Higher Ed 101: Endowments aren’t Monopoly money
At a recent debate among Republican candidates seeking to serve as Michigan’s next Governor, a number of them expressed their belief that the state’s public universities are swimming in dollars, particularly thanks to their endowments. Now and then we hear news stories about Harvard’s $53 billion stashed away in their endowment, the largest such fund in the world (leading to my favorite joke about the Ivy League, that Harvard is a hedge fund with a university tacked on). But what is an endowment? What are their purpose? And how exactly can – and should – they be used? Do the fifteen public universities in Michigan even have endowments? Let’s explore in today’s installment of my ongoing Higher Ed 101 series.
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The answer is yes, all 15 state universities in Michigan have endowments, but they utterly pale in comparison to the Ivy League totals we read about in the media. An endowment is a permanent philanthropic fund that accepts donations and in turn generates investment income to fund some specified activity or cause, often in perpetuity. It’s not at all like a personal checking account. If we’re using household analogies, it’s really more comparable to a 401k or 403b retirement plan that you put money into and let grow over time, before you start withdrawing gains later in life.
Here's an example. Let’s say I want to donate to my undergraduate alma mater, Michigan State University, and I want to make college more affordable for a low-income student, just like I was. I could directly give $5,000 a year to some individual student for four years. At the end of those four years, I’ll have made a $20,000 donation that helped one student, and that would be the end of that. But what if instead, I gave $20,000 (at once or in installments, it doesn’t matter) to an endowed fund at MSU that was dedicated to scholarships for low-income students? After my $20,000 sat for a few years and generated returns from being invested in the market, MSU would then have an ongoing revenue stream from the returns on my initial investment that would go to financial aid every year. Endowments are by nature designed to turn one-time gifts into ongoing revenue streams.
So what happens when folks think that universities should “spend down their endowments?” There are three fundamental problems with doing so:
- It violates donor intent and would break contract law;
- It’s financial malpractice; and
- There’s not actually that much money “lying around.”
First, from a legal standpoint, donors specifically designate uses for their financial gifts. They want to make college more affordable through scholarships. They want to fund faculty and the expertise and the knowledge they advance. They want to support research to address some of the world’s greatest challenges. They love athletics and thus support student-athletes or athletic facilities. Endowment earnings support these types of causes and many more.
If a donor wants to fund left-handed tuba players from Osceola County, a university would probably encourage the donor to make the purpose of their gift a bit broader, but the donor would ultimately get to dictate the terms of the gift. That money is then contractually obligated to go to purposes that the donor laid out when making the gift. If a university violated those terms, perhaps by giving an award to a right-handed bassoon player from Iosco County, the donor could pursue action against the university and seek a return of their funds. Endowment dollars can’t be used like a blank check to fund sidewalk repairs, employee salaries, replace HVAC units, or the like. It’s all about donor intent.
Second, from the financial malpractice standpoint, it’s a terrible idea to spend down all your investment principal! While this sounds extreme, it’s the clear implication from some who proclaimed at the recent debate that they wanted to privatize universities and force them to live off their endowments. This is like a farmer eating all their seed corn, leaving them nothing to plant next spring. Even if it wasn’t illegal, an institution would get a one-time burst of spending and then be left with nothing. Universities need their endowments to grow over time, and that is done by making careful investments and only withdrawing and spending a portion of the proceeds. Think of it this way, a generally accepted safe withdrawal rate for a 401k is 4% a year. And that’s for a retirement account where, shall we say, the whole point of an account is only to be around for about 30 years at most. People die and then they don’t need to fund their retirement anymore. In contrast, the youngest public university in Michigan is already sixty years old. Endowments must last forever, just like public universities do, if they are to continue serving the common good of teaching, learning, and research.
Finally, there’s the plain truth that the 15 public universities in Michigan simply don’t have monstrous endowments, unlike the usual suspects in the Ivy League that get the media attention. I pulled from federal data the value of the 15 universities’ endowments at the end of FY20 as well as each university’s total FY20 expenditures.† When you look at the endowment values as a percentage of total annual expenditures, it ranges from a low of 9% to a high of 134%. But the median value is only 45%, and the average is 55%! In other words, for the typical state university in Michigan, a total spenddown of the university endowment would only sustain a university for half a year or less! Even at the highest figure of 134%, the endowment would only last 16 months. For Harvard, this figure would be 778%, or enough to live off of for almost eight years. This isn’t comparing apples and oranges, it’s comparing apples and aircraft carriers.
If we want to focus on college affordability at public universities in Michigan, the answer isn’t somehow ignoring contract law, financial standards, and the intentions of generous donors. The answer is, as always, simply funding the universities like the state used to back in FY02, when there was a billion dollars more per year (with inflation) going to the universities.
† (FY20 is the most recent year available. I checked and FY19 figures are comparable, so there was not a huge covid impact immediately evident.)
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You can follow along with other Higher Ed 101 entries as I post them by going here, or here for the entirety of our OPtimizing EDucation commentaries. Feel free to reach out with any questions or comments!
Bob Murphy is the Chief Policy Officer at the Michigan Association of State Universities.