Doug Smith: Social Impact Bonds – Right Result, Wrong Way (Part 1)

By Douglas K. Smith, Member, Board of Directors, SeaChange Capital Partners

Social impact bonds, a useful experiment underway in England, is gaining attention on this side of the pond, including from the Obama administration. We are glad to see this at SeaChange (a non-profit group seeking innovative ways to bring capital to the non-profit sector). What is deeply concerning, though, is how some elites are packaging and promoting social impact bonds as yet one more example of everything the market does is good while everything government does is bad. Moreover, these same elites betray a stunningly superficial grasp about how markets actually work.

This is lamentable. Think for a moment about a common method among athletic coaches. Whether its tennis, golf, baseball, or any other sport, coaches know that athletes might get the right or wrong results by doing things the right or wrong way. You might win a tennis match with a sloppy forehand – and, ultimately, if you’re to improve your game, you need to win matches hitting forehands correctly. My skepticism, then, is less about using and learning from social impact bonds than about the ‘right result, wrong way’ advocacy that links them to ideological ‘givens’ about always good markets and always bad government. Moreover, this same overly simplistic positioning threatens to create ‘wrong result, wrong way’ outcomes by too easily producing misuses of social impact bonds in ways that cause them to fail.

For those who’ve not heard of them, let’s answer the Times’ David Leonhardt’s question, “What are social impact bonds?

The short answer: a vehicle offering investors bond-like returns for taking equity-like risks on investing in potential solutions to socio-economic challenges. The key to success lies in the performance results achieved by the social service providers. If yes, investors gain bond-like returns sourced from cash linked to that performance. If the providers fall short, however, investors suffer equity-like losses. A group called Social Finance is experimenting with social impact bonds aimed at reducing recidivism among inmates in a UK prison. If they lower the recidivism rate by 10% greater than comparable prisons, investors gain between 7.5% to 13.5% returns. If the social service providers fail to do this, investors lose their money.

Let’s first look at the ‘right result, wrong way’ chorus on how social impact bonds derive from the wonderfulness of markets. Leonhardt does this. So does Harvard Professor Jeffrey Liebman in a Center for American Progress white paper on the subject.

Both are enthusiastic about how social impact bonds can bring much needed to capital to serious social ills. Terrific! Maybe we’ll get the ‘right result’. But why must each slide into the all-too-predictable ‘either/or-ism’ that bedevils our search for creative solutions to real problems. Not only do they premise support for social impact bonds on the monotonously dumb meme of ‘markets good/government bad’; but, they do so in ways that threaten to add the phrase ‘market discipline’ to ‘free markets’ and ‘shareholder value’ as yet one more entry in the mindless lexicon of the status quo.

Discipline is not a phenomenon uniquely linked only to markets – a point ignored by Liebman and Leonhardt. We can and do speak just as much about organizational disciplines, network disciplines and personal disciplines. What ‘market’, e.g., explains the discipline used by weekend tennis players to hit forehands correctly? Organizations, too, choose the disciplines used to achieve their purposes. Yes, sometimes those choices are influenced by markets – but not always and certainly not always in ways so ideologically implied by Liebman and Leonhardt.

Liebman notes that too many government programs have disciplines that focus more on defining activities than results. But it does not follow logically or empirically that ‘market discipline’ is the only cure when such an activity-focus has ill effects. (I say “when” because, while there are ill effects to address, Liebman’s ‘either/or-ism’ ignores the good effects of an activity-focus in governmental contexts; namely, the means and ends demanded by notions of fairness and due process inherent in some versions of the rule of law.) Most private sector organizations, by the way, also have various forms of activity-driven disciplines that arise from the operations of their hierarchies, management processes and shared values – patterns that emerge notwithstanding the effects of the disciplines imposed by the markets in which they compete. Consider only the long, sad history of American automakers over much of the last three to four decades. For them, activity-driven organizational disciplines trumped ‘market discipline’.

But the flip side is also in evidence. That is, in addition to observable private sector activity disciplines trumping market discipline, we also see plenty of examples of organizational performance disciplines instead of activity disciplines in the absence of any market. Over the past few years, for example, a range of Georgia state government leaders with whom I’ve worked have shifted their agencies toward performance disciplines for services ranging from driver’s license renewals to job preparedness to prison reform to education to highway maintenance and more. Millions of dollars have been put to more productive use, and dozens of innovations plus much better customer service and new capabilities have been spawned – and all in the absence of any discipline derived from any market.

Both/and. Not either/or. The bottom line: markets might impose performance disciplines on organizations. But, contrary to the ‘markets good/governments bad’ trope, there’s neither any guarantee that the existence of a market equates with a disciplined focus on performance nor the inevitability that the absence of a market prevents as much. Why then is there this deep-felt need by elites to hew their conversations to the ideological line of ‘markets good/governments bad’?

The absence of ‘market discipline’, then, does not prevent any agency at any level of government from a shift to performance: it’s a question of leadership and will. Might social impact bonds help? Yes. But it’s not the kind of sine qua non requirement suggested by Liebman’s and Leonhardt’s all-or-nothing use of a phrase like ‘market discipline’.

Next, the ideological use of ‘market discipline’ clothed in ‘market good/government bad’ rhetoric is, well, unreal. Liebman and Leonhardt are smart and accomplished individuals. They’ve been around. So, why the thundering silence about ‘market discipline’ and, ahem, you know, events of the past decade? How did this ideologically pure ‘market discipline’ work out in financial, residential and commercial real estate, health care, and other markets? Leonhardt points to the wasting of ‘billions of dollars’ in government programs. How about the trillions of dollars of value destruction in these arenas subject to ‘market discipline’?

The concept that market discipline guarantees efficiency and effectiveness is fallacious. Nearly four years ago, for example, it was clear that the performance disciplines used by the best non-profit housing groups far outstripped the performance disciplines used by the private sector in terms of delinquencies and foreclosures. Yet, the private sector got all the capital. So much for ‘market discipline’. What happened there? Was there no market discipline? Was there no link between capital markets and competitive performance?

No. Actually, the reverse. Capital market discipline combined with organizational and managerial disciplines to promote a peculiar kind of performance on private sector players. We all know the nice sounding words that were (and are) used for this: earnings, returns, ‘shareholder value’. It’s just that these melodious sounds became ever more narrowly and loudly linked to unsustainable and even criminal greed through the precincts of the shorter-term, the quicker buck, the larger bonus, and the faster, more untraceable shifting of risk to others. Yes, ‘market discipline’ focused all of the various players on performance – banks, mortgage brokers, real estate brokers, hedge funds, ratings agencies, lawyers, accountants and more. But instead of efficiency and effectiveness that maniacal performance focus gave us control fraud, speculation, looting and managerial–and-casino capitalism.

Does that make ‘market discipline’ evil and bad? No. Remember: both/and, not either/or. Liebman and Leonhardt would recoil at anyone who condemned ‘market discipline’ to be banished from human experience based on these gargantuan failures of the past decade. Why, then, do they crow so loudly in favor of market discipline as a panacea for government and social sector ills? Again, why only a reference to the billions wasted by (some) government efforts and not the trillions destroyed by (some) markets?

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  1. attempter

    Egypt just provided the latest proof that there are alternative modes of organization and discipline to markets or governments. There’s cooperative, directly democratic organization and discipline. (The worth and practicality of this has actually been proven lots of times, like during the Spanish Revolution, but such proofs are always suppressed by conventional history. We’re already seeing the Obama swine trying to depict Egypt’s preliminary victory as the result of Obama’s intercession, when in fact he did nothing but try to prop up the tyrant, even personally giving him moral support.)


    Why then is there this deep-felt need by elites to hew their conversations to the ideological line of ‘markets good/governments bad’?

    Because they’re elites. That means one worships either the market or government (or more often both). In both cases, one is worshipping elitism itself, and suppressing the very concept of democracy.

    Ideas like these bonds may possibly serve a constructive purpose in introducing the very idea of something other than market “values” into the equation. But the clear and present danger is that the end result isn’t to draw investment activity toward real values which aren’t easily quantified like rebuilding communities, but instead that the value itself ends up commodified and corrupted.

    We’ve seen that play out with the whole “social entrepreneur” scam. We see how corporate liberalism was never anything but a treacherous fraud.

    So while it’s often necessary for citizen activists to temporize with the hostile environment, we need to be all the more vigilant wherever we deploy such hybrid ideas and tools.

    The primary, disciplined idea and argument must always be that the real values are democracy, community, cooperation, and not those of the corporatist “market”. That’s the real sea change we need and want, and that’s what will also make for our long term economic prosperity. We know that the existing market will do nothing but enslave and then kill us in the end.

    1. attempter

      I should clarify that my remarks are meant to apply to ideas like this in general, but not this particular group, which is a Goldman Sachs front. If you click on the link, you’ll see its abstract, bloodless language, totally devoid of the slightest indication regarding what values the group allegedly serves (I suppose the very term “non-profit” is supposed to be a talisman). There’s also its suspicious emphasis on wanting to help with “collaborations” among groups (as opposed to actual initiatives undertaken by a group). It specifies mergers as one activity it encourages. Gee, I wonder why that might be.

      So this particular scam is only intended to inject the bankster parasite further into every kind of activity which hasn’t yet been commodified.

    2. leroguetradeur

      attempter, the possibility of non-market based economies is something you write about a lot. But the only example you can come up with is that of something you call the Spanish Revolution? When was that, exactly, and how long did it last? And how was it organized?

      The question we need to ask about this stuff is, show us a historical example of a real modern society complete with consumer goods and supermarkets that has worked for some reasonable period, like 20 years, under this alternative model.

      Also, explain in specifics exactly how its going to work. Like, for instance, how will people get to decide where to live, in what house? Will there still be money? Who will pay what to who? Will there still be stores? How will they get goods, from who?

      At the moment, its a bit like a rant about some imaginary medical treatment for malaria, which is not specified, but is said to have worked real well in France in 1742, but the exact description of it and how well it worked were suppressed by the main stream media.

      But we should start treating all third world countries suffering from malaria with this great treatment right away.

      Get real. Get specific.

      1. attempter

        The one and only reason I can’t provide modern examples which lasted for 20 years is that each functioning example was destroyed by violence.

        So your argument boils down to shooting someone in the head and then claiming that proves whatever he was working on can’t work.

        Meanwhile, we have complete proof that your way doesn’t work and isn’t intended to work, if the definition of working is that capitalism leads to an ever greater proportion of the populace achieving comfort, security, happiness, and greater leisure.

        Why didn’t it work? Capitalism certainly produced more than enough wealth for that. It still does. So why didn’t it work, if its ideology was on the level? Hmmm….

        And if it ever had anything to do with “freedom” and “democracy”, then why was every serious alternative subverted by fraud or smashed with violence? Surely if people really “want” capitalism the way you all claim, there would never have been any need for such unpleasantness? Hmm….

        So the end result is, as a result of capitalism’s violence I can provide only an incomplete evidence record to go along with the clear rational and moral superiority of the democratic ideal. But we have overwhelming proof of the absolute failure and mendacity of capitalism and its ideology.

        Putting it all together, I think any rational person with integrity would say we have enough to move forward. We have proof that the status quo is impractical and destructive. We have an alternative which makes sense in principle and has a promising record in practice. So what possible argument, other than having a vested interest in the existing bottleneck, could one have to oppose moving in the new direction?

  2. skippy

    Well it didn’t take them long to cook up another…soon to be raining down on our heads…financial boondoggle….Yes yes I know its for* our good* like housing/asset prices that never blow up in everyone’s face…save theirs (the bondholders par excellence).

    It is disconcerting to think the world (all living things) would be a better place, if only such a small percentage of the total population, would join a heavens gate cult and catch a ride out of here.

    Skippy…just another candy apple w/ a razor blade inside it, but, how could it go wrong…right? I mean all the other historical financial explosions were accidents…trust me baby, I won’t do it again.

  3. Paul Repstock

    Further to my earlier rant about the lack of integrity amoung Canadian politicians. Our estemed prime minister has just finished putting the ucing on the cake. I did not think it possible to sell an entire country including contents and cattle. But it would appear that mr harper has done just that. Without consulting Canadian voters, he has placed us under the authority of the united states. The lack of capitals is intentional, I nolonger respect any government in the least except perhaps Iceland (for as long as they survive). I consider that politicians have nowhere near the morals of prostitutes, at least prostitutes only sell thier own bodies, and they harm no one.

    Btw. in case you see water as a justification for annexing canada, you don’t need our water, you need a national water management plan. There just wouldn’t be enough profit in that for the “right” people.

  4. Dan

    I think the idea here, as it is being touted in England anyway, is not that this is a pure financial returns driven exercise, but rather a ‘middle-way’ social investment.

    It is not for hard-core investors looking to maximise returns.

    It is more for foundations that perhaps would have been providing that capital anyway as grants, but now have the potential of recycling it. Or corporates as part of their philanthropic/PR output, again with the potential to recycle. While impact measurement is notoriously difficult, it aims to improve on this area as well by developing new reporting tools – whether these will be effective or not remains to be seen.

    Obviously there is scope for abuse – in awarding contracts, in measurements carried out by the ultimate funder (government) which mysteriously never allow for those maximum returns – but to seek a new means of funding civil society organisations in the wake of massive cuts to statutory funding is a worthwhile experiment at worst. And at best, this could prove to be a real deliverer of positive change which benefits society, investors, and tax payers alike. But maybe i’m just not being cynical enough.

  5. Woosta007

    Great article.

    I think a more holistic approach to investing which encourages a broadness of perspective and a realization that any analysis based only on short term profit maximization without looking at broader impact of policy costs is always a better thing.

    Also, the self serving terminology of market cheerleaders and those seeking to promote the elitism and narrow vision should be pointed out so that better methods and ways to measure success are used.

  6. LeeAnne

    Welcome to the Alice-in-Wonderland of scholarly sounding papers for a trial balloon in the pursuit of schemes for privatizing everything on earth for profit and scamming widows and orphans

    The topic reminds me of a question in an economics undergraduate class about privatizing prisons; whether it was right or wrong.

    The correct answer was just as plain and simple then as now that we have experience with it and data: some things are just wrong.

    That wasn’t the right answer of course.

  7. Idealogue

    Anyone who has lived through 2008 with a home or a dollar invested in stocks or credit understands painfully that “markets good” is not always true. And, anyone who’s heard about the $1000 toilet seat understands that “government bad” is a reasonable conclusion at times. The point of Social Impact Bonds is not that they tame government excesses with free market forces, its that they shift risk from taxpayers and governments to investors who are willing to take it on. Investors looking for returns uncorrelated to equity or credit markets should be interested in taking on some risk that a social program will fail and capital will be lost, as long as they feel this risk is mitigated by proper management and oversight. And, governments that stand to realize cost savings throughout the system from effective preventative services should be thrilled to transfer the risk of failure to individual investors or Philanthropists, in exchange for sharing some of the gains. That is what is happening here — it’s a capital markets innovation that allows for risk arbitrage and recycling of philanthropic dollars, not a tired markets good/government bad meme.

    1. wtf

      Except that 2008 taught us all that the risk always gets passed on back to the government in the end. There is absolutely no reason to believe it will ever be otherwise.

  8. wtf

    This is an obvious boondoggle. Is there anyone out there who honestly thinks investors will ever be allowed to take losses on these things? Market discipline always means passing the losses on down to the poorest and the lowliest among us.

    1. john bougearel


      Love the effort here. Lots of good questions.

      Social Impact Bonds do have a nice melodious ring to them and trap us into thinking its a win-win scenario.

      You are right to caution that you can still produce the ‘wrong result’ outcomes if done the ‘wrong way.’

      However, I am inclined to agree with wtf’s cynicism that if social impact bonds ever caught on in a big way (like making housing more affordable) the risks would always “get passed on back to the government in the end.”

      They’d have to be regulated in a way that they couldn’t be gamed by the various parties involved. And we all know how well Fannie and Freddie was gamed and morphed into giant black holes for taxpayers

  9. Schofield

    Yep! I can really see Greed Street taking a haircut on a Social Impact Bond for a government Wealth Redistribution Program!

  10. Bill

    Mission Related or Impact Investing has been around a while. The media has just discovered it. Here is the preeminent project studying its use:

    It may make sense for a nonprofit foundation to use its principal, in addition to the income it makes from investments, to further its mission whatever that mission is. It clearly doesn’t work in all circumstances and, arguably, in market failure circumstances.

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