Beyond the Payout Debate: a New Use for Endowments

Judging from the heated debate and the flood of new reports on the topic, the current “hot-button issue” in philanthropy is the percentage of their assets that foundations are required to give to charities each year.

Some watchdog organizations are trying to pressure grant makers to increase their payout rate by a percentage point or two. Others call for Congressional intervention to eliminate rising administrative costs from the payout calculation. Foundations steadfastly answer that any increase in the current 5-per-cent minimum level will seriously threaten their ability to exist in perpetuity.

That the rhetoric and resistance surrounding the issue are so intense is surprising because, in the grander scheme of things, the stakes are so low. Rather than quibble over payout, the time has come for non-profit organizations and their Congressional allies to urge private foundations and the largest 5 per cent of non-profit organizations — which hold 89 per cent of the assets of the non-profit world and obtain 80 per cent of its revenue, respectively, according to statistics from the Internal Revenue Service — to use their endowed funds as a source of working capital for other non-profit institutions.

For years, we have been told that the investment of assets and the distribution of a portion of the interest earned is an efficient and effective means to deal with social and cultural concerns. But a 1998 I.R.S. study of income and asset allocation among non-profit groups reveals that this approach is not working.

According to the study, 93 per cent of the accumulated assets of foundations and 55 per cent of the assets of non-profit groups are in various forms of savings and investments. Relatively little of that capital is directed to accomplishing social purposes. Instead, a pattern of hoarding has developed. The result is that hunger and homelessness are permitted to stand side-by-side with unimaginable accumulations of wealth by large non-profit institutions. As endowments grow, tuitions continue to climb, the costs of health care rise, and the gap between the haves and the have-nots widens.

Clearly, a fundamental rethinking of how available capital can best be used to fulfill social goals is needed. And that may require a re-examination of American philanthropy’s underlying premises and practices.

One promising but underexplored alternative to the current investment-and-payout approach is for foundations and the larger non-profit institutions to use their huge reservoir of tax-exempt endowment funds as a source of working capital for the entire non-profit world. Under this approach, foundations and endowed charities would work with an independent entity to form an insurance pool to underwrite and guarantee the borrowing by non-profit organizations of tens of billions of dollars. Banks and credit unions would then “book” the loans to charities and the loans, in turn, would be packaged as securities and sold to investors.

Such an approach would involve foundations’ moving their investments away from the stock market and into the credit market — where they could earn a steady and predictable rate of return and, at the same time, provide working capital to American non-profit organizations so they could fulfill their social and cultural purposes.

That idea is not as far-fetched or fanciful as it might first appear. Just like the federal mortgage-insurance programs that have successfully made housing available to millions of Americans, insured or enhanced short-term and long-term credit issued directly or indirectly by foundations and large non-profit groups could provide the working capital that financially strapped charities need.

The case of the federal insurance program that made mortgages available to middle-class people, known as the Ginnie Mae Pool No. 1, is instructive. After issuing more than 380,000 mortgages over the past 30 years, the pool was closed recently, with only 10 mortgages in default. The notion that a guaranteed loan program could create the basis for a profound change in American home ownership — with bankers, investors, homeowners, and the government all winning — is a prime example of how credit-based strategies are well-suited to dealing with social concerns.

This new approach, of course, would require more American non-profit groups to learn how to gain access to credit. Organizations would substitute borrowing and the use of credit for endowments, cash reserves, building and equipment ownership, and the attendant costly capital campaigns that each require. Fund raising would still continue, although without emphasis on endowments, cash reserves, or buildings.

Under this new approach, businesses and entrepreneurs would be encouraged to invest in buildings and equipment that would be leased to non-profit organizations. Given access to working capital, those non-profit organizations would be much more attractive as tenants. Indeed, a new class of social entrepreneurs would arise to become the owners of buildings and equipment used by non-profit organizations.

Such an arrangement would free non-profit groups from the liability of ownership while they would enjoy the benefits of controlling their space. What’s more, it would provide a suitable and appropriate focus for community-minded venture-capital entrepreneurs.

Access to working capital is a perennial problem for charities. The cost and time associated with raising operating support is formidable, donor resistance to providing working capital is problematic, and increased competition for funds is driving up the cost of raising them. Over the past 20 years, available funds from all gifts and grants have just kept pace with inflation. For small and middle-sized charities, that has been especially burdensome. Being able to obtain working capital at their local bank will allow institutions to focus more directly on accomplishing their missions.

By using their assets both directly and indirectly to provide credit and working capital to smaller charities, foundations and large charities would be fulfilling their social purpose. They also would be operating with far lower levels of risk, since investing in securities may prove to be safer than playing around in the stock market.

And, in many cases, the investors in the loans could be the foundations and large non-profit groups themselves. From their earnings on their credit-market investments, foundations would continue to make grants to worthy charities.

In short, a break from the old system of investment and payout could insure a much brighter future. With the use of credit and prudent borrowing by non-profit organizations, more people could be served, and worthwhile goals that might have been thwarted by the lack of funds would have a better chance of being achieved.

Richard Linzer is a consultant to non-profit organizations, businesses, and government agencies and the author, with Anna Linzer, of It’s Simple: Money Matters for the Nonprofit Board Member. He lives in Indianola, Wash.