Home > Uncategorized > Goldman Sachs explains: social impact bonds are socially bankrupt

Goldman Sachs explains: social impact bonds are socially bankrupt

November 9, 2015

Have you ever heard of a social impact bond? It’s a kooky financial instrument – a bond that “pays off” when some socially desirable outcome is reached.

The idea is that people with money put that money to some “positive” purpose, and if it works out they get their money back with a bonus for a job well done. It’s meant to incentivize socially positive change in the market. Instead of only caring about profit, the reasoning goes, social impact bonds will give rich people and companies a reason to care about healthy communities.

So, for example, New York City issued a social impact bond in 2012 around recidivism for jails. Recidivism, which is the tendency for people to return to prison, has to go down for the bond to pay off. So Goldman Sachs made a bet that they could lower the recidivism rate for certain jails in the NYC area.

Or who knows, maybe they sold that bond three times over to their clients, and they are left short the bond. Maybe they are actually, internally, making a bet that more people are going to jail in the future. That’s the thing about financial instruments, they are flexible little doodads.

Also, and here’s a crucial element to look for when you hear about social impact bonds: the city of New York didn’t actually put up an money to issue the bonds. That was done instead by Goldman Sachs and MDRC, a local nonprofit. However, NYC might be on the hook if recidivism rates actually go down. On the other hand fewer people would be in jail in that case, so maybe the numbers would work out overall, I’m not sure. Theoretically, in that best case scenario, the city would also have the knowledge of how to reduce recidivism rates, so they’d be happy for that as well.

Which is how we get to the underlying goal of the social impact bond: namely, looking for privately financed “solutions” to social problems. The reasoning is that governments are inefficient and cannot be expected to solve deep problems associated to jails or homelessness, but private companies and possibly innovative non-profits might have the answers.

As another example, there’s a Massachusetts anti-homelessness social impact bond initiative, set up in 2014 with $1 million in philanthropic funding and $2.5 million in private capital investments, with the following description: “the investors assume project risk by financing services up front with the promise of Commonwealth repayment only in the event of success”.

There are actually a ton of examples. This is the new, hot way to create social experiments. Take a look here for an incomplete list. It’s international, as well; it’s done mostly in the US and the UK, but New Zealand is throwing its hat into the ring as well.

It’s a good idea to try things out and see what works for the big problems like homelessness and recidivism. That’s not up for debate. However, it’s not clear that social impact bonds are the best approach to this. There’s a real danger that it’s going end up being a lot like the charter school movement: they juice their numbers by weeding out problematic students, they are unaccountable, and even when they tout success their “solutions” don’t scale.

Here’s a big red flag on the whole social impact bond parade: Goldman Sachs was caught rigging the definition of success for a social impact bond in Utah. It revolved around a preschool program that was supposed to keep kids out of special ed. Again, it was hailed by the Utah Governor as “a model for a new way of financing public projects.” But when enormous success was claimed, it seemed like the books had been cooked.

Basically, Goldman Sachs got paid back, and rewarded, if enough kids who were expected to go into special ed actually didn’t. But the problems started with how find the kids “expected to go into special ed.”

Namely, they administered a test known as the PPVT, and if the kid got a score lower than 70, they were deemed “headed to special ed.” But the test was administered in English, when up to half of the preschoolers didn’t speak English at home. And also, the PPVT was never meant to measure kids for special ed needs in the first place. In fact, it’s a vocabulary test. Kids are shown a picture and a word or two of description – in English – is spoken, and the kid is supposed to say the number of the picture associated with the description. Here’s a sample:

Weird how non-native speakers didn't do so well, don't you think?

Weirdly, non-native speakers didn’t do so well.

Lo and behold, after a couple of years where the kids learned English, most of them headed to normal classrooms, and Goldman Sachs got paid back. From the article:

From 2006 to 2009, 30 to 40 percent of the children in the preschool program scored below 70 on the P.P.V.T., even though typically just 3 percent of 4-year-olds score this low. Almost none of the children ended up needing special education.

Let’s take a step back. We’re asking for help from private finance companies to solve big hard societal problems, and we’re putting huge money on the line. There’s a problem with this approach. We asking for gaming such as the above. We should expect to see more of it.

Worst case scenario: financiers are betting against the “socially beneficial” outcomes. It’s possible, we saw it happen in the housing crisis. From their perspective, it doesn’t make sense to have a market where you can’t bet against something, and if they think the chances of a positive outcome are overblown, they’d be stupid not to. And of course, if they can influence the result directly, then why not. It could get ugly.

Here’s my hope: that we soon realize that engaging like this doesn’t solve any problems, and moreover it wastes time and money. Financial incentives are not compatible with the scientific approach, and basic research depends on money not being directly involved. When private financiers want to get involved in this stuff, it’s because they can profit off of it, not because they want to help.

Categories: Uncategorized
  1. November 9, 2015 at 7:06 am

    Hey kiddies, can you spell “i-r-r-a-t-i-o-n-a-l e-x-u-b-e-r-a-n-c-e”?
    (I do give the financial marketeers credit for unbounded creativity.)


    • November 9, 2015 at 7:43 am

      They’re a lot like con artists in that way.

      Oh wait …


    • Neel Krishnaswami
      November 9, 2015 at 8:02 am

      Shecky R: ironically enough, Robert Shiller (the man who coined the very phrase) was[*] a huge proponent of using exotic derivatives to massively expanding the welfare state.

      [*] I’m not sure if he still is — he may have changed his mind about this. (This is meant as a compliment. When I worked for him, he struck me as refreshingly immune to getting married to his ideas.)


  2. November 9, 2015 at 8:54 am

    Fred Klonsky has written a number of reports about social impact bonds.


    • November 9, 2015 at 9:09 am

      Interesting, thank you!


    • Jon Lubar
      November 9, 2015 at 5:39 pm

      Dang, beat me to it! How low can you go, I mean getting paid for keeping Special Ed kids from getting the services they’re entitled to under the law by keeping them off the SPED roles in their own schools? Kids are nothing more than commodities to these people.


  3. Gordon
    November 9, 2015 at 9:22 am

    My (limited, imperfect) understanding of the Utah bond is slightly different to yours. The school district used the PPVT as its proxy for “at risk of going into special education”. The proxy was imperfect, in that a relatively small percentage of the kids identified as “at risk” actually went into special education. Goldman agreed to use the school district’s definition of “at risk”, with the knowledge that the mismatch between the proxy and the outcome weighted the odds of success in its favour, which to me sounds different to, “it rigged the definition of success”.


    • November 9, 2015 at 10:14 am

      OK, so I agree. It looks like Goldman identified a school district with a methodology that far overestimated the chances a given student would end up in special ed, then negotiated a contract that made them profit off this mismeasurement. Goldman Sachs did not actually set up a bad methodology, in other words; they just took advantage of it.

      I still think of this as a rigging. After all, we can guess that Goldman looked into many deals of this nature and only went in for the ones where they could easily estimate their chances at good that the methodology was flawed. This is tantamount to rigging in my book.

      In any case, even if we don’t agree on the usage of “rigging,” I think we can both agree it doesn’t help poor kids get educated.


  4. November 9, 2015 at 10:48 am

    Hi, partially agree with:
    “Here’s my hope: that we soon realize that engaging like this doesn’t solve any problems, and moreover it wastes time and money. Financial incentives are not compatible with the scientific approach, and basic research depends on money not being directly involved. When private financiers want to get involved in this stuff, it’s because they can profit off of it, not because they want to help.”
    Sure, if there are financial incentives things might be less than ideal, but are we sure that this doesn’t solve any problems at all?
    I think that this way one can still create opportunities to do some good that otherwise wouldn’t be there. This doesn’t mean that we shouldn’t strive to aim to do the best we can whenever we can, but sometimes some compromises are necessary (of course there are compromises and compromises…).
    Point in case, private companies have surely contributed hugely to the development and growth of our knowledge and hence to our capacity of doing good.

    I’ll throw an idea: how about a compromise between social impact bonds and donations. Company X donates some money to some foundation to do some good, the foundation promises to return (part of) the money to Company X after certain number of years – an interest-free loan if you like. Not sure how it would qualify for tax purposes, and hence what monetary incentives companies could have, but hopefully it could make it easier to donate money to some causes. Thoughts?


    • November 9, 2015 at 10:52 am

      But we already do that, and we return the money immediately. It’s called a tax break.


      • November 9, 2015 at 11:29 am

        It’s similar I guess. With a tax break a corporation donates some personal money to a specific cause and at the same deprives the government of some proportional budget in favor of this cause. For the 0-rate loan I imagine it would depend on how the return payment is to be taxed.

        But at the end of the day any two transactions can be transformed one into the other with the right transformations in the middle, it’s a matter of finding a strategy that is “smoother” in one way or another


  5. November 9, 2015 at 5:43 pm

    I had the chance to talk with someone who was instrumental in creating to nyc bond which subsequently defaulted due to not hitting their targets. I asked her why Goldman would be involved in something like social impact bonds given that the margins are so small and even best case for scaling, it is a tiny market hat can’t be worth the upfront cost of pricing out bonds.
    Ironically, given the feelings you express in this article, she said that they were doing it primarily for pr and essentially eating the cost as a marketing expense.

    Now I don’t necessarily believe this, but I think it is very plausible, and when you are lookin at the world through the blinders of big financial company wants to exploit everyone always, you may miss another just as cynical explanation for the phenomenon.


    • November 10, 2015 at 4:28 am

      This is a likely reason, or one of the reasons, that GS would be involved. Also, PR has an internal dimension, too. Post 2008, the earlier attractions to a banking job have gone away or been reduced significantly. New recruits want to feel that they are part of something meaningful and “good.” However, remember the old adage about which is more dangerous: someone evil who is aware they are doing wrong vs someone misguided who is convinced they are doing good. My bet is usually on the latter for more damage.


  6. November 10, 2015 at 4:41 am

    Unfortunately, the class of “social impact” financing structures seems so broad that the term is practically meaningless. Similar to financial derivatives, some could be useful, some could be benign, some could be harmful, most could be any of these depending on the context.

    If there are any helpful generalities, however, it seems to be in two areas:
    (1) Government financial commitments contingent on the behavior of some third party.

    This is how the GS/MDRC deal was described.

    This is generally an unwise structure. From the perspective of origination governance, it seems that the government authorizers are often much more lax about this structure than if there were a more central to the deal. I think the extra layer of complexity is a problem, possibly people intuitively assume their organization can’t/shouldn’t be on the hook for someone else’s actions, or some variant of I’ll-be-gone-you’ll-be-gone syndrome.

    (2) interventions are only weakly causal of the outcomes we desire

    While we may have good ideas, deep problems generally come from a system of interacting factors and need to be addressed by a similarly comprehensive collection of interventions. Crediting or blaming one intervention for an outcome is popular, since most of us have a strong illusion of control and causation. The mild risk is that we over-reward for actions that weren’t really valuable. The larger risk is that, through the game-like incentives, providers are encouraged to find or create opportunities that are stacked in their favor. Like the GS in Utah example ….


  1. November 10, 2015 at 6:22 am
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