Foundations and the 'New Normal': A Q&A With Bradford K. Smith, President, Foundation Center

(The following Q&A with Foundation Center president Bradford Smith appears as part of a special feature on "Philanthropy in a changing world economy" in the June 2013 issue of Alliance magazine. It is reprinted here, with minor revisions, courtesy of Caroline and her team.)

Caroline Hartnell: To what extent are U.S. foundations changing in response to austerity?

Bradford K. Smith: I started this job two weeks after Lehman collapsed. On my first day in the office, we had a press call about what foundations were doing about the economic crisis. I put down the phone and walked down the hall to our research department and said, "Quick, I need a statistic," and they came up with a really good one. Foundation giving for the previous year, 2007, was around $45 billion -- about 6 per cent of the first stimulus package announced by the federal government. So one thing the crisis really showed up was the scale of foundation resources. When the economy gets into serious trouble, it takes government to try to keep it from collapsing. Foundation dollars alone aren't enough to solve problems. That made foundations think more about how they can leverage money from each other, how they can collaborate with other sectors rather than trying to do it themselves.

A second interesting thing is that foundation giving held up quite well during the recession. One reason is that U.S. foundations calculate their mandatory payout on a rolling three-year average of the value of their assets, which cushions them from big market swings. It also held up well because foundations actually went beyond the federally mandated payout rate of 5 percent.

CH: The recession has changed things for the foreseeable future. Do you think U.S. foundations see this as a "new normal" and are rethinking their role?

BKS: I think most of them are adjusting to the idea that long-term expectations for returns on investment need to be reduced. 2012 was a good year in the financial markets, but nobody really expects that it will go back to the boom years when, as one foundation investment manager put it, for a number of years "all we had to do was get out of bed in the morning and we could make a 20 percent return on our endowment."

CH: What will that mean for foundations? Spending down part of their assets? Trying to get the mandatory 5 per cent figure changed?

BKS: I don’t think foundations will try to get that changed. They've fought hard, during strong years in the stock market, to maintain the 5 percent level.

But with declining assets, going above 5 percent in the years following the crisis means that they've been spending their assets. In order to maintain the value of those assets, they'll have to give less or do better on their investments in the future. We did some research on whether or not more foundations have made the decision to spend down, and the answer is not really.

The decision to spend down or exist in perpetuity is less a strategic one than a question of donor attitude. Sixty percent of U.S. foundations are family foundations, so many decisions are about expectations of family involvement in the future. We found that the largest group was those who have left it open for future generations to make that decision. Does this mean that families in the "open" group are also open to the possibility that they might not exist forever? At the very darkest point of the recession, there was some soul searching among foundations about the fact that if their assets declined enough and they maintained their grantmaking at the same level, the result would be either to spend themselves out of existence or to resign themselves to being smaller foundations. But we haven't seen evidence of a conscious decision to adopt a spend-down approach because of the recession.

Some of these foundations have been around a long time: Rockefeller and Carnegie are celebrating a hundred years, Ford is celebrating seventy-five years, and they've seen a lot of bad markets. The Ford Foundation suffered such a decline in the value of its assets in the 1970s that it took until the mid-1990s to recover. But that didn’t change Ford's view of perpetuity. What it changed was the amount of resources it had available to achieve its mission.

CH: You mentioned that foundations have adjusted the way they work. Can you give an example?

BKS: Approaches to grantmaking have changed. There is more interest in providing general operating support. The Weingart Foundation, for instance, a large foundation that funds primarily in Southern California, responded to the recession by adopting the provision of general operating support as a strategy. When the crisis was at its worst, the best thing it could do to help nonprofits was to make sure they could pay the bills, pay their staff, and do the work they're supposed to do.

The other thing we saw was greater willingness by foundations to make program-related investments -- PRIs -- where they make subsidized loans to nonprofits for activities that produce income, which might in turn provide a monetary return for the foundation. During the recession, a number of foundations joked that their best returning assets were those PRIs. There was something like a 2 percent interest rate on some of those loans and the nonprofits were paying that back, whereas foundations were losing 17, 25, sometimes 30 percent on their stock market investments.

That was one reason why interest in PRIs increased. The other was that, in a situation where endowments were declining, it was a way to extend the use of foundation resources beyond their grantmaking, because PRIs come out of foundations' equity.

Related to that, the recession gave a push to mission-related investing, which some people call impact investing, which also uses the equity part of a foundation portfolio. This is different from socially conscious investing, which is basically trying to make sure there is nothing toxic in your portfolio. Omidyar Network provides a good example of this. As part of their work on mobile technology, they made an equity investment in a Mexican telecommunications services provider, Micel (formerly Finestrella), to enable access to smartphones and affordable mobile Internet for those without bank accounts or credit cards.  Mobile phones are increasingly seen as a means to deliver essential services and empower low-income consumers to make informed decisions. But if you don’t have mobile access, you can't have mobile delivery of anything, and you probably wouldn't fund a nonprofit to expand cellphone access. So, although it's still a minority, I think more foundations are looking seriously at how they can use their endowment to do this kind of thing.

CH: What about renegotiation of relationships with different sectors, for example between foundations and the state.

BKS: There is a lot more interest in public-private partnership at all levels, though it is tempered a bit by foundations' wariness about being stuck with the bill. In the U.S. and Europe, there has been a tendency among governments, local and national, as their revenues have declined, to say, "We'll stop funding, for example, the arts and we'll get foundations to do it." There was even a case in California where foundations were written into a state budget. They were cutting back their spending, and they put a plug on the revenue side called "foundations."

Still, there is more interest in partnership. In cities like Detroit and parts of Ohio and Pennsylvania, the old Rust Belt region where steel and automotive manufacturing used to dominate, you see foundations stepping in and trying to work with government. Again there is a certain reluctance, because foundations don't feel they could ever be a substitute for a viable public education system, for example.

But some foundations have taken the lead on re-envisioning certain cities. Detroit, for example, is never going to be the city it was -- the epicenter of automobile manufacturing and the birthplace of organized labor -- so the Kresge Foundation, the Skillman Foundation, and others in the region have tried to re-envision it. I think it's a good use of foundation resources because they can work without electoral or market pressure. It also brings into play another strength of foundations, which is their ability to convene. In Detroit, there is now public-private collaboration called Detroit Future City involving corporations, community groups, state officials, and foundations.

CH: Are foundations also collaborating more with each other and with the corporate sector?

BKS: There has always been some collaboration with companies, particularly on economic development and job issues. But you're also seeing more collaboration around technological innovation, especially with companies like Google that see themselves in some way as contributors to the public good. There's more of an appetite for foundations to collaborate with each other. It's not an easy thing to do: the costs are high, partly because of the individual nature of foundations, which means that each has a unique information system. They might not even see the possibility of collaboration, because it's difficult for them to see that they’re working for the same thing.

CH: Do you think these changes are a stopgap until the crisis passes, or are they being consciously adopted as a long-term strategy?

BKS: I think they are likely to continue because the economic crisis altered the resource base available to the private sector, the public sector, and philanthropy. But there are other factors. Technology is making it much easier to get information and collaborate. Impact investing is taking off because there are more vehicles for foundations that want to do it. The typical argument against impact investing used to be that there weren't enough investments for foundations to put money into. Now there are special investment funds, a whole body of literature, groups working on this. I think it's fair to say that although the recession induced some rethinking of the philanthropy industry, these changes are not just a result of the bottom falling out of the economy.

CH: So you don't agree with some of our editorial board members who have said that foundations have put their heads in the sand rather than rethink their strategy?

BKS: Obviously, the foundation world is varied, with a small number of richly endowed foundations and a sea of very small ones. What's more, there's a sort of demographic replacement as some wind up and new ones are founded. So there are new ideas coming in all the time, and I believe there is more thinking going on in philanthropy than people give it credit for.

CH: Do you see the rethinking and changes that have come out of the recession as by and large positive?

BKS: I think so. You're not going to see a radical transformation of philanthropy -- it's not the kind of field that radically transforms itself -- but we are seeing change that's important. Growing inequality is a phenomenon in the U.S. as well as everywhere else.

CH: What are foundations doing about that?

BKS: From the end of 2008 to 2010 we were able to track about $550 million worth of grants made by U.S. foundations to address the recession. A lot of it was service provision for emergency situations, like people losing their homes. What we didn't see much is grantmaking focused on the nature of the financial and economic system itself, looking at why the crisis happened and what we can do to try to make sure it doesn't happen again -- though there are one or two exceptions. The Sloan Foundation in New York has done work in this area and is now supporting a project to create a unique identifying system for all parties to financial transactions. When Lehman Brothers collapsed and the regulators had to liquidate it, it turned out to be seven thousand different corporations, all over the world. So this would create a fast way to uniquely identify all parties to financial transactions and then link them back say to Lehman or Goldman Sachs. I think the MacArthur Foundation and the Hewlett Foundation are interested in working on the challenges posed to democracy by inequality, but it's a relatively small amount of work.

Philanthropy of the kind we're talking about -- and that Alliance tends to write about -- comes from big money, from accumulated wealth. At some point, the person or family or company that owns that wealth decides to put it toward public benefit. So it would be surprising if philanthropy came up with a new economic system all on its own.

What is interesting is the growing support for social entrepreneurship, which in some ways is a challenge to the structure of the economy. There are social problems that all these years of foundation funding and aid programs have not been able to solve, and maybe we can solve them through social entrepreneurship. A lot of it is technology-driven and there is a lot of energy and creativity in that space. For instance, there are interesting things happening around payment systems that allow people in remote parts of the world to work and get paid through their mobile devices, so people who were outside the economy can become part of it. Whether this will fundamentally address inequality is another matter, and no amount of innovation will allow us to duck the big question of what kind of world we want to create.

I was talking earlier to the president of a foundation that funds universities, and the whole notion of residential education is being challenged, first because it's expensive to house students on a campus, and second, because more and more people want to take classes online. A lot of what we assume about institutions is being reinvented. This is happening partly because of the economic crisis but also because of changes in information and technology.

-- Caroline Hartnell