(Bloomberg News) New York City and Massachusetts are turning to a mixture of philanthropy and profit to fund projects tackling homelessness and inmate recidivism, using a program that can offer investors returns as high as 13 percent.
It's the first embrace in the U.S. of a public-private funding method known as social-impact bonds. Also called pay-for-success contracts or social-innovation financing, the model allows governments to transfer the risk of expanding prevention programs to investors. Taxpayer money is spent only if the results exceed a measurable goal set by both parties.
"This makes it possible to invest more in prevention, which are often the first programs that get cut in fiscal stress," said George Overholser, chief executive officer of Third Sector Capital Partners, a nonprofit financial-advisory firm in Cambridge, Mass.
"It's also a way to be sure that the programs that get funding are also the programs that work," he said. "And it's a way to align socially progressive goals with fiscally conservative goals, which is a real political winner."
Overholser, who was on the founding management team of Capital One Financial Corp., has been advocating innovations in social financing since 2001. His company is advising the nonprofits that will run Massachusetts's programs.
Private Capital
State and local governments are seeking private capital to fund projects after the 18-month recession that ended in June 2009. Local-government revenue has fallen for six straight quarters, according to a report this month from the Nelson A. Rockefeller Institute of Government in Albany, N.Y. State tax revenue was still 1.6 percent lower in the first quarter of 2012, when adjusted for inflation, than it was four years ago, the group said.
Social-impact bonds don't function like traditional debt. They're more like pooled equity vehicles in which investors provide financing with no promise of a fixed return, according to the Rockefeller Foundation.
The New York-based philanthropy helped fund the first social-impact bond program in 2010 at HM Prison Peterborough in the U.K. and promotes those in the U.S. Officials in New York state, Connecticut, Los Angeles and Ohio's Cuyahoga County have also expressed interest, said Justina Lai, a foundation associate.
U.K. Pilot
The U.K. pilot program focuses on the rehabilitation of 3,000 short-term prisoners incarcerated at the correctional facility north of London. If recidivism drops by more than 7.5 percent, investors receive an annual return that can rise as high as 13 percent, according to Social Finance U.K., which developed the financing structure.
The original lenders, including the Rockefeller Foundation and the London-based Esmée Fairbairn Foundation, were mostly charitable trusts and nonprofits, though proponents want to attract a broader range of investors.