Harvard: When Interest Rate Swaps Go Sour

(November 11, 2013) — Harvard University has spent more than $1.25 billion unwinding debt derivatives since 2008, according to its own figures.

The most recent payments to exit the interest rate swaps were linked to around $942 million of existing and future debt, the Cambridge, Massachusetts-based university, which has an endowment of $30 billion, said in a financial report.

The majority of the swaps, which assumed that interest rates would rise, were taken out in 2004, when Lawrence Summers, now President Barack Obama’s economic adviser, led the university.

These “forward” swaps provided a fixed rate before the bonds were actually sold, enabling them to exchange their interest rate payment periods. Forwards cost nothing up front, but required the university to post collateral in the event that interest rates fell—which they did.

The situation became so bad that the school was forced to borrow money in 2008 to terminate some of the swaps.

The costs resulting from unwinding the derivatives were $497.6 million in fiscal 2009; $277.6 million in 2011; and $134.6 million in 2012, according to a Bloomberg report.

Harvard had an operating deficit of $34 million for the past year. This marked an increase from $7.9 million the earlier period, but was still a relatively small proportion of its $4.2 billion 2013 revenue.

In moves designed to stabilize its finances, the university raised holdings in cash and liquid investments outside its endowment to $1.5 billion from $1.3 billion at the end of the earlier the 2011 fiscal year, Bloomberg reported.

Outstanding debt fell to $5.7 billion from a high of $6.3 billion on June 30, 2011.

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