Most institutions of higher education have been hurt three ways by the financial crisis: endowment returns are down; donors have less money to give; and families need more financial assistance to cover tuition. Just about every college and university has been affected. But one college has had the misfortune of having financial fraud and poor governance thrown into the mix. That’s Yeshiva University, a distinguished Jewish institution.
The headlines started running in 2008. Bernie Madoff was on the Yeshiva board of trustees. The university endowment had $110 million invested with Madoff, and some of its other trustees and donors lost their savings in the fraud. Many other universities saw donations dry up from Madoff victims, but Yeshiva was heavily affected because its donors are almost entirely Jewish. (Most of Madoff’s victims were Jewish; for many years, the joke was that his fund was so safe that it was the “Jewish t-bill”. That’s because fund investors recommended it to their friends and associates, the same way any fund managers find individual investors.)
Yeshiva’s problems are deeper than the Madoff fraud, however. It would appear that two governance issues came into play, the willingness to spend principal and conflicts of interest with the board.
An endowment is in place to provide permanent support to the institution. Most institutions have a policy on how much of the endowment will be spent, usually between 3% and 6% per year. Yeshiva’s spending policy was 5.5%, on the high side but not freakishly so. With a $1 billion endowmment, an institution with a 5.5% spending rule would have to come up with $55 million in cash each year to give to the institution for its operations. The money can come from new cash donations to the endowment, cash generated from interest and dividends on the investments, and from cash raised by selling investments in the endowment. Ideally, the principal value of the endowment would grow each year even after money is spent; endowment and trust managers like to joke that the 11th Commandment is “Thou shalt not invade thy principal.”
Yeshiva’s board decided to put money into hedge funds in order to get a higher return than they had been earning. This in and of itself is not a bad investment; despite the negative reputation that hedge funds picked up in the financial crisis, many performed admirably. However, in the move to hedge funds, the investment committee seems to have overlooked the need for cash. Maybe they thought donations would be high enough, or that they would generate enough cash from portfolio restructuring. Who knows. But what happened is that to meet the spending policy, Yeshiva’s board had to sell off assets, often happened at depressed prices during the financial crisis. Instead of growing the endowment, they were liquidating it for a few years.
Spending endowment principal may be acceptable in a dire emergency, such as a natural disaster that destroyed half the campus. I’m not sure that the Madoff fraud and the financial crisis reached the level of dire emergency – with the possible exception of the 2008-2009 school year.
Then, there’s the problem of conflicts of interest. Being based in New York, Yeshiva is close to Wall Street, and many movers and shakers of the investment industry served on Yeshiva’s board. That’s good in that the campus was able to draw on the expertise of people who absolutely knew what they were doing. The problem is that many of those people had conflicts of interest. No one wanted to enforce the policy because it seemed like a way for the university to cut off its nose to spite its face – until it turned out that one of these trustees (Madoff) was running a Ponzi scheme and others recommended investments that were more beneficial to their employers than to the university.
We’re all human. We look out for ourselves. We screw up. Heck, some people even develop neurological conditions that impair their judgment. That’s why conflict of interest policies exist. They keep people on the straight and narrow. And yes, sometimes they seem overly restrictive. That’s the whole point.
The Yeshiva community has suffered a nasty confluence of events. It would be tragic if it destroyed such a distinguished university – but it is good for everyone who can learn from it.
