In the late 1800s, colleges and universities started building large amounts of invested capital for the first time, as their leaders came to appreciate that endowment income is more reliable than tuition, grants, gifts, or government subsidies.
Some schools accumulated more capital than others, and higher education started to become stratified by wealth. Between 1870 and 1920, nine universities with the largest endowments — Chicago, Columbia, Cornell, Harvard, Johns Hopkins, M.I.T., Princeton, Stanford, and Yale — formed a top tier and competed to build the largest endowment. In 1920, Harvard first attained the lead in endowment size that it still holds today.
Below those nine, 30 more schools formed a second tier in the 1920s, including the public universities of California, Minnesota, Texas, and Virginia. Together, these two tiers comprised about 4% of the 965 nonprofit schools at the time. Nearly all remain in the top 4% of endowment size today.
The persistent lead of these richest schools was small at first, but the wealth gap grew dramatically after 1950 due to what we call the “wealth advantage” of the rich colleges and universities.
This advantage started with unequal fundraising, which became related to Americans’ wealth inequality. Wealthy schools have more rich alumni, who make large gifts and bequests. Today, each additional increment of $100 million of endowment is associated with an additional $2 million in annual donations. Compounding that factor, wealthy schools spend less per dollar raised than do less endowed schools.
Social critics and reformers in the past often denounced this fundraising advantage and complained that such benefactions were “tainted” by the exploitative business practices of wealthy donors. But colleges and universities generally believed that “the only trouble with tainted money is t’aint enough of it,” as the saying went.
This fundraising advantage was compounded by key factors of endowment investing, called “portfolio management” today.
During the 1920s, scholars observed that wealthy schools had greater access to financial expertise because their trustees had ties to the best portfolio managers. In addition, rich schools could afford to hire those managers, who achieve higher returns but also charge high commissions.
After World War II, these factors were compounded by a three-stage revolution in portfolio management. In the 1950s, wealthy schools initiated the now common 60/40 rule and began investing 60% of their endowment in the stock market and 40% in fixed-income securities. In the 1970s, these institutions started “total return” investing in riskier “growth” stocks, strongly encouraged by the Ford Foundation. In the 1990s, Yale University led the wealthiest schools to invest in even riskier “alternative assets,” including hedge funds, private equity, and natural resources.
Enormous returns from these three aggressive tactics vastly widened the wealth stratification because the great majority of colleges and universities, having little capital, could not afford to take such risks. They lagged behind each stage of the revolution, and many invested heavily in low-yielding, fixed-income securities.
Also, despite joining the revolution in portfolio management, the wealthiest schools followed conservative rules that limit the spending of their endowment income. They plowed the unspent income back into their invested capital, which grew more rapidly.
Finally, if the wealthiest schools stumbled, they could issue bonds to cover current obligations until their investments recovered, like the $2.5 billion in bonds that Harvard issued during the Great Recession. Less endowed schools, particularly historically Black colleges and universities, found it harder to issue such bonds and paid more in underwriting fees to do so.
All these factors constitute rich schools’ wealth advantage and parallel those benefiting wealthiest Americans, as shown by this remarkable fact: The richest 1% of nonprofit colleges and universities (which include Emory, Duke, and Vanderbilt) own 54% of endowment in higher education today, while the richest 1% of American households own 53% of households’ invested capital.
The parallel also helps to explain the rising debt of undergraduates.
Most undergraduates holding large debt come from working-class or middle-class households whose income comprises wages or salaries. Over the last four decades, this income has not grown as fast as either the cost of living or the return on invested capital, which is owned predominantly by the wealthiest Americans. The financial resources of these students therefore fall ever further behind.
These undergraduates generally attend less expensive or less endowed colleges and universities. These schools’ capacity to meet their students’ growing needs has diminished as their endowments (and government subsidies) have slipped further behind that of wealthy schools, which do provide aid to meet all their students’ financial need, as Princeton recently announced.
Consequently, undergraduates who depend on wages and salaries and do not attend the schools with large endowments have ever greater need for loans and fall into debt. Inevitably, the prospect of debt — now totaling about $1.7 trillion for all students — discourages those in the working class and middle class from attending college, and impairs the social mobility that higher education has historically contributed to democracy.