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Saving and Borrowing

December 12th, 2009
money  [html]

I've been reading about the financial problems at harvard university. Harvard started building a huge expansion in 2001. With the financial crisis,
All that growth has now come to a crashing halt. The half-finished science lab in Allston has been mothballed; the faculty, only recently expanded, will now have to shrink. ... The biggest item was interest payments - the buildings were mostly debt-financed, in a sharp departure from Harvard's past practice of raising the money first. ... Was it wise to borrow so much? The Arts and Sciences dean explained that it was like a homeowner assuming a mortgage. Going into debt was OK, because incomes rise. And President Summers termed the whole borrowing-to-build plan "an extraordinary investment".
What harvard did was foolish in that it didn't turn out well and they should have realized it wouldn't. But the idea of both borrowing and saving at the same time is something I hear of many organizations and people doing, and I don't understand why. If you have an endownment that's invested and earning interest, why would you borrow money to finance an expansion? Instead, why not pay for it out of the endowment? You could even set things up internally so the facilities budget pays the endowment budget back with interest. This way all the interest is staying within the organization instead of leaving. The only reason I can think of to borrow money instead of using endowment money is if the endowment is expected to increase at a higher rate then the interest on the loan. If that's true, however, harvard should have been borrowing more money and investing that money too. No one thinks that makes sense, right?

Individuals do this too. They save money in mutual funds while at the same time paying off a mortgage on a house and car. How does that make sense? I understand keeping some money liquid to deal with emergencies, right. Keeping some money earning %X interest while having other money borrowed at %X+N interest just doesn't make sense to me. I know mortgage income is tax deductible, which confuses things somewhat. Is that enough to explain how this makes financial sense for people? Very confused.

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