September 29, 2016

Report: Cornell Lost $280 Million in Interest Rate Swaps

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A report released by the Roosevelt Institute, Cornell’s first student-run think tank, asserts that the University may have lost as much as $280 million over the past 16 years due to interest rate swaps.

An interest rate swap is a deal that colleges conduct with banks, often when universities issue debt to raise money. The think tank asserts that this financial instrument was a major contributor to Cornell’s $25 million dollar budget deficit in fiscal year 2015.

According to the report, Cornell’s $280 million loss was one of the most drastic out of the 19 schools examined in the study. Only Harvard, which lost over a billion dollars — but enjoys a significantly greater endowment than Cornell — lost more money.

Interest rates on debt often correlate with broader national interest rates, but schools would often rather pay a fixed rate because they are less risky, so they buy interest rate swaps from banks.

When schools buy interest rate swaps, they promise to pay the banks a fixed interest rate, while the banks pay the variable rate on the debt that the school issued. When the variable rate is higher than the fixed rate, the school makes money. However, when the variable rate is lower than the fixed rate, schools lose money.

Therefore, in 2008 — when interest rates plummeted to nearly zero percent and Cornell had bought swaps at four percent — the University lost millions of dollars. Eighty percent of the deficit in 2015 was due to costs from interest rate swaps, according to the University.

Cornell is not alone, however, in losing money on interest rate swaps. The report shows that the 19 schools sampled in the report lost approximately $2.7 billion dollars due to swaps and based on a random sample, 58 percent of schools own interest rate swaps.

Jack Polizzi ’18, one of the report’s contributors, explained that the numbers are just estimates based on data on the swaps that Cornell provides on its website and the LIBOR rate, which was used as the benchmark variable rate in the swap deals.

He said that he hopes Cornell will release the actual data on the interest rate swaps.

“The thing that we want to see is transparency here,” he said. “We want to get answers, figure out why this happened, what we can do to prevent things like this in the future and hopefully actually get Cornell to release documents pertaining to these swaps so we can really take a look at what happened.”

He added that interest rate swaps are zero-sum deals because either the banks lose money or the schools lose money. That system presents a problem when the banks have a lot more people to predict how the Federal Reserve will set interest rates, which the LIBOR rate is strongly correlated with.

“It’s to some degree unavoidable because you have one party whose entire business model is based around understanding credit markets, Fed watching, trying to predict where the economy is going to go and then you have schools where that’s not their job at all,” Polizzi said.

He pointed out that banks can take advantage of their resources to make money off of schools and said some of the interest rate swaps that schools have bought are set for 30 years, much longer than swaps sold to any other type of institution.

“[Schools] have an investment committee which is maybe a few people who are not versed in instruments like this, so right away you have an information asymmetry which makes it relatively easy for the banks to take advantage of schools,” he said.

Joanne DeStefano, executive vice president and chief financial officer at Cornell, said the University has historically had a good track record in strategies designed to minimize interest paid on debt.

“However, in a plan designed to manage the University’s long-term capital plan in the most cost-effective manner, the University entered into certain interest-rate swap agreements in 2006 and 2007,” she said. “As with all financial instruments, swap agreements carry with them a degree of market risk; the great recession affected these swaps in a negative way.”

Despite DeStefano’s comments, Polizzi found records of swaps from other years besides just 2006 and 2007. In addition, he found that the results of the swaps has been extremely negative. According to the report, the total loss to colleges from these deals could pay for tuition for 108,000 students across the country.

  • Reality Check

    This story needs to be broadened with some detail about two chief investment leaving Cornell under less-than-admired circumstances during the 16 year period. And where was the investment committee of the trustees as these events unfolded? Cornell’s non-academic governance could use some overall scrutiny.

  • Dan

    Your chart at the top of the page is misleading. First, it doesn’t explain the period over which the loss was sustained. Second, and more egregiously, it shows Cornell as sustaining the largest loss by far. It excludes Harvard, and, as you say, “Harvard, which lost over a billion dollars…lost more money.” This chart is currently posted as the lead photo on the Sun homepage. I suggest that it be removed until these corrections are made.

    • Reality Check

      The chart is not sound on several levels. As noted above it omits Harvard, and also 14 other from the 19-school study. It also fails to identify losses as a percentage of endowment. Cornell’s $280M loss was about 5% of the average endowment. A loss of $100M at Harvard would have been about 3% of the Harvard endowment.

      • Reality Check

        Correction to the above: A $1 billion Harvard loss on rate swaps (not $100M) would have been about 3% of the Harvard endowment.

  • Bill

    No transparency-just like other events at Cornell!

  • Tom

    More Transparency Needed

  • Erik

    Headline should simply read “Cornell Managed Risk”. This sort of thing is done all the time to limit downside exposure.

  • Terry

    Are there members of the Board of Trustees whose banks profited from Cornell’s unfortunate investments?

  • Duh

    How is this even news? It’s common knowledge that Cornell and other academic institutions suffered from the recession, and that for Cornell specifically, IR swaps were part of this.

  • Hotelie Alum

    Interest rate swaps can be an important risk-reduction tool, if used properly by those who understand how they function. It is a sad state of affairs when one of the top universities in the world cannot employ investment managers who know how to take one end of a swap trade. At a university, as in life, ignorance is no excuse…

  • Who needs hedging anyways ?

    How is this news? First of all you don’t compare endowment size to the loss. Second, this is what is called risk management. It would be more dumb to directly face the interest rate risk. Third, no one would have predicted the FED and central banks cutting rates for this long. This article is just another cheap headline used to grab attention and channel anger to “the man” in charge of finances. I don’t appreciate this naively written article.

  • Old Alum

    I am pretty sure the endowment grew under the former CIO. This is one loss compared to larger gains.

  • Your not serious right?

    If you honestly think that these endowments aren’t well informed investors whose job it is to understand the market, you are a fool. This article is so bogus.

  • Seriously?

    I’m glad you are just reporting one leg of the trade. Investing 101 you take a position and then you hedge it. You can’t win on both legs. Ignorant.

  • Barry Hecht

    This article complete misunderstands the role of swaps, futures, and contracts. At worst, it is deliberately misleading.

    The loss of $250 million is certainly not a good thing, but here we have a relative loss, the loss of $250 million not earned (could have been more earnings had Cornell invested in floating rates bonds), not a true negative loss.

    Entities invest in swaps/futures/contracts to stabilize and predict their cash flow, not necessarily to come out ahead. Southwest Airlines did great in fuel contracts when the price of oil was spiking. Other airlines (and transportation companies in general) bought fuel at higher prices, when Southwest was buying a three year old prices. Good for them, until prices of fuel began to fall. But their contracts stabilized prices.

    Farmers buy futures to stability their cash flow. Sometimes they win, sometimes they lose. They need predicatability, and shift risk to the financial sector.

    All of this is about shifting the risk; not necessarily always coming out on top.

    Cornell was NOT outmaneuvered by the banks, who are “better at this.” I am sure that the advisors to college investments are at least as good as the banks. The schools want a stable return, so they buy swap.

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