Why then is there a concern regarding the financial situation at MIT? This article, invited by Professor Lawrence M. Lidsky, is intended to demystify the current situation and will be one of several broad communications regarding the financial situation at MIT. MIT finances are complicated. Patience will be required to understand the issues and the nature of the problems beyond the simple conclusion that we are spending more money than we receive. Teamwork and collegiality will be required to both understand and address these issues.

An important fact is that MIT's underlying financial health is good, but we do face some problems. Prudent stewardship of the resources of MIT suggests that some changes are needed, in order to ensure long term financial well-being for MIT. The time frame of such changes is three to five years, and during this time it is anticipated that we will need to reduce net expenses and/or enhance net revenue. As developed below, the magnitude of the problem we face is an operating gap of about $20 million in 1992 dollars. A second issue is that we must bring the rate of growth of expenses to the same value as the rate of growth in revenue, in order to avoid chronic budget deficits in the future. The notion that a one-time budget cut is not the solution to our problems is summarized by the sketch in Figure 1.

The support from the federal government for undergraduate financial aid has declined dramatically in the last decade, an amount by itself which is larger than the anticipated $8.5 million deficit in MIT's FY93 operating budget. Government support of the cost of education in connection with its NSF Predoctoral Fellowships has not kept pace with increases in costs in the university, resulting in more of the costs being born by the institution. More recently, the NIH traineeship programs have been adversely affected by new rules governing the fraction of tuition that can be supported by this mechanism. Changes in the indirect cost recovery rules in FY92 alone resulted in losses in revenue of more than $2 million. The lower recovery of indirect costs has the favorable effect of tempering the indirect cost rate, but now more of the legitimate, but indirect, costs of research must be supported by general funds. It now appears that after October 1, 1997 we will no longer be allowed to use the fringe benefit pool to support tuition for graduate research assistants and graduate teaching assistants. This is presently estimated to represent a loss of more than $10 million in annual revenue for support of graduate student tuition.

While the external forces are outside of our control, we must cope with them and address the attendant problems--- MIT is not alone in dealing with such issues, as many news accounts will attest. In 1990-1991, 45% of the nation's colleges and universities announced mid-year budget cuts to deal with their financial problems. In 1991-1992, 57% implemented mid-year cuts. Fortunately, the leadership and stewardship of President Paul Gray and Provosts Francis Low and John Deutch positioned us well, and we have been able to absorb a high degree of adversity. Now we must draw together as a community to first understand and then deal with these financial issues.

Revenues for MIT's activities come from tuition payments and other fees, research grants and contracts, gifts, and endowment income. Research grants and contracts, comprising a sponsored research volume of about $700 million, represent the largest revenue category. All other revenue is thus only about $400 million. Tuition payments were about $170 million, but this number is complicated by the fact that a large fraction of the graduate student tuition payments are from the fringe benefit pool funded both from research grants and contracts and general funds used to pay salaries. Endowment income for all purposes was about $100 million, and gift income for all purposes was about $100 million. These data are summarized in Figure 2.

MIT's operating budget is dominated by expenses attributable to sponsored research programs, largely supported by the grants and contracts. Indeed, when one removes the $700 million in sponsored research, the overall operating budget is reduced to about $400 million. Further, "Auxiliary Activities" which pay their own way such as the MIT Press ($16 million) and the Campus Dining and Housing Services ($18 million) further reduce the remaining operating budget. The point is that the FY92 budget deficit of $6.3 million is even more significant when viewed against this $370 million "core" operating budget directly controlled by the Institute. The $6.3 million deficit is just under 2% of this core operating budget.

1. Excellence in Science and Technology. President Vest and I are committed to working to enhance MIT's position as a leading research university focused on science and technology. The Institute is regarded as the leading institution of its kind in the world, and we aim, above all, to preserve and enhance its stature. We all recognize, however, that a focus on science and technology is expensive. We can be proud of what has been achieved with the resources available to us, but it is evident that there will be increasing "competitive" pressures that we will need to address, if we are to maintain our preeminence.

2. Affordable Tuition. An important objective in our financial planning must be to maintain MIT as a place that is accessible and attractive to students of diverse economic circumstances. Continued temperance in the rate of growth in tuition is viewed as critical, and yet this is the only income stream over which we have immediate and certain control. Last year's increase in tuition of just over 6% was the second lowest in two decades. MIT's self help level (academic year income from jobs, UROP, or loans) at $6,600 is also high in comparison to other institutions, and efforts must be expended to temper growth in this area as well.

3. Merit-Based, Need-Blind Admissions. A strong traditional practice and one which we have aggressively defended is the process of merit-based, need-blind admissions. The rewards of this policy are evident in the undergraduate student body, diverse in every dimension, and excellent by every quantitative measure. Our education and research programs are accessible to the best students wherever they may find themselves on the family income ladder. We have the objective of maintaining our highly successful admissions policy, despite its considerable cost. Table I shows that the amount of undergraduate scholarship aid beyond that from endowment income restricted for this purpose exceeds, by a factor of two, the FY92 budget deficit. The six-year trend in resources committed to undergraduate financial aid shows no abatement, and the growth in endowment income has been too low to cover the growth in need. Recent government legislation suggests that changes in the basis for establishing "need" will add to our undergraduate financial aid burden in coming years.

4. Competitive Salaries. Despite the weak economy, salaries for the "best" are being increased at rates beyond the consumer price index. MIT must continue its efforts to provide compensation packages which properly reflect the high quality of its personnel. Salary freezes or many years of low raises would compromise our overarching aim of attracting and retaining the most outstanding people to the Institute and must be avoided.

5. Faculty Development and New Programs. We must maintain the financial strength needed to attract and nurture the careers of the most outstanding faculty. In science and engineering, experimental facilities are especially expensive, but outstanding faculty in these areas are vital to preserving MIT as the leading institute of science and technology. Further, there will be no financial excuses for not attracting more women and members of underrepresented minority groups to the faculty. Additionally, from time to time, faculty need resources to initiate new programs. New resources have been wisely dedicated to initiatives like those associated with enhancing the Athena Computing Environment with new hardware, the Program in Environmental Engineering Education and Research, the Joint Program on the Science and Policy of Global Change, the introduction of the new biology requirement, and the institutionalization of the Leaders for Manufacturing Program. These initiatives required seed and/or continuing financial resources to become successful, and we must preserve our flexibility to undertake major experiments in education and in research.

Finally, regarding faculty development, I am pleased to report progress on an important objective, "hardening" of faculty salaries. The rationale for this objective is several-fold: (1) the commitment to faculty salaries improves the quality of life of faculty; (2) federal agencies, such as NSF, are increasingly reluctant to support academic year salaries, (3) academic year salaries budgeted in research proposals make our applications appear to be less competitive than those from many of our peer institutions which pay full academic year salaries; (4) when a proposal is funded there is often a "bottom line" support level such that full academic year salary support can be used to fund more students; (5) there is less pressure to undertake uninteresting research projects; and (6) full academic year salary support builds morale and Institute loyalty. All new faculty appointments now carry full academic year salary support, as do all new appointments to named professorships. As Table II shows, the fraction of all faculty academic year salaries charged to research grants and contracts has dropped significantly. There is still a great deal to do in the School of Engineering and in certain departments in the School of Science. The point to note is that steady progress has been made and one can see that significant resources have been expended for this purpose. The equivalent of about $100 million in endowment has been dedicated to hardening faculty salaries. Unlike the undergraduate financial aid problem, this one shows a favorable trend!

2. Recent History of Use of Reserves and Discretionary Funds. For the past several years, we have expended all current unrestricted gifts for the purpose of supporting the current operations of the Institute. The sum of unrestricted gifts for the past four years was in excess of $29 million, all applied to meet needs of the ongoing operations. This $29 million is in addition to the over $15 million of other discretionary funds and reserves spent to cover budget deficits at year-end for the past four years. Thus, nearly $50 million in discretionary resources have been expended to meet current needs during the past four years--- this is significantly more than the amount of new endowment added for undergraduate financial aid during the same time period. In better economic times, the financial situation has been such that a substantial fraction of the unrestricted gifts were put in unrestricted endowment, thereby making available an income stream which could be used to achieve our objectives of tempered growth in tuition, hardening of faculty salaries, or increasing salaries. The point now is that we are rapidly expending our financial flexibility, and this is occurring at such a brisk pace that we must now consider changes in what we do and how we do it. The ideal situation would be to close the operating gap in FY93 by $16 million.

A $10 million deficit is not a large fraction of the general budget, but in absolute terms this deficit is large. To give a sense of what a $10 million deficit represents, I will give a few examples to illustrate. $10 million is equivalent to the anticipated income from $200 million in unrestricted endowment. In the School of Engineering, $10 million is about the sum of the FY93 base general budgets of the Departments of Chemical Engineering and Civil and Environmental Engineering. In the School of Science, the base general budgets of Physics and Mathematics are each about $10 million. $10 million is about 1/2 the entire FY93 base general budget of the School of Humanities and Social Science.

To illustrate another dimension of complexity in the financial situation, consider the Libraries budget. $10 million is somewhat less than the total budget for the MIT Libraries. However, even if we were to cut the entire budget for the libraries, we would not have a net savings of even $10 million, because about 1/2 of the cost of the libraries is attributed to research and is a component of the indirect costs of research. (In a similar vein, cutting the entire Office of Sponsored Programs would apparently save nothing net, because most of the costs are covered as an indirect cost of research.) The point is that in suggesting some mechanism for "solving the problem" one has to be cognizant of gross versus net savings. It is estimated that a net savings of $10 million could be achieved by gross cuts of $15 million, depending, of course, on just what it is that is cut.

It should be emphasized that the foregoing specific examples are intended to illustrate what $10 million represents and some of the complexities underlying the support for even our core departments and services.

The magnitude of the problem in connection with the divergent slopes of expenses and revenue, Figure 1, is a small percentage, but a small percentage of $1.1 billion can be significant in absolute terms. Three contributors to the increase in expenses are increases in salaries, increases in academic program (recently $1.5 million per year), and increases in services and administrative functions (recently $0.7 million per year). Understanding other factors contributing to the divergent slopes requires more detailed study.

Decapitalizing the endowment, that is spending some or all of its principal, is the only other alternative and this has the unfavorable consequence of accelerating the problem, because funds that create income are depleted. Decapitalizing the endowment erodes confidence in MIT among future donors and threatens the high rating we currently enjoy in connection with bond offerings to fund capital projects such as the new biology building. Lower bond ratings would, of course, escalate financial problems as lower ratings mean higher interest payments. MIT's endowment is invested such that the buying power of the income remains constant or even increases slightly. For example, a donor of an endowed professorship expects that a professor will be supported, even though the individual will enjoy increases in salary while holding the professorship. Basically, our investment policy is one which reflects the wish of the contributors to provide lasting support to the Institute.

Consider now the two major reserves and their purposes. The purpose of the Investment Income Reserve is to make the "cash" payments on the Pool A shares of the endowment, in the event that the endowment income is inadequate to meet payout commitments. The point is that not all of our endowment is invested in assets that yield cash income, and in some years the cash generated may not be enough to meet the declared rate. This year, for example, each Pool A share yields $13.70. This "yield" is analogous to the income from a share of a mutual fund, and our management goal has been to maintain or slightly exceed buying power of the income year after year. In the last several years the Pool A share income has increased nearly 5% per year. The "market value" of each Pool A share is almost twenty times the income. Thus, the spendable income from endowment is a little less than 5% of its market value. At one point in recent history the Investment Income Reserve was about equal to the total payout from the endowment. Now, with a payout total of about $100 million, the Investment Income Reserve is only 2/3 of the total payout. Even so we are fortunate to have this "flywheel" in the system which provides a degree of certainty in spendable endowment income. It should be realized, too, that the Investment Income Reserve earns income. Importantly, the earnings from the Investment Income Reserve will be applied to support interest expenses from the borrowings needed to construct the biology building. Thus, spending the Investment Income Reserve itself, in order to cover the deficit, creates the problem of having to cover more of the biology building expenses with other general funds.

The Research Reserve was created, in part, to cover faculty salaries for a short period in the event of a catastrophic collapse in federal funding. Considering the uncertainties in federal support at present, it should be comforting to know that such a reserve exists. Having made progress in hardening of academic year salaries for faculty, one could argue that the magnitude of the Research Reserve can be smaller. However, there may be unanticipated needs to assist faculty and research staff in the event of interruptions or loss of research support. Further, earnings from the Research Reserve were critical to funding the deficit at the closing of FY92 and similar needs are expected at the end of FY93. Rapid depletion of the Research Reserve can be anticipated if the budget deficit goes unchecked.

MIT's reserves are simply too modest to be relied upon as the source of funding for a deficit of $10 million. The two major reserves that we have are prudently deployed and play a vital role in maintaining our strength and flexibility.

In the Summer of 1992, when the adverse financial factors affecting the FY92 budget became apparent, President Vest and I began to review the Five-Year Planning process which is done by all units on an annual basis. In view of the projected financial difficulties and after several discussions with Academic Council, I asked all individuals reporting directly to me to provide a scenario for coping with a 2% per year reduction in budget in each of the next three fiscal years. The Five-Year planning exercise is our usual process for establishing budget priorities, but it is true that this year I called for greater emphasis on how to cope with a more constrained financial era. The plans were to contain priorities and costs for ongoing programs and for proposed new programs. I have recently reviewed the Five-Year Plans, and there has been much creative thought given to ways of improving our educational and research programs. The department and section heads have worked very hard, and their efforts are evident. Some important decisions regarding both new and ongoing programs are to be made in the weeks ahead, and the Five-Year Plans advanced by the academic units have provided much of the input needed.

In parallel with the call for the Five-Year Plans an effort has been made to communicate the essence of this article to the leadership of the Institute. President Vest's annual report dealt with the costs of higher education, and has been disseminated broadly here and elsewhere. I briefed Academic Council on several occasions during the Fall of 1992; the Department Heads were briefed twice; Faculty Council was briefed with the same materials by President Vest; I have met with School Councils and individually with each person reporting directly to me; the Faculty Policy Committee was briefed; I met with the senior staff of the Dean for Undergraduate Education and Student Affairs; the senior staff of the Libraries was briefed. The MIT Corporation Executive Committee has been briefed on two occasions, and the entire MIT Corporation was briefed at its December, 1992 meeting. The Corporation Joint Advisory Committee and MIT Medical Management Board were briefed in early December, 1992. I remain receptive to more invitations to speak on the issues we face; each group has had valuable input, questions, and suggestions.

The Academic Council held a day-long retreat to discuss MIT finances on November 19, 1992. The group reviewed progress since President Vest's inauguration, and held an extensive "brainstorming" session on how to balance our objectives, aspirations, and goals with fiscal reality. In subsequent regular meetings of Academic Council, the 20 person group has agreed to undertake a review of cross-cutting issues. Four sub-groups have been formed and each will draw on members of the MIT community as it undertakes its task. One group, chaired by Vice President Glenn Strehle, is to examine opportunities for enhancing revenue; a second group, led by Associate Provost Sheila Widnall, will review academic areas; a third group, led by Vice President J. David Litster, will review support services; and a fourth group, led by Vice President James Culliton, will review administrative functions. These are cross-functional groups; each is served by at least one academic dean and a high level member of the administrative support staff. The objective is to provide guidance in closing a $20 million operating gap (including a $10 million budget deficit) over a three to five year period. In providing this guidance the review groups will focus on improvements and efficiency enhancement, as well as areas for possible reduction, reorganization, or elimination. A budget plan is to be submitted to the MIT Corporation Executive Committee in May of 1993.