Cochrane on Higher Education

A few thoughts. Why does a university simultaneously borrow $3.6 billion but have $6.7 billion Invested? If borrowing is such a big deal, why not just spend the endowment on new buildings?

Answer: universities can borrow at municipal rates, free of federal tax, if they are building something. Borrowing tax-free makes financial sense, even you just stuff the marginal dollar into endowment. Of course the endowment is not invested in Treasuries — universities don’t do simple tax arbitrage. So the model is more that of a leveraged hedge fund — borrow at low tax-free rates, up to the limit imposed by tax law, and invest in high risk, (hopefully) high-return projects like hedge funds, private equity, real estate etc. The fact that investment returns are also not taxed makes this a doubly advantageous strategy. Donors: if you give now, your gift grows tax-free, while if you earn the rate of return and then give the money to the university, you pay taxes.

Ah, yes, but some donate to universities to raise status and put their names on walls. That requires big nominal (as opposed to Present Value) checks.

Here is what I think is happening: The U of C’s leaders think there will be about 5 big, global, high-prestige, science-oriented, big-idea-generating research universities left in 20 years. The gap between those and second-rate schools will grow, especially as the top 5 educational content goes online. Who wants to take an online class from the #11 university? We want to be one of the big 5. We’re behind, especially on the transition from arts and humanities to science and engineering. And if research funding moves from government to billionaires, scale and rank will be even more important. This is the “ambitious program to improve campus life while bolstering highly regarded academic programs.” Harvard (5.7) and Stanford (4.8) have more debt than us (3.6) and Yale (3.6) the same, an indication of who is in this race, and that they’re ahead of us.

Lots more to read here

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