Risk management has been on my mind all week, irrespective of whether I wanted it to be! Apart from the drama with Greece and the larger questions being posed vis-a-vis the global financial system (the potential fallout from which we should be considering), the FInancial Times ran a fascinating story on Wednesday (June 13, 2012) regarding the recent disclosure by JPMorgan that it had a trading loss of some $2 billion in April.
The article would be useful reading for school leaders and trustees, in terms of seeing through the lens of risk management. I have heard the assertions that being "mission-focused" and "on message" all the time is the best form of risk management. Vital though those pieces are, external risk events--the ones that we simply cannot control through our mission-focused discourse--are things we need to consider, and this article provides us with a no-nonsense approach (financial modeling).
"In March, Gregory Baer, deputy general counsel, presented a plan to policy makers and bankers illustrating the results of a hypothetical $50bn loss. It showed the bank would fail, shareholders would be wiped out and Jamie Dimon, chief executive, would be fired" (16, emphasis mine).
Tom Braithwaite, the author of the article, goes on to say that "the presentation, given at a Harvard Law School event, is also an unusually frank acknowledgement that there are limits to the capital buffers of even healthy banks. In the doomsday scenario [...], a $50bn loss would trigger 'a run on the bank,' with $375bn of funding, including bank deposits draining away. The government would then step in and mark down the bank's assets, leading to an additional $150bn loss. Shareholders would be wiped out but senior creditors would be transferred to a new bridge company that allows 'critical activities to continue to operate smoothly.' Their debt would be restructured into equity."
Let's consider how such a scenario might look in terms relevant to independent schools:
- A significant event occurs, and a large percentage of parents immediately stop paying their tuition payments; what's more, pledge payments from major donors cease, and the remainder must be written off. The endowment corpus shrinks substantially, more than 25%, and perhaps as great as 50% to 75%.
- The school undertakes yeoman efforts to collect tuitions due, stating that the funds are needed to continue to operate the school through the remainder of the school year.
- Other parents panic, thinking that the school will be unable to keep its doors open, and they begin to contact other schools for immediate transfer; or, if they're generous, they look for admission elsewhere for the next fall. This is the equivalent of the 'run on the bank.'
- A strong percentage of parents accept offers of admission to other institutions, whether mid-year or for the following year, and the school can no longer count on those tuition dollars.
- The trustees step in, and, based on reduced enrollment projections, outline faculty and staff cuts. Unless the Head has been doing something egregious, it is unlikely that the board will fire the Head, as s/he will need to implement the massive reduction plan.
- Any debt that the school has been carrying will now be revisited by the lending authority. It is likely that this scenario is causing debt covenants to be breached, and the lending authority may alter its terms altogether, if the school is unable to meet debt service, up to and/or including seizing the school's facilities as collateral assets, to meet the debt.
- During all this turmoil, what happens to the school, as a corporation, let alone to all the students, families, faculty, and staff?
In the JPMorgan illustration, or as we saw during the 2008 crisis, the government stepped in and loaned money to recapitalize the banks, restore confidence, etc. However, in the case of independent schools, what happens? Do you have donors who would step in, capitalize the running of the school for the remainder of the year, pay off all debts, and fund a major marketing campaign for the next 2-3 years?
My point with this post is not to scare anyone; rather, it is meant to serve two larger purposes:
- to illustrate bluntly what is indeed possible, should a major risk event occur
- to suggest strongly that schools should be engaged in risk management--modeling for external risks in particular