The Other Debt Crisis

Much has been said about the rising cost of college—and how student debt loads are threatening to financially hobble graduates for decades to come. But as a Cornell economist and his student write, there’s another debt crisis: that of colleges and universities themselves, which are increasingly relying on borrowed money to finance ever-more-ambitious campus facilities. […]

Much has been said about the rising cost of college—and how student debt loads are threatening to financially hobble graduates for decades to come. But as a Cornell economist and his student write, there’s another debt crisis: that of colleges and universities themselves, which are increasingly relying on borrowed money to finance ever-more-ambitious campus facilities.

How has Cornell's borrowing affected the University?

By Ronald Ehrenberg and Ross Milton

Much public attention has been focused on the growing debt burden of highereducation students. One New York Times article proclaimed that this is "a generation hobbled by the soaring cost of college," citing more than $1 trillion in student loans outstanding. The authors focused on one graduate with $120,000 in debt and no good job prospects.

While such cases are dramatic, most graduating students have less debt. At Cornell, thanks to the University's need-based financial aid policies, a majority of students graduate with no debt or only modest indebtedness. For the 45 percent of the Class of 2012 that had ever borrowed, the mean cumulative student debt at graduation was only $20,490.

There is, however, another debt crisis in higher education—one from which Cornell has not been immune. While most people understand that colleges and universities hold financial assets, it is less well known that they also borrow funds and incur debt. The New York Times has reported that, for the more than 500 academic institutions whose debt was rated by Moody's, college and university debt doubled in inflation-adjusted terms between 2000 and 2011 and stood at more than $205 billion in 2011. At Cornell, the total external debt level (for Ithaca and the Medical College) was $495 million on June 30, 2003; ten years later, on June 30, 2013, it had risen to almost $1.9 billion—a 375 percent increase.


Why do universities borrow money?

Academic institutions borrow for many reasons. They may finance building projects— partially or entirely—that have revenue streams associated with them that will cover the cost of debt service; for example, residence life projects such as student housing and dining facilities, where debt-service costs can be included in the housing and dining rates. They also may borrow to finance infrastructure projects such as IT networks or for utilities (heating, electric power, cooling), where debt-service costs can be charged out to users and recouped through tuition and other revenues that the units receive.


Many construction projects, especially academic and research buildings, are financed largely by gifts from individuals, corporations, foundations, and the government. Academic institutions—and Cornell is no exception—have used a process in which the Development office makes a feasibility assessment of the number and size of gifts that are likely to be received for a project; typically the project is undertaken only if the projections exceed the expected cost. However, debt financing may be used "strategically" if otherwise the institution would fund part of the project with its endowment and the expected return on the endowment exceeds the cost of borrowing funds. It may also be used for buildings in which externally funded research is conducted, because the interest payments on such debt can be at least partially recovered from the research grants.

Even if the projections are accurate, sometimes gifts are received at a slower rate than anticipated and the institution must borrow "bridge funds" to finance a project until the anticipated gifts have all been received. In some cases, the project costs more than expected or the gifts fall short. When this occurs, institutions must borrow using long-term debt. The funds needed to service the debt will come from the general operating budget, which includes revenues from tuition, gifts, endowment spending, and cost recoveries on external research grants. For universities with a medical college, revenues from physician practice plans may also be included.

Academic institutions also use lines of credit—short-term borrowing—to help cover operating expenses, as the revenue that a university receives does not necessarily generate a smooth flow of funds over the course of a year. For example, tuition payments flow primarily at two points of time (the start of the fall and spring semesters), but staff salaries and other expenditures occur all year. Similarly, funding from the federal or state governments may not arrive until after expenditures have been made.

If an institution has sufficient financial assets invested in very liquid form (short-term money market instruments), this reduces the need for lines of credit; however, if the rates of return on longer-term assets such as stocks, bonds, and private equity are substantially higher than money market rates, asset managers may focus their investments on these and seek to preserve liquidity through lines of credit. Prior to the financial collapse of 2008, many institutions, including Cornell, did not worry a lot about the liquidity in their asset portfolios and depended on lines of credit to assure that they had the funds to make payments. During the crisis, when it was feared that lines of credit might be frozen, many institutions borrowed large sums to generate liquidity and avoid having to sell endowment assets in a depressed market. In 2009, Cornell borrowed $500 million, split equally between five- and ten-year maturity bonds.

How do universities borrow?

Nonprofit institutions can borrow using tax-exempt debt—which allows them to pay lower interest rates—for qualified capital projects such as new buildings, renovations, and infrastructure that are used for educational purposes. These projects cannot be used for any taxable activities or for business incubators. Borrowing to support operating expenses, either long-term or via lines of credit, must be done at taxable rates.

Long-term borrowing can be done at either fixed or variable interest rates. Variable- rate bonds have weekly or daily maturities and interest rates that are tied to a broad index rate; their interest rates may increase or decrease over the life of the bond. Decisions on whether to issue fixed- or variable-rate securities are based on the institution's expectations as to what will happen to interest rates over time.

To provide protection when an institution is unsure about the direction in which interest rates will move, it can buy "swaps"—contracts that require it to sell bonds in the future with a variable or specified interest rate. For example, if an institution is planning a construction project that will start in three years and it believes that interest rates will rise, it can buy a swap that allows it to lock in a lower future interest rate for the bonds needed to finance the project. This has a risk: if interest rates fall, the value of the swap becomes negative because it will force the institution to borrow at a higher rate than the then-prevailing market rate.

In some circumstances, a university can try to "unwind" a swap by paying market price at the time to get out of the contract.Unwinding swaps can be costly— and in some cases it is not possible to exit the contract, so the institution is locked into borrowing at a higher rate than necessary. Last July, Bloomberg News reported that Cornell purchased more than $1 billion of swaps before the financial collapse, that it had paid $30 million in termination fees in 2010 to unwind some of these swaps, and that it is continuing to pay interest on bonds that it has never issued because of the swap contracts that it could not unwind. Cornell has never confirmed the report's accuracy.

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