(co-authored with Bryan Fike)

The pandemic and post-pandemic period have been defined in many respects by capital. Beginning with the CARES Act and continuing with the American Rescue Plan Act, the Infrastructure Investment and Jobs Act, the CHIPS and Science Act, and the Inflation Reduction Act, this capital period has seen the federal government dedicate trillions of public resources for a broad set of activities, initially related to rescue and recovery (a focus on preserving existing businesses and communities) in 2020-2021 and then economic transformation (an industrial/energy transition of monumental proportions) in 2021-2023.

The sheer volume of federal funding has masked the odd duality of the moment, a confounding juxtaposition of capital abundance and scarcity. The federal government is subsidizing certain things, ignoring others; fully funding some activities, partially funding others. This is an uneven world: public funding abounds for large scale, nation shaping projects (e.g., building a new electric vehicle production plant in the middle of nowhere) while adequate funding for critical local investments (e.g., acquiring, building or preserving workforce housing) is almost impossible to source.

To complicate matters, this capital period has also seen federal funding delivered via a vastly extended set of beneficiaries, recipients and distribution mechanisms. Contrast the initial CARES Act creation of the Paycheck Protection Program (delivered through financial institutions of one sort or another) with the American Rescue Plan’s flexible support for state and local governments and school districts with the Infrastructure Law’s penchant for public authorities with the CHIPS and Science Act and Inflation Reduction Act’s orientation for manufacturing firms, climate exchanges, university partnerships and the like. These federal funds are accretive; new resources sit on top of fossilized programs, an uneasy co-existence within and across layers of government and sectors of society.

To complicate matters further, the form of capital differs across programs, agencies and institutions. The firehose of federal funding comes in many odd shapes (and mis-shapes): block grants, competitive grants, guaranteed or low-cost loans, tax incentives and procurement contracts. Public capital is complemented by private debt and equity instruments and corporate and philanthropic commitments in the tens of billions of dollars, particularly to address racial wealth gaps and enable inclusive and sustainable growth. Some of these commitments have been aggregated via new consortia (e.g., the Economic Opportunity Coalition) with major announcements a regular fare.

The capital moment, in other words, is inordinately complex and confusing. Our federated system, networked economy and financialized culture have created multiple channels for allocating, distributing, leveraging, blending and stacking resources, usually without any settled norms or clear guidance.

All things must pass, of course. At some point we will wake up and the federal faucet won’t be flowing with largesse. When that time comes, it will be critical to ask whether this exceptional moment will have created new ways of financing the future, with built to last capital products, practices and partnerships, that will continue long after the Biden Administration. The New Deal created the Federal Housing Administration and the 30-year mortgage. What will persist from this era?

And so, a central question: will 2024 be a year of financial innovation? A capital moment requires a commensurate, intentional focus on capital innovation. Only in that way will breakthroughs be catalyzed, captured and codified, so that they can be routinized and scaled going forward. And that will only happen if a mix of governments, financial and philanthropic institutions, corporations, and supportive intermediaries come together, grasp the potential of the moment and, painstakingly, dedicate sufficient time, effort and research around defining new capital products, practices and partnerships.

This is more difficult than is commonly acknowledged. The US excels at engendering what President George Bush (41) famously called a “thousand points of light”; innovations that organically bubble up across the nation. We are less adept at systematizing separate financial discoveries into repeatable norms.

The good news is that systemic change is happening, albeit in a haphazard and uncoordinated manner. An eclectic mix of governments, financial institutions, corporations, philanthropies, business organizations and capital intermediaries, are intentionally pursuing three distinct kinds of financial innovations: remedying product deficiencies (where financial products either do not exist or are misaligned with market realities); filling capital gaps (where public, private and philanthropic resources need to be blended around singular transactions); and practicing a new level of ecosystem coordination (where multiple kinds of initiatives, projects and enterprises need to be financed simultaneously via multiple kinds of entities).

Each of these distinct kinds of financial innovations needs broader explication.

First, networks of communities and capital providers are working to remedy product deficiencies that vary depending on the sector or challenge and the mix of new or expanded government programs and incentives.

In the entrepreneurship space, for example, the State Small Business Credit Initiative (SSBCI), administered by the Department of Treasury, is helping capital providers and networks deploy new financial products that are better aligned with the needs of small business owners. It is increasingly understood that conventional financial products focus too much on traditional debt and too little on non-dilutive equity and particularly penalize emerging Black- and Brown-owned businesses which do not have access to traditional sources of collateral to meet underwriting demands. To correct this, a growing number of mission-driven lenders like Grow America have been piloting Revenue Based Financing (“RBF”) products in their portfolios. Catalyze and the Nowak Metro Finance Lab have teamed up to release a practical guide entitled “The State of Revenue Based Financing and CDFIs,” exploring an emerging spectrum of RBF providers and case studies of real RBF deals. (A subsequent newsletter will tease this out in greater depth). Along the same lines, states and a host of capital providers are exploring new approaches to supply chain financing, which leverages contracts as collateral, so that small enterprises can take full advantage of increasing government procurement, particularly in the construction arena. Leading intermediaries including Calvert Impact and CRF USA are also creating secondary market products for SSBCI loans (in New York, New Jersey, and elsewhere), channeling private capital at scale to expand the reach and liquidity of mission-driven small business lenders.

Similarly, in the climate space, the Inflation Reduction Act’s monetization of tax incentives is spurring a cottage industry of climate exchanges that can channel mission- and return-driven capital to critical decarbonization activities historically deemed too risky for private capital alone. The $27 billion Greenhouse Gas Reduction Fund (GGRF), administered by the Environmental Protection Agency, will implicate a host of capital providers and intermediaries including state governments, private capital markets, CDFIs, and nonprofit intermediaries. Two components of the GGRF – the National Clean Investment Fund and the Clean Communities Investment Accelerator – are spurring new consortia across multiple capital providers with $20 billion in federal funds. The goal: innovate and routinize new kinds of financing for clean energy and energy efficiency projects across different segments of the economy (e.g., single family and multifamily housing, transportation, school buildings, non-residential small business).

Second, governments, investor groups and philanthropies are experimenting with filling capital gaps to enable the financing of projects in sectors like housing where market challenges are fierce and new federal resources are rare. The aim is to build imaginative stacks of public, private and philanthropic resources to fill capital gaps that emerge from the mismatch between the costs of acquisition and construction/renovation and the prices/rents owners or landlords can charge. This capital gap is present in a varied set of circumstances: downtown office-to-residential conversions, the acquisition of vulnerable single-family homes (to counter large scale investor purchasers) and the acquisition and preservation of workforce housing. In each of these cases, the existing suite of legacy federal housing programs and tax incentives are insufficiently flexible to enable the purchase of buildings or homes at scale and the imposition of long-term affordability covenants. Alternatives might include the creation of large funds, built with private equity and de-risked by local philanthropic capital that takes a first loss position. As described in earlier newsletters, some early examples of this capital stacking occurred via the much-maligned Opportunity Zone program.

Capital gaps are not limited to the housing sphere; they also exist in the industrial arena. Cities can attract small manufacturing firms but only if the acquisition and remediation of fit to purpose industrial sites can happen quickly at reasonable cost. The Cincinnati Jobs Bond provides one local example of how cities can level the playing field between brownfield and greenfield development of manufacturing sites.

In clean energy, the Department of Energy’s Loan Programs Office (LPO), bolstered by tens of billions in increased lending authority from the IRA, aims to address private debt gaps for deploying innovative energy technologies before they reach full market acceptance. Requests for LPO financing span a range of technologies, from renewable energy deployment to storage, carbon management, and advanced and electric vehicles.

Finally, a broad mix of state and local government agencies, universities, community colleges and business intermediaries are practicing a new kind of ecosystem coordination, to enable an integrated approach to industrial policy, infrastructure investment and place regeneration.

While the federal government, corporations and the media celebrate the announcements of large semi-conductor and electric vehicle factories, smart states and communities recognize that the full potential of reindustrialization will only be realized by simultaneous investments in supply chain firms, workforce development, applied research and development, logistics and energy upgrades, housing production and the like. Each of these separate but related investments involve different public, private and civic entities and different stacks of public, private and philanthropic capital. The states and metropolitan areas (and their business/civic organizations) that are leading the reindustrialization of the US economy understand this; Columbus and Syracuse know that the industrial dance starts but doesn’t end with attracting Intel or Micron. It takes an industrial ecosystem that enables a series of separate but related transactions.

The modernization of US infrastructure, like the reshoring of production, is also a main target of federal investment. But most of that investment is delivered by separate, balkanized programs, even though infrastructure projects around roads, rail, transit, ports, airports, water/wastewater and energy ultimately must come together on the ground in city, metropolitan and rural geographies. Our recent missive on Emerging Projects Agreement shows the emergence of a different kind of federal-city partnership that aggregates and integrates related infrastructure projects around common themes and goals.

What is true for the industrial and infrastructure sectors is also true for the regeneration of commercial corridors and downtowns. In many respects, the building of quality places with diverse uses requires access to resources that are not rigidly compartmentalized. Detroit’s Strategic Neighborhood Fund is an early example of place rather than product financing.

These examples show that intentional financial innovation is bubbling, around different kinds of capital challenges. Three moves are required if the US is to go from sporadic bubbling to systemic scaling.

• First, we need a recognition — by major government agencies, financial institutions, associations of capital providers and philanthropies — that financial innovation must be a critical component of this period. It is not sufficient to make commitments around transactions today; the goal must be to stimulate innovation that provides a platform for capital deployment going forward. This should be a period of drive and possibility: there are capital gaps to be filled, financial products to be invented and modified; capital stacks to be tried and tested; and capital exchanges to be created. Financial innovation must become baked into every new initiative and consortia.
• Second, we need concerted, intentional efforts to capture and codify innovative products, practices and partnerships so that scaling and routinization are made more probable. The Catalyze and Nowak Lab effort around RBF must become the norm rather than the exception and apply to each of the distinct capital challenges described above. The cost for funding purposeful innovation is infinitesimal compared to the volume of capital out there. Philanthropies and financial institutions, in particular, need to step up their game in this area.
• Finally, we must bring more capital players to the financial innovation table. Too much of the innovation effort has been driven to date by a small set of large banks and community development financial institutions. A broader network of capital sources (e.g., pension funds, wealth management offices), capital providers (e.g., institutional investors) and capital implementers (e.g., industrial and energy companies) must be part of the action. We are experiencing a profound industrial/energy transition; financial innovation must reflect and further that reality.

Will 2024 be a year of financial innovation? Only if we make it so. Gobs of federal funding are not sufficient. Purpose and intentionality must be the order of the day.

Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Bryan Fike is a Research Officer at the Nowak Lab.