Peter Greene educated himself about “social impact bonds” and has graciously taken on the task of explaining what they are and how they work.


He writes:


Here’s the basic structure of a Social Impact Bond. Note: I am not an economist, banker, or investment counselor, nor do I play one on TV, so I may cut a few corners here.


My house is drafty. My windows leak and my heating bill is $10,000 a year.


My landlord goes to the bank. She says, “Banker, I would like a bond of $4,000 for new storm windows. I think they would reduce my annual heating bill by $3,000.”


And the investor issues a bond for the program costs, in return for which he gets a healthy cut of the $3K saved by installing the new windows. My landlord’s savings from the successful Stop Freezing My Butt Off Social Program become the bond holder’s profit– but only if our goals are met.


Typically a third party will come in to judge the result, making sure that I didn’t just turn the thermostat down or it wasn’t just a warm winter or my landlord didn’t actually save $6K and hide it from the bondholder. Also, it’s worth noting that bonds generally come with negotiated maturity dates, at which point the original loan amount is to be paid back. And remember kids– bond holders are different from investors. An investor owns part of the company, but a bondholder is just a fancy debtor, and as such has legal priority for being paid back.


In this example, the government is, more or less, my landlord. For a more thorough explanation, we can look here. Here’s the shortened version of their explanation:


In the classic… social impact bond, a government agency sets a specific, measurable social outcome they want to see achieved within a well-defined population over a period of time. …The government then contracts with an external organization—sometimes called an intermediary—that is in charge of achieving that outcome. … The intermediary hires and manages service providers who perform the interventions intended to achieve the desired outcome. Because the government does not pay until and unless the outcome is achieved, the intermediary raises money from outside investors. These investors will be repaid and receive a return on their investment for taking on the performance risk of the interventions if and only if the outcome is achieved.


Okay, Watch Carefully Now


From New York Times coverage of a SIB program that failed. “Social Impact Bonds offer a strikingly different way to pay for social programs. Governments, rather than tapping taxpayers, can turn to outside investors and philanthropists for funds, and reward them only for programs that work.” If the program fails, the taxpayers are off the hook. If it succeeds, the bond holders are paid off with what would have been taxpayer savings of taxpayer dollars.


But the finances get muddier because in the couple of years we’ve been trying this, we’ve learned a useful insight:


“The tool of ‘pay for success’ is much better suited to expanding an existing program,” Andrea Phillips, vice president of Goldman’s urban investment group, said in an interview on Wednesday. “That is something we’ve already learned through this.”


But issuing bonds for existing programs means we’ll have public and private money swimming in the same pool.


For the rest, and the links, open the article.