Harvard Admits to $1.8 Bil. Blunder in Cash Holdings

Harvard University, one of the world’s richest educational institutions, stumbled into its financial crisis in part by breaking one of the most basic rules of corporate or family finance: Don’t gamble with the money you need to pay the daily bills.

The university disclosed yesterday that it had lost $1.8 billion in cash — money it relies on for the school’s everyday expenses — by investing it with its endowment fund, instead of keeping it in safe, bank-like accounts. The disclosure was made in the school’s annual report for the fiscal year that ended June 30.

Typically, companies and big institutions manage their cash conservatively in order to have it readily available, by keeping the money in such low-risk investments as money-market mutual funds.

But Harvard placed a large portion of its cash with Harvard Management Co., the entity that runs the university’s endowment and invests in stocks, hedge funds, and other risky assets. It has been widely reported that Harvard Management’s endowment investments were battered in the market crash — down 27 percent in its last fiscal year. Not revealed until yesterday was that the school’s basic cash portfolio had also been caught in the undertow.

“I think that was an interesting way to handle the grocery money,” said Harry R. Lewis, a former Harvard dean who is now a professor of computer science at the university. He said the loss raises a basic question: “Did Harvard administration and Harvard Management have the kind of conversation that ordinary households have with their investment managers — about risk and liquidity and what they need the money for and when?”

Harvard chief financial officer Daniel S. Shore said the practice of having the endowment managers invest part of the university’s cash had paid off in previous years, when the stock market was rising. But it had a disastrous effect when the financial markets collapsed last year, causing huge losses.

“We were invested fairly heavily with them and that’s what led to the losses,” Shore said in an interview with the Globe. “The problem as much as anything was we weren’t as diversified as we could’ve been.”

The Harvard endowment losses prompted university president Drew Faust to issue a sudden, jolting warning about the school’s finances in December. Since then the school has laid off 275 staff, offered voluntary retirement to others, imposed salary and hiring freezes, halted its campus expansion in Allston, and borrowed $1.5 billion with a bond offering to boost its cash position.

Shore said that the layoffs and other measures were not linked to the losses in the cash portfolio and that the debt offering ensured the school would be able to meet its obligations.

Meanwhile, at Harvard Management, the $11 billion in endowment losses prompted firings of top investment professionals and an internal restructuring to get its risk-taking ways in check.

At Stanford University, which has experienced a similar decline in its endowment and also undertaken layoffs, spokeswoman Lisa Lapin said it would be highly unusual for the California school to put funds from its general account into long-term investments.

“We wouldn’t take a cash account and invest it with the endowment,” Lapin said.

At Harvard, Shore would not say exactly how much cash the university had placed with endowment managers. The school’s annual report said Harvard had been working to reduce the amount but ran into difficulty when the financial crisis made it harder for the endowment manager to sell investments.

At the beginning of the last fiscal year, July 1, 2008, Harvard reported having $3.2 billion of “university balances” in its general operating account; by year’s end, June 30, 2009, it had $506.3 million in that account.

Part of that decline came from another costly financial blunder last year. It cost Harvard $500 million to get out of a complicated investment in interest-rate swaps. These investments, aimed at protecting the university against rising interest rates, backfired when rates instead fell.

Harvard would not identify which officials had specifically elected to have the endowment manage its cash. In a statement yesterday, Harvard treasurer James F. Rothenberg said the fault for the losses doesn’t “sit with a single individual: the corporation plays a role, the university’s financial team, including the CFO, play a role, and I play a role as treasurer.”

He noted that the university had installed both a new financial chief, Shore, and a new head of Harvard Management, Jane Mendillo, in the past year. Mendillo replaced Mohamed El-Erian; Shore succeeded Elizabeth Mora. Another top Harvard official, Edward Forst, an executive vice president who was deeply involved in the university’s finances, left in August after less than a year on the job.

“We’ve always benefited from strong managers. The results reported today have to do with the global financial crisis more than anything else,” Rothenberg said.

University officials also moved to reduce some of the financial risk the school has faced. Last summer, the school assembled a 10-member financial management committee, including faculty members and outside investment experts, to advise Shore and other members of the financial staff. Forst, a former executive at investment bank Goldman Sachs, remains a member of that committee, which meets monthly.

Shore said the losses have caused him and others at Harvard to greatly emphasize managing its risks. “I think we’ll be in a much better position going forward,” Shore said.