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Beyond the hallowed halls of Harvard University’s Cambridge, Massachusetts, campus, across the Charles River in Allston and just behind Harvard Business School, lies a largely abandoned 8.5-acre construction site. What was once to be a $1.2 billion, 537,000-square-foot science complex — the first step in a grandiose 50-year plan to expand the famed university’s already sizable footprint — is now an eyesore, a gaping hole that residents claim has sent rats scurrying into their neighborhood. That’s because, after years of double-digit investment returns, Harvard lost a stunning $10 billion during the 12 months ended June 30, 2009, from its once–$36 billion endowment fund.

Harvard is far from alone. In the past year, amid the worst economic downturn in decades, the ten largest U.S. endowment funds lost a combined $36 billion. Yale University’s $16.3 billion endowment, second in size only to Harvard’s, lost $5.6 billion on its investments. The endowments of Stanford and Princeton universities, which now each have about $12 billion in assets, saw their holdings drop in value by $3.5 billion and $3.7 billion, respectively.

Although virtually every college and university suffered during the devastating bear market — with an average loss of 19 percent in the fiscal year ended June 30, according to the Wilshire Trust Universe Comparison Service — the biggest were generally hit the hardest, thanks in large part to their unmitigated devotion to alternative investments, especially private equity and hedge funds. To make matters worse, many schools had grown dependent on using earnings from their endowments to cover as much as half of their operating budgets, as well as to help fund building projects like Harvard’s science complex. So as markets tanked in 2008, schools had to resort to dumping public equities at fire-sale prices or shopping their private equity holdings for pennies on the dollar. Many had little fixed income and cash to fall back on, even as hedge funds erected gates to prevent redemptions, further squeezing their liquidity. 

“You might say that certain schools fell too much in love with alternatives,” says Thruston Morton III, a former CEO of Duke Management Co., which manages the endowment of $4.6 billion Duke University, and now head of Global Endowment Management, a Charlotte, North Carolina, investment advisory firm.

The fallout has been fast and furious. Hundreds of universities across the U.S. have put building projects on hold, closed classes, fired staff, frozen salaries and scaled back benefits. Harvard, for example, eliminated 275 jobs this year in addition to halting construction in Allston. Yale reduced staff salaries and other nonpersonnel costs by 12.5 percent and froze several hundred job vacancies. Princeton, which chose to skip a transfer of funds from its endowment to its operating budget last spring, convinced 145 staff members to take early retirement as part of a two-year, $170 million (13 percent) budget cut and is now facing further staff reductions. Stanford has laid off 412 staff members, and 60 more people will lose their jobs by the end of the year.

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