The Revelation of the Full Extent of American Endowment Problems
Entering 2009, the world knew that trouble was afoot at America’s largest endowments. Reports were emerging from Yale, Princeton, Stanford, Harvard, and others as early as September 2008 that losses were mounting at an increasing rate. In the absolute chaos of the time, this didn’t strike anyone as all that exceptional. These were the funds, after all, that had pioneered the Yale, or Endowment, Model of investing. Could it really be that bad?
What wasn’t fully understood as 2009 dawned was the extent to which these endowments had been misjudging their liquidity needs. Harvard (to use the most prominent example) still had $26 billion as of June, 2009, but because of certain decisions made—the two most prominent being an interest rate swap gone wrong and the decision to invest much of its operating cash alongside its illiquid endowment—it was still forced to cut staff, sell assets, freeze salaries, issue bonds, halt building projects, and admit publicly to its failings.
The end result: a refocus, at Harvard and across the endowment space, on factors other than pure performance. If the mantra once was “perform,” then 2010 will expand that, as one prominent endowment chief told ai5000, to “perform, protect, provide.” The annual competition to bring the highest rate of return at any cost is over. Providing enough capital and liquidity to maintain university growth, even in downturns, is the new Endowment Model.
The Equity Bull Run v. The Gold Bull Run
The equity bull run—with the Dow Jones Industrial Average up some 70% since mid-March—is an obvious highlight of 2009. World markets have seen similar growth. Volatility has been reduced. Large asset owners, for the most part, have refused to flee from stabilizing securities.
However, at the same time, gold—a safe haven in times of crises—has enjoyed a similar bull run. With gold being hawked on every cable news show and with investors fearful of inflation, the price of this precious metal has risen 25% since January.
So, which is it? A renewed belief in the global economy, or an overwhelming fear of what is to come? Commentators often make the mistake of ascribing human emotions to the market. In real life, it’s much too complicated for that. If ai5000 were to do that, we would say that the market is schizophrenic. Instead, we’ll simply say that there’s a bubble somewhere. 2010 will tell us where it is.
The Dubai Default and the Retrenchment of SWFs (with One Exception)
Sovereign wealth funds went from feared to desired to burned in the four years after 2005. First, they were the Barbarians at the Gate, looking to acquire strategic assets and commodities in a quest for world domination. Then, they were the White Knights, saving the global financial sector with their long-term investment horizons and undemanding capital. Finally, they were The Timid, afraid to make large moves into Western economies after they saw billions in capital vanish into bad banks.
Now, they’ve come under suspicion again. The reason: Dubai. Once the darling of the financial world—the new London! Watch out New York!—Dubai has now effectively defaulted on its debt, surviving only at the pleasure of Abu Dhabi. While it’s unfair to lump the oilless Dubai in the same group as other petroleum-fueled funds, the final two months of 2009 have seen just that. When Dubai property developer Nakheel declared that it could not repay a sukuk worth upward of $4 billion, cries of “Who’s Next?” erupted, and other sovereign wealth funds were one of many targets.
There is one obvious exception to this retrenchment and skepticism: China Investment Corporation (CIC). While the Gulf funds largely were drawing back from deals of size and keeping a low profile in 2009, the CIC went on a spending spree unmatched in its brief history. It put money into Canadian oil, into American hedge funds, and into South American resources. It reportedly is ready to accept a $200 billion infusion from the Chinese government. Things look decidedly good for the Chinese sovereign wealth fund.
The sovereign wealth cycle has come full circle. In the past four years, the funds have been feared, desired, burned and, following Dubai’s default, are once again feared. Only 2010 will tell if these massive funds return to vogue, or whether fear—and the inevitably corresponding protectionism of Western economies—continues.
The American Placement Agent Scandal
Of course, it happened in New York. That concrete jungle where dreams are made, also, so very often, is the epicenter of scandal. The year 2009 was no different.
In March, two political helpers of former New York State Comptroller Alan Hevesi were charged with taking kickbacks in exchange for setting up alternative asset managers with the state’s $120 billion state pension fund. The scandal’s details were of the quotidian variety, but New York’s and the Securities Exchange Commission’s (SEC) reaction to the “placement agent scandal” was anything but. Instead of pursuing changes to the sole trustee structure that allowed the scandal to occur, it went after the easy target: placement agents, the middlemen who connect asset owners and asset managers. While there is no word as of yet on the SEC’s ultimate actions, many of the most prominent state pension plans, which together control trillions in assets, have banned the use of such middlemen.
While within the larger arc of history the placement agent scandal is but a small bump, the way in which the SEC and state officials reacted will redefine the landscape of how institutional investors interact with, and indeed choose between, all types of institutional asset managers.
The More Things Change…A Surprising Lack of New Regulations that Impinge on Financial Markets
“When the facts change, I change my mind. What do you do, sir?”
John Maynard Keynes is enjoying a renaissance that Tiger Woods can only dream of. Many of his prescriptions on how to curb financial crises have been adopted wholeheartedly across the globe—who would ever admit to believing in the infallibility of the Chicago School of Unfettered Free Markets now? —and it is generally accepted that governments must intervene at some points to avoid the sturm and drang of 2008. However, while many have changed their minds along with the facts (just like Keynes once did) regarding the need for increased—or at least more nuanced—financial regulation, possibly the most startling news of 2009 is the lack of news on the regulatory front.
In fact, 15 months after Lehman Brothers pushed the financial markets to the edge of a Dionysian abyss, relatively little has changed. The Troubled Asset Relief Plan (TARP) has doled out and taken in billions of dollars, leaving the taxpayer effectively at neutral—or possibly even with a profit. Goldman Sachs is about to distribute its largest bonus pool ever. Rating agencies still are paid by the very people who want robust ratings. Hedge fund managers, although there are fewer of them, are still occasionally taking home billion-dollar paychecks. It’s like 2006 all over again.
The most worrying aspect of this stasis is that governments from around the globe—and in America, in particular—have done little to stop Lehman from reoccuring. Change has happened, but it has happened only at the margin. There has been talk of Consumer Protection Agencies, of mortgage renegotiations, of dark pool changes, and of the politicization of the Federal Reserve system, but the net result of the past year, of TARP, quantitative easing, and a massively increased debt ceiling, is that the big got bigger, and risk became more centralized. If Bear Stearns was too big to fail, then Goldman Sachs circa December 2009 most certainly is.
Perhaps politicians are waiting for the dust to settle before they attempt to clean it up. Perhaps they view other reforms as more pressing and in need of political capital expenditures. Whatever the reason, little has been done to alter the fundamental problems with the American financial sector and the global systemic risk that it produces. The facts have changed but, so far, the opinions—or at least action based on them—have yet to change as well.
To contact the <em>aiCIO</em> editor of this story: Kristopher McDaniel at <a href='mailto:firstname.lastname@example.org'>email@example.com</a>