Social Impact Bond Launches in U.S. Backed By Goldman Sachs, Mike Bloomberg Billionaires See Profit in Prisons, But It's a Good Thing This Time

Goldman Sachs is making an unusual loan: $9.6 million to help young men stay out of New York City jail. And they could earn millions on the deal. But it's taxpayers more than shareholders who should be pleased with the plan.

New York City Mayor Michael Bloomberg proudly announced a new kind of City spending yesterday. "As the first city in the nation to launch a Social Impact Bond, we are taking our efforts to new levels and we are eager to see the outcome of this groundbreaking initiative,” he said in a statement. As Bloomberg and Goldman go, expect other banks and mayors to follow.

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Social impact bonds were invented in the U.K. and have yet to be fully proven but a small handful of states, cities and federal agencies are hot to test the concept.

Here's the idea: take a problem that costs the government money -- in the NYC case, paying to house teen prisoners -- and see if the private sector can create a program to solve it. Measure the results closely. If the plan works, split the savings between the city and the investors who funded the program. If it doesn't work, then investors foot the bill. Taxpayers only pay up if the plan succeeds, and only when it actually saves money. Lefties rejoice at the possibilities because it means more funds for social programs. Conservatives cheer because it reduces wasteful spending and taps the private sector to innovate.

“Right now government is ... paying for programs that work and paying for programs that don’t work" says Antony Bugg Levine of the Nonprofit Finance Fund and author of Impact Investing. "This shifts money to just the programs that do work.”

New York testing the idea on a real problem is big, and if it works, could easily spark replications that could remake municipal finance.

Consider what Goldman Sachs is paying for. The descriptions of the services in this bond will prickle the hairs on conservatives, "recreational activities that reduce idleness." And several line items that could be accurately summarized as "throwing money at criminals."

It is politically difficult to pay for services that go to marginal populations like prisoners, says Bugg Levine. “What the social impact bond does is it transforms the political conversation around that spending." The only way taxpayers pay for a program that helps prisoners learn job skills, is if the program has already worked, and has saved money. “It’s hard for anyone to argue against that,” he says.

In New York, half of the adolescents who pass through city jails, end up back there within a year. Cutting re-incarceration rates by 10 percent could save the city millions on jailing the teens, processing them in court, and of course, it's just better for society to have fewer criminals. That's worth something.

So Goldman's $9.6 million loan will go to the nonprofit group MDRC to pay for a suite of education, job training, and life skills courses for teen offenders. A third party, the Vera Institute for Justice will evaluate the success of the whole program, and if it determines the MDRC interventions reduced re-incarceration by 10 percent or more, Goldman gets its money back. If the rate drops by more than 10 percent, Goldman starts to earn a profit. The better the program works, the more the city pays—up to around a 21% profit.

The only reason this works though, is because Bloomberg Philanthropies wrote a $7.2 million loan guarantee for MDRC. So if none of this works, Mayor Bloomberg's foundation will pay the bulk of the costs, capping the potential loss to Goldman at about 25% This isn't normal for social impact bonds, small as the sample set has been.

That's a better deal than investors in the original U.K. deal get. They can lose all their money, but also potentially double their money, or more. In Massachusetts investors are also facing greater risk. In Minnesota a similar plan is in the works that goes under the name Human Capital Bonds.

That's what Goldman Sachs does though: gets the best deal around. There’s an upside, though, to Goldman Sachs being Goldman Sachs. Antony Bugg Levine points out, “by getting a good deal, Goldman has created a template that will make it more likely that other similarly minded investors will follow.”

So, Massachusetts may have announced a pair of SIBs earlier this week, beating NYC to the punch, but New York's will have more copy cats because it brings in the most notoriously profit-sniffing investment bank into the social impact investing arena. That will make a different class of investor pay attention.

“It's exactly the kind of proof point that everyone is looking for,” said Steve Goldberg, Managing Director of Social Finance US, the domestic wing of the British organization that invented the social impact bond. The U.K. pilot was funded mostly by foundations and high-net worth philanthropists trying to prove the concept could earn a profit.

Goldberg is working with several states on developing their own social impact bonds. Though praising the NYC announcement, he wants to see the fine print before declaring it a triumphant step. “We think that the structure of the NYC project looks encouragingly like a true social impact bond, but we need to learn more about the details.” Things like how success is measured, who audits which books, and how the profits are calculated.

And of course, if it will work. Results are still pending in the U.K. pilot and it will be years before the measurements are in on any social impact bond. In the mean time, cities and states and government agencies will be experimenting with variations on the model for reducing homelessness, improving education and criminal justice. Expect the NYC bond to be a model for many others.

Image (cc) by Flickr user abardwell.