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Big banks such as Goldman Sachs (NYSE: GS ) have been getting kicked around a lot lately, dealing with problems like a mass exodus of partners over the past 18 months as well as a nearly 6% drop in global investment banking jobs. Add to that the continued bad press when, once again, investment banking giant and fellow bad boy JPMorgan Chase (NYSE: JPM ) gets slapped with yet another lawsuit pursuant to its dodgy mortgage-backed securities sales. It's enough to make a big bank think twice about getting into a new line of business.
First investment of its kind for a U.S. bank
Well, maybe not entirely. Goldman has embarked on a new investment project, based on an experimental program first trialed in the United Kingdom. The bank has invested nearly $10 million in an anti-recidivism program at Rikers Island, N.Y., through a social impact bond partnership with the city. Simply put, if reincarceration rates fall below 10%, Goldman makes money. If not, the investment bank could lose up to $2.4 million.
These bonds, which put the emphasis on results, fund social programs using investors' money, not taxes. The parties contract with agencies that implement the programs, such as those for young offenders or the homeless. Outcomes must match up with expectations -- such as the 10% recidivism rate in the Rikers Island example -- or investors don't get paid and may lose money.
Good PR, possible profits
Goldman is a trailblazer here, but the risk has been ameliorated by Bloomberg Philanthropies, which is putting up a $7.2 million guarantee for the project. This is unusual, and it will seriously limit the bank's loss if the program fails. This surely made the investment a lot more attractive to Goldman -- and probably was necessary to get the idea off the ground -- since investors could conceivably lose all of their money if the project fails. If the contract delivers on the agreed-upon results, though, the bank could pocket a cool $1.1 million on the deal.
There is a definite public-relations aspect here as well. Goldman looks like a do-gooder of sorts, even though the money is an investment, not a donation. In the current big-bank-hating climate, this is no small thing. Other banks, such as JPMorgan, which has suffered much vitriol about its trading gaffe earlier this year, as well as Bank of America (NYSE: BAC ) , could find these vehicles a painless way to drum up some warm and fuzzy public feelings and make a profit at the same time.
Massachusetts has recently awarded contracts under its own Social Innovation Financing plan, which has a booster in George Overholser, one of the founders of Capital One Financial (NYSE: COF ) . Overholser's former company might be another investor candidate in need of good PR, having just settled with federal regulators for $210 million for selling dicey credit-protection products to credit card holders. Bank of America quit selling the product on the heels of that settlement, before it was taken to task, too.
As the Massachusetts state Secretary of Administration and Finance notes, the program is not only about doing good; it could save the state money, reduce crime, and create value for investors. As an example, he points out that a typical homeless person incurs costs to taxpayers of approximately $35,000 per year because of various issues such as addiction and poor health. Reducing those costs would be a boon to everyone involved, including the homeless.
Other states, including Connecticut and Oregon, are also looking into these partnerships, as well as municipalities and counties in Ohio and California. This method works by figuring out how much social problems cost and then coming up with a plan -- with a profit motive attached to encourage positive outcomes -- to not only save money but to actually fix some of the causes of the problems. If it plays out, this type of program could truly please everyone.
Conservatives will like it because it puts private money at risk rather than tax dollars, and it might lower taxes as well as bring in money for the state. Progressives will like that the program goes to the root of the problem, and social-service contractors will make money administering the contracts. Naturally, the people on the receiving end of the services, whether prison inmates or the homeless, will also experience better outcomes and rehabilitation if successful.
Then there are the investors. Although Goldman's possible profit seems small at $1.1 million, the investment is only $9.6 million -- translating into an 11% takeaway. Not a bad yield at all, particularly in this low-return environment.
Will these programs work, and, if so, will they catch on? This is a new direction worth watching, as success could mean investment products that deliver positive results for both society and investors -- a true win-win.
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