Imagine being an investor in the stock market—a scary thought in these times—examining investments in potential securities, but being unable to distinguish and disaggregate equities (stocks) from bonds, cash equivalents, and other assets. You may think you’re buying into a fund of large cap equities but you discover you actually just landed a bunch of U.S. treasuries or even a Real Estate Investment Trust .

Welcome to the bollixed up way we think about the similarities and differences among U.S. foundations!

It was a recent conversation with a famous, independent-minded philanthropist in New York City, the inimitable Lewis Cullman, that resurrected this long-held thought: Our understanding of foundations is faulty, because we lump all different kinds of foundations together in our analysis of their grantmaking and spending practices, like a ball of string or rubber bands. We need a new set of measures about philanthropic practices—based on a new and more discrete classification of foundations.

At this time, many observers typically—in almost all cases, actually—look at all private grantmaking foundations, sometimes all grantmaking foundations whether private or “public” (like community foundations) together in terms of their grantmaking distributions. The result is an amalgam of 70,000 or more foundations of different types that make almost no sense when analytically glommed together. For foundation practice and public policy making, sometimes it’s hard to make heads or tails out of what you see.

For example, the Foundation Center says that the grants payout of, “independent foundations,” in 2007 was roughly 6.1 percent of assets (and that for a few years the payout has been around that mark, certainly above 5 percent. But when asking foundations about their stance regarding possibly raising the minimum 5 percent spending (not grants payout) rate, they will claim that the consequence would be to put foundations out of business. Dramatic? Pablo Eisenberg recounts a conversation with Susan Berresford, at the time head of the Ford Foundation and strident leader in opposition to raising the payout rate, to that effect. Although, she didn’t predict in which millennium a minor increase in the payout rate would have brought the Ford Foundation to its knees At the time, the legislative threat was to change the composition of the mandated 5 percent to all grants rather than including their administrative costs.

Why would foundations, if they’re typically hitting 6 percent in grants despite growing endowments (until this past year), be so virulently opposed to upping the payout rate? What makes 5 percent so sacrosanct in face of foundations’ actual grantmaking behavior? What makes foundations fight so many things on the grounds that philanthropy is one big undifferentiated amalgam, except when you want to make a point about philanthropy, and the defense is the shopworn, “when you’ve seen one foundation, you’ve seen one foundation.”

The problem is, “misplaced aggregation.” In economics, it is the analytical error of lumping together very diverse things (the opposite mistake is, “illegitimate isolation,” looking at things as very different and discrete when they should be viewed as a group).

So how, for example, does misplaced aggregation muck up our understanding of foundation grantmaking? It’s obvious that the Foundation Center’s above-5 percent payout rate makes foundations look deceptively generous, because it lumps in the following:

• Foundations that are, “spending down,” that is, consciously trying to make grants from their corpus that will deplete the assets over some period of time. It is true that the majority of foundations are not in the spend-down modality; there are some major ones that have been and are spending down, notably Atlantic Philanthropies (one of the arms of Chuck Feeney’s remarkable societal commitment) and the Open Society Institute (George Soros’s money). Even the grantmaking of the Bill and Melinda Gates Foundation, a foundation pledged to terminate by the end of the principals’ lifetimes, will eventually factor into this. The high grants payouts of spend-down foundations camouflages the much lower payouts of asset-protection foundations.
• The presence of living donors, which changes the payout equation. Living donors using their foundations to put their money out quickly are different than foundations living off dead donors’ estates and restrictions. Take again the Gates Foundation, where donor Warren Buffett is requiring the foundation to spend all of his annual capital infusions in the year in which they are made.

The misplaced aggregation is obvious: The reported grants payout rate of 6.1 percent is being calculated against a swath of foundations where the preservation of endowments is not a factor. What would the grants payout rate be if spend-out foundations and living donor foundations were excluded from the calculation?

Often, some defenders of the 5 percent floor on private foundation spending will include corporate foundations in their mix. Corporate foundations file 990PFs as private foundations, just like family and institutional foundations. But for the most part, corporate foundations are minimally endowed if they have any endowment at all, most depending on annual capital infusions from their corporate parents. So, a payout rate calculated against corporate foundations is a payout rate measured against a minuscule asset base.

Foundations may actively use misplaced aggregation for any number of causes, not just to fend off pressures for higher grants payout. For example, foundations have also protested against regulation that might, in their minds, hamper their ability to hire lots of necessary program staff. Their argument is that on average, foundations are pretty thinly staffed. That too is misplaced aggregation. The proportion of foundations that are staffed is minimal, only 3,546 foundations (17.2 percent of over 20,000 surveyed by the Foundation Center) reported any of the 19,027 staff counted in the survey, an average of 5.4 and a median of 2.0 staff per reporting foundation. In other words, a very tiny number of large foundations account for most foundation staffing, skewing the averages much higher than the medians. Most of institutional philanthropy operates with minimal or no staff and would not be adversely constrained if their administrative expenses were excluded from their payout or qualifying distributions.

Similarly, foundations may actively complain about misplaced aggregation as well when it serves their purposes. Perry Mehrling’s analysis of foundation payout rates, done for the National Network of Grantmakers in 1999, was savaged by foundation critics because he had included operating foundations—which make some grants but not nearly as much as explicitly grantmaking institutions—into his overall calculation of the grantmaking/payout levels of private foundations. Their argument was that the low and sometimes minimal grants payout levels of operating foundations artificially lowered the payout levels of grantmaking foundations.

For too many endowed foundations, particularly those without living donors, their grants payout has been much closer to 5 percent—or lower—than 6 percent. Now, with the analytical fallacy of illegitimate isolation, foundations will be able to point to their upcoming 2009 grantmaking and say, “look how high our grants payout percentage is,”even though the actual grant dollars are likely to plummet. That’s because with shrunken endowments, foundations will be able to raise their payout percentage even as they slash actual cash grantmaking.

We need to be a lot smarter and stop treating all foundations like they’re one big philanthropic asset class. Until we get to compare apples to apples—that is, endowed foundations to endowed foundations, culling out the unendowed and spend-down foundations that make foundation payouts artificially higher—we will never be able to understand them, much less advocate about and regulate foundations appropriately and accurately.