Goldman Sachs: Starting a Trend in Social Investment?

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.

A win-win?
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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Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase and Bank of America. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On August 26, 2012, at 8:20 AM, jlogsdo wrote:

    So, let's get this one boiled down to the basics. The timeline goes something like this:

    - Glass Steagal Act goes down in flames under

    Uncle Billy Clinton in 1999.

    - Banks start muddling funds together in 2000 \

    (like investments, checking accounts, etc.)

    - By 2007 (8 years) Uncle George is dealing with

    Uncle Billy's stupidity and big bank/investment

    industry greed and the economy is tanking

    - 2008 sees "the Great Recession"

    - Stock market bottoms in March 2009

    - Gobs and trillions of taxpayer money poured

    into the "too big to fail" plan under Uncle Obama

    - Meanwhile we have no one left to buy homes

    and cars in the USA (except for the ones who

    got the outlay of cash from stupid investment

    mortgage schemes) except for the Chinese

    (more Buicks sold in China in 2007 vs. USA).

    "Stupid is as stupid does...that's all I got to say 'bout that."

  • Report this Comment On August 27, 2012, at 1:38 PM, joshuaboone wrote:

    At the risk of sounding stupid, why exactly is it bad to sell more cars in the emerging economic superpower?

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