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Saturday, February 26, 2011

Social Impact Bonds: I Couldn't Disagree More

My response to those who condemn Social Impact Bonds

A few days ago I came across a post entitled "The Hidden Reality Behind Social Impact Bonds".  As I've mentioned several times, I believe the Social Impact Bond Model has true potential for progressing social finance in Canada.  The author of this article, however, has taken an extreme opposite stance, and I couldn't disagree more with his opinion.

If you aren't familiar with what a Social Impact Bond is, I suggest you read my explanation on a past post, "Social Impact Bond Model: 7 Easy Steps" before continuing. It's a short but comprehensive read, I promise.

Here's the part of the author's post that inspired me to explain why he is missing the whole purpose of Social Impact Bonds:

"Let’s take a systems approach to understanding the biggest flaw of the Social Impact Bond program. We have to ask the question, where does the money funding the Social Impact Bond come from? Obviously, it comes from the budget of the federal government. Now, where does the federal government get the money for its budget? It comes from taxpayer dollars. This is where a Social Impact Bond starts to make no sense at all.
Here is a more concrete example. Assume that a given program is successful in meeting its predefined measures. The program was funded by a private investor. The government now has to pay the private investor its profit, using taxpayer dollars. Taxpayer dollars are explicitly going into private hands through the use of the Social Impact Bond. On a side note, assume that a given program is bound for failure. What investor would invest in something with no return? One might as well donate money instead...The problem is when you or I are forced to pay a profit to that private individual via a tax. It is no longer a voluntary exchange..."

Alright, Let me begin by clarifying that the purpose of the Social Impact Bond is to SAVE the usually-wasted taxpayers dollars in the long-term.  If you look to the yellow-highlighted words, the author attempts to illuminate the absurdity of using tax-dollars to pay back investors.  In my mind, this is no "hidden reality"...in fact, using our money  to pay for private return is CLEARLY what is happening.  And it's happening because the investor was willing to take a risk on the given social program, it worked, and will now save taxpayers' money in the future because the government no longer needs to waste time or money on its traditional, failing methods.  The return paid to the private investor will be only a fraction of the total our government will save going forward... that's the whole point.  It's a math game.

Are you okay with that?
I certainly am.   
 
Now let's take a look at the words highlighted in blue, and remind ourselves that ANY investment, be it for high financial returns, blended value, or pure impact, involves risk. 

The author asks, "What investor would invest in something with no return?", and I respond, "Ugh, many people invest without receiving a return."  The risk factor is what drives the market to work.  Just as investors take on the risk of losing money in the stock market, investors in Social Impact Bonds take on the risk that the given social program/venture will not be effective.  But at least it will have allowed us to see what doesn't work, which will make for more effective solutions going forward.

And so to the question of "What investor would invest in something with no return?", my second response is: Impact Investors, of course.

And there are a growing number of these people.  We need them, because relying on donations and government grants does not allow for risk-taking in the non-profit world.  And without risk-taking, the big solutions won't come.  It works the EXACT same way in the main-stream business world. 

SO, as you might tell, I am a little heated by this topic.  But it's only because I believe in its potential and want taxpayers to understand the powerful influence of Social Impact Bonds and non-profit risk-taking.  

In Obama's recent budget announcement, $100 million is allocated to social impact bonds.  While this is only a meager .003% of the entire U.S. budget, it is at least a step forward.
 
Only time will tell how well the model will work and how taxpayers will respond.  
Stay tuned, it will be an interesting ride!

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