Ever since the United Kingdom savvily matched private investments to social-problem solutions, the idea has been spreading like wildfire here in the U.S. Social impact bond (SIB) legislation has passed in fourteen states and the District of Columbia since 2012 -- in fact, four of these states are already implementing projects financed by SIBs -- and Harvard's Kennedy School has set up a Social Impact Bond Technical Assistance Lab.
Social impact bonds are not bonds in the classic sense. Rather, SIBs are "better understood as a rigorous outcomes-based contract between multiple parties," according to Kristina Costa and Sonal Shah, authors of a new paper on social finance. In other words, the government contracts with a private-sector intermediary to buy social services and pays the intermediary -- but only if it meets performance targets. The payments are funded at least partially by the cost savings the project achieves.
Last year, the first SIB in the U.S. was signed: A $9.6 million loan to an evidence-based program for young adults in New York City's Rikers Island Correctional Facility. The program -- the Adolescent Behavioral Learning Experience (ABLE) -- teaches young inmates skills and counsels them on personal responsibility in an effort to reduce recidivism. Goldman Sachs provided the financing; Bloomberg Philanthropies put up money for an initial grant; and MDRC, a nonprofit agency, is overseeing its implementation. If recidivism among those in the program is reduced by 10 percent, the government saves enough money to pay back the investor's principle. If the reductions are higher than 10 percent, investors start to make money.
But are these investments just a variation of charitable giving or are they bona fide financial bets? Goldman Sachs CEO Lloyd Blankfein and Alicia Glen, who heads up Goldman Sachs' Urban Investment Group, both had a lot to say about SIBs at a November conference sponsored by the Center for American Progress. Here's a quick rundown of the key points they made on some of the issues facing local governments interested in finding a private partner for a social impact bond.
Why Goldman Sachs is interested in social impact bonds as an investment
Lloyd Blankfein (LB): Recent trends in social investing demonstrate how much value we can create by targeting investments to social problems. In dollars and cents you determine what's the economic cost burden if people are reincarcerated. Reduce that statistic and you have a return the market will go to. Dollars up front have a leverage effect. If you spend $1 today and you can make $4, the private sector will come up with the $1. It's the logic of spending now for enormous returns later. Results are results. How much return for how much investment rivals those in the purely financial sphere.
The kinds of projects that lend themselves to SIBs
LB: The outcomes have to be measurable and the savings measureable -- and where people agree on those elements. If the [projects] are sustainable people will beat a path to your door.
How to attract investors to the bonds
LB: Sometimes investors are motivated by standing for something. We want it to be combination of people's better instincts and their desire not to lose money. If it works, it'll get bigger and bigger, and have a life of its own.
How to balance risk and returns
Alicia Glen: These investments are not pure private-sector driven, but they aren't philanthropy either. There's a tipping point for investors, such as foundations, financial institutions and pension funds. They have to think about the long-term costs of these issues [and if] they can deploy capital into these solutions for social problems. So what is a fair return for the risk the investor is taking? The biggest problem is the perception that you're paying the private sector too substantial a return. If it's 8 percent, people should question that. Social investing is a new field -- like the low-income housing tax credit [once was] -- and eventually the market will begin to price the correct yield. Only two [SIBs] have been done but [as more are done] yields will go up and down. The market will get to a point where yields will normalize. There's nothing wrong with understanding the sensitivity to it. We're a long way from saying we need to price it so it's consistent.