reported as saying that attrition at Yale is at its lowest point in a decade. New Haven's economy is smaller and much less diversified than that of Greater Boston, but the general economic conditions suggest that normal turnover and the effects of Harvard's employee retirement incentives will have to be monitored carefully; to the extent that voluntary departures from the staff fall short of financial goals, Harvard, with its larger planned budget cuts, could be confronting staff layoffs, too.

Second, in assessing the state of the economy and the credit markets, Levin and Yale are updating their view of universities' borrowing capacity. The Daily News cited Yale deputy provost Lloyd Suttle's concern about the inability to borrow, even for an institution with a top credit rating (like Yale or Harvard). Moreover, he said, rating agencies take into account the ratio of debt to endowment value in assessing institutions' financial strength, limiting borrowing for those schools which wish to maintain top-tier creditworthiness. Given Harvard's $2.5 billion of borrowings in December, and the forecast reduction of the endowment's value to perhaps $24 billion by the end of the fiscal year, it is approaching a 4:1 ratio of endowment to debt outstanding--and there are indications that that is near the rating agencies' tolerance limit for AAA institutions' leverage.

Finally, Levin emphasized the importance of gift income. Yale has been conducting a capital campaign, and raised $487 million during fiscal year 2008, according to data released yesterday by the Council for Aid to Education (see the New York Times story here; Harvard raised $650 million, but that total includes Rockefeller's extraordinary, $100-million gift). But apparently giving has fallen precipitously of late; the Times quoted Ann Kaplan of the council to the effect that several institutions' fundraising had "hit a wall" in January; based on past recessions, she forecast a decline in giving throughout 2009 and 2010, before growth resumes. Harvard is emphasizing current-use giving, in the absence of a capital campaign. Any reduction in gift income compounds the problems of funding current operations or planning new investments--designing capital projects or launching new programs.

Analysis. Yale's further belt-tightening, and Harvard's decision to slow and rethink the Allston science project, reflect a second wave of administrators' adjustments to a deteriorating financial situation. The rising awareness last fall that endowment values would decline sharply coincided with the national credit and financial crisis. Now, as that crisis has provoked a deepening recession, with rising joblessness and further damage to the financial markets (and investment assets), university administrators are refining their plans. They see a period of potentially protracted negative investment returns, and a delayed market recovery; adverse pressure on gift receipts, again for a perhaps extended period; and curtailed access to the credit markets in which they have borrowed for capital expansions.

The odds have risen both for layoffs among the institutions' workforces, and for more extensive changes to programs. Harvard's plan to open a research and study-abroad office in Beijing has been postponed, to take only one recent and relatively small example. Decisions on the big-ticket items—whether the first Allston building will be mothballed or redesigned; the resumption of planning for what had been envisioned as its many successors, now clearly delayed and with no timetable at all; whatever decisions are made on the art museum, House renewal, and more—will give a clearer picture of whether and when the University regains the financial flexibility and wherewithal to proceed on what had been its highest priorities. And across Harvard, myriad smaller decisions on reducing staff, folding academic centers into departments (or letting them wind down), consolidating library functions, and other measures will unfold throughout the spring in response to the financial blows that have already been sustained.

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