Friday, December 11, 2009

Shrouded in secrecy, decision makers gambled and Harvard lost

Boston Globe article "Shrouded in secrecy, decision makers gambled and Harvard lost" (December 12th, 2009) makes two economic errors in his excoriation of Harvard's dealing with its endowment.

Harvard’s treasurer acknowledged that in hindsight, the university might have managed its investments differently. Yet, he noted, even with the downturn, the endowment grew over the past decade at a healthy annualized rate of 8.9 percent. True enough, but the Corporation manages not only Harvard’s balance sheet, but the expenses of the university as well. The 8.9 percent growth of the endowment wasn’t nearly healthy enough to cover the staggering growth in costs.

First, the touted 8.9% growth rate over a decade with the endowment's 30% fall still means vast growth over the decade. Indeed, the endowment is only around where it was in 2005. Second, it is not clear ex ante that the idea was poor ex post. We cannot say if Harvard failed to understand the probabilities in the bets it was making, or if the bets simply failed to materialize. We would be wrong to censure a man who loses millions on a bet that has 1:1 payoff and 90% chance of winning. He made the right decision, ex ante. The same may be true of Harvard--the world it expected to materialize as time went on may have been wrong, but that does not imply that it was wrong ex ante. Third, while the "staggering growth in costs" may be true, the University also gained from those costs. An increase in costs in and of themselves imply nothing. The difference between benefits and costs do.

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