The Future

TWO years ago, as the recession was just getting a foothold, Dr. Paul Light, the Paulette Goddard Professor of Public Service at New York University's Robert Wagner School of Public Service, and a nationally prominent commentator on the public sector, wrote an article entitled “Four Futures” in which he painted four possible scenarios on how the tolls of this recession would unfold for nonprofits. At the time, many thought he was overblowing the situation. We recently interviewed Light about his prognosis—to see which scenarios are playing out. What does he think now? Equally as important—what do you think?

Ruth McCambridge: Paul, you made some prognoses at the beginning of the recession about the future of the nonprofit sector. At least one of these was very controversial. I would like to revisit these with you now as we look towards the end of 2010 with no clear end to the down turn in sight at least as it may affect nonprofits. Your controversial prediction was that as many as 100,000 nonprofits might go out of business as a result of the recession. Where are you on this now?

Paul Light: When I first said this I was at a conference where people were talking about the recession and basically whistling past the graveyard. They were very hopeful that the recession would be over quickly. This was almost immediately after the Lehman collapse as I remember and I got increasingly frustrated about the hopeful tone in the room given my sense that this would be a long recession and that it would hit the nonprofit sector particularly hard. 

So, when it came time for me to speak, I said, “Look, this is a very, very serious situation that is going to last a long time.” At that point, another of the big investment houses had just been bought and then we had the AIG collapse and the subsequent bailout. So, I grabbed a figure from thin air based on what we had seen in the past in terms of the failure of small business during much milder recessions. Traditionally, even in short recessions, small businesses drop like flies and they are replaced to some degree or another by very small businesses created by unemployed workers. The dynamics are not identical but similar enough to make an educated guess and my current guess is that I may even have estimated on the low side, given that the IRS is in the process of decertifying a number of non-reporting nonprofits at the same time the effects of the recession are being felt.

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We really don’t know how many nonprofits have mothballed already as a result of the financial strain. Nonprofits are not required to announce their dissolution. Many of them who do suspend operations keep their certification letters in their back pocket hoping for a change; but, a very large percentage are on the edge. Surveys report that a number between 15 and 30 percent have exhausted their reserves and are in cash flow difficulty. A recent GuideStar survey found that 8 percent of respondents said that they were in imminent danger of closing—if you used this percentage as a guide—this alone would work out almost exactly to 100,000 [nonprofits] at imminent risk.

But, to be realistic, we don’t know how many of the nonprofits that have reported imminent risk are actually going to go under. But even recognizing that the plural of anecdote is not data, we’re seeing a ton of anecdotes out there [telling] of serious damage. Here in New York City, for example, we’re seeing the creation of what we might call service deserts where nonprofits are going under or sharply limiting their reach, their coverage, facing increased demand by imposing significant limits on what they can actually deliver.

That varies across the country and if we mapped it on Google Maps and used zip code indicators of where the nonprofits are, I think we’d find that here in New York City the deserts would be in places like the Bronx; and, you know, we’re going to see more and more of that as smaller grassroots community-linked nonprofits drop away or sharply limit services. I think the better measure right now would be the number of people served by the nonprofit sector and I guess that that’s down significantly but I couldn’t put a figure on it one way or the other.

There are three indicators that the nonprofit sector should be paying attention to—state budgets, housing prices, and joblessness—and none of these look good right now. 

I think that people are underestimating just how weak state and local governments are in terms of their budget flexibility. There is an awareness out there of the current budget situation in states and the fact that the federal government is not going to rescue the states. We could have the collapse of some states, although I think that’s unlikely; but, I think people are underestimating just how deep states are going to have to cut. 

We’re seeing that in California already. We see it in New York right now but I think the sector as a whole just doesn’t understand how depleted states are in terms of meeting their obligations on pensions and other entitlement programs. I think that we’re just underestimating how bad it is out there and I think that it’s the real problem that’s coming along for the nonprofit sector. The tax cuts at the federal level are, in all likelihood, going to be extended though there will be further revenue erosion at the federal level and states are just in cut mode. Delayed payments are just the front end of what I think is going to be a very, very rough three, four, five years. 

The housing market continues to be a leading indicator. Today’s figure on the housing market shows sales down, construction down. I do not expect the housing market to recover anytime soon except in some isolated regions and cities and as the housing market goes, so goes state and local revenue streams. 

If nonprofits want a simple indicator of the future, they should pay attention to the foreclosure trends. The numbers are still going up. 2011 looks like a record year. More foreclosures means less revenue, of course, but also underpins despair and nervousness. It's a very bad sign.

I don’t want to terrify nonprofits but I don’t think this is going to end anytime soon, two years, three years, four years, who knows? But, I don’t expect next year to be a banner year for employment. The Federal Reserve board just lowered its estimates of economic growth for next year. So, I think we’re really in a steady state system or situation and models that rely on nonprofit performance or that rely on history to predict nonprofit revenues are just completely irrelevant because past recessions have been relatively mild and relatively brief.

Ruth McCambridge: Does the recent Obama tax agreement affect any of the nonprofit sector's futures?

Paul Light: The tax deal did provide limited help to disadvantaged Americans as did the payroll tax for all taxpayers, but it does not change the nonprofit future. It's still business as usual for the next two years. I have little hope that the president and Congress will reach major compromises on larger-scale programs that might provide much help.

The much bigger story these days is the continued evisceration of state and local budgets. Worries about defaults are rising daily. I see nothing but delayed payments and further cuts in discretionary budgets over the next two-five years. It is starting to look like the U.S. version of the Euro debt crisis. Despite the sluggish recovery, states are cutting like crazy. Nonprofit compensation is also in the crosshairs, in part because of a misreading of my concerns about high salaries. My concern is not high nonprofit salaries, but pay compression in the federal pay system.

In addition, federal employees are now under a two-year pay freeze with pay cuts very high on the Republican agenda, with little defense from Democrats. There is virtually no interest in cutting contractor pay, for example, and Republicans are preparing for even deeper cuts in the federal discretionary budget. These cuts will roll down the hill like a snowball. Moreover, the housing market remains locked in crisis, which is one of several drivers of further retrenchment at all levels of government. There are no miracles coming.

Ruth McCambridge: So, which of the four futures, that you alluded to in your article with us back in 2008, do you see us headed for at this point? You laid out “the rescue fantasy,” where a superhero swoops in and saves the organization from failure, a “withering wonderland,” where everything withers and starves, an “arbitrary winnowing,” where larger and better known organizations would survive and smaller and mid-size ones would struggle, and, finally “transformation,” where organizations would reinvent themselves. 

Paul Light: Well, I think we have some combination of the middle two—withering and winnowing—right now.

But first, in terms of the rescue fantasy, I think the buffering miracle of the stimulus is over. There were many states and nonprofits that benefited from it but we’re not going to get another stimulus and if we do it’s going to be in the several billion dollar range, maybe $20 billion or $30 billion but I don’t expect that from the new divided Congress. So, I think we’re out of miracles if we had them. I do not think that the Buffett/Gates decision to spend more and the lineup of some funders and philanthropists to give more offsets the very dramatic decline in discretionary funding from the federal government. That decline is now under 5 percent but will almost certainly go up to 15 to 20 percent next year. You must add this to the tremendous drop in support from state governments. So, I think the miracles are not here and they’re not going to come. 

Ruth McCambridge: So, that would have been your rescue fantasy—that somehow government was able to step in.

Paul Light: That is the rescue fantasy. But the landscape looks bad. Unemployment benefits are about to run out. That’s certainly a key leading indicator of what’s going to happen. Medicaid, you know, is protected to a certain degree but states are going to cut that. Nebraska being one exception because of the deal making en route to healthcare reform by Senator Ben Nelson. But there are no miracles afoot—the probability of the rescue fantasy is zero percent.

That brings us to the second scenario which I described as withering where organizations starve themselves into a weakened organizational state. This shows itself through hiring freezes, pay freezes, layoffs, and deferred organizational maintenance. Ironically and anecdotally we’ve seen some shuttering of fundraising operations and transfer of grant writing responsibilities to program staff who are under great stress already to meet demand. I think that’s a short-sided decision but I don’t know how much of that is going on. 

At some point this results in organizational closure or suspension for many. Is it going to be a hundred thousand, is it going to be fifty thousand, is it going to be two hundred thousand? What’s the offset in terms of the creation of new nonprofits? We just don’t know. 

There has been great deal of hollowing out but this is not across the board which brings us to the winnowing concept. There has been some growth in healthcare and some growth in educational institutions. There are some big organizations that have expanded even swallowing up smaller organizations, so there is a have and have-nots division within the nonprofit sector right now and some of the haves, have grown and have had the brand identity, the brand equity, the donor base to keep going although there is an issue in the volunteer sector that indicates declines in repeat giving so you’re having to do more prospecting. But, we’ve seen hollowing out in midsize and smaller nonprofits as they deal with cash flow problems, furloughs, pay holidays if you want to call them that—as they use reserves and run debt. 

As for transformation, I don’t see much of it. I don’t think many nonprofits have been able to generate the capital to undertake significant thoughtful restructuring. I think there’s been accidental restructuring through attrition based downsizing, through decisions not to fill vacancies. 

One of the problems, of course, in the nonprofit sector is we don’t know much about what’s going on. We don’t have good reconnaissance. We don’t have ongoing research. We do have the GuideStar survey. We do have The Giving USA survey and we do have just enormous information on the decline in the payment—on declined and state and local budgets, as well as the late payments problem. I mean nonprofits that didn’t have a good reserve strategy and didn’t have some capacity for maintaining their current status, nonprofits, as Nonprofit Quarterly has shown, that were already experiencing problems with their internal capacity have suffered the most. Any weakness has become a wedge for potential decimation within nonprofits and there’s not a lot of money for capacity building out there. Big funders are concentrating on program delivery and, near as I can tell, to the extent that they were giving capacity-building grants, have either trimmed them greatly or eliminated them altogether. As for operating support, that’s always been a problem and the late payments issue by state governments has drawn down reserves and lines of credit are tight. I mean it’s a perfect recipe for this hollowing out.

Ruth McCambridge: So, you’re really talking about the hollowing out, not just of individual organizations but the hollowing out of community capacity in a way.

Paul Light: Absolutely. The hollowing out has its own pernicious effects on service deserts or what we might call nonprofit deserts, which we could easily spot through more systematic analysis. Part of the problem of even spotting the service deserts is that we have no money for deep research. I think after this is all over we’re going to see these service desert effects but we don’t know when it’s going to be all over and I think there are some in the philanthropic community who are saying to themselves, “Well, so be it.” It’s a survival of the fittest and if the fittest happen to be the mainstay of specific communities, that’s just the way it is. 

We have that article by Senator Bradley and the McKinsey people several years ago that argued for some effort to certainly transform nonprofits but I think that that article had some influence and did reinforce prevailing opinion among philanthropists that it was time for some sort of winnowing and hollowing out and the result has been—when coupled with the lack of funding for capacity building and transformation, the result has been winnowing and hollowing out and I don’t see much transformation going on although there are some funders such as Edna McConnell Clark that are investing in capacity building.

Ruth McCambridge: So, we’re looking at a kind of an arbitrary process here that in fact may have the effect of punishing communities that are less well moneyed or in some other way marginalized.

Paul Light: Well, we do not have a transformational strategy in the funding community for dealing with the recession. Institutions that are not particularly valuable and not particularly strong are under fire but so are institutions that are valuable and not particularly strong. The lack of good measurement or performance and value really is affecting the sector’s ability to do the downsizing or the transformation in a thoughtful way. It really does appear, and I emphasis the word “appear” to be a random process out there where some very valuable nonprofits are being either winnowed or hollowed out and other nonprofits that are not particularly effective may well survive because they have a high brand equity and at least a reasonable funding base.

Now is the time to act to make this rational.

Ruth McCambridge: If you were to say something which was a kind of a call to arms for nonprofits during this period including the nonprofits that are really experiencing that danger of imminent demise, what would you be calling them to? What would you say to them?

Paul Light: I’d say get around the table with nonprofits that are engaged in the same mission and at least consider shared administrative services. Maybe nonprofits have relatively high administrative cost structures. They can trim those cost structures relatively quickly through shared back office activities. We’re not seeing much in that. Frankly, the administrative costs structure of the sector is off the agenda right now. People remain angry and agitated about Charity Navigator and other methodologies who are indicating problems in cost structure and we’re ignoring the possibility that we could get significant savings and better revenue deployment through at least some shared services but many nonprofits are still in distinctiveness mode, meaning that they want to retain their identity and their afraid of shared costs of one kind or another. 

Also I think, a significant injection of capacity building money directed to collaborations, mergers and acquisitions, and other forms of shared administrative costs is called for. So, you’ve got a double agenda here, one for nonprofits and one for their funders. Now, as for a third recommendation, I talk to state and local people from time to time who ask, “What should we do? How can we help the nonprofit sector?” And at every meeting, my main recommendation, in fact my only recommendation to states and local officials is to pay their damn bills on time. That’s the single most important thing they could do and that’s when they say, “Oh, well, let’s move on to something else because they can’t pay their bills on time and that’s part of their strategy for getting through the crisis.” You know you’re in trouble as a sector when the sectors you depend upon are also in trouble, but that really is a missing piece of this equation.

I think we’ve got to get quite real and quite serious about what’s going on and try to figure out a way to be deliberate about our response as a sector. That requires better data. That requires a good deal of courage, a good deal of frank conversation but right now we’re letting this recession happen to the sector rather than the sector trying to manage it carefully with good deep information.