Harvard University had to scramble last year to raise $2.5 billion.
Although the bonds authorized through a Massachusetts financing authority were covered by the media last year, a new report out Friday from Bloomberg News spells out the troubling reasons why Harvard had to raise money so fast.
It turns out the university spent $1 billion just to get out of volatile investments it owned.
Harvard had bought these financial derivatives in 2004. The university was trying to lock in interest rates for debt — for financing the huge, multi-billion-dollar construction project planned in Allston, which recently was halted. Interest rates were very low at the time. And with a project of that size, if rates go up, costs rise by millions of dollars.
Mark Williams, a risk management expert at Boston University, said not having enough cash on hand was Harvard’s fundamental mistake.
"It'd be the equivalent of you going on vacation and not looking at your tank and making sure it's full of gas," Williams said. "And getting out in the middle of the desert, running out of gas, and being forced to sell your car just to buy a bus ticket to get home."
Harvard was trying to lock in rates and make their costs more predictable. But some of the swaps were for as many as 16 years out. That makes it really hard to forecast risk, said Peter Shapiro, a Harvard alum who works at Swap Financial Group, a New Jersey company that advises on such financial decisions.
"The problem is," Shapiro said, "that degree of confidence whether your judgment is right shrinks when you have to go very far forward, when the timing and the size of the future project is less certain."
"It'd be the equivalent of you going on vacation and not looking at your tank and making sure it’s full of gas. And getting out in the middle of the desert, running out of gas, and being forced to sell your car just to buy a bus ticket to get home."
--Mark Williams, risk management expert
That made these auction-rate swaps more volatile. When interest rates actually fell, just by a percent or two, the value really crashed. Within about a year, Harvard was already $500 million in the hole.
Harvard did not necessarily have to get out at that low value. But as part these deals, Harvard had to pay to show it could make good on the future debt. When the market value went down, these so-called collateral calls picked up.
And they became the real issue, because Harvard had way too much other money tied up in investments. The university's financial position was not very liquid.
As it turns out, Harvard sold these financial instruments at practically the lowest point in the market. The university would have saved millions had it been able to wait out the volatility.
The university’s treasurer, Jim Rothenburg, said last fall’s credit crisis was a perfect storm, and that getting out of these swaps came at a cost, but at least now the university’s much less risky going forward.
Still, according to Peter Shapiro, the tragic irony is that the university could have gotten a better deal from Wall Street firms.
"A big AAA-rated institution like Harvard could have — if they knew to ask for it — gotten swap documents that would not have required them to post collateral," Shapiro said. "Unfortunately, they didn’t ask for that."
The unfortunate repercussions range from Harvard's decision last week to ice its development in Allston to the lost resources available for many of the amazing educational opportunities that exist there.
The Bloomberg News report raises questions about responsibility for the financial decisions made. The auction-rate swaps were authorized and begun under then university president Lawrence Summers. Even after Summers resigned, risk management needed to continue.
The report also highlights the names of the Harvard alums at the Wall Street firms involved in the deals.
This program aired on December 18, 2009. The audio for this program is not available.