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Risk and Reward in Taking On Homelessness and Recidivism

Shifting the risk for delivering measureable social progress from government to private investors is supposed to be one of the key features of “social impact bonds,” a promising new way to finance programs tackling nitty-gritty challenges such as homelessness and prison recidivism (see “How Financial Innovation Can Save the World”).

But investors have been wary of shouldering such risks on their own. The two social impact bond programs announced this week, in Massachusetts and New York City, will provide early evidence of what the market might bear.

In New York, Goldman Sachs will provide a loan of $9.6 million for a four-year program to reduce the rate at which young men at Riker’s Island return to prison. If recidivism goes down by more than 10 percent, Goldman stands to gain a profit of $2.1 million, paid by the city’s Department of Correction out of savings it captures from a reduced prison population. If it drops by 10 percent, Goldman will get only its principle back. But if it drops less than 10 percent, Goldman will lose only $2.4 million, not the full amount, the result of a $7.2 million loan-guarantee provided by New York City Mayor Michael Bloomberg’s personal charity, Bloomberg Philanthropies.

That’s a shift from the original structure of social impact bonds, sometimes called pay-for-success contracts, in which private investors were to bear the full risk of unsuccessful programs.

“The objective of the government is to transfer the risk. The objective of the investors is to have someone share the risk,”Steven Godeke, a financial advisor who has been working with the Rockefeller Foundation to assess investor interest in the new financing mechanisms, told Impact IQ even before the recent announcements. “Early deals will have some risk-sharing. Social impact bonds will be about risk sharing, not risk transfer.”

The details of the Massachusetts offering are still being worked out, in particular the metrics to be used to determine the repayments to investors and the agencies carrying out the program. Philanthropic investors are the most likely candidates, given the likely deal structures. “There will be profits, yes, but always at a very modest level,” George Overholser of Third Sector Capital, which will manage the offerings, told the Globe. “The returns are well below the market rate, compared to the risk.”

In that regard, the New York City program may be more interesting in terms of gauging the commercial market for such offerings.

“The goal should be for there to be risk-sharing, to lure in the commercial investors, so they learn how to underwrite and assess these transactions,” Godeke said. “Down the road, they will need less and less credit enhancement, and they will be able to do it without the government and philanthropies having to provide the risk-transfer.”

(Note: For a terrific primer on social impact bonds, see Laura Callanan’s report from McKinsey & Co., “From Potential to Action: Bringing Social Impact Bonds to the U.S.” And there’s a wealth of information at the Nonprofit Finance Fund’s Pay for Success learning hub at http://payforsuccess.org/.)

About the author: David Bank

1 comment

  1. jane006 says:

    A great start for enticing funding and strategies for these tough social issues.

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