One of the utterly neglected stories of 2013 was how investment banks are attempting to profit from providing public education. Let’s review (boldface mine):
Goldman Sachs is making its second foray into an experimental method of financing social services, lending up to $4.6 million for a childhood education program in Salt Lake City.
This “social impact bond,” in which Goldman stands to make money if the program is successful but will lose its investment if it fails, will support a preschool program intended to reduce the need for special education and remedial services. The upshot, in theory, is that taxpayers will not have to bear the upfront cost of the program.
Goldman is being joined in this effort by the Chicago investor J.B. Pritzker, who is providing a subordinate loan of up to $2.4 million, bringing the total financing to $7 million. The loans will be announced at an event in Chicago on Thursday…..
The loans are going to the United Way of Salt Lake, which oversees the Utah High Quality Preschool Program. The investment’s success will be measured by the level of cost savings when children do not need to use special education services, which are financed by the state.
The loans carry an interest rate of 5 percent, which is paid along with the principal if the program is successful. In the best case, Goldman and Mr. Pritzker would make additional “success fees.”
Now they’re spreading into the recidivism prevention business (boldface mine):
Goldman Sachs Group Inc., which wagered more than $300 billion last year on things like yen rates and bond spreads, just laid down a bet that guys like Nelson “Johnny” Aguilar can stay out of jail….
Such crime-blotter moments are Goldman’s concern thanks to a financial product called a social-impact bond. Goldman is anchoring a $21 million plan to help a Boston-area nonprofit called Roca expand its efforts to steer young men like Aguilar away from dealing drugs, stealing cars or committing assaults and murders.
Under the deal, if men targeted by Roca spend 22 percent fewer days in jails and prisons than their peers, Massachusetts would save enough to repay Goldman’s $9 million loan. An even bigger drop in recidivism would hand Goldman as much as $1 million in profit. If Roca fails and too many men end up behind bars, Goldman will lose almost everything it ventured….
Regardless of Roca’s performance, Goldman will get 5 percent annual interest on its loans. As senior lender, it’s first in line to earn back its principal, triggered by the 22 percent drop in days that participants are incarcerated as well as their success in getting and keeping jobs. With a 40 percent drop in incarceration, Massachusetts would repay the investors $22 million, the same amount it would save. Above that, the state would begin keeping part of the savings.
The reason this is necessary has nothing to do with the need for free market incentives or any other hooey like that. Instead, it is the unwillingness of the commonwealth (and the Commonwealth) to provide necessary services through taxation. If the program works as advertized, there’s no reason why the state can’t or shouldn’t fund this, rather than giving Goldman Sachs a cut of any potential savings (and guaranteed five percent interest*).
Given their history of financial chicanery aimed at municipal governments (Goldman Sachs played too), it’s also hard to believe that they won’t game the metrics. Probably not in this specific case: too much attention will be paid. But down the road, expect municipal and state governments to be fleeced, all because the idea that we are members of a commonwealth, that if you are strong, you are supposed to aid others because it is the right thing to do, has withered.
This will end badly.