"Frightening" Investment Strategies Hit Harvard

The Harvard Crimson published a very interesting story a few days ago about Iris Mack, an analyst at the Harvard Management Company who brought attention to "frightening" trades involving derivatives via e-mails to the office of the university's then-president, Larry Summers. Like many other whistleblowers, Mack was promptly fired:

In an e-mail sent May 30, 2002 to Marne Levine, chief of staff for then-Harvard President Lawrence H. Summers, Mack detailed her concerns regarding what she deemed HMC’s “frightening” usage of derivatives and statistical modeling techniques, as well as the Company’s lack of a timely and portfolio-wide risk management system, high employee turnover rate, and low level of productivity in the workplace, specifically among managers...

Mack, a derivatives researcher for Enron before coming to HMC, says she was “shocked” by the mishandling and ignorance of derivatives at the HMC international equities division where she worked, led by Jeffrey B. Larson. At the time, Mack says, Larson’s group had only recently begun exploring more sophisticated financial instruments such as credit default swaps and capital structure arbitrage.

Larson left his job at Harvard in 2004 to start his own hedge fund, Sowood Capital Management, with $500 million worth of seed money courtesy of the university. What happened next?

Sowood collapsed in 2007 due to heavily leveraged investments in corporate debt—making national headlines as one of the first high-profile hedge fund implosions of the subprime mortgage crisis—costing Harvard $350 million.

Oops. 

More broadly, however, that a university-- not an investment bank or insurance giant-- was fiddling around in credit default swaps up until very recently bears some serious consideration. Also worth thinking about: the $17,256,161 that Larson pulled in during FY2003 and the $35,099,300 that Maurice Samuels, a Senior Vice President for the Harvard Management Company, netted that same year, according to tax records. While salaries for HMC employees have dropped to less astronomical levels since 2004, some still rake in millions. Here at Princeton, the three highest compensated employees all work for the Princeton Investment Company and a list of other educational institutions where the top earners are investment managers would be long. 

A few years ago, when the money was pouring in, all of this might have been unsettling but excusable and perhaps that's why Larry Summers apparently was not too interested in hearing about the trouble at HMC. Today, however, with endowment losses at Harvard and Princeton both estimated to end up around 30%, it might be time to rethink how universities manage their billions while injecting a little transparency into the process. Not that I'd get my hopes up. 

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TPMMuckraker has a post up on the Mack story.