How Harvard Nearly Went Bankrupt After A Rogue Interest Rate Swap Went Very Sour

Tyler Durden's picture

The school that epitomizes the dangers of groupthink (especially by very intelligent people) and tends to get caught in both the virtues and vices of its own ingeniosity, saw just how expensive hubris can be in 2009. Harvard's endowment dropped 27.3% in 2009 to $27 after hitting roughly $10 billion higher the year before.

And this is how the Ivy league safety school characterized their own performance:

With a few notable exceptions, nearly every asset class did poorly. Our real estate portfolio, for example, suffered a loss of over 50% during the year after considering all final marks through June 30, 2009. While diversification has been a mainstay and a driver of the portfolio’s return over the long-term, the benefits of diversification did not bear out through the rapidly evolving and widespread events that unfolded in fiscal 2009.

With perfect hindsight we and most other investors would have started this year in a more liquid position and with less exposure to some of the alternative asset categories that were hardest hit during fiscal 2009. It is important to note, however, that our portfolio has benefited greatly from our asset allocation over the long-term, which has included substantial exposure to less conventional asset classes. Private equity, for example, has earned an average of 15.5% per year for the Harvard portfolio for the last ten years even after a 32% correction in fiscal 2009. Our natural resources portfolio, a more recent addition, has returned 13.0% per year for the last ten years. It would be a mistake to categorically avoid these types of investments because they are less liquid. But the balance of liquid and illiquid investments within the portfolio needs to remain in the forefront of our portfolio strategy.

Yet most notable in the entire report is an interesting story for all those who claim that representing the $200 or so trillion in interest rate swaps on the books of the Big 5 banks is completely irrelevant as the net exposure is just a couple trill here and there. Yeah, that's what Harvard thought too until it had to eat a 45% loss on $1.1 billion in IR swaps. And nearly go tits up in the process.

The University has entered into various interest rate exchange agreements in order to manage the interest cost and risk associated with its outstanding debt and to hedge issuance of future debt. The interest rate exchange agreements were not entered into for trading or speculative purposes. Each of these exchanges is collateralized, as described in Note 3, and thereby carries liquidity risk to the extent the relevant agreements have negative mark-to-market valuations (pursuant to methodologies described below). The interest rates in the table on page 35 reflect any applicable exchange agreements. In fiscal 2009, the University terminated interest rate exchange agreements with a notional value of $1,138.0 million, for which it realized a loss of $497.6 million. A portion of this loss was offset by $85.9 million in gains on the sale of U.S. Treasury bonds which had been purchased to hedge a portion of the liquidity risk associated with the interest rate exchange agreements.

And here is the double whammy of jumping into the fire of margin calls by issuing opposite pieces of paper: locking your liquidity escalating losses anyone?

Also in fiscal 2009, the University entered into additional interest rate exchange agreements with a notional value of $764.0 million, under which the University receives a fixed rate and pays a variable rate. These new interest rate exchange agreements, or ‘offsetting’ agreements, were intended to reduce the risk of further losses in value (with associated collateral posting requirements) within the portfolio of interest rate exchange agreements.

This is what Daniel Shore, Harvard CFO had to say about this near death experience:

When we went into the fall, we had some serious
liquidity management issues we were dealing with and the
collateral postings on the swaps was one.
In evaluating our liquidity position, we
wanted to get some stability and some safety.”

Funny how Harvard, one can argue, was in a comparable situation to none other than Lehman itself. Had Harvard's instantaneous liquidity situation gotten even worse, it would probably have spelled doom for the university Larry Summers, in his inimitable wit and wisdom, used to preside over.

Full Harvard report here:


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Fritz's picture

No sweat.

The squid showed them a powerpoint about how to borrow taxpayer money at no cost.

Lever up a few T-Bonds and its green grass and high tides baby.

Anonymous's picture

Ivy League safety school going tits up is right. And anyone who knows Harvard can tell you they have some ugly tits at that place.

pigpen's picture

Anon, you aint kidding in terms of the pulchritude of the mammaries.  So funny they are doing fundraising calls right now for the endowment and I love speaking with the freshmen callers and discussing our former president mr. summers. He and all the crony money managers at the asset management company can go fuck themselves as they don't deserve a dime in alumni donations.



Anonymous's picture

Wait for Yale's follies next week

Miles Kendig's picture

The esteemed quality of the HBS process shines through once again, this time doing its own home.


torabora's picture

Was Larry Summers the set-up man?

Look where he landed.

Fritz's picture

"In fiscal 2009, the University terminated interest rate exchange agreements with a notional value of $1,138.0 million, for which it realized a loss of $497.6 million."

Any guess as to who the counter party was?

I'll just throw it out there that it may have been another squid attack.




ZerOhead's picture

There is a 97% chance you are correct. But which squid?

Anonymous's picture

You don't say much.

You say a lot.

SWRichmond's picture

They just needed to find the right counterparty to net with.  See?  You just write one, then write an opposite one, and then it's time for crumpets!  There's so little risk!  Some might even say it's tiny!

I hate myself for saying that.

ZerOhead's picture

Ha ha ha... Some did say 'tiny' didn't they? :-)

ChickenTeriyakiBoy's picture

Presumably these agreements were conceived by Mohamed El-Erian.


Nice exit from Boston, though, Mohamed. The 10x salary in Newport Beach must be a nice new normal..



Anonymous's picture

You beat me to it. Why do we not hear anything from Mo-El Arian and his over-emphasis on Harvard's private equity deals?

Green Sharts's picture

Presumably these agreements were conceived by Mohamed El-Erian.

Yeah, let's just presume that whether we know it to be true or not.


ChickenTeriyakiBoy's picture

Wow...Pimco employee? I'm just saying...exposure that big would have to be signed off on from the top. No?

Green Sharts's picture

Yeah, I must be a Pimco employee.  Turn it on me.  It doesn't matter whether the transactions were initiated during El-Erian's tenure at Harvard and/or if he knew of them. Let's just trash him.  He's a public figure and he's not here to defend himself.

ChickenTeriyakiBoy's picture

Hey buddy--not turning anything on anybody. I thought When Markets Collide was a very good book. The guy is clearly smart. But I think it does matter when the transactions were initiated. El-Erian wasn't at Harvard for a long time, and Swensen may be more responsible for creating the vogue endowment investment strategy, but such a massive miscalculation should be traced to somebody. If I were a donor, I would want to know whether the current or former CFO is responsible for this miscarriage. That's a lot of tuitions for a single position. Or a couple of fully decked out institutes/centers.


If I had money with Pimco, I would also want to know.


Nothing personal. If I were interested in defending every market participant simply because they are a "public figure", I'd be reading and posting on another website.

Anonymous's picture

green sharts is crying now his employer is the one getting trashed.

many would disagree with you on his book chicken:

I bought this book because it won the Financial Times Book of the Year Award (not a top ten winner or something, #1 mind you). Historically, a reliable guide (e.g., the masterpiece China Shakes the World, and theoretically dubious but highly provocative Friedman's World is Flat). It has dawned on me belatedly that advance praisers probably don't read their books. All these absolutely glowing endorsements by serious people...for a book that *clearly* isn't top notch.

T. Bojko's review may seem harsh, but it's spot-on. I can live with the ponderous writing style. I initially thought the big words concealed some new or profound thinking...but not at all.

The problems are: 1. there's almost nothing new or inspired about the "markets of tomorrow," and 2. there is nary a sliver of new, actionable advice about investing. The whole thing is a compendium of the superficial. Seeking to cut a swath a mile wide, it is everywhere one inch deep.

In regard to the first, the following are superficially summarized: global trade/capital flows (rightly footnoted to Martin Wolf, but Wolf's own columns are better on this); a cocktail of snippets on behavioral finance - called a "cocktail" - just read Shiller straightaway; some stuff on global trade and commodities, see latest Economist; a paraphrase of Taleb's colorful insights (just read Taleb directly); a woefully weak primer-not-really on securitization; a brief primer on asset classes that repeats everything I've got in a dozen other finance books; and too much material on IMF (e.g., not a single mention of Basel). I agree the topics per se are important, but most of them here are superficially derivative of other, better works.

Here are the four insights from Chapter 2: we are coming from a period of aberrations, many puzzles; too many dismissed them as noise; the inability to distinguish signal from noise is a bad thing; the adjustment caught people off guard. I'm not kidding. The blinding insight is: take care to distinguish signal from noise! Noise bad, signal good....

Strangest of all, in my opinion, is that the author appears to have nothing to add to the field of risk management, which stuns me given his unique vantage point. Risk management is reduced to a few catchphrases: tail risk, moral hazard, principal-agent. Say it ain't so...

Finally, T. Bojko is right about the mundane asset allocation plan: "the author just lays out a pretty mundane asset allocation plan (which is available for free on any number of websites) and then fills a couple dozen pages with worthless blather. Seriously, that's it." That's exactly right.

The book boils down to: big "structural" change is coming, try to sort signal from noise, here's pointers to a bunch of good reading material, I worked at the IMF, start with this generic plan.

I saved you a few bucks. More to the point, I wasted my time reading this book so you don't have to. Since that time is lost to me forever, the least you can do is vote my review "helpful."

Anonymous's picture

If this was an unhedged bet it seems awfully large for the total size of the fund, if this was supposed to be hedged it is truly a disaster, was it hedged with California real estate? I can understand if they took 3% of the fund and went for a big interest rate bet, if this was from a hedging disaster it is far more embarrassing.

Anonymous's picture

They hedged it with a stack of Barry Bonds rookie cards.

putbuyer's picture

I wait for the day that Harvard is one giant piss hole. I will be there to make a deposit. I worked between HaRRRvard and MIT for a while. Everyone back then was a drone - ready to obey. I actually was able to play people.

1. here is a buck, get me a bagle. drone - it's 2 bucks?, me, onion and now. They paid the rest like good little Obamabots.

Anonymous's picture

I don't doubt this for a second. El-Erian is an apologist for the celebrity-in-chief as well, even though he cannot fully back as to why he is a supporter (then again, NONE of them can).

lizzy36's picture

amazing how quickly a liquidity issue become a solvency issue.

wonder if their luck will hold the next time around?

Miles Kendig's picture

Cramer's, Jamie's & Meg's trust will pony up...

Give the GOV a hurrumph

Anonymous's picture

I'm just re-reading Bill Bonner's and Addison Wiggin's 2003 book 'Financial Reckoning Day'.

Funny how they could see it coming in 2003 and all the collective brain power of one of the USA's premier Universities couldn't, six years later.


Howard_Beale's picture

Bonner, Wiggins, myself and others considered to be "perma-bears" were not seeing the future. It was already done when the Nasdaq burst. THe lost decade in the Dow and S&P prove that.  The problem is, and always has been, that people get sucked into endless bubbles, out of control debt, and shady accounting with an incredible faith in the USA. They just don't realize that this bear market didn't start in Oct 2007--it started in 2000. I've read the Daily Reckoning for over a decade. While timing has not been perfect--those of us that were aware of the reality behind the facade, have done well.  The Harvard boys were not just Summers and El-Erian. It was a gang of Hedgies, Goldmanites, and other super brains that got screwed by the bear. No brain science necessary. You play the leverage game, you pay the price. BTW, there was a great article in Vanity Fair on the Harvard endowment 5 months ago that went into the players extensively. No one person is to blame.

Anonymous's picture

which can be the basis of a perfect conspiracy....

on the other hand, big bucks are paid for someone
to be the responsible adult so while i
understand your point someone - whether fully
culpable or not - must be accountable....if not, then problems like this occur after which folks
blunder on and stumble on to the same mistakes and mess....
institutionalized incompetence....

daily reckoning is good...john williams' data
supports the notion that the collapse had already
begun in 2000.....after a decade of weak gdp
growth in the 1990s the entire 2000 decade is marked
by chronic gdp contraction which sort of explains
the loud wailings about recession throughout the
decade by the leftwing press while the rightwing
press was trumpeting for more war and mayhem....

personal and imperial overstretch have killed can only save itself through
retraction and liquidation of empire and military
adventures abroad while its people pay down and
liquidate debt at home....

Anonymous's picture

Why can't they just invest in baseball cards?

Anonymous's picture

Marla. Music.

Green Sharts's picture

Funny how Harvard, one can argue, was in a comparable situation to none other than Lehman itself. Had Harvard's instantaneous liquidity situation gotten even worse, it would probably have spelled doom for the university

I don't think one can credibly argue it, but it's certainly easy to innuendo it.

Green Sharts's picture

Andy, is it just me or is ZH's quality control well on the way to going completely out the window?  As in we throw shit on the wall and it's up to somebody else to disprove it?

This piece started with a comment on the danger of groupthink among bright people and my first thought was how they could write that without grasping the irony.  This place is on the way to becoming a lynch mob; accuracy and fairness be damned.  Look at the thread on J.P. Morgan.  ZH put up a half-baked "analysis" from an anti-semitic crackpot who directed people to his hate filled website.  Did you know the Jews funded the Nazis?

pinkboxtrader's picture

momo traders heatmapping newly unjunked stocks as allegory for ZH's own rise in the financial blog-o-whatever?

Tyler Durden's picture

While we are amused by your very own use of ironic hyperbole, maybe you can elaborate what exactly you disagree with in this post?

Green Sharts's picture

maybe you can elaborate what exactly you disagree with in this post

The comparison of Harvard to Lehman, the suggestion that a loss of less than $500 million net on an interest rate swap and hedge gone awry almost caused a university with an endowment of over $30 billion to go broke.

Howard_Beale's picture

Yale lost even more money in their endowment YOY. I agree with you Sharts that the comparison is shoddy regarding Lehman. While there are buildings that will never be completed when Summers got ambitious, the truth is that both universities hired hot shots that got crazy with leverage and paid the price.

Tyler Durden's picture

As others pointed out a liquidity crunch can become a solvency one practically instantaneously. It is not a matter of an absolute margin call value, but how that affects other collateral backing related assets (think chained downgrade calls in GE's capital structure for example). The Lehman analogy is relevant in that a seemingly controlled (in liquidity terms and otherwsie) variable, sunk the firm. Lehman's balance sheet was over 700 billion: how much of this cost the firm the liquidity crunch that brought the whole house of cards down?

And, by the way, the whole point of this post is to demonstrate the gross to net (close) identity. However, if the Harvard issue touched a nerve, we apologize profusely.

Green Sharts's picture

The Lehman analogy is relevant in that a seemingly controlled (in liquidity terms and otherwsie) variable, sunk the firm.

Lehman had a balance sheet loaded with toxic waste and relied on continuous short-term credit from the financial markets for its survival.  In looking at the investment allocations of the Harvard endowment which are in the annual report it appears to me that they had something in the neighborhood of $13 billion of investments that could have been liquidated (U.S. and foreign equities, corporate debt, etc.) to cover a problem of less than $500 million.

if the Harvard issue touched a nerve

No, I have no connection to Harvard and certainly have no affection for it.  But the ridiculous attempt to compare Lehman to Harvard insulted my intelligence.  Seeing you dig your heels in to defend it is even worse, particularly given that you guys act like you're an oasis of intellectual integrity in the middle of a sea of corruption.

Anonymous's picture

the comparison in its limitation seems apt...

too much leverage chasing too little asset =
wipeout potential when the margin man comes
calling...lehman died, harvard escaped but
at considerable cost...

I am a Man I am Forty's picture

If an endowment of $30B can't come up with $500M in short order then everyone should be fired.


Counterparty's picture
Counterparty (not verified) Green Sharts Oct 17, 2009 8:34 PM


Lately, I detect a palpable increase in the tin-foil brigade here, egged on, it seems, by weak or facile analysis. In early days, the occasional whack-job commentary was easily ignored, because it was far outweighed by interesting analysis.

As some of the commentariat has become simultaneously more virulent and less useful, the same tone & lack of rigor seems to be slipping into main stories.

As Sharts points out, it's an insult to some of your readers' intelligence, while aggrandizing the idiocy of others. And aside from Marla, I've not seen anyone actually perform a call-out when the idiocy gets rampant.

There are many interesting commenters here, some of whom are also periodically idiots. Please don't allow their presence to infect the tone & method of the main editorial content, otherwise ZH will see, in retrospect, that the speed of its rise from nothingness is exceeded only by the speed of its return to same.

And that would be a shame.

Anonymous's picture

Larry, don't you have better things to do besides post on blogs? Is this why you are ALWAYS falling asleep when your boss starts spewing his hollow rhetoric?

Green Sharts's picture

Tyler, did you guys see this website which belongs to the guy whose half-baked "analysis" of JPM was posted late this afternoon?  Surely you weren't aware of it.

Howard_Beale's picture

Sometimes free speech makes my stomach sick. Awful site.

Tyler Durden's picture

No, and frankly we don't care. If people have a passionate opinion on a topic, we are willing to provide a forum to voice their (hopefully logical and justified) grievance. If that site promotes satanic worship and 3 headed vibrators, that is of no concern to us, nor should it be the concern of our readers. There are many posts that link up to the WSJ, the NYT, Bloomberg, and other MSM, which an objective person can find much more fault with than the site you referenced (I imagine at least their agenda is clear cut). W/r/t "messenger" issues, we refer you, and anyone else who shares your skepticism, to our manifesto.

Green Sharts's picture

There are many posts that link up to the WSJ, the NYT, Bloomberg, and other MSM, which an objective person can find much more fault with than the site you referenced

Pathetic.  Absolutely pathetic. 

Anonymous's picture

You need to show a little respect to the owner of the website that you post so many of your garbage ideas on.

ZH needs a timeout room for people like 'Green Sharts'. Maybe it will give you time to clean your shorts and get with the program. Ideas can be shared on this website.

I just donated $100 to the very website that you are so fond of.

"We are not racist, xenophobic, homophobic, or prejudiced against any race, creed, or national origin. We are prejudiced only against criminals".


Anonymous's picture

STFU and go away then green. you obviously have a connection to harvard and while you have
been dishing it out, you clearly cannot take it.

lizzy36's picture

It is not that site it is "his site".  It is where he promotes his thoughts and work.  His piece directed one to that site.   

And in giving him a voice you are by association giving his website a voice. Like you noted when one links to a MSM piece you are giving the whole MSM site a voice.    

If one links to a Tyler Durden piece, one is by association giving ZH a voice.  And while a single piece may give ZH and/or Tyler Durden notoriety, the totality of the work on this site gives you credibility.  

Perhaps there are objective people better than I.  Prior, to linking to his site, I found his piece on JPM at best to be somewhat immature and his analysis deficient.  Once i linked to his site, (which he must be proud of because he directed me there), I thought he was a crackpot who ideas have little merit.  I will never take anyone seriously, who espouses and promotes the views that he does on his website. 

There is passionate opinion, difference of opinion and logical debate. Which is why i come to and believe in ZH.  I don't come here for crappy financial analysis and to be linked to some website promoting the Protocals of the Elders of Zion.


Anonymous's picture

sorry but site content is a matter about which
discerning and moral readers will be concerned....i'll
decide what should be of concern to me - not
some pompous website operator....