Impact investing just got a boost from the San Francisco Fed after the Community Development Investment Review dedicated its latest issue to exploring the recent hype over social impact bonds, or SIBs.
SIBs have jumped from obscurity to government fad in barely four years, starting with a grant from the Rockefeller Foundation to Social Finance UK in 2009. The concept is simple: a government fails to fix a social problem, so they hire a nonprofit or private firm to take over. The government compensates the nonprofit based on their success in meeting a specific social goal. For example, New York City contracted with nonprofit MDRC to reduce recidivism among 16- to 18-year-olds. If recidivism falls by 8.5 percent, MDRC gets $4.8 million. A 20 percent reduction pays $11.7 million.
In theory, governments can use SIBs to target social problems that cost them money while nonprofits recoup their expenses when the program ends. Any return is better than the 100 percent loss charities usually see after spending their grant money, authors Kristin Giantris and Bill Pinakiewicz point out in one article. White House advisors Jonathan Greenblatt and Annie Donovan argue in their piece that President Obama’s new $300 million Incentive Fund, dedicated to Pay for Success programs like SIBs, will eliminate government inefficiencies while opening up a whole new market for mainstream investors.
However, SIBs are still a risky endeavor. Here are five important facts about them, as highlighted in CDIR’s most recent issue:
1. Not all SIBs are the same. Somebody has to finance the project up front, either through a grant or a loan. This might be an individual, a bank, or a hedge fund. Author Hanna Azemati also notes that a foundation or NGO might lead a project to test a new idea, or an outside consultant might do the planning for them. Giantriz and Pinakiewicz list four different models, none of which is obviously more successful than the others.
2 Governments often pay before seeing results. Bridgespan Group’s Daniel Stid points out that it takes time for governments to see a project’s real benefits, so partial payments are often made based on future projections.
3. Most success stories are still speculation. It’s worth noting that even the MDRC project, the first major SIB in the United States, hasn’t finished yet. Until SIBs have more of a credit history, mainstream investors probably won’t be interested in them.
4. SIBs are a global phenomenon. Azemati mentions about eight countries that are trying out SIBS, from the UK to India.
5. There are plenty of cynics out there. Pay for Success programs in general have a spotty history, from housing subsidies to the foster system. Several authors are quick to point out the failures inherent in older PFS projects and try to think of ways to prevent SIBs from repeating the mistakes of the past.
This collection of articles gives a snapshot of the current debate on social impact bonds, from supporters and enthusiasts to opponents. It's a lot of discussion about a still-immature idea -- but interesting new ideas don't mature in any other way.
Read the full report here.