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Explaining the Structural Deficit

At Friday’s budget meeting, President Kim spoke repeatedly of the College’s structural deficit. What did he mean?

It’s not complicated: the previous administration had long had the College on an unsustainable spending jag. The growth of expenses outpaced revenues for many years and the only way to make up the difference was to draw an ever greater amount of money from the endowment. As President Kim pointed out, over the past few years the College’s draw on the endowment went from below 5% to over 7% (the highest in the Ivy League) — and this figure grew even as the endowment itself was growing robustly: a 77% rise between 2003-2007.

To put things another way, between 1998 and 2001, the College more than doubled its draw off of the endowment (from $48.7 million to $106.3 million). Then between 2001 and 2009, the amount of drawn money more than doubled again (from $106.4 million to $229.6 million). That’s an increase over 11 years of 371%, while the College’s spending grew by 122% over the same time period (from $329.8 million to $735.5 million). Conclusion: the College’s other revenues could not keep pace with spending.

The traditional draw rate of 4.5-5.5% is considered to be sustainable over the long run. Actually, the endowment will probably grow faster than that in most years, but the extra growth is rainy day money, funds that we can draw on when there is a market downturn (yes, Virginia, there is always a market downturn). Had the previous administration been thoughtful in its budgeting and maintained the draw at around 5%, then in the current recession it would have been possible to hike the draw to the 7% range for a year or two. And in doing so, we probably could have avoided many of the painful layoffs that will mark the coming year. That is not 20/20 hindsight, folks, just careful financial management.

By the end of fiscal 2009, the endowment had dropped by $935 million from its fiscal 2007 peak, a 25% decline. But even if we still had that prodigious amount of money, it would have only generated $42-$50 million of usable funds each year for the College budget — given that the Kim administration has re-introduced fiscal conservatism and would only draw against this sum, and the rest of the endowment, at the traditional rate of 4.5-5.5%.*

That is why, even after the Wright administration put in place budget reductions last year of $47 million, President Kim is still obliged to make another $100 million of cuts over the next two years. Only then will the overall structure of the College’s finances be back in balance.

In explaining the above, I have pointed a finger at the previous administration, but in truth the responsibility for the College’s imprudent budgeting lies with the current Trustees. It seems like the Board just did not have its sharp pencils out during the past decade’s financial negligence. It spent more time on politics, trying to squelch an alumni rebellion that events have now shown to be eminently well founded, rather than reining in the administration’s out-of-control spending. Will anyone be held accountable?

*Note: The difference between a 5% draw and a 7% draw is more than a piddling 2%. A 5% draw on our 2009-fiscal-year-ending endowment of $2.824 billion is over $141 million; a 7% draw on the same sum of money is almost $198 million: that’s a difference of almost $57 million.

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