financializing social services
Do people know about social impact bonds? I hadn’t heard of them till recently. Since then, though, I’ve developed a train-wreck fascination. They have the potential to combine all the worst features of the public and private sectors. And they can be securitized, to boot!
Let’s take a step back. What is a social impact bond, anyway?
Well. Imagine you have a social problem you’d like to solve. Say that you want to reduce recidivism among young people in prison. That sounds good, right? The problem, of course, is that taxpayers don’t want to pay for rehabilitative programs, and there’s lots of disagreement about what kind of program would actually help solve the problem, anyway.
The government says, Wouldn’t it be nice if somebody would take care of this for us, and we’d only have to pay them if they actually succeeded?
Enter Goldman Sachs.
To oversimplify a bit, Goldman Sachs (or some other investor) puts up the money to implement the program for youth in prison. (This is a real example.) They provide the money to a social service agency that actually carries out the program. There’s a target that indicates success—let’s say, cutting recidivism by 10%. If the target is hit, Goldman gets paid back—with interest. 22% in this case, and Bloomberg Philanthropies is being nice enough to cover most of the potential loss. Yay, profit! But if the target isn’t met, Goldman doesn’t get paid back in full. Boo, losing money.
Sounds good, right? Goldman takes the risk, everyone has incentives to succeed, and taxpayers only have to pay for successful programs. What could possibly go wrong?
Well, I can think of a couple of things.
First, social program success is difficult to measure and very game-able. When an investor has a large interest in hitting some narrowly defined “success” target and little or no inherent interest in the actual, long-term outcome, there are going to be efforts to game the system.
Think of law school deans trying to beat the rankings in ways both frank and fraudulent—and one assumes that they are not only in it for the money.
Or think privately funded charter schools where the investors only get payouts if test scores hit a certain target.
Or, closer to (Goldman’s) home, think ratings agencies who will lose important clients if they don’t come up with ways to produce favorable ratings on financial instruments.
Investors whose payout depends on hitting a number + social service agency whose revenues depend on demonstrating “success” = lots of potential for bad behavior.
Second, if social impact bonds catch on in any significant degree, they are going to end up creating all sorts of new groups who have a big interest in creating bonds and only a secondary interest in long-term social outcomes. The folks promoting these should be reading Josh Pacewicz’s excellent work on tax increment financing.
Tax increment financing is a now-common way of financing municipal economic development projects. It allows cities to sell bonds secured by the future increases in tax revenue that are expected to result from a development project. So the city borrows money for, say, waterfront development, and promises to pay it back with the tax revenues that it projects will come from the newly developed waterfront. But if the revenues don’t materialize, the city isn’t on the hook. Like social impact bonds, part of the appeal is that the risk is shifted away from the taxpayer.
The problem, though, is that cities have gone overboard with TIF. This means high debt levels and committing most of the tax revenues resulting from development to paying back the debt that made it possible.
According to Pacewicz, TIF didn’t take off because of huge investor demand for the debt. Its expansion was driven by a new group of economic development professionals who worked for cities. TIF gave these professionals influence because it made municipal finances more complex—to the point where they gained control over city budgets because no one else understood them.
These professionals are very aware that TIF is overused—that projections of tax revenue increases are too optimistic, that cities are taking on too much debt, and that many development projects are basically corporate welfare. And they regret it. But they advance in their careers by putting together big TIF projects. So they put together TIF projects, even when they think it’s bad for the city.
How does this apply to social impact bonds? Well, if SIBs take off, we can expect to see a new group of government professionals emerge whose job it is to create social impact bonds. And they, too, will most likely want to advance their careers by creating big, splashy SIBs. This could lead to the replacement of plain-vanilla government-provided social services with privately financed services, even if the latter cost more or involve more layers of bureaucracy than the original ones.
Finally, if you’re not convinced that social impact bonds will go very wrong in either of those ways, here’s the kicker. They can be securitized! Massachusetts is structuring its social impact bonds—also targeted at recidivism—like collateralized debt obligations, to expand the pool of potential investors by creating lower-risk tranches. What could possibly go wrong?
I have no doubt that many of the people involved—maybe even at Goldman—are genuinely and deeply motivated by a desire to find innovative solutions to social problems. (Okay, maybe not at Goldman.)
But this kind of solution reflects way too much faith in our ability to distinguish between successful and unsuccessful programs—which is absolutely key to the whole thing working. And it involves way too little cynicism about how hard it will be to create a structure that works the way it was intended, and does not simply become self-perpetuating, regardless of cost or degree of success, by creating lots of people who have an interest in keeping the thing rolling along.
It’s possible social impact bonds won’t go anywhere. One of the earliest recidivism experiments in the UK just announced that investors won’t be paid back yet, though they’re on track to be paid in two more years. And so far most of the actual support for SIBs has come from philanthropists, not private investors.
Nevertheless, SIBs have the flavor of the next big thing. They promise to encourage private capital to support innovation in publicly supported social services. What could be more broadly appealing?
If only people’s enthusiasm for evidence-based policy extended to policy innovations designed to promote evidence-based policy.