Monday night I was having drinks in downtown San Francisco with some seriously smart people — top-level IBM scientists and strategists involved in Big Blue’s Smarter Planet initiative. 

Given the room’s collective interest in creating smart electrical grids, smart water systems, advanced electric car batteries and other green technologies, the talk naturally turned to how to create sustainable cities.

Solar panel installation in San Francisco.Solar panel installation in San Francisco.Photo courtesy bkusler via FlickrThe technology largely exists, the IBMers agreed, but what’s really needed is a great leap forward in financial engineering to allow cities to finance all the cool stuff being developed in labs at IBM and elsewhere.

“We need a business model for cities,” Deborah Magid, director of software strategy at IBM Venture Capital Group, told me.

In fact, a few hours earlier, San Francisco Mayor Gavin Newsom unveiled GreenFinanceSF, a $150 million program to green up the city’s homes and businesses by financing the installation of solar panels, energy efficiency retrofits, and water conservation improvements.

It’s the latest and largest iteration of the Property Assessed Clean Energy, or PACE, model pioneered by the city of Berkeley across the Bay and now spreading across the country.

In a nutshell, cities float bonds to pay the upfront costs of cutting the carbon footprint of its homes and businesses. Homeowners pay back the money through a surcharge on their annual property tax bills for 20 years. When a home is sold, the assessment rolls over to the new owner. (For the nitty-gritty financial mechanics of such programs, see my earlier Green State column.)

But San Francisco is the first big city to adopt the municipal financing model and GreenFinanceSF is notable for its for size and scope, given that most such programs just focus on installing solar arrays.

“What’s really exciting about San Francisco is that it’s moving toward whole-home retrofit, from insulation to solar to help reduce energy use and increase cost savings,” says Cisco DeVries, president of Renewable Funding, an Oakland startup that rolls out PACE programs for cities and states.

DeVries developed Berkeley’s program when he was chief of staff to the city’s mayor. He subsequently co-founded Renewable Funding, which is involved in setting up scores of funding initiatives across California and elsewhere.

“This is the first of a wave of large-scale programs,” DeVries says of GreenFinanceSF.

In the coming months, Los Angeles and San Diego will roll out PACE programs, according to DeVries, as well as 14 California counties that have banded together to offer municipal green financing.

In other words, we’re talking about laying the groundwork for transforming mom-and-pop energy efficiency retrofit shops into a big business akin to the solar and wind industries.

Starting March 1, San Francisco homeowners can apply to GreenFinanceSF (GFSF) for up to $50,000 in financing to insulate their homes, install new windows, lighting and furnaces and make other energy efficiency improvements.

But what caught my eye was the program’s bankrolling of water conservation measures.

 “GFSF will also finance water efficient fixture/equipment upgrades, including faucets, showerheads, high-efficiency toilets, rainwater catchment systems, and smart irrigation controllers,” Rich Chien, the green building coordinator for San Francisco’s Department of the Environment, wrote in an email.

“Water conservation will be important,” says DeVries, who added that Renewable Funding recently conducted a survey of 1,000 California homeowners in an attempt to gauge demand for PACE-financed water conservation improvements.

“For a lot of people, their water bill is a fairly large cost,” he says. “Water is a big issue and over time water efficiency could be a big part of this program.”

Which is why a truly sustainable municipal financing program needs to take a “whole house” approach. It makes no sense, for instance, to install a $20,000 rooftop solar array only to have energy escape through drafty windows or be consumed by inefficient light bulbs and appliances.

“GFSF will first require an independent energy analysis for the home as condition for requesting financing, as well as a post-installation inspection to verify projects and to provide quality assurance for the program,” says Chien. “GFSF will also finance renewables (such as solar electric photovoltaic systems), but only after demonstrating that the other building improvements have reduced the building’s energy load by 20 percent.”

Of course, the $150 million question is whether if you build a green financing system will homeowners and the nascent home retrofit industry be able to step up to the plate.

“We will confront whether the home retrofit industry is really ready for all this demand and whether the demand is there from the homeowner,” allows DeVries, “but the tailwind is incredible.”