Tuesday, March 12, 2013

Social Impact Bonds: Making Money from the Misfortune of Others?

The term "social impact bond" (SIB) is synonymous with "pay for success bond" and "social benefit bond." It refers to an agreement between a group of investors and a government agency that does not actually possess the characteristics of a bond. It is more of a proposal to perform a specific task with the agreement that if the task is performed successfully, the investors will be compensated for expenses and provided a profit of a certain level. The logic behind the arrangement assumes that the government will have been saved sufficient funds via the deeds of the proposal that the expenses can be paid and both parties come out ahead. The peculiar part of the agreement is that if the performance target is not met, the investors receive no compensation and the return on investment is zero. The first such project was initiated in Britain in 2010 with a program aimed at lowering recidivism among prisoners at Peterborough Prison. 

An article in The Economist discusses the issue of SIBs as an investment vehicle. Under the terms of the Peterborough agreement the investment appears rather risky.

"The Peterborough SIB dangles an annualised return of up to 13% if reoffending rates go down by enough; but investors lose everything if recidivism does not fall by at least 7.5%."

In spite of the potential for zero return, a number of such proposals are in place or being planned. The bulk of the article describes a project aimed lowering the cost of providing services to the homeless.

"The cash will fund a three-year programme, the success of which is measured by everything from the number of nights that the rough sleepers spend on the streets to their visits to hospital. As targets are met, payments will flow to investors from the Greater London Authority (GLA), the SIB’s commissioning body."

"The arrangement suits all parties. The rough sleepers are frequent users of government services, including accident-and-emergency wards. Cutting their number should save the GLA enough money to fund payments to investors if goals are met. At a time when public spending is under pressure, the taxpayer stumps up only if results are achieved. Investors have the prospect of a return to entice them, of up to 6.5% if targets are met."

It would seem unlikely that your average investor would be interested in such a vehicle. The nature of the activities proposed suggests that a fraction of the funds, perhaps the largest fraction, comes from philanthropic sources.

An article in the New York Times by Caroline Preston, Getting Back more Than a Warm Feeling, describes a similar program in the US aimed at limiting recidivism at New York City’s Rikers Island jail. This project is being organized and funded through Goldman Sachs.

"In New York City’s case, Goldman is lending $9.6 million to MDRC, a nonprofit group that oversees the work of two charities running the jail program. A fourth nonprofit evaluates the results of the four-year program."

"If recidivism rates drop by 10 percent, Goldman gets its money back. The bank could make up to $2.1 million if the rates fall further. (Bloomberg Philanthropies is guaranteeing $7.4 million of the loan, leading some to say the New York City deal is not a true test of the bonds’ appeal to commercial investors.)"

Whether or not SIBs are enticing investment opportunities is perhaps a trivial question compared to the need to ask if this approach is in any way a good idea for government and society.

Proponents of SIBs suggest that this is a way for governments to get work done without actually having to go through the usually futile exercise of trying to fund the effort directly. Implicit in the process is the notion that the private investors somehow have come up with a better approach than the government currently utilizes, and if successful, this approach will be incorporated in government efforts.

That sounds good, but it is reminiscent of the entrance of philanthropy and finance into the education system. Every billionaire seemed to have a better way to educate our children, and all have been wrong thus far. Charter schools were intended to be trials of new learning approaches that, if deemed successful, would be incorporated into public school systems. Charter schools turned out to be no better than the public schools, and, on average, worse. That has not stopped moneyed interests from using charters to launch an all-out assault on public education in this country.

Introducing the profit motive into education was supposed to solve a variety of shortcomings. For-profit schools have mainly become a means of imposing heavy debts on unsuspecting students and raiding the public treasury for income.

Complicated issues like childhood learning require long-term investments in efforts by dedicated professionals. It is the natural domain of the government to nurture and oversee such activities. People who swoop in and claim that in one, two, or three years they will have impacted a critical social problem are deceiving themselves and their potential sponsors.

Of greatest concern is that this is just another means transferring responsibility from the public sector to the private and thereby diminishing the sense of community between citizens that government is supposed to reflect. What kind of society do we have if every public interaction becomes one defined by price and return on investment?

We probably can’t stop these SIBs, but we should be very careful in dealing with them.

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