Can fancy finance fund fights against social ills?

A new method of financing government programs such as early childhood education and prison reforms is generating a near giddiness among states and philanthropists eager to participate.

Social impact bonds allow foundations and private-sector investors to participate in funding programs aimed at easing social ills and earn a financial return if the programs are successful.

“Interest in social impact bonds is sweeping the United States,” said philanthropist Phillip Fisher, whose Mission Throttle organization in Southfield is at the forefront of this emerging social investing model here.

Michigan is among a handful of states that are in the process of developing projects that can be financed by social impact bonds.

“I’ve never seen anything move as quickly from concept to execution as I’ve seen with this social impact bond model,” said Joe Pavona, Gov. Rick Snyder’s special adviser on the project.

In September, Michigan was one of eight states chosen in a national competition to receive technical assistance from the Harvard Kennedy School of Government in designing social impact bond projects.

Established with support from The Rockefeller Foundations, Harvard’s Social Impact Bond Technical Assistance Lab conducts research on how governments can foster social innovation and improve results from social spending programs.

But social impact bonds aren’t really bonds. And there’s little evidence so far that they can alleviate social ills while earning profits for investors.

“It’s a misleading term,” Pavona said. “We’re trying to use the term ‘pay for success’ instead of ‘social impact bond.’ We think of a bond as a financial instrument. But this is a private-sector financing arrangement that does not require government to issue debt.”

Here’s how it works:

A government unit contracts with an intermediary that raises capital from investors. The intermediary then contracts with a nonprofit service provider to run a multiyear program that attempts to alleviate a social problem, such as homelessness or prison recidivism.

An outside adviser monitors progress and works with the nonprofit to make any needed modifications during the course of the program.

At the end of the contract, an independent assessor determines the results of the program and how much the government should repay investors.

The programs usually are judged on their ability to be replicated and expanded to serve a larger number of people.

Depending on how the deals are structured, investors can lose a portion or all of their money if program goals aren’t met.

Social impact bonds are such a recent invention that no one really knows how effective they can be in easing social ills and saving money for taxpayers, the two main goals of this financing structure.

“It’s so new that the jury is still out. We’re all just learning about this now,” said Gilda Jacobs, president of the Michigan League for Public Policy, which advocates on behalf of economically vulnerable state residents.

Social impact bonds were first used in Britain in 2010 to try to reduce recidivism rates in a prison there where 60 percent of prisoners released landed back behind bars within a year.

The six-year program, which provides housing and other support, has so far led to a 6 percent drop in recidivism, according to a government report.

New York City launched the first social impact bond program in the country last year, focusing on reducing recidivism among 16- and 18-year olds detained at the Riker’s Island jail.

The program is being financed by a $9.6 billion loan from the investment banking firm Goldman Sachs. A portion of the loan is guaranteed by Bloomberg Philanthropies, the charitable giving arm of New York City Mayor Michael Bloomberg.
Goldman Sachs will be repaid if recidivism rates at the jail drop by 10 percent. The bank could make up to $2.1 million if the rates fall further, according to the New York Times.

Massachusetts is developing two social impact bond programs targeting juvenile justice issues and homelessness. The state also has established a $50 million Social Innovation Financing program to pay for positive outcomes in future programs.

In June, Goldman Sachs, Chicago investor J.B. Pritzker and the state of Utah announced a social impact bond program in which the two investors will lend $7 million to expand early childhood education for at-risk children.

Social impact bonds also have found a cheerleader in President Barack Obama, whose administration has proposed hundreds of millions of dollars in federal budget support over the past several years to implement them.

But so far, Congress has balked at approving the funding requests.

Philanthropic groups in Michigan are making a variety of similar investments under the broad umbrella of “impact investing” that includes social impact bonds.

In 2007, the W.K. Kellogg Foundation in Battle Creek created a $100 million fund in which it invests in businesses aligned with its mission of improving the lives of vulnerable children and families.

Traditionally, foundations have made grants to communities and organizations that provide no financial return to the foundations.

“The main issue that everyone recognizes is that resources are tight in the public sector and that social impact bonds are one of the options for new opportunities in financing services,” said Rob Collier, president of the 350-member Council for Michigan Foundations.

“Our governor heard about this and is moving forward on it. Clearly, the foundation community needs to be engaged, as well,” he said.

But some are skeptical that social impact bonds can be scaled up enough to significantly ease social ills, such as illiteracy, homelessness or crime.

In Michigan, Pavona said the state likely will engage in two or three social impact bond pilot projects totaling about $5 million. It could be years before it is known whether the projects can be expanded.

Pavona said social impact bonds are designed to be most effective in preventive projects such as addressing homelessness, childhood development and women’s prenatal health.

Fisher at Mission Throttle is pushing the state to create a social impact bond pilot project to expand early childhood education in the state.

Some experts worry about the potential for corruption in social impact bond projects.

Jon Pratt, the executive director of the Minnesota Council of Nonprofits, recently wrote that the drive to succeed could be similar to the federal No Child Left Behind that led to “cheating scandals by pressured school administrators throughout the United States.”

Others say that social media bonds look suspiciously like another form of privatized government services, which have had mixed results.

“If this is going to work—great,” Jacobs said. “But I don’t want the government to think it no longer has responsibility to look at these programs. We have to be careful that we don’t leave the repair of social issues to the private sector.”

Investments in things such as early childhood education can take years to pay off. It’s unclear if investors would be willing to wait that long for a payoff, she said.

Fisher said social impact bonds could be a powerful lever to expand resources aimed at easing social ills.

The needs of communities are typically the greatest in economic downturns when government is under the most financial stress, he said. And philanthropic organizations are able to provide only a fraction of the money needed for social services.

Social impact bonds can help fill the funding gap by attracting socially minded corporate and individual investors, Fisher said.

“Historically, we’ve depended on government and foundations to solve our problems,” he said. “The governor wants to engage citizens in an opportunity to invest in their own communities.

“This is not privatization,” Fisher said. “It’s acknowledging that the capital government has to spend is just a piece of what needs to happen in our state.”