The Problem of Non-Profits and Risk

For some time I have been worrited about non-profits. It goes like this.

A proper actor in the market economy is owned by someone. For a mom-and-pop business it is the owner/manager. For a corporation it is the stockholders. For the government it is the bondholders and the people.

But what about a non-profit? Answer: nobody. OK, there's a Director, or some such. But he is just the manager.

This is important because in all economic transactions someone has to pick up the risk of everything going wrong. Or, more prosaically, someone has to pick up the losses, if there are any.

But a non-profit doesn't have anyone that picks up the profits or the losses. Except the institution itself.

So, imagine a non-profit institution that goes broke, like a university once the current education bubble has popped. Who picks up the losses?

The answer is pretty simple: it is the holders of the debt.

But wait! Debt is supposed to be covered by collateral. That is how debt works: you pledge collateral to guarantee that the debt will be repaid. The problem in, e.g., a financial panic, is that it turns out that the collateralized debt isn't fully collateralized, and as a consequence all the financial actors "lose confidence" in certain distressed financial institutions, and if the "lender of last resort" doesn't step in the whole economy goes down the toilet.

But obviously, someone must be responsible for the losses at any institution, whether a profit-seeking corporation, a non-profit foundation, or a government. In the corporation the stockholders are responsible for losses; in government the taxpayers and bondholders and bank-balances of ordinary citizens are responsible. And that is to say nothing of the holders of hyper-inflated cash. But what about the non-profit? Nobody. Unless you count the banks that loaned it money. But remember, the loans are supposed to be collateralized.

The other day I found out how it works. Non-profits have endowments. If they have a surplus, it goes into the endowment. If they happen to own a building and sell it for a big profit, the profit goes into the endowment. And if the non-profit has losses, the losses come out of the endowment.

Do you see that this is a Very Bad Thing? In a profit-seeking capitalist corporation the capital is the value of the stock: the present value of all future revenue from the corporation, as currently valued by the players in the market. It is not a pile of cash, or bonds or stocks in some other enterprise. The "savings" of the corporation is the very value of the corporation to the rest of the world.

But a non-profit just has a pile of cash. How much?

As of fiscal year 2015, there was some $547 billion tied up in university endowments in the United States. Harvard, Yale, and Princeton alone accounted for $86 billion of that figure.

The universities of the United States have over half a trillion dollars in endowments. And is that endowment contributing to the university? Is is the very sinew of the university? No. It is just a pile of just-in-case cash: money in a mattress. And it is sterile capital.

If I had my druthers I would make all non-profit institutions illegal. I would say that all institutions must be owned by someone, or some group, and that someone and that group should fully understand that they have signed up for the risk proposition connected with the institution.

And I would certainly forbid governments to engage in business.

Here's an idea. We could pass a law to mandate that all college administrators and tenured professors should own the equity in the university they serve. That way they would not just be interested in getting their share of the loot, as at present, but in the long-term welfare of the university.

You would know what a good idea this was by the absolute outcry from all university professors and administrators if this idea were ever proposed in the halls of Congress.

But sooner or later we are going to have to confront this issue: that in any organization, someone has to own the losses.