Behind the Numbers

Social Impact Bonds: The anti-philanthropy

November 21st, 2012 David Macdonald · 3 Comments · Criminal Justice, Democracy, Poverty and Income Inequality, Taxes and Tax Cuts, Youth

Interest in Canadian “Social impact Bonds” has spiked following HRSDC Minster Finley announcement that the federal government is investigating them for use in Canada. I’ve already commented on the story in The Toronto Star and on The Current (min 16) but I wanted to write my thoughts up in a fuller blog post for readers.

So what is a “Social Impact Bond”? The idea is that a banker or foundation decides to fund a particular service or program. When (you’ll see why I say “when” and not “if” below) the program hits its goals, the government pays the funder back all they invested and includes a profit margin of somewhere in the neighbourhood of 7%-15% on top of the initial investment.

For example, in New York City there is a youth recidivism program. In NYC, half of all youth released from prison will re-offend within a year. This is obviously bad for society and the kids, but it’s also expensive for the government to pay for these kids to be in prison. So a social service agency and the government convinced Goldman Sachs to spend $5 million on a youth recidivism program. The program will take in a portion of the kids released and give them an intensive program. If the program manages to reduce the re-offence rate by 10% compared to the average, then the government pays Goldman back their original $5 million and an additional 13% profit of $650,000, in total paying them $5,650,000.

This stands in stark contrast to actual philanthropy of say a company donating $20,000 to the local food bank at Christmas. They get a tax break for the donation to be sure, but they don’t expect to get their $20,000 back from the government with interest after homeless folks get their Christmas meal.  But that is what happens with social impact bonds—they get the entire donation/investment back with interest once the program is delivered. If anything, social impact bonds are anti-philanthropy.

It’s no surprise why some social service agencies are open to social impact bonds. The backdrop, in Canada and elsewhere, has been a decade of tax cuts and reduced expenditures on social services, leaving social service agencies stuck between a rock and a hard place. On the one hand, they see a growing need for their services and, on the other, governments are cutting back resources to deal with the need. If the government is offering them the opportunity to raise new money for social services, its pretty hard to look a gift horse in the mouth.

But this new way of funding social services is a significant departure from how Canadian governments have done it in the past.  en years ago, if a social service agency had a good idea that had been tested elsewhere or tested on a small scale and worked, they’d pitch it to a government granting committee and get it funded. Governments used to just fund new ideas: social service agencies could help kids who’d run afoul with the law, governments would save on prison expenditures and importantly, no one would make a profit.

Social Impact Bonds are a very different approach as they insert a middle man into social service delivery, someone like Goldman Sachs. The bankers are there because they smell an opportunity to make large, government-guaranteed profits. We have to remember that the same industry that took down the world economy not four years ago is the one interested in becoming social services middle men. Whenever there is a middle man, there is always a middle man mark-up.

Often times, these Social Impact Bonds are pitched as if they transfer risk to the private sector. That is, if the project doesn’t hit its 10% reduction in recidivism for example, then the government pays them nothing. In the real world it is quite a different story.

First of all, the projects that would make it to the funding stage are not experimental. They need to have been proven on a smaller scale and in other places. There is no way that Goldman and others are going to put up $5 million with a 50/50 chance of losing it all. Instead they are much more likely to back projects that have a proven track record. Experimentation is almost always going to be on a smaller scale and funded by government money because of the high risk of failure.

But if by some fluke, the project still doesn’t work as expected, say they only get an 8% instead of a 10% reduction in recidivism; it’s highly unlikely that the government will not pay Goldman Sachs the $5 million. If Goldman Sachs loses $5 million, they aren’t going to come back next year and neither are any of the other bankers and foundations. The investor demands to be paid…with interest. If the government allows project backers to lose their investment, the money to back these projects is going to dry up very quickly.

In either the traditional model or the social impact bond model, it is always the government that pays. However, for social impact bond, the government now has to pay a middle man mark-up. Not only that, but they also have to make sure that Goldman Sachs’ shareholders are happy. If the shareholders aren’t happy with their returns, they aren’t going to pony up the cash next time around.

It is this change of who government serves that really concerns me. People pay their taxes (and expect corporations to as well) in part because they want the government to deliver good services to the people that need them. However, social impact bonds direct tax dollars to bank profits instead of to a homeless person trying to get off the street. This dramatically changes who is being served by the government: from those who need a helping hand to the shareholders of a bank.

There is an alternative. Since the government is going to pay either way, let’s say “thanks but no thanks” to a middle man mark-up. Instead, the government could create its own fund to push forward ideas that have been proven elsewhere. Again, since the government is going to pay either way, why not borrow at historically low rates of 1% instead the of 7%-15% offered by a middle man? When these projects succeed, we can provide them to more people instead of lining the pockets of a bank.

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3 Comments so far older updates

  • Purple Library Guy

    Somehow this reminds me of the Merchant Banker Sketch. Finally the banker gets an answer.
    http://www.youtube.com/watch?v=YUhb0XII93I

  • Sara

    “There is no way that Goldman and others are going to put up $5 million with a 50/50 chance of losing it all”

    I have to disagree with you on this one. $5 million is a rounding error to Goldman Sachs. They are not doing this to profit from the government. They are doing this because it’s great PR and makes them appear to be concerned about the community.

    “In either the traditional model or the social impact bond model, it is always the government that pays. However, for social impact bond, the government now has to pay a middle man mark-up.”

    I also disagree with this statement. While the government may be paying the bondholder a ‘mark-up’, you are not considering the significant savings they are achieving by reducing crime by 10%. Social Impact Bonds are structured so that the payout given to bondholders is less than the savings achieved from the reduction in crime, therefore providing the government with additional funds to address other social problems.

  • Paul

    In response to Sara’s comment:
    “While the government may be paying the bondholder a ‘mark-up’, you are not considering the significant savings they are achieving by reducing crime by 10%. ”

    This is assuming that the wonderful idea that results in a 10% reduction in crime could only ever become a reality in the context of an SIB. Why must we assume that?

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