Social Impact Bonds are a new means by which private dollars are helping fund government services and initiatives. Generally, the bonds are tied to specific projects, such as reducing recidivism and pay-outs are based on whether the programs meet their agreed-upon goals. Ideally the bonds will be used to fund programs that, if successful, will save public funds, thus allowing the government to make the payments.

Q. There’s news today that Goldman Sachs has invested almost $10 million in new Social Impact Bonds issued by New York City. What are these things?
A. Really fascinating development in getting private money to drive improved governmental services. The proceeds of social impact bonds are used for some public purpose… in this case, for a program to reduce recitivism. If the program meets certain specified goal, the bonds pay off; if not, the bondholders lose some or all of their money.

Q. So, just to be clear, the city’s on the hook to pay the bondholders, but only if the program to reduce recidivism works at some specified level?
A. Right, the idea is that if the program works, the city will save a lot of money over time… obviously, its expensive to have repeat prisoners. So the bondholders are paid out of those savings, if they exist. Here, GS gets repaid if the rate drops 10; they get a profit if its more than that, and take a haircut if its less. The idea was first tried in the UK a couple of years ago, also with a prisoner recidivism program. This is the first real trial of the concept here in the US.

Q. And so what’s really driving this whole initiative? What’s the big benefit?
A. Innovation is not the government’s sweet spot, and given the budgeting process and pressures, it’s almost impossible for governments to spend on new, untested programs, no matter how good they sound. This is like a smart way for governments to have a R&D program. The private sector vets the quality of the idea and its likely success; if they thinks it will work and they can make a profit, they put up the capital for the innovation. And if the government winds up saving a bunch as a result, no problem sharing some of the savings with the bond investors. Pretty nifty, really.

Q. So how broad an impact might these bonds have? What can they be used for?
A. The real trick is that you have to have very measurable outcomes to determine whether or not the government is actually saving enough from the program to pay the bondholders back. Of course, a lot of stuff isn’t tracked well enough to tell that, but some ideas include: early childhood education, reducing time spent in hospitals, and cutting down on the homeless population. Companies like GS aside, it’s an extremely interesting way for endowments and philanthropic organizations to look at achieving their policy goals … while preserving or even enhancing their own capital.