Changing Higher Education

Another sign that the business model for higher education is broken

The National Association of Independent Colleges and Universities (NAICU) put out a report yesterday that bravely tries to put a good spin on the tuition news:

Private College Tuition Rises at Lowest Rate in 37 Years
NAICU Washington Update

June 29, 2009

With families facing one of the worst economic crises in the nation's history, private, nonprofit colleges and universities have responded with the smallest average increase in tuition and fees in 37 years, according to the final results of a membership survey conducted by the National Association of Independent Colleges and Universities.

It is great to know that higher education has responded well to this crisis! So what is the result of this wonderful restraint?

The 4.3 percent increase for 2009-10 is the smallest since 1972-73, when average tuition and fees at private institutions rose by the same rate. The increase is slightly higher than the 2008 Consumer Price Index of 3.8 percent.

Oops!It is, of course, customary to compare next year’s academic year tuition increase to last year’s calendar year CPI increase, and by that standard the tuition increase that is only .5% above inflation shows some restraint.   However, these have not been ordinary times in the CPI world. While the first half of last year was reasonably well-behaved, the second half was much less so as jobs and equity vanished at a rapid rate - a trend that has continued to this date.   Another comparison that might well be made is next academic year’s tuition increase compared to the CPI increase over the past 12 months. Not only would that better describe today’s economic realities by including  the recent tumultuous times for the economy, it has the benefit of being almost an academic year CPI increase that we can compare with an academic year tuition increase. .

If we use this CPI increase for the most recent 12 months available (through May) for our comparison, we see a vastly different picture. According to the June 17 report of the Bureau of Labor Statistics the (unadjusted) CPI has actually decreased by 1.3% over the past 12 months.  Plus 4.3% for tuition no longer sounds restrained - or responsible - when compared to minus 1.3% in CPI! 

Whatever CPI one wants to compare the 4.3% increase to, it obviously is a very significant increase at a time when unemployment at all income levels is at a very high level, and uncertainty about economic security is on the minds of most families.  Unfortunately, for all of the NAICU  rhetoric about new “innovative affordability”ideas, this result demonstrates clearly that the higher education business model still demands price increases that are well above CPI increases.

As Stein’s Law assures us, “If something can’t go on forever, it will stop.”   A model that demands that prices always rise significantly faster than CPI clearly will break down at some point.  It is time to work harder imagining a new, more sustainable model, and to spend less time trying to defend what in the end will not be defensible .

How is Harvard like Lehman Brothers?

As I read Bernard Condon and Nathan Vardi’s fascinating recent article in Forbes, it would seem that Harvard and Lehman had rather similar investment philosophies - and ended up with similar results.

Harvard, in its search for ever higher returns and a conviction that the good times would roll forever, had as of last July managed to become more than fully invested - it had a 105% long position.  But then the economy began to turn, and leverage started to work against them. Condon and Vardi report:

Harvard had derivatives that gave it exposure to $7.2 billion in commodities and foreign stocks. With prices of both crashing, the university was getting margin calls--demands from counterparties (among them, JPMorgan Chase  and Goldman Sachs  for more collateral. Another bunch of derivatives burdened Harvard with a multibillion-dollar bet on interest rates that went against it.( Interest rate swaps that Larry Summers authorized as President.)

Unfortunately for Harvard, the 105% leveraging meant that Harvard University had no cash on hand to meet the margin calls.  So they had to do what we see so many investment firms had to do - begin to sell stocks into a falling market.  In addition, they had their own version of mortgage backed securities sitting in their portfolio. These were private equity partnerships, which are not only hard to price to market, but also typically commit the owner to significant future additional purchases.  Pretty illiquid, especially in a falling market.  Harvard has tried to sell these, but purchasers are hard to find.  So:

Now, in the last phase of the cash-raising panic, the university is borrowing money, much like a homeowner who takes out a second mortgage in order to pay off credit card bills. Since December, Harvard has raised $2.5 billion by selling IOUs in the bond market. Roughly a third of these Harvard bonds are tax exempt and carry interest rates of 3.2% to 5.8%. The rest are taxable, with rates of 5% to 6.5%.

It doesn't feel good to be borrowing at 6% while holding assets with negative returns. Harvard has oversize positions in emerging-market stocks and private equity partnerships, both disaster areas in the past eight months.

Andrew Rosenfield, also writing in Forbes, says

Harvard is the world's best-financed university with an endowment today worth well over $25 billion, more than 20 times the size of its endowment in 1970. Yet the Harvard endowment may have lost as much as $12 billion in 2008. (It had $37 billion as recently as 12 months ago.)

It is likely that Harvard lost more in 2008 than the total amount of the endowments of each of Cambridge, Chicago, Columbia, Duke, MIT and Oxford. In fact, it seems Harvard lost more last year than the total value of every other university endowment in the world with the exception of Yale, Princeton and Stanford. 

So now we understand why Harvard decided to go for a 3.5% tuition increase when the CPI showed a 0% increase.  Like so many of the investment houses, they need a bail-out. Unfortunately, TARP does not seem to be written to include cases like this, so Harvard has had to turn again to students and their families for their bail-out.

More on the “tipping point” for globalization of US higher education

The ongoing and very widespread economic problems are having a major impact on higher education, as I noted in a previous post.  Two recent articles in the New York Times provide some interesting examples of the problems.  The first, Tough Times Strain Colleges Rich and Poor, outlines some of the steps being taken to meet plummeting revenues.  They include, of course, deferring construction, hiring freezes, lay-offs, and cutting back on need-blind admissions goals. Students, feeling the economic pressures from all sides, are looking more favorably at  lower-cost public higher education, but there they are finding that states are cutting back on funding due to the hard times. Several states, including California, are considering, or planning to limit freshmen enrollments because of these cuts. 

The second, Beyond the Ivied Halls, Endowments Suffer, describes difficulties several universities are having with “alternative investments” in their endowments, including real estate partnerships, venture capital, and hedge funds.   Such investments have grown in popularity over the past years because of their potential huge gains, and university endowment managers have plunged into these alternative markets in a major way:

Endowments with more than $1 billion in assets reported 35 percent of their holdings in these types of investments on average last year.

Unfortunately, such investments are typically not very liquid, and often require periodic additional investment.  In these times, liquidity can be a problem, and additional investments become difficult if not impossible.  As a consequence, several major universities (including Harvard) are trying to sell some of their alternative investments, and having to accept greatly discounted offers in the process.  Does this sound familiar in other contexts?

All in all, this is developing into a very serious problem for higher education that is unlikely to be solved in a satisfactory and appropriate way by simply cutting costs.  Nor does it seem likely that a “government bailout” of higher education will occur.  More serious thought about the future of American higher education is called for, including, as I have previously discussed (here, and here), changes in mission and organization.

Are we approaching a tipping point in the globalization of higher education?

The unsettling financial events of the past few weeks have undoubtedly pushed the cost/price model of American higher education much closer to the breaking point.  In an earlier post, I argued that any significant limitations on price increases could cause fundamental problems for our basic business model.  We now are in a much more complex situation than I discussed in the earlier posts. The state of the economy certainly will lead to greater pressure from parents and government to halt increases in the real price of higher education, so we can expect more intrusive legislative actions, and much stronger push-back from parents.  Loans to parents and students, which have provided the undergirding support of our large price increases, will not be so easy to get in the future for a multitude of reasons including large drops in home values.   In addition, we face a situation in which philanthropy will be quite uncertain for some period, and endowments and their returns have been greatly battered.   For public institutions, there is the reality that states are seeing greatly reduced tax returns, and furious budget cutting is evident everywhere.   And on the cost side, the cost of borrowing (when it can be obtained) will certainly go up significantly. This will impact higher education directly in many ways, as in  our facilities programs where we usually use considerable long term debt.  In addition, many  higher education institutions have significant short term debt that is used to pay bills in between the huge inflows of income that occur at the beginning of each semester (trimester or quarter).

In my view, all of this pushes American higher education much closer to a globalization tipping-point, similar to the one  that occurred in Great Britain and Australia a decade ago.  In both cases, governments told public higher ed institutions that state funding would not be sufficient in the future to maintain their growth and quality, and that other sources of funding would have to be found - without passing the burden to domestic students.  The solution was to bring international students in at high tuition, and to open campuses and programs around the world.

The Senate keeps up the pressure

In How higher education will contribute to greater access I picked up a theme of earlier posts - both Democrats and Republicans are very interested in increasing access to higher education, lowering college costs is one way to increase access without increasing government spending , and one good way to get costs down is to get the universities and colleges to somehow foot more of the bill themselves.  The most obvious way to get higher education to pay more of the bill is to look to their endowments for greater payout.

Continuing to keep the pressure on this theme, yesterday Sen Max Baucus (D), chair of the Senate Finance Committee, and Sen Charles Grassley (R), senior Republican on the Committee, sent out a letter to 136 of the best endowed colleges and universities asking for considerable data on costs, financial aid, endowment management, growth and payout.   Just in case anyone missed the focus of this request, the press release about the letter quotes Grassley as saying  Tuition has gone up, college presidents’ salaries have gone up, and endowments continue to go up and up. We need to start seeing tuition relief for families go up just as fast. It’s fair to ask whether a college kid should have to wash dishes in the dining hall to pay his tuition when his college has a billion dollars in the bank.

It seems likely that this request will produce considerable data that has not been publicly available previously. And that probably will be a very good thing. However, since each of these institutions differs from the others in sometimes obvious, sometimes subtle ways, viewing the responses in a one-size-fits-all way could lead to some very shortsighted policies.   In any case, it looks as if Higher Education will be following with great interest the activities of the Senate Finance Committee this year.

Why has globalization had such a small effect on higher education - and when will that change?

I recently wrote an article that addressed these provocative questions. It has been accepted for publication in New Directions for Higher Education, to be published by Jossey- Bass. I will just cover some of the main points of the article in this post, and point interested readers to the preprint.

I argued the first premise of this question - that globalization has had a small effect on higher education - by using the taxonomy that Samuel Palmisano defined to classify the stages of industrial globalization (see Globalization and internationalization, June 7, 2006).   I argued that most of what occurs in higher education today fits Palmisano’s 19th century “internationalization” model of hub-and-spoke activities.  I then described the relatively few activities in higher education that fit the early 20th century “multinational” phase, and the even more uncommon higher education activities that have real parallels with “globalization” as the term is generally used in the business literature.  I argued that the “international” activities have little potential to cause major change in higher education, but that both the “multinational” and “globalization” stages have the potential to cause as radical change in higher education as they have in industry generally.   

How higher education will contribute to greater access

In At last, a Democratic alternative to the McKean tuition cap proposal (May 18, 2007), I suggested that although Democratic and Republican approaches to assuring access are somewhat different on the surface, at heart they are quite similar - the universities should pay for increased access, not the government.   The Boston Globe report today on the latest Democratic ideas for increasing access further emphasizes the role that both parties expect higher education to play in assuring affordability and access:

Congress to look at college endowments

By Reuters  |  October 25, 2007

WASHINGTON - Congressional tax writers are taking a hard look at elite US universities' multibillion-dollar endowment funds and considering steps to make them spend more of their riches to help students.

In legislation being developed in the Senate Finance Committee, top universities such as Harvard or Yale might be told to spend at least 5 percent of endowment funds annually, as private foundations must do to keep their tax-free status.

Other steps being considered could slap new endowment rules on colleges that raise tuition above certain annual limits; require more money to go to student aid; or require endowments be more open about operations.

The measures are being hammered out as part of a bill focused on education tax credits that Finance Committee chairman Max Baucus, Montana Democrat, has said he wants to consider this year.

Glittering profits - earned in large part through investments in hedge funds and private equity - and tax breaks at endowments are a talking point in the House, as well, said Representative George Miller, California Democrat.

The breakdown of the price-productivity-cost model of private research universities

I have learned a lot recently  participating in a project on Global Higher Education led by Paul Jansen and Debby Bielak of McKinsey &Co.  The project is sponsored by the Forum for the Future of Higher Education. Paul and Debby have collected a group of university CFO’s, a college president, and an old provost (me) together to apply a McKinsey sector-wide analysis to higher education. It is fascinating to see what such an analysis tells us about our world.

The team recently made a presentation entitled Higher Education Trends and Risks: Implications for Leading Institutions and Sector Performance  at the annual Aspen Symposium of the Forum.  My assignment was to talk about trends and risks for private research universities - in 15 minutes.  I approached this impossible task by first apologizing to the audience for the egregious simplifications that I would have to make in order to describe the situation in 15 minutes, and then introduced my simple one-parameter model to describe the problems facing the research university.  Since this model met with some approval at the Symposium, I thought it might be worth repeating here.

I began by describing what I called our Mission Box. Excellence - as defined by us in a very self-referential way - has become the visible driver of our mission.  Our mission, in a very general way, focuses on traditional undergraduate education, graduate and professional education, and research.  Focusing on excellence means that if it is worth doing (i.e. one of our mission foci), it is worth doing better.  Doing it better costs more money, so at some point the customer can’t, or won’t pay for it, so we lose money.  As a consequence, over time, losing money has become our very visible surrogate for excellence (my one parameter model). (Clayton Christensen, who also spoke at the symposium, has pointed out the often catastrophic outcomes of making your product better than the customer wants or needs. See also Disruptive Technologies:when great universities fail? March 3, 2006)

Real income vs educational level- a problem for higher education

An article in Foreign Affairs, and recent reports from the Pew Trust and ETS all have recently made similar, and very important, points about education and the American economy.  The first article talks about falling real wages and the relationship to protectionism; the Pew Trust looks at decreasing economic mobility in the US, and ETS considers the impacts on the US of a “perfect storm” of divergent skill distributions, the changing economy, and demographic trends.  Taken together, these reports raise some important questions for higher education.

Kenneth F. Scheve and Matthew J Slaughter, writing in the July/August 2007 issue of Foreign Affairs, discuss generally falling wages in the US, and their connection with increasing protectionism.  They point out that real income growth recently has skewed significantly in favor of high earners, with a strong correlation to educational level. They report:
Less than four percent of workers were in educational groups that enjoyed increases in mean real money earnings from 2000 to 2005; mean real money earnings rose for workers with doctorates and professional graduate degrees and fell for all others....Even college graduates and workers with nonprofessional master’s degrees saw their mean real money earnings decline.
In particular, the mean real earnings of college graduates fell by almost 4% between 2000 and 2005, while the mean real earnings of the MBA, JD, MD group rose by about 10%.  Hardest hit, not surprisingly, were high school dropouts, whose mean real earnings dropped by about 5% over that time period.

Supplement to Price and Cost in Higher Education: Price

In Price and Cost in Higher Education: Price I discussed briefly debt load for graduate students.  This note adds a bit of detail to that discussion.

Kenneth Redd of the Council of Graduate Schools reports that in 2003-2004, 43% of minority students were taking out loans to finance their graduate study, with the average annual loan being about $19K.  Thirty four percent of white graduate students were taking out loans, averaging about $18K annually. Upon completing the doctorate, 65% of minority students had outstanding debt, with an average of $51,263, while 51% of white students had an average cumulative debt of $51,648.  These numbers are roughly twice as large as comparable numbers from a decade ago.

Bad as this situation seems, it is better than in some professional schools.  Equal Justice Works recently published a study of debt loads of graduating law students. They found that more than 80% of all law students borrow to support their education.  Upon graduation, students in public institutions had an average debt of $51K, while those from private institutions had an average debt of $79K. While these debt numbers are not prohibitive compared to the $135K median starting salary for an associate in a big law firm in a large city, they are overwhelming for someone looking at public interest law, where starting salaries are in the $36K-$44K range.  This is clearly a situation in which the cost of education is having a significant social impact.