The combination of rapidly growing endowments and increasing tuition costs at universities around the country has drawn recent scrutiny from Congress, which has threatened to remove the tax-exempt status of endowments if they fall below a minimum annual spending requirement similar to those placed on non-profit foundations.
Stanford University President John Hennessy told The Daily he is against any attempt by Congress to introduce legislation that would tell universities how to spend their endowments.
"I oppose it for two reasons," Hennessy said. "We have legally binding agreements with donors as to how we spend the money, [and] we have a permanent time scale, so no matter what happens, we still have a university."
Sen. Chuck Grassley (R-Iowa) along with Sen. Max Baucus '63 J.D. '67 (D-Montana) sent letters last month to 136 universities with endowments greater than $500 million, including Stanford, asking for data about endowment spending, tuition and financial aid. The Senate Finance Committee, of which Baucus is chair and Grassley is the ranking member, also held a hearing on the topic.
"I just want colleges to be aware of the fact that the purposes of college are teaching, educating and research, and that the money ought to be used for that purpose," Grassley said Monday in a conference call with The Daily. "A college endowment should not be a storehouse of funds."
Stanford's endowment grew 22 percent last year to $17.2 billion, while next year's tuition also increased by 3.5 percent to $36,030.
Stanford, along with other universities, uses a sophisticated "smoothing formula" that lowers the actual endowment payout below the target payout in years of exceptional investment performance and increases actual payout above the target payout in lean years in an effort to produce a steady payout level. While Stanford has set target payout levels of 5 percent or more in each of the last 10 years, actual payout has fallen below 5 percent six times in that period.
Hennessy said the practice is essential to the University's permanent timescale.
"You have these great endowment years, but you also have some lousy years," Hennessy said, referring to the 1970s, "and you don't want to set a rate based on just great years."
Hennessy said that the rules that apply to foundations should not be extended to universities because of their permanent timescale.
"If the Ford Foundation goes bankrupt, that's not a disaster," he said. "If Stanford ran out of money, then that would be a disaster."
Grassley did not agree with Hennessy's explanation of current endowment spending practices.
"It seems to me that there is one thing that endowments have over foundations," Grassley said. "They continue to have money coming in, while most foundations do not have money coming in."
Grassley said that the threat of poor investment years in the future is not a valid excuse for limiting endowment spending, especially because of the tremendous growth among university endowments and the enormous wealth that they have accumulated. The top 20 university endowments add up to almost $200 billion.
"If you've got a down time, instead of 20 percent growth if you have 5 percent growth, there could be some expenditure of principal until you get a chance to build it back up," Grassley said.
Stanford's Chief Financial Officer Randy Livingston explained that although the smoothing formula seems counterintuitive -- as it results in smaller payments during good years and larger payments in bad ones -- it is necessary to achieve budget stability.
"If we simply try to keep spending constant from one year to the next, then in a year when the value went way up, those [bse] expenditures would be a small percentage of the endowment, and when value goes down, the expenditures would be a large percentage of the endowment," Livingston said.
Livingston said that it was important that base operating expenditures represent a relatively constant portion of endowment spending, so that faculty salaries and other key expenses do not fluctuate with the market.
Another point of conflict between colleges and Congress is the restrictions placed on endowments. In its response to the Senate Finance Committee inquiry, the University said that over 70 percent of endowment funds are restricted by donors to particular uses.
"The endowment is not one big account with a lot of cash in it; there are thousands of funds," Hennessy said. "Congress could say, 'Spend on Financial Aid,' but that would require us to violate contractual agreements [with donors]."
Grassley disputed the notion that spending restrictions tie the hands of University officials.
"I think that you've got to realize that endowments have a lot of flexibility, even though there is a lot of designated giving," Grassley said. "Even though 99 percent might be [restricted], even if you take 1 percent of your endowment that's still a lot of money I'll bet, and don't forget that probably a lot of that 99 percent was donated for student aid as well."
Livingston agreed with Grassley in that the University does retain some flexibility with the 30 percent of the endowment that is not restricted. But he emphasized that when you redistribute money to particular causes, you must make sacrifices elsewhere.
"There is no free lunch here," Livingston said. "Any time we increase allocation of money to one area, we have to say what do we take away from. Although there is widespread support for the improved Financial Aid package, we wouldn't do that at the expense of cutting back faculty, or other things."
Grassley was optimistic that the Senate inquiry into endowment spending will lead universities to make changes on their own and that legislation will not be necessary. Several top universities have already made significant changes to their financial aid programs, with Stanford eliminating tuition for all families earning less than $100,000 a year.
"In the 6 years I've been investigating non-profits and just recently this higher education aspect, we have seen a lot of self-correcting," Grassley said, "and so the extent to which your President [Hennessy] would not like to have [legislation] exactly the same as for foundations, then to the extent which [universities] continue to help students with their endowments as opposed to other uses of the endowments, I think there is less chance that Congress would legislate."
Grassley strongly believes that increasing endowment spending is in the best interest of universities.
"Colleges and universities who tap endowment dollars to help more students access top-notch education are investing in the American dream," Grassley said. "That American dream is going to keep these colleges and universities going."
But President Hennessy is not sure that members of Congress fully understand the complexities of endowment management.
"We've got to do a lot of education for people in Congress about how endowments work," he said.
© 2008 The Stanford Daily via U-WIRE