How Modern Finance Promises to Break the Cycle of Recidivism

BY Paul Solman  March 14, 2013 at 11:13 AM EDT

A new type of financial investment being pioneered in the United Kingdom may be the key for breaking the cycle of recidivism — and it could be coming soon to a prison near you.


Paul Solman visits Riker’s Island penitentiary in New York to meet participants in a program aimed at reducing the likelihood of reincarceration. Private investors fund the intervention through a private contractor and the government pays the contractor only if the program meets its goals. Photo by Kevin Cloutier/NewsHour.

Paul Solman: In an upcoming PBS NewsHour report, we focus on a potentially breakthrough cognitive therapy program for young offenders at New York’s Riker’s Island jail, which holds 88,000 prisoners every year as they await trial. The program is being financed by a new financial instrument known as a “social impact bond.”

One of its champions is Judith Rodin, president of the Rockefeller Foundation. In a recent interview with her, she explained the workings of this new piece of financial engineering.


What Is a Social Impact Bond?

Paul Solman: What is a social impact bond?

Judith Rodin: A social impact bond is a new way of bringing financing into social and environmental support issues. And [it's meant to help finance] either preventive or rehabilitation services that the government is providing and paying for.

What [society] does is look for very well-proven, well-demonstrated, data-driven social interventions. Then it looks for private sector financing to support those interventions [that have been proven effective] based on performance.

So it’s a triple win because the government gets a proven intervention, the organization giving the intervention gets to take it to scale, and the investor — the buyer of the bonds, whether it’s an individual investor or an endowment or some kind of private wealth fund — gets a chance to have a double bottom line investment: something that can produce quite a significant financial return, but at the same time produce social returns as well.

So there’s a financial return on the social impact bond, but there’s also a social return because they are supporting a proven intervention, they are helping the government to deliver more effective services at lower costs.

Paul Solman: What’s in it for me as an investor?

Judith Rodin: In the U.K., it was young investment bankers who were talking to wealthy clients who didn’t want to separate their philanthropy from their investing. The bankers wanted to respond to what they saw as a potentially growing market where affluent individuals wanted to do well and also have a financial return.

The individuals were asking: “Isn’t there anything innovative? Isn’t there a new way that I could fulfill both my social concerns and my financial obligations?”

So that led to the creation of the social impact bond. It’s like any other debt. It’s a bond paying between 2 percent and 9 percent. The payback is based on the performance of the social organization.

So if I’m to reduce homelessness or prevent criminal recidivism among juveniles, I have to generate empirical data that shows my success rate. The eventual payment is based on that.

Paul Solman: So if I’m the organization that’s receiving the money, I will have to pay a higher or lower interest rate depending on how well I meet my goals?

Judith Rodin: No, it’s the government which is paying the bond, not the organization. The organization gets a flat fee for achieving the goals. If they don’t achieve the goals, they get no more money for further interventions. And the government for which the service is being provided — a criminal justice system, say, where the goal is to reduce recidivism — doesn’t have to pay if the intervention doesn’t work. So the investor doesn’t get paid out. The innovation here is around the financial instrument not the social delivery organization.

Paul Solman: The first experiment was in Peterborough County in England, where investors backed a nonprofit with a track record in reducing criminal recidivism. If recidivism was reduced, the county would pay the investors interest on the bonds. If not, it wouldn’t, correct?

Judith Rodin: In this initial Peterborough experiment, the recidivism rate they were trying to reduce was 60 percent: 60 percent of the offenders went in and out of prison within the first two months over two or three times. And it was costing the money of the reincarceration, plus all of the costs to society of re-offending, because these people don’t get put back in prison for doing nothing.


How Governments Save Money

Paul Solman: I see why it costs a fortune. How does the social impact save the government money?

Judith Rodin: There are these great small social programs, many of which have been collecting very, very good data over a number of years showing how they intervene and how they actually can reduce the rate of people going through that turnstile over and over again.

Paul Solman: So there are good, but very small, localized programs that can do a better, less expensive job than bureaucratic, unwieldy government?

Judith Rodin: Yes. And those that stand out often work with reoffenders, with homelessness, with workforce development programs. That’s why we call this other sector the NGO sector — the non-governmental organizations that are much more nimble, typically smaller, and often far more rigorous in collecting data about what works and what doesn’t.


Paragons of Efficiency

Paul Solman: So since government is spending the money anyway and not doing a very good job of it, and there are other people who are doing a good job, can we somehow change the system so that the people who do a good job get the money?

Judith Rodin: That’s innovation No.1. Innovation No. 2 is a win for the local organization. It gets to scale up its efforts because government is buying its services wholesale rather than supporting little boutique programs.

The social organization that is successful and has good evidence base is now able to go to scale with the government as their buyer, the government as their client.

Paul Solman: And that’s a sustainable pool of income?

Judith Rodin: Totally. Win No. 3, government. It is always seeking new sources of capital and this is a particularly rough time for many governments, especially in the West, where the resources to run social programs and the challenges about the efficacy of social programs are quite significant.


Government Finally Gets New Capital

Paul Solman: So win No. 3 is government getting capital to solve social problems it hasn’t been able to?

Judith Rodin: Correct, and maybe allows government to deploy some of the money it was spending towards other things that would be harder to fund from the outside.

Paul Solman: Because if the program supported by the social impact bonds is successful, the government would save money?

Judith Rodin: Correct. The fourth win is for the investors. There is a growing cadre of investors who would like to not only make a financial return but also produce a social return. “Do well by doing good” is the mantra for this category of investor.

Paul Solman: That’s an old mantra.

Judith Rodin: It’s an old mantra but with a new flavor in the bottle. And because you can allow many different kinds of social impact bonds, the degree of risk and the pricing for the return can vary actually considerably. So an investor can get a bond that is likely to pay out 2 percent in financial return but have a massive social return, or get one that’s paying 9 percent financial return but doesn’t have the same sort of walloping social impact.

Paul Solman: I’m imagining people would be thinking: “Hey, I can get 9 percent and do social good? What investment is that?”

Judith Rodin: That was the Peterborough experiment. We haven’t yet seen the payout but that bond was sold and priced on the basis of the success rate of that service organization. It showed that the government could pay 9 percent because the recidivism rate would be reduced so significantly, they can gain more money by paying out at 9 percent than the cost to them for never going into this in the first place.

Paul Solman: In other words, government was so inefficient that if this provider came in it would so lower the cost and achieve better outcomes then Peterborough could afford to pay investors 9 percent a year?

Judith Rodin: Absolutely.

Paul Solman: Is this a next step in the realm of what’s been called, for the past decade or more, “venture philanthropy”?

Judith Rodin: It’s a different form of venture philanthropy, with almost the opposite emphasis. Venture philanthropy is investing in a lot of innovative things and seeing what works, then doubling down and bringing to scale.

Paul Solman: Enlarging it so that it applies in lots of places?

Judith Rodin: Exactly. That’s venture philanthropy operating in the same way a venture capital fund would. This is taking a very traditional investment vehicle, the bond, and making it adventuresome, making it innovative, and socially relevant. Innovative finance, Paul, I think, is the next big step in solving social problems.


Cancer Research-Backed Securities

Paul Solman: We’ll be doing this story with Andrew Lo, a finance professor at MIT’s Sloan School. He wants to set up a diversified fund to back cancer research and sell shares of that fund to the public: not mortgage-backed securities, but cancer research-backed securities.

Judith Rodin: Interesting.

Paul Solman: And we’re going to do a story with him because I suspect you may be right: there may be a huge potential for innovation using the techniques of modern finance which have become so stigmatized that they’re not being used at anywhere near the rate they might be to achieve positive goals.

Judith Rodin: I think those ideas are critical: bringing the positive tools of Wall Street to Main Street. CDOs didn’t work out right but there are lots of securities that are much less risky and could be important social innovations, whether cancer research-backed securities or climate securities. Insurers are developing Cat bonds against catastrophes. There are ways to develop bond structures to promote good things like healthy behaviors.

Paul Solman: And with social impact bonds, to promote good things for society as a whole? Things that are in everybody’s interest, like keeping criminals from repeating their crimes, which, in the sense of promoting a safe society, is good for the investors as citizens, not just as people looking for a financial return?

Judith Rodin: I think that people ought to be thinking about social returns and environmental returns on their investments and we are absolutely seeing that more and more.

Paul Solman: Because it’s in their interest?

Judith Rodin: It’s in their interest. We ultimately will not be a sustainable society unless we solve some of these problems. So it is with an entirely self-interested lens that I could take the view, “It’s worth me investing in this in order to protect my environment, to protect my overall health, etc.”

Again, this is a whole system and so we’ve got to really get everybody engaged in new and different ways. Enabling government to act creatively is in everyone’s self interest.


This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions