Could the White House’s 2014 federal budget kick-start the social impact bond market?

No casual observer of the social impact bond (SIBs) market could be faulted for believing that the interest in SIBs exhibited by the U.K. has yet to spread to the U.S. After all, 13 SIBs have been funded in the U.K., compared to only one in the States. But these numbers are deceptive, owing more to structural differences between the countries’ governments than a gap in interest. New provisions within the White House’s proposed 2014 federal budget, if approved, may help the States’ SIB market begin to look more like the one thriving across the Atlantic. The budget includes a $500 million allocation to SIBs and similar financing structures (five times more than the 2013 budget earmarked to such setups). Social impact bonds ask private investors to assume the risk of government-funded social programs’ possible failure by requiring investors to pay the programs’ up-front costs with an understanding that if the services don’t achieve their desired outcomes (like fewer emergency-room visits, lower recidivism, decreased homeless populations, or something else), the investors receive nothing. But when investors’ funds go to programs that prove successful—and thereby alleviate drains on public funding—the government pays investors back their principal, plus a return tied to the social programs’ levels of success. The concept was born in the U.K., where the first SIB contract was signed by the Ministry of Justice in March 2010. It asked investors to bank on the success of a recidivism prevention program at a prison in the city of Peterborough. Since then, 12 more SIB contracts have been funded in the U.K. Last summer saw the funding of the U.S.’s first SIB, when Goldman Sachs signed on as the investor and funder of a program to reduce recidivism among youth incarcerated on Rikers Island. (Goldman’s risk was largely attenuated by a loan guarantee from Bloomberg Philanthropies, Mayor Michael Bloomberg’s private foundation.) It’s still the only bond to have crossed that threshold in the country.But that seeming stagnation in the U.S. belies the activity just beneath the surface where interest in the SIB concept sparked and spread after the Peterborough launch. U.S. public social programs are seeing record demand against a backdrop of shrinking funding: According to a survey conducted by the Nonprofit Finance Fund, a New York–based organization that supports nonprofits via loans, consulting and other services, 78% of non-profits saw demand for their services increase in 2012, and 85% expect to see that climb in 2013. Despite these trends, one in three not-for-profit organizations received less government funding in 2012 than they did in 2011. And, for the first time in the survey’s five years, more than 50% say they’re unable to meet demand for their services. Not surprisingly, then, states, cities and counties of all political persuasions across the U.S. have expressed interest in the SIB model. But compared to the U.K., relatively few have achieved fully funded SIB contracts, in large part because of a structural complexity within public social funding systems in the U.S. that doesn’t translate to the U.K., which benefits from more government centralization. For example, the U.K.’s Department of Justice, which signed the Peterborough deal, doesn’t have an equivalent in the U.S., where prison systems are overseen by states and other local governments. “In the last six months or so, we’ve just been realizing how hard it is to make [SIBs] work in the messy reality of how we currently fund our social system,” says Antony Bugg-Levine, CEO of the Nonprofit Finance Fund, which received a $400,000 grant in 2011 from the Rockefeller Foundation along with the charge to organize a conversation around how to adapt the social impact bond concept to the U.S. The U.S. federal government is seeking to address the specific messiness of its system in its proposed budget. One of the provisions in the White House’s budget is a “top-off fund,” which would help smooth complicated accounting
problems that arise when multiple government agencies or jurisdictions see savings from a social program that one single agency or region is funding. Bugg-Levine says another major problem he’s encountered as he’s sought to oversee SIB development in the U.S. is a disparity between the risk profiles of potential investors and the risk within early SIB investments. “There are quite a few banks right now in the U.S. who are organizing internally to raise pools of investment capital to put into SIB deals; at least four banks are in active conversations with us,” Bugg-Levine says. “But all of them are eager to put in relatively low-risk money. There’s a real focus on avoiding capital loss.”The proposed budget has an answer for that problem, too: a new $300 million “incentive fund,” which would offer credit enhancements for investors in SIBs, potentially lowering the risk of the investments. Though the details of the incentive fund and the White House’s other SIB budgeting specifics have yet to be written out, Bugg-Levine says these supports may be just what the future U.S. SIB market will need to grow. “What the Obama administration is proposing in their budget, were it to be implemented, we believe would make a big difference in accelerating the transition from talk to action in SIBs in the U.S.,” he says. “But we also know there’s a long road between what the president proposes in his budget and what ultimately gets funded.”