By Richard Vedder
One fallout of the current turmoil in financial markets that I did not fully anticipate was revealed in the Wall Street Journal today, namely that hundreds of colleges have literally billions of dollars of assets tied up in a frozen Wachovia account. Wachovia administered the monies for the Commonfund, which the Ford Foundation helped create nearly 40 years ago to help colleges get higher returns on endowments by engaging in more aggressive (i.e., riskier) investment strategies. The Short Term Fund portion of the Commonfund had nearly one-quarter of the Commonfund's total assets.
Colleges now cannot withdraw their funds from the Commonfund. Some of the assets were invested in mortgage backed securities, which are trading at a meaningful discount from par value, so the assets of the fund do not fully cover the stated values of deposits (the fund "broke the buck.") Small schools naively thought they could earn a bit more interest putting their money in this fund instead of treasury bills or keeping funds in cash. Some schools used these funds to meet immediate (e.g., payroll) needs, and are now scrambling to deal with the problem.
I have been worried for some time about the rise of highly risky investment strategies by greedy endowment managers, and the Wachovia/Commonfund problem shows my worries are justified.
Is the bailout bill passed by the Senate something that must pass? I very, very reluctantly had concluded that the risks of a true economic melt-down from a loss of confidence was small, but sufficiently large that an insurance policy with a hefty premium was needed --something like the bailout package that failed to pass the House. People lose money all the time on homeowners insurance, since their house typically does not burn down or suffer big damages. But that does not mean you should not have homeowners insurance. The revisions in the rescue package bill made to win House votes, are mostly bad, in my judgment. I know a little bit about deposit insurance (I wrote my doctoral dissertation on the FDIC), and I consider a 2.5 fold increase in coverage done hastily to be a questionable thing, and one that would likely only have modest positive effects in any case. I think requiring health insurance policies to mandate mental health coverage is bad, bad, bad, and certainly not germane to the bill. As usual, Congress is taking a simple proposal --the original bill was only 3 pages long --and making it complex and less useful to the matter at hand. I am close to indifferent on the bill as it currently stands, and I believe that there is a very high probability that private market-based solutions would work better, for example, strong institutions and private investors buying shares in weaker institutions, infusing them with capital (that is already happening to some degree).
George Soros, a refugee from Communist Hungary, wants a return to the good old days of government ownership of the means of production, it seems, as he favors the government taking significant financial interests in financial institutions. Fortunately, that idea is a non-starter in Congress (I think). At the same time, however, there are ways that the taxpayer can be protected, and even benefit, from a bailout package, but as the bill gets longer and more complex, the important issues --restoring stability to the financial system --get subordinated to the whims of the special interests.