In the words of a university staff member, 'Harvard’s the richest place around here. If they can’t even afford the coffee, it makes us wonder, you know.'

Rich Harvard, Poor Harvard

Only a year ago, Harvard had a $36.9 billion endowment, the largest in academia. Now that endowment has imploded, and the university faces the worst financial crisis in its 373-year history. Could the same lethal mix of uncurbed expansion, colossal debt, arrogance, and mismanagement that ravaged Wall Street bring down America’s most famous university? And how much of the turmoil is the fault of former Harvard president Larry Summers, now a top economic adviser to President Obama? As students demonstrate, administrators impose Draconian cuts, and construction is halted on an over-ambitious $1.2 billion science complex, Nina Munk follows the finger-pointing.

Early last May, I attended a town-hall meeting of undergraduates at Harvard University in Cambridge, Massachusetts. The topic that evening: cost-cutting. As I settled into my chair, in Boylston Hall, student activists, members of the “Student Labor Action Movement,” were making their way through the auditorium, handing out flyers. “Rethink. Resist,” urged the bold black letters. It was a call to action. “no layoffs!” At the top of the printed page was Harvard’s historic coat of arms: three small open books. Cleverly, the university’s Latin motto—normally inscribed on the books as “ve-ri-tas“—had been replaced with a near anagram, “av-ar-ice.”

Ignoring the agitators as best he could, Michael Smith, dean of the Faculty of Arts and Sciences, Harvard’s biggest division, called the meeting to order. Sitting casually on a desk, wearing jeans and a short-sleeved polo shirt, Smith, a professor of engineering and applied sciences, and a former competitive swimmer, looked more like an athlete than an administrator. He got straight to the point: his division—which includes Harvard College, the Graduate School of Arts and Sciences, and the School of Engineering and Applied Sciences—was facing a budget deficit of $220 million.

That’s a huge sum: $220 million! Nearly 20 percent of the Faculty of Arts and Sciences’ current budget had to be cut. “That frightens me,” Smith said forthrightly. “It should frighten you. We obviously can’t sit around and do nothing. We’ve got to find a way to try and get the income back in alignment with the expenses.”

Smith’s audience listened intensely. Already, they had seen evidence of the cutbacks Smith was alluding to. All across campus, as a preliminary measure, thermostats had been lowered during the winter months, from 72 degrees to 68 degrees. Students and faculty were no longer entitled to free coffee at the university’s Barker Center. The Quad Express, which shuttles students between the Radcliffe Quadrangle and Memorial Hall, would soon be running every 20 minutes, not every 10 minutes. More recently, despite loud protests from Harvard’s athletes, among others, it was announced that hot breakfasts would no longer be served on weekdays at undergraduate residential houses. Instead of bacon, poached eggs, and waffles, students would have to get by on cold ham, cottage cheese, cereal, and fruit.

Such cost-cutting measures—“alignments” and “resizements,” as Harvard prefers to call them—are painful for everyone involved. In the words of a university staff member, as quoted by The Harvard Crimson, “Harvard’s the richest place around here. If they can’t even afford the coffee, it makes us wonder, you know.”

But this evening at Boylston Hall, Michael Smith seemed to be suggesting something bigger, more serious, than the absence of free coffee. “What will that mean for students in practical terms?” asked one coolheaded member of the audience. “Are we going to have fewer resources in terms of advisers? Are we going to have fewer office hours for our professors? Are we going to have fewer professors?”

Smith would not be specific. “The resizing that we’ve done is nothing compared to what we’ve got coming up,” he said, hinting at imminent upheaval.

Someone else asked a tough question: Instead of cutting undergraduate budgets, why not cut the salaries of Harvard’s top administrators?

Smith sighed. If only it were that easy. His colleague Evelynn Hammonds, dean of Harvard College, answered this time round: “I’d rather use the words ‘reduction,’ ‘shifting things around,’ ‘reorganizing’—rather than saying something that says ‘cuts,’ which implies you whack the heads off flowers,” she said. “What we’re trying to do is make those kinds of priority-driven changes.”

Smith looked at the audience. “Are we done?” he asked. Then, glancing at the clock, he stood up. It was eight o’clock. “We’re done!” he concluded.

Outside, along the Charles River, the cherry trees were in bloom. In Harvard Yard, the wide grassy lawn was soft and green. To my left was a bronze statue of John Harvard, the university’s first major benefactor, his shoe polished to a high gloss by passersby. Then something else caught my eye: discarded paper cups, torn and crumpled candy wrappers, an empty Evian bottle. The trash can in front of the stately, granite University Hall was overflowing. It was a bad sign.

There are going to be a hell of a lot of layoffs. Courses will be cut. Class sizes will get bigger,” conceded a Harvard insider, who, like every other administrator on campus, was not permitted to speak openly to me on the classified subject of alignments and resizements and belt-tightenings.

Radical change is coming to Harvard. Fewer professors, for one thing. Fewer teaching assistants, janitors, and support staff. Shuttered libraries. Less money for research and travel and books. Cafés replaced by vending machines. Junior-varsity sports teams downgraded to clubs. No raises. No bonuses. No fresh coats of paint or new carpets. Overflowing trash cans.

The recession has been hard on most Americans. We know that. At Harvard, however, adjusting to the end of the gilded age, the champagne age, is proving especially wrenching: the university’s endowment has collapsed, donations are down, budgets are overstretched. With so many enormous fixed costs—and with much of its endowment restricted by the narrowly defined wishes of donors—there’s almost no room left to maneuver.

What’s more, the university is facing the onerous financial consequences of over-building. Consider this: Over the 20-year period from 1980 to 2000, Harvard University added nearly 3.2 million square feet of new space to its campus. But that’s nothing compared with the extravagance that followed. So far this decade, from 2000 through 2008, Harvard has added another 6.2 million square feet of new space, roughly equal to the total number of square feet occupied by the Pentagon. All across campus, one after another, new academic buildings have shot up. The price of these optimistic new projects: a breathtaking $4.3 billion.

In Allston, a Boston neighborhood just across the Charles River from the school’s main campus, you can view Harvard’s billion-dollar hole in the ground, a vast construction pit. It’s the foundation of Harvard’s most ambitious project of all: the sprawling Allston Science Complex, once scheduled to be completed by 2011 at a cost of $1.2 billion—but now on hold.

It’s become a symbol, that vast hole in the ground, yet another indication that Harvard University is facing the worst, most dangerous financial crisis in its 373-year history. Adding to the instability: the university is on its fourth president in eight years. And every few weeks, or so it seems, Harvard announces the departure of yet another administrator—most recently the university’s executive vice president, Edward Forst, who just last year came to Harvard from Goldman Sachs and intends to step down on August 1.

“They have to do what businesspeople do—they have to make hard decisions,” one Harvard business professor told me, referring to the university’s administrators. But, of course, Harvard is not a business, nor is it being run like a business; it’s a distinguished, high-minded research university, arguably the greatest university in the nation. “Balancing their budget is going to be very traumatic for them,” the professor added, in case I’d missed his point.

Already, the inevitable recriminations and backbiting have started. Harvard is in trouble, and no one can decide who’s to blame, or what to do next. In reporting this story, I found myself caught up in a nasty, self-serving whisper campaign: back and forth, “on background,” Harvard’s hostile fiefdoms are pointing anonymous fingers, each accusing another of “pulling the trigger” on this and that high-ticket capital project. They disagree about who made the flawed investment decisions in the first place, insisting that they themselves had never been consulted on the matter, or had been overruled, or pushed aside and ignored. Invariably, somebody else had the “ultimate fiduciary responsibility.”

Meanwhile, the campus itself is in turmoil. Faculty members are angry. Students feel betrayed. “Why haven’t the faculty been asked to sacrifice at all?” reads one typical comment posted on the Crimson’s Web site. “The lowest paid professors make over 150k+, and yet they have the nerve to tell students to suck it all up.”

“Were the judgments we made reasonable ones?” a former top Harvard administrator asked me, rhetorically, addressing the sharp increase in expenses and capital commitments of the last decade. “At the time, I think they were reasonable judgments. It turns out, with the benefit of hindsight, you might have preferred less ambitious plans.” (Which is not to say that the administrator in question accepts a grain of responsibility for those judgments.)

Incensed, one member of the board of Harvard Management Company, the fund that manages Harvard’s endowment, told me, “This story is about leadership. It isn’t about money.” He may be right. At some point in the last five years, the men and women who run Harvard convinced themselves that the endowment would grow at double-digit rates forever. If Harvard were a publicly traded company, those people would have been fired by now.

“Apparently nobody in our financial officee has read the story in Genesis about Joseph interpreting Pharaoh’s dream—you know, during the seven good years you save for the seven lean years,” remarked Alan Dershowitz, a professor at Harvard Law School since 1967. “And now they’re coming hat in hand, pleading to the faculty and students to bear the burden of cutbacks. It’s a scandal! It’s an absolute scandal, the way Harvard has handled this financial crisis.”

Once upon a time—that is, the fiscal year ending June 30, 2008—Harvard’s endowment stood at $36.9 billion, way, way up from $4.8 billion in 1990. No other university endowment in the world comes close to matching Harvard’s. Yale’s endowment, the second-largest in the nation—$22.9 billion for fiscal 2008—is nearly 40 percent smaller than Harvard’s. Stanford’s is less than half the size: $17.2 billion, as of last year.

Then came the Great Recession. In the second half of 2008, even more quickly than it had taken off, Harvard’s overheated endowment collapsed. Last December, in a letter written to the university’s deans, Harvard’s president, the historian Drew Gilpin Faust, and its executive vice president, Ed Forst, revealed that Harvard’s endowment had lost $8 billion, or 22 percent, in the first four months of the fiscal year, from July through October 2008. To put that number in context: $8 billion is greater than Columbia University’s entire endowment ($7.1 billion as of fiscal 2008). Not since 1974, when Harvard’s endowment shrank by 12.2 percent, had the university seen losses of such magnitude. Anticipating more dire financial news, Faust warned her deans to expect a 30 percent loss in the endowment for the year. Other universities were showing big losses in 2008, but at Harvard, given the scale and size of its endowment, the numbers seemed inconceivably large.

Right away, some commentators said that Faust was being far too optimistic. On the Huffington Post, the financial journalist Edward Jay Epstein argued that, adjusted for the true value of Harvard’s illiquid assets—that is, its private-equity partnerships and other assets that don’t sell on the open market—the endowment’s losses for those first four months alone were closer to 50 percent, or $18 billion. Forbes magazine, noting that Harvard faces a staggering $11 billion of unfunded commitments—money promised, but not yet paid, to various private-equity funds, real-estate funds, and hedge funds—concluded that the university was in a kind of death spiral, forced to sell healthy portions of its portfolio just to stay afloat.

If Harvard were a serious business facing a liquidity crisis, it would have done something drastic by now: fired senior employees, closed departments, sold off real estate. But Harvard, like most other leading universities, is stubborn and inflexible. “None of these schools has the ability to cut expenses fast enough” is how a hedge-fund manager who counts Harvard among his investors explained the problem. Running the numbers for me, proving how impossible it is for a shrinking endowment to keep up with the university’s bloated, immovable costs, the hedge-fund manager concluded, “They are completely fucked.”

Here’s what we do know about Harvard’s response to the crisis: at some point in the fall of 2008, Harvard Management Company tried to sell off a big chunk of its private-equity portfolio, about $1.5 billion worth of investments that were locked up in such long-term buyout funds as Apollo Investment Fund VI and Bain Capital Fund IX, among many others. The planned auction was a fiasco: no one was willing to pay anywhere near the asking price for those assets.

A money manager I spoke to described his meeting late last year with Jane Mendillo, who in July 2008 became president and chief executive officer of Harvard Management Company. Knowing that Mendillo was trying to unload assets, he offered to buy back Harvard’s sizable stake in his private fund. As he recalls, the surreal dialogue went something like this:

He: “Hey, look, I’ll buy it back from you. I’ll buy my interest back.”
She: “Great.”
He: “Here, I think it’s worth—you know, today the [book] value is a dollar, so I’ll pay you 50 cents.”
She: “Then why would I sell it?”
He: “Well, why are you? I don’t know. You’re the one who wants to sell, not me. If you guys want to sell, I’m happy to rip your lungs out If you are desperate, I’m a buyer.”
She: “Well, we’re not desperate.”

Was Harvard desperate then? Is Harvard desperate now? One clue is this: last December, the university sold $2.5 billion worth of bonds, increasing its total debt to just over $6 billion. Servicing that debt alone will cost Harvard an average of $517 million a year through 2038, according to Standard & Poor’s.

To be clear, even if you’d tried hard, you could not have picked a worse time to sell bonds than December 2008; that was the precise moment when credit markets seized up. But Harvard, it seems, had no choice. Unwilling to sell its assets at fire-sale prices, it needed immediate cash to cover, among other things, what my sources say was approximately a $1 billion unrealized loss from interest-rate swaps. That’s a staggering figure: $1 billion, roughly a third of the university’s entire operating budget for last year.

Those swaps, put in place under Harvard’s then president, Lawrence “Larry” Summers, in the early 2000s, were intended to protect, or hedge, the university against rising interest rates on all the money it had borrowed. The idea was simple: if interest rates went up, the swaps would bring in enough money to cover Harvard’s higher debt payments.
Instead, interest rates went down. And for reasons no one can explain to me, even as interest rates were plunging in 2007 and 2008, the university simply forgot, or neglected, or chose not to cancel its swaps—with the result that Harvard wound up facing that $1 billion loss! Whose responsibility was that? Where were Harvard’s chief financial officer and treasurer while all this was going on?

In the financial press, it’s been suggested that Larry Summers is to blame for the interest-rate-swaps crisis, despite the fact that he left Harvard in 2006, long before interest rates plunged. The university flatly refuses to speak publicly on the subject. Which leaves journalists free to turn Summers into a scapegoat. But that’s too easy: the real story of Harvard’s financial catastrophe, and of Larry Summers, is far more nuanced.

In the days when Harvard’s endowment provided only a fraction of the university’s operating budget, a loss would have been unfortunate, but not tragic. In recent years, however, Harvard’s soaring endowment has become the engine fueling the university’s growth. In 2008 alone, so-called distributions from the endowment were $1.2 billion, representing more than a third of Harvard’s total operating income, up from only 16 percent two decades ago.

During the boom years, it was assumed without question that the value of Harvard’s endowment would keep rising. Trusting in that false certainty, the already profligate university went wild, increasing its annual operating budget by 67 percent, from an inflation-adjusted $2.1 billion in 1998 to $3.5 billion in 2008—this, even as the number of students remained constant. While I was reading through Harvard’s financial reports from the past decade, the word “delusional” sprang to mind. So did “unsustainable.” It was like feeding an addiction, having access to so much quick and easy money.

Harvard’s biggest operating expense is salaries and benefits, which eat up almost half the operating budget. In the past year alone, that single expense jumped 7.5 percent. Today, on average, a full professor at Harvard earns $192,600, before benefits; that’s more than he or she would make at any other school in the nation. (At Yale, for example, the average salary is $174,700. At the University of California, Berkeley: $143,500.)

Harvard is also generous with its financial aid to students. In the past decade, the cost of subsidizing students has increased nearly threefold, from $125 million a year to $338 million.

Officially, the university charges $48,868 a year for undergraduate tuition, room, and board—that’s an increase of 50 percent over the last 10 years—but only a small number of students actually pays that much. Back in 2004, under growing pressure from Washington, and in response to outsiders who accused the school of (a) elitism and (b) hoarding its immense wealth, Larry Summers shook up the world of higher education by announcing that students whose parents earned $40,000 a year or less would be able to attend Harvard gratis. Two years later, that cutoff was increased to $60,000, a figure well above the median U.S. household income.

Still, Harvard pressed ahead in its efforts to ease the growing burden of tuition. In December 2007, declaring that “excellence and opportunity must go hand in hand,” the university’s new president, Drew Faust, made another stunning announcement: henceforth, students whose parents earn as much as $180,000 a year would pay no more than 10 percent of their family’s annual income in tuition fees.

“Harvard’s new financial aid policy is the boldest move yet to mitigate the soaring costs of a college education,” applauded an editorial in The New York Times.

No one could have known it then, but two months before Faust’s munificent offer to the upper middle class, the Dow Jones Industrial Average had peaked. By the time Harvard’s new financial-aid initiative took effect, last September, right at the start of the school year, Lehman Brothers had filed for bankruptcy and the stock market was in a sickening free fall. By year-end, the Dow Jones Industrial Average had plunged almost 40 percent from its 2007 high, dragging with it Harvard’s overheated endowment.

Years ago, when I was a reporter for Forbes, we revered Jack Meyer, the man who ran Harvard Management Company from 1990 to 2005. Together with his competitor David Swensen, Yale’s long-serving chief investment officer, Meyer transformed the way universities manage their endowments.

When Meyer arrived at Harvard, the endowment was in a deep rut, going nowhere. Walter Cabot, who’d run Harvard Management Company since its founding, in 1974, had survived the stock-market crash of 1987 magnificently. But afterward, weakened by a heart attack, Cabot remained cautiously on the sidelines, even as the market took off again. His time was up. Meyer, then 45, a Harvard M.B.A. and the former chief investment officer for the Rockefeller Foundation, was hired to take charge.

Meyer was a pioneer. He was daring, or reckless, depending on your point of view. Instead of abiding by the old, prosaic rule of 65/35 (whereby 65 percent of your portfolio is invested in U.S. equities and 35 percent in bonds), Meyer and his team of portfolio managers moved Harvard’s money into all sorts of things: private equity, real estate, oil, gas, fixed-income arbitrage, timberland, hedge funds, high-tech start-ups, foreign equities, credit-default swaps, interest-rate swaps, cross-currency swaps, commodities, venture-capital funds, junk bonds. As if all those exotic, illiquid investments weren’t enough to amplify the returns, Meyer added a heap of leverage. It was dizzying, Harvard’s portfolio.

The best money managers in the country dreamed of working for Meyer. “It was an intellectually charged place,” recalls a portfolio manager who worked at Harvard Management Company in the 1990s. “They were the brightest people that I have ever met,” I was told by another portfolio manager who worked under Meyer.

If outsiders viewed the money managers at Harvard Management Company as cowboys—and they did—it may be because Meyer demanded performance above all. “Jack basically said he had no use for anybody who couldn’t contribute value,” said an admiring Frank Dunau, who worked for Meyer until 2001. “Unless you can beat the S&P, there’s no reason for you to be here” is how Meyer put it, according to Dunau. “I mean, if you’re not adding value, why am I paying you?”

For a long time, Meyer’s daring strategy worked flawlessly. Between fiscal 1990 and 2008, Harvard’s endowment boasted an average annual growth rate of 14.3 percent. That’s a spectacular performance. The Wilshire tucs index, which tracks the performance of 1,200 U.S. foundations and endowments, grew by a median annual rate of only 9.7 percent over that same time frame.

For all that, the long-term performance of Harvard’s endowment doesn’t tell us the whole story. What really happened is that somewhere along the line, around the year 2000 by most accounts, Harvard Management Company, like the university itself, lost its way.

In droves, the best portfolio managers started to leave Harvard Management Company. For most of them, the issue was money, pure and simple. Under Meyer, what Harvard paid his people was based on performance—in most cases, about 10 percent of what they made for the university. As the endowment got bigger, their incentive bonuses got bigger, too. And before long, the (mostly) men at Harvard Management Company were by far out-earning any administrator or professor at the university they were working for.

Jon Jacobson, aged 34, was Harvard’s top earner in 1995. He made $6 million that year, roughly 25 times more than the university’s then president, Neil Rudenstine. Two years later, in 1997, Jacobson, a former trader at Shearson Lehman Brothers, made $7.6 million. By 1998, Jacobson was making $10.2 million.

Resentment followed. At first, articles criticizing Harvard’s well-paid or overpaid money managers were limited to The Harvard Crimson and The Boston Globe.Then The Wall Street Journal got its hands on the story. Soon after that, in 1998, and backed by $500 million of seed capital from Harvard’s endowment, Jacobson quit to start his own hedge fund; no one had to know how much money he was earning.

Complaints about excessive compensation at Harvard Management Company gathered force, like an avalanche or a mudslide. By the early 2000s, Harvard’s top moneymen were making as much as $30 million to $40 million a year. Finally, in 2003, seven members of Harvard’s class of 1969 wrote a strong letter of protest to the university’s president, Larry Summers. They spoke out loudly, publicly, informing any member of the media who would listen that compensation at Harvard Management Company was “obscene.”

At other American universities, where investing money for the institution is regarded as a kind of public service, Harvard’s swagger raised deep suspicion. “Harvard became a bunch of mercenaries,” the chief investment officer of another big private university told me.

One day in late April, I visited Walter Cabot—Harvard College class of 1955, first president of Harvard Management Company, and a descendant of one of Boston’s most distinguished First Families. Almost 20 years have passed since Cabot was pushed out of Harvard Management Company and replaced by Jack Meyer. He’s now 76 years old and semi-retired. “I always told people I had the greatest job in the world,” Cabot said, nostalgically. “I could’ve probably made a lot more money doing something else, but my goal was to do something unique and different for an institution that I went to.”

For nearly two hours, as I sat in his modest office in Wellesley, Massachusetts, Cabot reminisced, in monologue. Again and again, he kept returning to the subject of money and its discontents: “I mean, unlike New York, I guess we weren’t greedy. We didn’t know any better.” Wearing a blue oxford-cloth shirt and khaki trousers, Cabot moved slowly across the room, supported by two metal canes. “We tried to run an honest, simple business. We tried to abide by the rules,” he continued. “Obviously, we weren’t there to go to the poorhouse, but you were there to do an honest trade and work hard and produce results and take pride in what you did. And money for the sake of money, or power, or whatever money is, was really not the objective.”

Under Jack Meyer, making money was the sole objective of Harvard Management Company. That was its job. Located in a modern skyscraper in downtown Boston, well insulated from Harvard’s right-thinking campus, on the other side of the river, Harvard Management Company resembled a typical Wall Street trading floor. That its portfolio managers were being paid according to the rules of Wall Street should have surprised no one.

In response to the growing protests about “obscene” compensation, Meyer tried to reason with the Harvard community. If Harvard were to outsource its portfolio to various hedge funds, instead of managing its money in-house, he argued, the fees would amount to at least twice what he paid his traders. The end justified the means: consider the billions of dollars that his team was earning for the university!

Meyer’s pragmatic line of reasoning was ignored. Meanwhile, more of his best people left in disgust. “You get to the point where you just don’t want the ugly calls or the press coverage,” I was told by one of Meyer’s former portfolio managers. “I just said enough’s enough.”

There were other pressures on Meyer. Ever since Larry Summers, a renowned economist who’d served as secretary of the Treasury under Bill Clinton, had become president of Harvard, in 2001, he’d been questioning Meyer’s investment strategies. Meyer, who was used to running things his own way, was insulted. Something else: Summers implied that Meyer was encouraging his top money managers to strike out on their own. By investing Harvard’s money in their new hedge funds, and allowing them to keep their deferred compensation, Meyer was making it far too easy for his best traders to quit. “I think Larry is largely responsible for blowing up the place,” one Meyer loyalist told me, still bitter at the memory of Summers’s meddling. “Harvard Management Company worked perfectly when the board left them alone!”

Another critic should be cited: Robert Rubin, Summers’s mentor and his predecessor as secretary of the Treasury under Bill Clinton. Rubin—a powerful member of the Harvard Corporation (the university’s executive governing body), a former director of Harvard Management Company, and a graduate of Harvard College, class of 1960—was contemptuous of Meyer’s daring investment strategies. As one person put it to me, Rubin was on the “warpath.” To anyone who would listen—Harvard’s board, Wall Street, Larry Summers—Rubin kept chipping away at Meyer’s credibility.

By 2005, Jack Meyer had had enough. After 15 years at Harvard Management Company, frustrated by the circular fights about compensation, and sick of justifying himself to Summers and Rubin, he walked out and started his own giant hedge fund. Shamelessly, he took many of Harvard Management Company’s best people with him, about 30 portfolio managers and traders, along with the chief risk officer, chief operating officer, and chief technology officer. Harvard’s trading floor was decimated. It was “like a Ferrari without the engine,” I was told by a portfolio manager who arrived after Meyer left. Rubin, for one, was furious, according to someone who knows him well: “In Rubin’s opinion, Meyer crippled the institution.”

It took almost a year for Harvard Management Company to find someone to replace Meyer; few qualified people wanted the job. Meanwhile, under an interim manager, Harvard invested more and more of its money passively, in pools of stocks, bonds, and commodities intended to mirror the performance of the markets as a whole. It was safer that way; as long as Harvard’s portfolio managers didn’t underperform the broader stock market, no one could blame them for making bad calls.

But the bigger issue for Harvard was timing: Meyer’s departure coincided with the peak of hedge-fund mania. With a reduced staff, and no particular investment strategy, Harvard foolishly sank huge sums of money into the latest, most glamorous hedge funds: notably, $500 million went to Old Lane Partners, a “multi-strategy” fund co-founded by Vikram Pandit in early 2006.

Some of these investments were a disaster—Old Lane folded last year after posting giant losses. Moreover, like other investors late to the game, Harvard was paying its outside managers preposterously high fees: typically an annual management fee of 2 percent of assets under management, plus a performance fee equal to 20 percent of that year’s return. Harvard Management Company agreed to other conditions—conditions that contributed to Harvard’s frantic scramble for cash late last year: long “lockup periods,” whereby investors can’t take back their money for five years, more or less, and “gate provisions,” which limit how much money investors can withdraw at the end of the lockup period.

Finally, in February 2006, Meyer was replaced by Mohamed El-Erian, an economist with a Ph.D. from Oxford, whose most recent job had been overseeing $28 billion in emerging-market debt at pimco, the big money-management firm. Hoping to improve relations with his bosses across the Charles River, El-Erian lectured at Harvard Business School; he also spoke regularly with the editors ofHarvard Magazine, and he created a Web site devoted to news and information about Harvard Management Company.

In terms of his investment strategy, El-Erian largely followed Meyer’s aggressive approach to Harvard’s portfolio. In fact, in some respects, El-Erian turned up the dial on risk: moving heavily into emerging markets, for example, he invested in a fund with EFG-Hermes, an investment bank based in Cairo that specializes in the Middle East and North Africa. At the same time, guarding against a possible downturn, he put in place more and more “tail-risk hedging,” insurance against risk. In El-Erian’s book When Markets Collide, written during his time at Harvard, he describes his hedging strategy as “Armageddon protection.”

El-Erian stayed at Harvard for less than two years. In September 2007, having barely settled in, he announced that he was returning to his former employer, pimco, as co–chief executive officer. According to a friend, El-Erian felt suffocated at Harvard and couldn’t wait to get out.

Under El-Erian, Harvard’s endowment climbed 23 percent in fiscal 2007, comfortably above that year’s 20 percent increase in the Dow Jones Industrial Average. Despite that success, El-Erian, an outsider, quickly became the subject of unsubstantiated attacks, many of them based on rumor and malice. Harvard tends to be like that. He was “a complete fraud,” a former Harvard Management Company employee assured me. He “wrecked the place.” “He’s not an investor,” opined someone else. He didn’t belong.

On July 1, 2008, after a drawn-out search for yet another leader, Jane Mendillo took charge of Harvard Management Company. Having spent 15 years there, from 1987 to 2002, working for Walter Cabot and then Jack Meyer, Mendillo was a safe choice, a well-connected insider. That said, her only experience running an endowment was at Wellesley College, where for six years she capably oversaw the school’s relatively modest endowment, helping it grow from $1 billion to $1.6 billion.

Congeniality and competence may or may not be assets in the money-management business. If they are, no one I’ve spoken to has a bad word to say about Mendillo. “She’s a very pleasant and analytic person,” attested Scott Sperling, co-president of Thomas H. Lee Partners, who worked with Mendillo at Harvard Management Company in the 1980s and 1990s. Said someone else who used to work with Mendillo, “You know, she was someone that always was there early, always there late. I think she was very dedicated.” A third source: “She’s very orderly. She’s organized.”

Is Jane Mendillo the right person to lead Harvard Management Company? It’s too early to tell. During the crisis of the past year, she’s performed as inadequately as everyone else, nor has she given her nervous public much in the way of reassurance. We do know that she’s laid off about a quarter of her staff and that she’s cautiously moved more of Harvard’s portfolio into cash, even as the market climbs. Otherwise, there has been no news, good or bad, from Harvard Management Company since late 2008.

On May 2, at the annual gathering of Harvard’s Committee on University Resources—a privileged group of donors who have each given $1 million or more to the university—Mendillo was the luncheon speaker. According to one discouraged alumnus who was present, Mendillo used nothing but empty rhetoric and dodged all the tough questions. A “pep talk” is the way her speech was described to me.

Any week now, Harvard will be releasing its final year-end results. One of my sources on the board of Harvard Management Company reports the endowment is down less than predicted and in line with losses at other universities: in the range of 23 to 25 percent. Give or take a few percentage points, however, what really matters is that Harvard’s endowment is way down, and, more, thanks to (1) the unhappy arithmetic of investing and (2) the need to withdraw money from the endowment to fund the university’s operations, it will probably take more than a decade for the value of the endowment to return to where it was in the heady days of 2008.

Let’s back up for a moment and return to more prosperous times. It’s 2001 and Larry Summers has just been named president of Harvard University. Unapologetically combative, Summers is determined to lead (or force) the university into a glorious renaissance. Gazing into the future, Summers envisions smaller class sizes, a more diverse student body, a younger and more energetic faculty, a revitalized core curriculum, cooperation among Harvard’s Balkanized divisions, and a greatly expanded campus. Above all, at a university best known for its focus on the humanities, business, and law, Summers hopes to make science a priority. Belatedly, Harvard will match and even surpass the lavish investments that Princeton and Stanford have plowed into the sciences.

As Summers recently remarked to one of his colleagues, “I held out the hope that Boston would be to this century what Florence was to the 15th century.”

Harvard’s soaring endowment was the key to Summers’s blueprint for the future. Instead of promoting fiscal restraint, he argued, Harvard should loosen its purse strings. The endowment should be used for “priorities of transcendent importance,” he proclaimed to The New York Times in 2008, after resigning as Harvard’s 27th president. “There is a temptation to go for what is comfortable,” he added, “but this would be a mistake. The universities have matchless resources that demand that they seize the moment.”

Caught up in the exuberance of the new millennium, and guided by Summers’s transcendent vision for the university, Harvard embarked on a plan of action. In September 2003, Summers cut a crimson ribbon marking the opening of the $260 million New Research Building, at Harvard Medical School: at 525,000 square feet, it was the largest building in Harvard’s history. The previous year, construction had started on the 249,000-square-foot Center for Government and International Studies (cgis). Designed by Henry N. Cobb, architect of Boston’s John Hancock Tower, cgis, with its two identical buildings covered in fragile terra-cotta panels, ended up costing a reported $140 million, more than four times what the planners had first anticipated.

The New College Theatre came next—a beautiful 272-seat space, built on the site of the Hasty Pudding Theatre of 1888 and retaining, at great expense, the Hasty Pudding’s historic façade. A few months later, in November 2007, Harvard’s Laboratory for Integrated Science and Engineering was completed. Its vital stats: 137,000 square feet, an internationally esteemed architect (1996 Pritzker winner Rafael Moneo), and a $155 million price tag, funded almost entirely with debt.

To be fair, when the Laboratory for Integrated Science and Engineering was still in the planning stage, Harvard intended to defray the cost of the building by selling naming rights. Nevertheless, for some now hazy reason, construction was well under way before a willing donor had been secured, and by then it was too late to seize the moment. “It is a lot harder to raise money for a building that has already been built” is how a former dean of Harvard College explained the situation at the time.

Where in the world were the voices urging restraint? “Some people really wondered at the expanse of the new buildings and the pace at which it was happening,” I was informed by Everett Mendelsohn, a professor emeritus in the Department of the History of Science, who’s been at Harvard since 1960. “Periodically, discussions would take place at the Faculty Council, and one of the deans or the presidents would come, and there would be questions asked. But there wasn’t a regular give-and-take... I’d say there was a sense that the critics were not being heard.”

Even today construction is going on at Harvard. The polished 520,000-square-foot Northwest Science Building, designed by Skidmore, Owings & Merrill, has just opened. Over at Harvard Law School, a $250 million project, designed by the firm of Robert A. M. Stern, is a work in progress: a giant limestone building with a 700-car underground garage.

On the subject of Harvard’s billion-dollar construction pit in Allston: over the years, quietly, the university had been assembling and buying hundreds of acres in the Allston-Brighton area, more land than it owns in Cambridge. Once home to slaughterhouses and stockyards and stench, Allston seemed the most likely place for Harvard to expand. In a 2006 interview with Harvard Magazine, Summers described Allston as “the launching pad for something new that reflects the dreams of the most creative young scientists in the world.”

The university’s master plan called for a “seminal” transformation of 220 acres in Allston over the next 50 years: in place of broken pavement and abandoned warehouses, Harvard would build new walkways and bicycle lanes. A paved piazza would be surrounded by theaters and museums. A new pedestrian bridge would span the Charles River. Here and there, landscapers would plant abundant, well-tended gardens. Small, charming shops would be adjacent to outdoor cafés. All that and more was the Utopian plan.

After decades of planning, construction began in Allston in 2007. Part one was to be the $1.2 billion Allston Science Complex. At 589,000 square feet it would include four buildings designed to house the Harvard Stem Cell Institute, the Harvard Medical School’s Department of Systems Biology, the Department of Stem Cell and Regenerative Biology, and the new Wyss Institute for Biologically Inspired Engineering.

Earlier this year, however, when it became clear to everyone at Harvard that the effects of the global recession would be profound, construction at Allston was abruptly stopped. Not, mind you, that the verb “to stop” is part of Harvard’s current vocabulary—the project is being “re-assessed” and “recalibrated.” Once its mammoth foundation has been poured (for otherwise the unstable mud walls could cave in), the Allston Science Complex will be on hold.

Meanwhile, as Harvard pauses to recalibrate, five huge and silent cranes, like prehistoric relics, like monoliths, dominate the local skyline—or at least they did when I was there in May. Residents of Allston are furious; they think they’ve been double-crossed. you dirty rats, screamed a cover of the Boston Herald,referring to Allston’s growing rodent problem and, subversively, to “rats” at Harvard jumping ship.

In theory, Larry Summers, who now heads the National Economic Council under Barack Obama, may have been the right person to lead Harvard into a glorious renaissance. In reality, however, when Summers was president of Harvard, he alienated just about every faculty member who crossed his path. Instead of being admired as a visionary, he was said to be arrogant. Instead of being recognized as a bold and fearless leader, he was perceived as a cerebral bully. That Summers suggested women lacked a natural ability for sciences did not help matters one bit. Nor did his very public feud with the professor of African-American studies Cornel West, who decamped for Princeton. In early 2006, anticipating a vote of no confidence by the Faculty of Arts and Sciences, Summers resigned. 

“The fact that they fired him is a symptom of everything that’s wrong with Harvard,” one of Harvard’s big donors told me. “He’s not politically correct or diplomatic—he’s incredibly provocative. What he really got fired for was attacking waste and abuse in the Faculty of Arts and Sciences.”

Above all, what Harvard needs right now is stability. “Harvard, institutionally, never had change when I first came here,” the law professor Alan Dershowitz told me. “It was like the old baseball teams; you were born here and you died here.... But the turnover now has become like corporate turnover—and that always takes a toll.”

The need to restore calm may explain why the unprovocative Drew Gilpin Faust, a well-respected academic and the founding dean of Harvard’s Radcliffe Institute for Advanced Study, was installed as president in 2007 (following a year in which Derek Bok, a former Harvard president, temporarily led the university).

Faust is not known as a visionary. In fact, outside of academia, no one I’ve spoken to has any idea who Drew Faust is or why she got the job in the first place. One undergraduate I spoke to described Faust as “expressionless.” An alumnus, having recently attended a dinner where Faust was the guest speaker, told me she was exceedingly dull—so dull he was reminded of those animated Peanuts cartoons from the 1970s, the ones where adults appear offscreen as so many disembodied, insubstantial “voices” that say nothing but “wa-wa-wa.”

To leave her imprint on Harvard, and possibly to distance herself from Summers with his tight focus on the sciences, Faust has dedicated herself to elevating the arts. Last December, outlining her vision of the future, Faust released a written statement: “In times of uncertainty, the arts remind us of our humanity and provide the reassuring proof that we, along with the Grecian urn, have endured and will continue to do so.”
Of course Harvard will endure—but in contrast to Keats’s Grecian urn, which is poetically frozen in time, Harvard must change. Aside from making speeches and releasing inspirational statements about the permanence of art, what is Drew Faust doing to change things in Cambridge? What is her vision? According to Dershowitz, “Her vision at this point is preserving the university. She’s in a defensive posture.”

As you may have guessed by now, Harvard refused to cooperate when I was reporting this story. At first, the university’s public-relations apparatus ignored me. Week after week, e-mail after e-mail, I’d be assured that someone or someone else was unavailable—in meetings, or on vacation, or away from his desk, or out of the office, ill. When I did manage to track someone down, I was thrown a sop of evasive prose. (“I don’t feel we’ve made a decision about how to best engage for your piece,” the vice president for public affairs told me in an e-mail.) A formally scheduled interview with the dean of the business school was canceled at the very last minute. (“Glitch” was the subject heading of an e-mail informing me that the meeting was off.) Even requests for basic, public financial information were bungled. When I asked him a simple question about Harvard’s debt, one of the university’s many communications directors stonewalled: “I’m not a numbers person at all,” he said, wide-eyed.

One day, desperate for someone in authority to talk on the record, I caught up with Michael Smith, dean of the Faculty of Arts and Sciences, as he was leaving the town-hall meeting of undergraduates at Boylston Hall. Unaware that I waspersona non grata on the Harvard campus, he talked openly to me.

I walked with him from the meeting to his car. How did the university get into this mess? I asked as we cut across Harvard Yard. Smith stopped. “First of all,” he remarked, reinforcing what I already knew, “the endowment growth did not keep up with the expenses. We hired faculty faster than we really should have We put up buildings based on debt financings—not fund-raising. And we decided the right thing to do was this financial-aid package, even though, again, we didn’t have new finances behind it to actually do it.”

A popular professor with an undergraduate degree from Princeton and a Ph.D. from Stanford, an expert in computer architecture, and co-founder of a data-security company called Liquid Machines, Smith, 47, is a driven and dedicated man. Yet even he conceded that his current job has been taxing. He’s held the position for less than two years; still, as he remarked to me, it “seems like forever.”

We were in the parking lot, Michael Smith and I. The sun had set. Smith looked tired. It can’t be easy to be charged with cost-cutting at a university that refuses to use the term “cost-cutting” and instead goes on about “alignments” and “resizements.” He added: “The hope was that the endowment would continue to increase, and we could get some support from our alumni base to help pay for those changes in the program.”

He paused. “And then, of course, the bottom fell out of the market.”