NEWS FROM THE WALL STREET JOURNAL: DECEMBER 17, 2005

When $26 Billion Isn't Enough

By JOHN HECHINGER
Staff Reporter of THE WALL STREET JOURNAL

Ernot Wagner, a 2002 graduate of Harvard University, knows just what to do when he gets a letter asking him to donate to his alma mater. "I rip it up," the 25-year-old graduate student says.

It's not that Mr. Wagner dislikes Harvard. He just figures his $100 wouldn't matter to its endowment -- almost $26 billion, more than the gross domestic product of Bulgaria.

"If you give one dollar to sub-Saharan Africa, it could save a life," he says. "One dollar to Harvard is 10 more staples."

The wealthiest colleges and universities are so flush with cash that, increasingly, alumni and philanthropy experts are starting to wonder whether these schools really need more money -- and why they spend so little of it. SEE GRAPHIC

Ordinary Americans and the U.S. government are often attacked for spending beyond their means. Critics level the opposite accusation at higher education. They say some of the richest universities are hoarding money that could be spent on enrolling more students or providing more financial aid, in keeping with the public purpose -- education -- that qualifies them as tax-exempt charities. The criticism comes as tuitions continue to increase at twice the rate of inflation.

Higher education gets $24 billion in donations annually, about 10% of all U.S. charitable giving. But despite what are often double-digit investment returns, many wealthy colleges are withdrawing less than 5% -- some about 4% -- from their endowments, according to data collected by The Wall Street Journal. The U.S. government, worried about hoarding, has for years required foundations to pay out at least 5% of holdings annually. But colleges aren't included.

Even fractions of a percentage point make a big difference in the realm of endowments. Consider what would happen if Harvard were to bump up the rate of spending -- about 4.3% for the fiscal year ended in June, and as low as 3.3% in 2000 -- by a mere one-half of a percentage point. The university, while still being conservative with its savings, could give a free ride to more than 3,000 students, based on the school's total fees of $42,000 a year. Last year alone, Harvard raised $590 million in donations, more than most schools' entire budgets. The university expects its rate of spending to "inch closer" to 5% by 2010, says Donella Rapier, Harvard's vice president for alumni affairs and development.

Many other rich schools -- including Yale, whose endowment passed $15 billion last year, and Princeton, which exceeded $11 billion -- have been taking out similar -- and, in some years, smaller -- percentages from their savings.

Paul Jansen, director of the nonprofit practice at consultant McKinsey & Co., says that, for the most successful schools, a 5% annual withdrawal from the endowment is far too conservative. In his view, based on analysis of giving patterns and investment returns at a variety of schools, 6% would be more reasonable. At 4%, he says, schools are signaling they won't use new gifts for decades to come. Increasingly, he says, donors are going to realize "My money is going to mean very little to you."

At the same time, Mr. Jansen expects politicians may start questioning these schools, which as charitable organizations pay no taxes. Congress has already been taking a harder look at the finances and spending patterns at charitable foundations. "The potential for a backlash is very real," Mr. Jansen says.

Many colleges, especially smaller schools, need to keep raising money because they have little or no endowment, or savings. The elite private universities with lots stowed away say they need to be prudent to preserve money for future generations. At Yale, President Richard Levin notes that, before 1985, the school's endowment had poor returns. "You can't count on the good times forever," he says. "That's why you don't want to overspend."

They say their stashes have enabled them to give far more in financial aid to lower-income students. In recent years, Harvard started requiring no contributions from families earning less than $40,000 a year. Yale put the number at below $45,000. Princeton sweetened its grants to the point where students can graduate without any student loans.

Even apart from these initiatives, the schools say alumni giving helps fund research that benefits all segments of society, including the poor in the U.S. and developing world. "It's incumbent on us to demonstrate that these gifts matter tremendously," says Ms. Rapier of Harvard. Administrators also note that many of the largest endowment gifts come with restrictions from donors, so they're not at liberty to spend the money at will.

Still, no one can dispute that colleges and universities receive a hefty share (the second biggest slice, after churches) of charitable donations. The wealthiest schools continue to be the most blessed. Of the 400 largest U.S. recipients of charitable donations, 126 are colleges and universities, led by Harvard and Stanford universities, says the Chronicle of Philanthropy. Half of all charitable gifts that exceed $1 million go to higher education, according to the Center on Philanthropy at Indiana University. Forty-seven colleges and universities had endowments over $1 billion in 2004, with Harvard at the head of the pack.

Big donors account for more of that giving than ever before. Elite schools say they often get 90% of their gifts from only 10% of their donors. That's up from the rule of thumb years ago that 80% of the wealth came from 20% of the donors. Just this week, Harvard announced a $20 million gift from a member of the Saudi royal family for an Islamic-studies program. Yale recently said it received $100 million for free tuition at its music school.

But the percentage of all alumni giving to colleges is declining, suggesting that smaller donors are looking elsewhere. Only 12.8% of alumni gave to their schools in 2004 and that number has fallen each year since 2001, when it stood at 13.8%, says the Council for Aid to Education. Harvard College saw the rate of alumni giving drop to 40% from 44% recently.

No one's sure precisely why. But students, administrators and researchers say the schools' visible signs of wealth likely play a role.

Many schools are building posh student centers, gyms and hotel-like dorms to attract top students as part of a building boom, expected to total $14 billion this year. Even some Harvard Business School alums find the school's four-year-old Spangler Center "over the top," in the words of McKinsey's Mr. Jansen, a 1984 graduate who says he now gives only small amounts to the school while giving major sums to Katrina relief and other, more-needy causes.

The 121,000-square-foot neo-Georgian student center looks like a Southern mansion with stately columns outside and, inside, its central lounge, where students in sweatsuits and jeans sit in plush leather armchairs in front of roaring fires. Students can choose from two dining halls, one with lofty ceilings and chandeliers, featuring gourmet coffee and sushi, and another informal "Grille," with wood paneling and a full bar.

Such luxuries also help woo top applicants, and elite schools can more than afford them. Harvard, Yale and some other schools have notched roughly 20% annual endowment gains recently, having used exotic investments to sidestep the stock-market meltdown several years ago.

The conservative rule of thumb for schools is to spend about 5% of their endowment a year, says Matt Hamill, senior vice president of the National Association of College and University Business Officers. That's because, over time, endowment managers figure they can average an investment return of 8% to 9% annually. If they spend 5%, they can keep the purchasing power of the endowment constant, after inflation.

But few of the universities with fast-growing endowments actually spend 5%. And the financial statements that colleges, like all nonprofits, must file with the government often don't make clear exactly how much of the endowment is being spent. The Wall Street Journal enlisted the help of Profs. Roger Kaufman at Smith College and Geoffrey Woglom at Amherst, economists who have studied spending at endowments. The goal: Come up with a standardized way to determine what percentage of their endowments the wealthiest 10 universities and 10 liberal-arts colleges spent in a single year.

Our survey examined endowment spending for the schools' 2004 fiscal year, typically ended June 30, which was the latest period for which figures were available at all the schools. Then it compared that figure with the size of the endowment at the beginning of the year to determine a spending rate. The professors caution that these figures represent a single-year snapshot.

Nine of the schools, including Emory, MIT and Wellesley, spent 5% or more. But the rest fell short. Harvard and Yale, for example, each took 4.5% from their endowments. Amherst, Grinnell, Pomona and Princeton spent around 4% or less.

Some schools criticized the survey's method. They say their policy is in fact to spend closer to 5%. But they apply that figure to the average value of the endowment over three or more years. They say that method smooths out the withdrawals, which could otherwise be enormous in flush years and meager after a stock-market bust. Many of those schools appeared to have low spending rates, based on the survey, but their officials argued that a multiyear approach brings the total closer to 5%.

Profs. Kaufman and Woglom say such a method tends to result in low payouts over time. That's because markets tend to rise over time, and schools generally get more gifts with each passing year. So applying their target percentages to average endowment size over many years results in taking much less out for education.

"It's hard to argue that you need more money when you're taking only 4% out of the endowment," says Prof. Kaufman. "Is there a point where you are so rich you don't need to have all these capital fund drives?"

Randall Livingston, chief financial officer of Stanford, said he would worry if his school's payout from its endowment dipped to the 3% to 4% range, which he considers too low, given the investment returns and gifts the university can reasonably expect in coming years. "At that level, we're not using our donor's money effectively," he says. Stanford says it spent 4.6% in both its 2004 and 2005 fiscal years.

Profs. Kaufman and Woglom zero in on Princeton University. The school, with an $11.3 billion endowment, is relatively small, with 6,700 students. That's $1.7 million per student, higher than Harvard and Yale and just about every other college in the nation. Princeton spent only 4.1% of its endowment in the year ended June 30, 2004, and 3.9% in 2005. The rate fell to 3% in 2000 after the 1990s' roaring stock market.

Christopher McCrudden, Princeton's treasurer, says the school takes a cautious approach because it depends less on tuition than other schools. Almost half of Princeton's $900 million budget comes from its endowment and annual giving. And, unlike its peers, Princeton has no professional schools in fields such as law, business and medicine, which tend to be moneymakers because students often pay their own way.

Princeton expects to spend $60 million on undergraduate financial aid this year, up from $53.6 million in 2005 and $49 million the year before. Mr. McCrudden says improvements to its financial-aid package, including its no-loan policy, cost the school about $10 million a year. Its growing wealth is allowing the school to expand its undergraduate student body by 11%, or 500 students, by 2012 -- the first such increase since the early 1970s. Additional fund raising is still necessary, Mr. McCrudden says, because "We don't have the money to do everything we'd like."

Grinnell College in Iowa had the distinction of being the wealthiest liberal-arts college, with an endowment of $1.3 billion in 2004. But Grinnell spent only 4% of its endowment that year. In fiscal 2005, the figure fell to 3.5%.

Mickey Munley, vice president of college and alumni relations, says the school has a policy of spending 4.5% of the average size of the endowment for the last three years. He says the school relies on its endowment for half its spending and needs to be conservative about its withdrawals. In fact, Mr. Munley says, the school has plans to bring down the rate to 4% by 2007. At the same time, the school expects to raise its tuition and fees -- now just under $35,000 -- so they are more in line with rivals. "We are trying to be responsible for future generations of students," he says.

Administrators at public universities, such as those in California and Texas, point out that their institutions aren't as wealthy as they appear because they support multiple campuses and hundreds of thousands of students, dwarfing Ivy League and other elite colleges.

At Harvard, student fundraisers get a script preparing them for skepticism from alumni. "Harvard has such a large endowment," the crib-sheet reads. "Will my gift matter?" The suggested answer: "Absolutely."

Harvard's Ms. Rapier says the university is expanding its mission in ways that will cost money, beefing up undergraduate education and expanding from its main campus in Cambridge, Mass., into neighboring Boston.

Rob Waldron runs Jumpstart, a Boston-based nonprofit that tutors inner-city preschool kids. A graduate of Harvard Business School, Mr. Waldron notes that the increase in Harvard's endowment last year -- $3.3 billion -- is half the budget of the entire federal Head Start preschool program, which serves 900,000 poor children. When a friend and former classmate asked him to contribute to Harvard Business School, Mr. Waldron balked. In the end, he did, with a condition. His friend had to pledge to Jumpstart 10 times what he gave Harvard Business School. So Mr. Waldron gave the school $50, and inner-city children got $500 worth of tutoring.

Harry Holzer, an economist at Georgetown University and the Urban Institute in Washington, D.C., says he makes only small gifts to Harvard, where he received his bachelor's and Ph.D., while giving more to charities, such as Oxfam, that directly benefit the poor.

Prof. Holzer says he has warm feelings toward Harvard and he wants the school to have enough money so students from all backgrounds can afford to attend. But, he says, "They might well reach those goals without my modest contribution." Meanwhile, Harvard is already planning a new capital campaign.