Endowment Distribution to Be Reduced 8 Percent; Budget Cuts Loom

Distributions from the endowment will be reduced 8 percent in each of the next two fiscal years; that action sets the stage for significant budget cuts.

On March 18, the University advised schools and other units that distributions from the endowment to support operations will be cut 8 percent for Fiscal Year 2010, beginning July 1, and an additional 8 percent for Fiscal Year 2011. The reduction is driven by the sharp decline in the value of endowment assets first reported last fall (see here for the November 10 announcement and here for the December forecast that the endowment investments would depreciate by 30 percent during this fiscal year; more generally, see the continuing University financial coverage). But the magnitude of the change in endowment support for operations--apparently the result of a recent Harvard Corporation decision, deferred from last fall, when the credit crisis and recession were just unfolding--is larger than many units had anticipated. The Faculty of Arts and Sciences (FAS), for instance, had been building budgets on an assumption of level endowment distributions next year, or a possible 5 percent cut; the former figure would have left FAS facing a $100-million gap in FY 2010, and the 5 percent reduction, a $130 million gap—a problem that will now exceed $150 million in the coming year. Although FAS is particularly dependent on endowment distributions, the new budget guidance foreshadows significant reductions in operations and personnel in many parts of the University, to be announced later this spring.

The budget guidance. A memorandum to administrative and executive deans (the schools' principal financial officers) from Dan Shore, vice president for finance, circulated on March 18, cited "unprecedented financial circumstances that challenge not simply Harvard, and not simply the higher education industry, but practically all industries across the global economy.  When the University began its annual budgeting activities several months ago, we had limited visibility regarding both projected endowment investment results for the current fiscal year, and the trajectory of the endowment's potential recovery.  While our visibility is not meaningfully greater today, our strong sense is that an eventual recovery will take longer, and that we must therefore begin to accommodate a new economic reality for the University." (For similar recent statements by Stanford and Yale, see here and here; both institutions, which had promulgated initial budget reductions earlier, indicated that they were now making deeper cuts, given their expectations that the impairment of endowment values, and pressure on other financial resources, would be more severe and protracted than previously assumed.)
"With this as context," Shore's message continued, "we will be decreasing the endowment distribution for operations by 8 percent in FY 2010, and we expect in FY 2011 to decrease the distribution by at least the same magnitude.  We do not take this guidance lightly, as it inevitably will require you to consider profound changes in how your schools operate.  While this presents opportunities to consider new strategies or structures for fulfilling the University's mission, we recognize that the process will ask much of staff who already are working extremely hard to support our core teaching and research activities."

To put these figures in context: in the year ended June 30, 2008 (the last for which University financial statements are available), distributions from the endowment for operations totaled about $1.2 billion—nearly 34.5 percent of Harvard's operating revenues in the period: about 15 percent more than in the prior year. Clearly such distributions have been the principal engine for funding enhancements in financial aid, academic programs, faculty hiring, physical expansion, and so on. (These figures exclude the $400 million of administrative assessments for Allston development and "decapitalizations" also disbursed from the endowment in FY 2008, and comparable items in the prior year.) Endowment distributions for operations were provisionally estimated to rise further in the current fiscal year, to $1.4 billion or so. Faculties made long-term investments under guidance and the expectation that endowment distributions would continue to grow by some measurable amount annually; instead, they will decline by perhaps $100 million or more in each of the next two years. For FY 2010, that means Harvard must absorb a swing of $200 million to $300 million, compared to the resources only recently expected to be available for budgeted spending from the endowment, with a widening gap in the subsequent fiscal year; at the same time, even with increased spending on sponsored research provided by the federal government's stimulus package, the prospects for research funds are uncertain; donations may come under further pressure; and the need for financial aid is forecast to increase significantly.

FAS Outlook. The Faculty of Arts and Sciences—Harvard College and the Graduate School of Arts and Sciences—faces the largest absolute problem  (although Harvard Divinity School and the Radcliffe Institute for Advanced Study are, in relative terms, more dependent on endowment revenues). Its expenses have risen significantly in recent years, driven by factors such as a 22 percent rise in the professorial ranks (126 new positions) this decade; a debt-funded $800-million investment in science laboratories (for which debt- service payments are now rising, and for which the faculty now bears operating expenses); and multiple rounds of expanding and enriching financial aid. Dean Michael D. Smith told his faculty that FAS initially expected endowment operating distributions to rise from $650 million in the current fiscal year (when the budget is $1.15 billion; the distribution had been $550 million in FY 2008) to about $750 million in FY 2010, enabling the FAS to deal with an existing structural deficit and those rising costs. During the winter, he projected level endowment distributions, and a resulting $100-million budget gap in FY 2010, even after freezing salaries, reducing the number of faculty searches sharply, and curtailing hiring.

In a message to his colleagues yesterday afternoon, following the release of the University's budget guidance, Smith wrote,

The guidance instructs us to plan for the funds paid out from the endowment in support of our operations to be reduced by 8 percent in FY 2010, and for a decrease of at least that same magnitude in FY 2011. For the Faculty of Arts and Sciences, this guidance will mean a $52 million reduction in FY 2010 funds vis-à-vis our FY 2009 budget.

Because we in the FAS have been planning for a range of aggressive scenarios, we have the ability to absorb some of this decrease in funding by adjusting our FY 2010 budgets to implement more of the measures proposed in our planning. I deeply appreciate all the hard work, sacrifice, and institution-mindedness that has driven our planning to date. In addition, the academic deans and I will continue to work with senior administrators and our colleagues at other schools and in the [central administration] to find additional cross-cutting efficiencies. Whatever gap remains after those efforts are complete will be closed using our limited reserve funds.

Please know that we are taking every possible measure to protect our core mission, to support our priorities and even to pursue some new initiatives in the midst of this crisis. We are each joined here together in the pursuit of excellence in teaching and research, and we must support, in the best ways we know how, our very special community. The additional measures we pursue now will all be guided by these core principles. With this news, I ask again for your partnership, your understanding, and your patience as we continue to navigate uncharted terrain.

Smith reported in December that those "limited reserve funds"--the monies available for unrestricted use--amounted to about $100 million. Clearly, that is not sufficient to absorb large, multiyear budget shortfalls. Moreover, to the extent the reserves are expended to cover holes in existing programs' finances, they are unavailable for investment in new programs or fields--the lifeblood of intellectual renewal.

Smith's message did not address the implications for future years, but in an explanation of FAS finances distributed to the faculty in December (see pages 7-8 of "FAQs About the Endowment, 12/5/2008" here), he illustrated the long-term challenge to restoring the endowment's value under certain conceivable investment-return and spending assumptions. There, he projected a level distribution rate (which is of course sensitive to the amount of funds distributed, relative to the total endowment assets). But there is no guarantee that the Corporation will be comfortable with either a level distribution of dollars, as it has now shown, or an elevated payout rate (the result, today, of the decline in endowment value) over a sustained period. And of course, financial-aid costs will continue to rise, salaries cannot be frozen indefinitely, and so on.

In a February 17 message about FAS's voluntary early retirement incentive program for staff members (no equivalent plan has been announced for faculty members), Smith noted, "With more than half of our $1 billion annual operating budget dedicated to compensation costs, it is clear that realigning FAS for the future will depend on some changes to our current workforce. Let me assure you that we continue to explore every option available in order to limit staff changes forced solely by our budget challenges. We hope that the level of participation in the voluntary early retirement program will mitigate the need for further staff reductions. Such considerations will be made after the program has closed and results are assessed."

In prospect. The early retirement program was offered first to eligible staff members of FAS and Harvard Medical School (HMS); other schools and central administrative personnel are just receiving their incentive offers this week. The response from the 1,600 or so affected personnel will be known by early May. Thereafter, deans and other administrators will proceed to fit their FY 2010 budgets to the newly reduced level of funds. As in FAS, so throughout Harvard, compensation and benefits make up about half of University expenses, so workforce reductions—possibly extensive layoffs—seem inevitable. Already, contracted workers, such as janitors at HMS, are being let go, and other, sporadic cuts are being imposed (large layoffs at the Faculty Club, for example, where dining and meeting revenues declined beginning last fall, and where new, lower-cost services are being rolled out).

Many other adjustments are taking hold, or are in the offing. Some of the elevators in Holyoke Center have been shut down, for instance. As reported, the University has slowed construction on the marquee science laboratory complex in Allston, and will likely "pause" construction later this year or even explore redesigning the buildings to trim costs on what had been budgeted as a $1.1-billion complex; that action will, by year end, reduce the need for capital spending by many millions of dollars per month. Later this year, the University will have to decide whether to proceed with another high-profile, but expensive, capital project: the renovation of the now-mothballed Fogg Art Museum. Renzo Piano has been working on a complete reconfiguration of this central art complex, and major gifts to underwrite the cost have been announced, but the project as a whole has been estimated to cost $350 million to $400 million, posing further challenges unless the price tag can be reduced significantly.

Not yet visible are the changes in the core activities of teaching and learning. As FAS and other schools have imposed limits on the use of visiting or other temporary professors, there will be consequences for course availability as faculty members take scheduled leaves. The Crimson has reported that the economics department, the largest College concentration as measured by undergraduate enrollments, may be forced to curtail its junior seminars--a recent innovation, and the only small classes regularly offered by the department faculty. Some such rumblings may be heard in the lobbying over resources, but it is likely that the academic smorgasbord Harvard students have come to expect will be less well stocked in future semesters. Adjustments in student and faculty life and amenities will certainly follow.

The hard work of, in Dean Smith's words, "taking every possible measure to protect our core mission, to support our priorities, and even to pursue some new initiatives in the midst of this crisis," is nowhere near done, and in many respects, may be only just begun.





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