A Center of Greg’s Own

I can’t add much to the many moving tributes paid to Greg Dees at the memorial event held on February 11^th at his beloved Center for the Advancement of Social Entrepreneurship.  I've watched much of the video, read many of the blog posts, written my own, and remembered the sweet and brilliant man I knew far less well than so many others.

I do, however, have one question:  What would it take to name CASE in his honor?  

Speaking for absolutely no one but myself, I ask this for two reasons.  First, and most obviously, because it was Greg’s labor of love and genius.  Second, because I am indebted every day to the extraordinary work that emerges from his descendants.

I’ve had the great privilege and tremendous fun of guest-teaching Cathy Clark’s class in social entrepreneurship, and I’ve gotten to know many of her gifted colleagues.  But as someone who makes a substantial part of his living keeping up with the prodigious scholarship in the field, I can attest to the singular brilliance of the work coming out of CASE.  To mention just two of many examples, their work on scaling social impact is second to none, and their “Impact Investor” collaboration with Pacific Community Venture’s InSight (Ben Thornley) and ImpactAssets (Jed Emerson) is nothing less than seismic.

None of this would have happened without Greg.  Now, Ed Skloot might be right that social entrepreneurship itself “is the legacy he left which we now can assume.”  But I’m not so confident that we’ll always remember how we got here. 

And so I ask, could we have the J. Gregory Dees Center for the Advancement of Social Entrepreneurship at Duke University’s Fuqua School of Business, in deserved honor of the man who really was the better angel of our nature?

Do SIBs qualify for the Community Reinvestment Act? Oh, yeah.

[This post was originally published in SIB Trib No. 2.  I'm republishing it here to respond to the fine article by Diana Aviv and Antony Bugg-Levine, "Social-Service Groups Won’t Survive Without New Sources of Revenue," published in the Chronicle of Philanthropy.  Among other sound recommendations, the authors make the following proposal: 

"Expand the Community Reinvestment Act. For more than 35 years, the act has prompted banks to lend in underserved markets and spurred the creation of the community-finance industry. Expanding the law to facilitate easier investment in a wider range of organizations could make billions of dollars available to social-service organizations."

As sensible as this might be, modernizing any federal legislation, particularly one with fiscal implications, is exceptionally these days. I'm not a bona fide CRA lawyer, but I believe the act already covers SIBs.  If so, a simple interpretive letter from federal regulators might do the trick.  I'd welcome comments from CRA attorneys who actually know what they're talking about.]

Wouldn’t it be handy if there were some relatively painless way to attract commercial investment in SIBs that didn’t require all that messy business about outcomes and savings?  Something that didn’t involve financial modeling, risk management or counterfactuals?  Some incentive that was simple and pure, easy to fathom, but with a kick like moonshine whiskey?

Many have wondered if the federal Community Reinvestment Act might fit the bill.  Godeke and Resner think that “CRA capital may be a bridge between the first philanthropically-funded PFS financings and other investors.”  Social Finance US says that CRA qualification “would open up a new pool of institutional liquidity for SIBs within the banking community.”  Institutional Investor reports that Goldman Sachs intends to pursue CRA credit.  

So can SIBs take a page out of the Low Income Housing Tax Credit’s book?  “Many nonprofit executives spend a good chunk of their time trying to talk corporate executives into giving them money. And companies big and small often respond generously. But social entrepreneurs should also consider a less well-known technique for generating new revenues: lobbying for changes in government tax policy. Such changes can yield an enormous outpouring of new resources for the social sector.”  Doug Guthrie, “An Accidental Good,” Stanford Social Innovation Review, Fall 2004.  And with CRA, there’s no lobbying required.

Now, I’m an experienced regulatory lawyer, but I’ve never worked with CRA before.  The statute has more than a few technical hoops to jump through that keep bank legal departments plenty busy.  The statute is short, but the regulations are long, and the regulatory examination process is exacting.  

All that being said, however, the question of whether SIBs are eligible for CRA credit seems to be a fairly straightforward.  Subject to the particulars of specific transactions, SIBs are just the kinds of investments that the CRA wants banks to make.

Section 802 of CRA provides as follows:

“(a)  The Congress finds that – (1) regulated financial institutions are required by law to demonstrate that their deposit facilities serve the convenience and needs of the communities in which they are chartered to do business; (2) the convenience and needs of communities include the need for credit services as well as deposit services; and (3) regulated financial institutions have a continuing and affirmative obligation to help meet the credit needs of the local communities in which they are chartered.

(b)  It is the purpose of this title to require each appropriate Federal financial supervisory agency to use its authority when examining financial institutions, to encourage such institutions to help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions.”

Please allow me to translate:  The CRA requires banks and other regulated financial institutions to meet the credit needs of all of the communities in which they’re authorized to conduct business, rich and poor alike, and federal financial regulators can use their examination authority to enforce that requirement.

Section 804(a) prescribes, in very broad terms, how regulators are to use that examination authority:

“In connection with its examination of a financial institution, the appropriate Federal financial supervisory agency shall – (1) assess the institution’s record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of such institution; and (2) take such record into account in its evaluation of an application for a deposit facility by such institution.”

Again, in plain English, whenever a regulated financial institution applies for permission to open a new branch – something that hyper-competitive big banks do all the time – regulators must check to see if they’re making loans to low- and moderate-income customers in their host communities.  If not, the regulators can deny the application, which is an exceedingly strong incentive for banks to lend money to customers in those neighborhoods.  A bank that wants to take deposits from a certain community must also make loans to that community.

The obvious follow-up question is:  what kinds of lending activities count toward a bank’s “record of meeting the credit needs of its entire community”?  The answer is found in a “Questions and Answers” document jointly published in the Federal Register by all of the federal financial regulators, which provides official “guidance for use by agency personnel, financial institutions, and the public.” [Editor’s note:  This is a 40-page, single-spaced, 3-columned document with about 8-point type.  I read this stuff so you don’t have to.  You’re welcome.]

First, what counts?  To make a very long story as short as humanly possible, the CRA regulations and Q&A document broadly define a qualified investment as any lawful investment, deposit, membership share, or grant that has as its primary purpose “community development” to support the following endeavors: (1) affordable housing; (2) community services targeting low- and moderate income individuals; (3) activities that promote economic development by financing small farms and small businesses; and (4) activities that revitalize or stabilize low- and moderate-income geographies.

  

Second, how’s the counting carried out?  When federal regulators consider a bank’s application, they evaluate the performance of its qualified investments based on: (1) the dollar amount of qualified investments; (2) the innovativeness or complexity of qualified investments; (3) the responsiveness of qualified investments to credit and community development needs; and (4) the degree to which the qualified investments are not routinely provided by private investors.

We can already see encouraging signs for SIBs.  Community development loans for affordable housing, community services, economic development, and revitalization all qualify for CRA credit.  Banks gets points for the amount and innovativeness of loans, as well as for making loans when other private investment isn’t available.  Sounds a lot like SIBs.

But all qualified investments are not created equal:  “Examiners will consider the responsiveness to credit and community development needs, as well as the innovativeness and complexity, if applicable, of an institution’s community development lending, qualified investments, and community development services. These criteria include consideration of the degree to which they serve as a catalyst for other community development activities.” 

In fact, banks get points for applying “special expertise and effort on the part of the institution [that] provide a benefit to the community that would not otherwise be possible.”  So SIBs are likely to receive extra credit “when they augment the success and effectiveness of the institution’s lending under its community development loan programs,” including “a technical assistance program under which the institution, directly or through third parties, provides affordable housing developers and other loan recipients with financial consulting services.”  It would seem that banks that use SIBs creatively to expand the range of loan products, combined with advice about how to enhance their “success and effectiveness,” would be furthering the objectives of the CRA.

Even better, the Q&A provides specific examples of loans that are similar to SIBs.  Thus, “community development” includes “community- or tribal-based child care, educational, health, or social services targeted to low- or moderate-income persons, affordable housing for low- or moderate- income individuals, and activities that revitalize or stabilize low- or moderate- income areas, designated disaster areas, or underserved or distressed nonmetropolitan middle-income geographies.”  Revitalization and stabilization activities include “creating, retaining, or improving jobs for low- or moderate- income persons.”

Qualified technical assistance activities provided to community development organizations include “assisting in fund raising, including soliciting or arranging investments.”  “[M]unicipal bonds designed primarily to finance community development generally are qualified investments.”  Qualified investments also include “investments ... in ... [f]acilities that promote community development by providing community services for low- and moderate-income individuals, such as youth programs, homeless centers, soup kitchens, health care facilities, battered women’s centers, and alcohol and drug recovery centers,” as well as “job training programs that enable low- or moderate-income individuals to work.”  

Investments in community development “funds,” including “nationwide funds,” also count for CRA credit.  “[I]nstitutions may exercise a range of investment strategies, including short-term investments, long-term investments, investments that are immediately funded, and investments with a binding, up-front commitment that are funded over a period of time.”

I’ll refrain from pummeling the deceased equine:  SIBs are indistinguishable from the kinds of traditional and not-so-traditional lending activities that expressly qualify for credit under CRA.  The services they invest in, the reasons for issuing SIBs, the nature of the instrument itself, and the ways they are created all comprise “community development activities” within the meaning of CRA.

But, wait, you say.  What about that pesky language in sections 802 and 804 about “consistent with the safe and sound operation of such institutions”?  Does this mean that, in addition to geographic and income-related requirements, there’s a “safety and soundness” test that SIBs must pass?  If so, do banks need an official interpretation from regulators before they can claim CRA credit for these new-fangled “social investments” in “social innovation” by “social entrepreneurs” that are still completely experimental?  How can something be considered safe and sound if no one has ever done it before, successfully or otherwise?  

At least some risk-averse banks have questions.  As Godeke and Resner report, “[b]anks would like to have their CRA regulators signal that PFS financings would earn CRA credit before committing time and resources to specific transactions....  PFS financings are subject to the same investment committee ‘safety and soundness’ underwriting standards as other bank investments. Underwriting social service intervention based on social science research is difficult and will require the banks to assess new risks. ‘This is new work for the banks,’ was a common theme at a recent meeting of financial institutions to discuss SIB opportunities.”

The implication is that SIBs don’t count because they’re too new and risky.  But I think this reflects a fundamental misinterpretation of the language.  First, as we’ve already seen, CRA specifically encourages banks to make innovative and complex loans.  

Second, and more important, the safe-and-sound language doesn’t restrict banks, it protects them from overzealous regulators who might want them to engage in reckless lending practices.  It’s not a criteria that individual loans must satisfy.

Banks had long used phony creditworthiness arguments to take deposits from customers in poor communities and invest them in only in wealthier communities, an unlawful practice known as redlining.  The legislative history of CRA leaves no doubt that the statute was enacted because “of amply documented cases of redlining, in which local lenders export savings despite sound local lending opportunities.”  To expose this flimsy excuse, the Senate sponsor emphasized that “[t]he bill is not intended to force financial institutions into making high-risk loans that would jeopardize their safety.” 

Thus, the purpose of the “safety and soundness” language is simply to make clear that CRA didn’t require banks to make irresponsible loans in order to fulfill its community development obligations.  It means exactly the same thing as if the law read, “nothing in this act requires financial institutions to engage in unsound or unsafe lending practices.”  It’s a limitation on the CRA mandate, not an expansion.

Nonetheless, some politicians have tried to blame CRA for the 2008 financial crisis.  A November, 2008 staff analysis submitted to the Federal Reserve Board of Governors refuted critics who contended that “the law pushed banking institutions to undertake high risk mortgage lending.”  Rather than mandating reckless loans, the analysts said, “[t]he CRA emphasizes that banking institutions fulfill their CRA obligations within the framework of safe and sound operation.”

Safety and soundness simply isn’t a loan-by-loan determination.  Rather, according to the regulations, “[a] bank’s performance need not fit each aspect of a particular rating profile in order to receive that rating, and exceptionally strong performance with respect to some aspects may compensate for weak performance in others.”  Safe lending practices are examined in the context of a bank’s entire operations, not for each and every loan, which would be impossible to carry out.  Instead, “[t]he bank's overall performance ... must be consistent with safe and sound banking practices and generally with the appropriate rating profile ...”  

In other words, an otherwise safe-and-sound bank is perfectly free to invest in a SIB that raises all kinds of new and challenging questions.  Needless to say, it’s highly unlikely that even a basketful of dubious SIBs could disturb a bank’s business.  For example, even without the Bloomberg Philanthropy guarantee, the complete and total bust of the $9.6 million SIB investment Goldman Sachs made in New York City, or even an investment 10 times the size, would be completely inconsequential to a financial institution that, in the words of Time magazine, “only made [a] $1 billion profit last quarter.”  If JP Morgan Chase could suffer a $6.2 billion loss from bad trades and still earn a record $21.3 billion in 2012, it could probably invest a few hundred million in SIBs and not lose much sleep. 

To be sure, the CRA is a complex statute with a rich regulatory nimbus, and the compliance requirements for SIBs are no less tricky than for other community investments.  Consult a lawyer, your mileage may vary, and so on.  But assuming that banks continue to apply the same basic compliance standards they already follow, and nothing more, the question of whether SIBs can already be considered qualified CRA “community development” investments without further guidance from federal financial regulators does not appear particularly iffy.  

They can.

“SCALE FINANCE”

Giving meaning to “scale” and making progress to its achievement

[Published originally in SIB Trib No. 3.  Of course, I don't speak for any of the organizations mentioned below.]

“Scale” just might be the most reviled buzzword in the social sector lexicon.  An innocent victim of indiscriminate usage, scale has come to mean both everything and nothing, something that is desperately needed and hopelessly unattainable.  Virtually every visionary social entrepreneur ardently hopes his or her program will scale, while every level-headed executive director knows the safe answer to the question, “When will your program reach scale?” is, “At least twenty years from now.”

We’ve got to stop thinking of scale as something abstract and diaphanous.  If we continue to view scale as akin to chasing smoke, it will never be achieved.  Scale refers to something specific and important that can be measured and assessed.  If we set a proper benchmark, we can devise an approach that is fit for that purpose, and we can tell whether we’re on course within five to ten years’ time.  

While it remains to be seen whether meaningful scale can really be achieved within such a time horizon, I’m convinced not only that it can, but that the time to try has definitely arrived.  Herewith, some thoughts on how to get started, an approach I’m calling “scale finance.”

OUR GLASS IS LESS THAN 5% FULL

After more than two decades of development, it is fair to say that the once-disputed experiment known as “social entrepreneurship” has proved the skeptics wrong.   Social entrepreneurship has amply demonstrated its ability to produce innovative solutions to crippling social problems that have transformative potential.  Thanks to the sustained efforts of venture philanthropists and their grantees, we now know — albeit at varying levels of confidence — how to dependably prevent or materially reduce such long-standing social problems as premature births and problem pregnancies, child abuse and neglect, lagging early educational progress, acute asthma attacks, unnecessary and protracted foster care placements, high-school truancy, youth disengagement, juvenile incarceration, prisoner recidivism, and chronic homelessness.

This may come as something of a surprise, however, since every one of those problems remains as pervasive as ever.   As I lay out in my book, even the most effective social innovations have not become available to more than a very small portion of the people who need them.  Effective programs don’t scale and, generally speaking, scaled (governmental) programs aren’t nearly as effective as we’d like.  So while we know how to produce social innovations that “work,” we certainly don’t know how to “scale what works” to produce systemic change. 

All sides of the political spectrum are frustrated by our inability to scale.  EARN’s Ben Mangan complains in the Stanford Social Innovation Review about “rationalized mediocrity” and “stifling incrementalism” that allow nonprofits to “declare success despite the fact that our impact is embarrassingly small compared to the size of the problems we are trying to solve.”

Over at Bloomberg.com, Charles Murray of the American Enterprise Institute responds soberly to President Obama’s call for universal “high-quality preschool” with this hard truth:  “As of 2013, no one knows how to use government programs to provide large numbers of small children who are not flourishing with what they need. It’s not a matter of money. We just don’t know how.”

For all the tremendous progress social entrepreneurship has made, we still find ourselves at the very lowest end of the adoption curve.  I can’t find an effective social innovation developed in the last two or three decades that’s available to more than 5% of the eligible population.  And, with very few exceptions, almost none of the exemplary nonprofits that have developed these effective programs have realistic plans for “crossing the chasm” and reaching even 20% of the total need.

When we treat scale as a moving target that’s always receding over the horizon, we can’t devise realistic ways of getting there.  So what’s an achievable definition of scale, and how can social investment help us pursue it in a deliberate way?

“SCALE” IS THE PROGRESSIVE DISSEMINATION OF SOCIAL INNOVATION FOR SYSTEMIC TRANSFORMATION

“Scaling” is the explicit and active pursuit of systemic social change.  It comprises a set of activities designed to eliminate the gap between the demand for and the supply of effective social programs.  It has two essential elements, both of which are expressed in relative terms:  size and time.

By themselves, efforts to merely “grow,” “expand” or “replicate” programs are not scaling, unless the success of those efforts is measured against the total need.  If you’re trying, for example, to double in size or grow by 20% a year, that’s not scaling, unless the explicit target is to get as close to 100% as humanly possible within a reasonable period of time.  

Once we adopt that (more or less) objective benchmark, it becomes possible to develop and assess scaling strategies.  If your goal is to gain substantially universal adoption, then strategies like “creating a movement,” “government takeover,” “reaching a tipping point,” and “going viral” can’t work because they can’t be measured or assessed relative to an essentially fixed destination.  Almost always, these kinds of terms refer not to scaling but to something magical, like saying “and then a miracle happens.”  

Now, I am not wading into the endless debate about whether organizations themselves need to grow to achieve scale or entrepreneurs should expand innovation through knowledge sharing and the like.  Any approach that works is fine with me, as long as the actual objective is systemic change within a time horizon sooner than “someday.”

Scale poses the question, are you trying to substitute your effective approach for the ineffective way that most people are served now?  Are you actively working under a well-developed plan to accomplish systemic change on a time horizon that transforms the lives of the current generation of beneficiaries?  Do you consider yourself unsuccessful to the extent the glass is not yet full?

Now I may be a scale junkie, but I’m not a scale snob.  Scale isn’t imperative for every program.  More effective approaches to serious social problems are always a good thing, no matter how many people they reach.  Trying to grow by 20% a year is an admirable and worthwhile endeavor, and capable organizations should be encouraged to measure their performance against such accountable goals.  The social sector would be vastly more productive if many more nonprofits increased their impact using those kinds of yardsticks.  (Two masterful books explain how:  David Hunter’s Working Hard & Working Well, and Bob Penna’s The Nonprofit Outcomes Toolbox.)

But for a highly select group of organizations, growth alone — whether steady, rapid or accelerating — is not enough.  It will not lead to the kind of systemic change of which they just might be capable and which could bring a preventable or manageable social problem under control.  For a few programs that are demonstrably superior to the status quo and addresses such devastating social needs that it would be unconscionable not to make it universally available, we have to be willing to say that the time has come to really scale, and to be dissatisfied until we do.  In those cases, we must acknowledge that the sector is failing its most important goal.

You’ll have noticed, no doubt, that I’m conspicuously avoiding exactitude.  What’s so objective and measurable, you might well ask, about “more or less,” “substantially” and “essentially”?  For all my loft aims, I’m staunchly realistic.  I know we’re never going to completely prevent child abuse or house every single homeless person.  Not only can’t we solve pervasive and long-standing social problems entirely, we can’t identify every single person facing such problems or even those that could benefit from an effective intervention.  

But precision is not the point.  Because we know how to respond to some of these problems to an extent that we never could before, we must now ask how can we disseminate those innovations that “work” to the greatest extent possible.  Before we can know how to fill the glass, we must first have some idea of just how big and how empty the glass is now.  Whether we count the volume exactly or supply 100% of the water needed isn’t important.  Right now, we don’t even ask how big the gap is, nor do we try to fill it, because we find the task overwhelming, and not without reason.  

Scale is a relative term that is roughly measured by how far you have left to go, as opposed to various ways of talking about growth that just ask how far you’ve come.   Again, trying to go farther than you have is always commendable.  But if you have the means to climb the mountain, then you should ask how tall it is, how close you are, and what and how long will it take to reach the summit.  When you’re less than 5% of the way there, as we are now, just going farther isn’t good enough if you’re capable of getting to the top, or even nearly so.

SCALING IN PRACTICE

Few nonprofits not only commit themselves to solving massive social problems, but actually develop plausible strategies and plans for doing so to which they hold themselves publicly accountable.  Here are some examples:

National Center on Time and Learning

On October 2, 2007, NCTL announced a goal that “in ten years at least one million children in high poverty communities will attend schools that have redesigned their school day to expand learning time and a majority of schools with this new school design will cut the achievement gap at least in half.”  In 2011, I published a paper in the Philadelphia Social Innovations Journal that assessed the feasibility of this worthy goal.  I believed (and still do) that NCTL could reach that many students, but not in the way it seemed to be going about it.  Looking at their existing growth rate (line 1), I didn’t see any realistic way to increase their incremental growth (lines 2, 3 and 4) to reach the goal in time.  

The only way to do so, I concluded, was by changing their strategy from incremental growth (handfuls of schools at a time) to step-change growth (at the district or metropolitan level), as in line 5.  This would be similar to  the sector-based growth that the Omidyar Network’s Matt Bannick and Paula Goldman have proposed.  (See SIB Trib No. 1)  I didn’t realize it at the time, but now I see that “scale finance” could enable that kind of exponential growth. 

Year Up 

Year Up’s mission is to close the opportunity divide for disengaged urban youth.  In June, 2011, it published a prospectus for an “Opportunity Campaign” to raise $55 million “to increase Year Up’s capacity to close the Opportunity Divide on a national scale.”  Part of its strategy is to develop a “Million-Person Model” “that can grow rapidly to serve many more young adults across the United States ..., with a focus on innovations that allow for greater scale.”  The prospectus notes parenthetically that “serving all 1.4 million young adults in our target population would require us to raise $11.2 billion in private philanthropy each year.”  Lest anyone think that Year Up had taken leave of its senses, the prospectus characterizes that as “an infeasible fundraising burden.”   

Nurse-Family Partnership

In August, 2010, NFP published a “State Needs Assessment” document that is notable for its candor about what it will take to move the needle for Medicaid-eligible young women who are pregnant with their first child:

“In NFP’s experience, improving public health outcomes on a population basis depends on making home visiting and other effective programs and services widely available to a particular community in need. Small scale implementations rarely result in measurable public health improvements at a community level; States should aim over time to offer Nurse-Family Partnership to the majority of eligible women and families who are most at risk in order to achieve measurable improvements in their health, development, education, and well-being.”

Stepping away from vague generalities, NFP provides a detailed table comparing “the [estimated] total NFP-eligible population by States (first-time low income mothers), and ... the current service capacity of all established NFP programs in that States.”   It proposes that “the gap between current capacity and Statewide eligible population provides a broad target for multi-year, incremental, Statewide expansion of NFP services.”  The table shows what it would take to grow each of its current states to reach 50% of the eligible population (versus what I estimate to be its current reach of about 3% nationwide).

Lumina Foundation 

On February 3, 2103, the Lumina Foundation published its 2013-2016 strategic plan for  “Goal 2025.”  The new document updated its 2009 strategic plan which was “based on the goal that 60% of Americans obtain a high-quality postsecondary degree or credential by 2025.”  Lumina described the 2009 goal as “audacious but attainable,” and it reiterated in 2013 that “the goal has always been more than a vision statement—we believe it must be attained, and we believe it can be attained.”  The revised plan advances eight actionable strategies to help produce an additional 23 million degrees, certificates and other high-quality credentials: 

“Between 2009 and 2025 lie 16 years. Our first strategic plan covered the first quarter—the first four years—and this strategic plan will take us halfway to 2025. We have set the stage for reaching the goal, but we believe over the next four years we must do two things: develop a clear understanding of what we must do to create a system of higher education that can reach much higher levels of attainment, and make real progress toward the 60% goal.” 

CAN SIBS ENABLE SCALE?

A few big thinkers have started to connect impact investing to true scale.  In their fine book, Impact Investing:  Transforming How We Make Money While Making a Difference, Antony Bugg-Levine and Jed Emerson play out a metaphor first proposed by Jessica Freireich and Katherine Fulton in the Monitor Institute’s seminal report, Investing for Social and Environmental Impact.  They remind us that the 1980 Initial Public Offering of what was then called the Apple Computer Company “transformed the trajectory of a previously unheralded financial innovation” to such an extent that “what was previously viewed as a crazy approach is now a standard component of investment portfolios, known as the very mainstream concept of venture capital.”  So, they ask, “What Will Be Our ‘Apple IPO’?”:

“What will be impact investing’s Apple IPO?  In what geography or sector will the concept of impact investing for blended value find a success so compelling that it commands attention, overcomes the skeptics, and propels us into the mainstream? ... This ‘IPO’ will occur when we can point to a compelling social or environmental challenge that impact investment-backed enterprises solved at a level that would not have been possible for government or mainstream markets alone.”

Could scale finance develop the social-sector equivalent of the Apple IPO?  Could such funding expand our best social innovations to reach at least 20% of the eligible population in a defined geographical area over five to ten years, while maintaining established levels of effectiveness? 

I can’t pretend to know whether this can be accomplished until we try, but I do believe there are two basic steps to getting started:  selecting the right programs and designing the right transactions in ways that satisfy the following eight conditions:  

Program Selection

1. Evidence.  The intervention must have a “top-tier” evidence-base such that fundamental questions about effect sizes and attribution have already been answered to an extent that all stakeholders consider sufficient for this purpose.  These questions would not be revisited as part of any pilot project.

2. Fidelity.  There must be a reliable framework for implementing the innovation in substantial compliance with all key performance indicators.  Fidelity to the model would be a primary consideration in assessing project success, since the evidence base adequately demonstrates what the outcomes will be when the program is delivered properly.

3. Capacity.  Scale finance would be reserved for mature programs with clear potential for exponential growth.  The service providers must have “growth-ready” leadership, finances, operations, and performance-management capabilities.  It must also have a robust delivery network of significant scope that reliably provides the innovation at high levels of effectiveness at the current scale of operations.  

4. Data.  Robust and comprehensive data must be available on the affected population, existing services, costs, and social impairments, as well as on the outcomes, impact, cost, and potential savings of the innovations.  While pilots cannot proceed if there are major gaps in the data, they can and should integrate and analyze disparate data that have not been aggregated fully.

5. Savings.  Rigorous cost-benefit analysis must demonstrate that the innovation “math” has the potential to be financially self-sustaining at scale.  Again, the reliable results about cost, impacts and savings from existing research would be incorporated as givens and not be reconsidered as part of any pilot project.

Designing the Transaction

6. Origination.  Alongside these exceptional providers, investors, advisors and intermediaries would be full and active participants from day one.  Government engagement can wait until social entrepreneurs and investors confirm that the proposed transactions are financeable, with specific funding sources and structures identified.  They would then originate financeable transactions with low operational risk for consideration by governmental and non-governmental payers.

7. Size.  Transaction sizes must be large enough (north of $50M) to (a) amply cover all direct service costs, as well as necessary working capital for infrastructure, intermediation, performance and risk management, and course corrections, and (b) pay investors > 5% return.  Those fixed costs kill the ROI for smaller deals.

8. Governance.  The project must have effective cross-sector governance and payment mechanisms that avoid unnecessary legal or technical requirements that undermine the social and financial objectives of the project itself.  The formation of the project and its legal and financial structure would be developed “on a clean sheet of paper” and not by reference to governmental procurement processes or standard terms and conditions for public service delivery contracts.  Of course, any contract would have to comply with all applicable legal requirements, subject to any modifications the legislature might enact in SIB enabling legislation.

In order to shift gears from growth to scale, we should begin by asking highly successfully social entrepreneurs to come up with their “maximum feasible growth rates”:  the percentage of need they could realistically meet within a time horizon that investors would accept and without compromising their results if money were not the primary limiting factor.  Scaling these exceptional programs isn’t just a matter of adding money.  Read Gerald Chertavian’s wonderful book, A Year Up: How a Pioneering Program Teaches Young Adults Real Skills for Real Jobs-With Real Success, to see what it takes Year Up to place urban youth on career paths to the middle class.  Read Lumina’s eight strategies or NFP’s detailed manuals on “Implementation Overview & Planning,” “Guidance for Implementation and Quality of the Nurse-Family Partnership Program” or “Expanded Data Collection, Reporting and Quality Improvement Strategies.”  Try out NCTL’s frameworks for assessing teacher collaboration and enrichment programming, or its classroom time analysis tool.

If you asked these social entrepreneurs, “if money were no object, how big and how fast could you grow over five to ten years and maintain the same results you get now?”, I think they’d be happy to come up with an answer.  I’m fairly confident the answer would not be large enough to reach anywhere near half of the population-in-need, but it might be 10 or 20% in two or three states, which would far exceed anything they’re actively working on now.

HOW MUCH WOULD SCALING COST?

Ah, the hardest question of them all.  Based on the very few scaling plans available, it would unquestionably cost billions of dollars per year to fully scale each one of these rare programs.  Even I accept that SIBs and pay-for-success financing won’t have that kind of capacity any time soon, even though there’s clear evidence that several of these programs produce short- and medium-term savings that exceed their costs.  

But didn’t JP Morgan say that the emerging — and much broader — “asset class” of “impact investments” “offers the potential over the next 10 years for invested capital of $400bn–$1 trillion and profit of $183–$667bn” within just five global sectors:  housing, rural water delivery, maternal health, primary education and financial services?  For SIBs, it’s not premature to ask if we even have visibility to our first billion.  Can scale finance get there anytime soon?  For the strict parameters I’ve defined for scale-ready programs, could the answer to the maximum feasible growth question be expansion that costs hundreds of millions per year now?  Could an “Apple IPO” get us there?  

Andrea Phillips doesn’t think so.  Andrea was on the team at the Goldman Sachs Urban Investment Group that closed the $9.4 million SIB with New York City, the first and so far only SIB in the US.  She offered an estimate of the potential size of the SIB marketplace at a January 16, 2013 panel discussion entitled, “SIBling Revelry:  Are Social Impact Bonds the Next Big Thing?” hosted by the Hudson Institute’s Bradley Center for Philanthropy and Civic Renewal: 

“So in closing, a couple words about whether this is scalable or replicable. What I would say is I am cautiously optimistic. I don’t think three years from now we are going to have a $500 million dollar bond market that’s tradable in Social Impact Bonds, but I do think five years from now there will be a sort of healthy marketplace where financial institutions like Goldman Sachs are providing the capital for these types of initiatives. And it will be a growing market and a scaling market. Right now, $10 million is probably a good size for one of these deals. I hope five years from now they’re $100 million dollars.”

Keep in mind that she’s talking about the entire SIB marketplace:  $100 million in five years.  On that trajectory, when could $100 million grow to even $1 billion, let alone the several billion that a handful of our best organizations could deploy each year?  I suspect Andrea’s answer might  well be, “At least twenty years from now.”

Now, Andrea works at Goldman Sachs and I work in my basement, so if I were you, I’d listen to her.  But since I’m not you, I can think differently.  

Two words, my friends:  “scale finance.”

Knocking Down Strawmen

Let's debate about real -- not pretend -- issues.

You can tell that Social Impact Bonds are making headway by the increasing criticisms being lobbed in their direction.  I responded to one recent salvo here, and this post offers a response to a guest blog from Jon Pratt, Executive Director, Minnesota Council of Nonprofits, entitled “Flaws in the Social Impact Bond Craze.”

My reason for writing is to try to shift the debate from knocking down arguments that no one is making – strawmen – to legitimate issues about which reasonable and well-informed people can disagree, of which there are many.  I don’t know Mr. Pratt, but I have had some exposure to the Minnesota nonprofit sector, and I’ve long considered it to be more robust and effective than most.  (Here's an example.)  If Minnesotans decide not to pursue SIBs and other kinds of impact investments, that’s certainly their prerogative.  I would just invite them to consider the matter on real rather than imaginary grounds.

Mr. Pratt implies that the reason for the supposed “craze” is that “an extraordinary amount of enthusiasm is building among consultants, foundations and financial services firms.”  He calls this “the foundation/consultant enthusiasm stage of SIBs.”  He warns that, “[h]owever fast growing the Social Impact Bond promotion” may be, everyone should keep an eye on the “big money and very well-known supporters” behind the curtain.

Before we dismiss SIBs as “admirable but dreamy” and “almost too good to be true!”, as Mr. Pratt would have us do, let’s be honest and clear about the real reason for SIBs.  As one of the founding fathers of social investing, Sir Ronald Cohen, has put it, “Government is out of money and out of breath.”  We are enmeshed in a long-term fiscal and economic crisis that will increase the need, but decrease the funding, for effective social services long after unemployment returns to normal levels.  This is a “new normal” of government retrenchment, rising inequality and decreasing social mobility to which we have not yet adjusted.  The safety net ain’t what it used to be, plus we can’t afford it.

While there are many encouraging trends in social sector innovation, as well as room for improvement, beleaguered nonprofits are in no position to take up the slack left by an eroding public sector.  They don’t just, as Mr. Pratt puts it, “frequently feel under-compensated, need more resources, and blame their limited success on lack of funding,” they are under-compensated, in need of more resources and held back by a chronic and worsening lack of funding.  Nonprofits are fighting a holding action that they can’t win over the long term.  They, too, haven’t figured out how to cope with the new normal.

Mr. Pratt dismisses the notion that SIBs will attract “more resources” by setting up and then knocking down another strawman.  SIBs, he says, are “based on the idea that legislative bodies will appropriate additional funds based on a projection of future savings.”  But, apparently, this is just a sleight of hand:

“If your organization’s services reduce repeat trips to prison, saving government money, your organization (and its financiers) deserve to be rewarded with extra payments — made possible by the reduced expenditures required of government in housing these prisoners. 
The argument is a good one, certainly, which is why it is used constantly in every legislative and appropriation process — that this particular expenditure for (early childhood education/crime prevention/sanitary sewers/vaccinations, etc.) is better spent to prevent a problem than to try to remediate it later.  Legislative bodies understand this, and often agree — and these intended savings across all of these areas are already taken into account in the overall appropriation process.

You can certainly make the case that your particular service is special and new, and has a superior claim to savings, but your ability to get legislative approval is almost certainly a displacement from other funding — not an actual specific addition to total expenditures.”

SIBs are most definitely not “based on the idea that legislative bodies will appropriate additional funds based on a projection of future savings.”  It’s precisely the opposite:  we don’t ask legislatures to appropriate additional spending, we ask them to agree now to share savings that SIBs produce in the future, but only if those savings actually materialize and only if they’re sufficient to pay investors back. 

Even if SIBs succeed, we’re not proposing that nonprofits “be rewarded with extra payments.”  The financial benefits of SIBs for nonprofits is that they’ll know in advance that they’ll receive reliable and adequate funding over the entire five-year or longer duration of the SIB project, something that is rarely the case with grants or government contracts. 

As every nonprofit can attest, it’s not just the amount of money that holds them back, it’s also the unpredictability and tenuousness of the funding.  When a social enterprise has a one-year grant or contract, it can’t make long-term plans and can’t attract and train the talent it needs to accomplish big things.  Five grants or contracts of, say, $50,000 each, that have to be applied for and won each year, can’t accomplish as much as one $250,000 SIB for the same period of time.  This is especially true when the nonprofit is empowered to decide how to spend the $250,000 because the SIB investors know that’s the best chance they have of achieving the social outcomes upon which their financial returns depend under the outcomes-based contract with the state. 

Nothing could be further from the truth that “these intended savings across all of these areas are already taken into account in the overall appropriation process.”  Again, the reality is precisely the opposite:  government is forced to cut spending on prevention programs because they don’t even have enough money for emergency services.  We’re exploring SIBs because we find ourselves stuck in a downward spiral where funding for more expensive and less effective programs crowds out taxpayer funding for early intervention programs that have been shown to prevent people from becoming homeless or going back to prison, which then requires us to build more emergency shelters and prison capacity that takes more money from prevention, and on and on.

You don’t have to take my word for it.  A 2010 study funded by The Boston Foundation on “Adopting Effective Probation Practice” confirms our collective dilemma:

“The budget crisis has come at a time when the DOC, Parole and many sheriffs have begun to make progress in re-shaping agencies and focusing their resources on efforts that enhance public safety.  Some of these agencies have made significant strides in implementing evidence-based practices, those proven to reduce recidivism, and have begun to show lower recidivism rates.  Leaders of these agencies have focused on changing offender behavior in order to reduce the risk of re-offense rather than simply warehousing offenders and releasing them after the sentence is served.  Because of the massive fixed costs in the corrections system, corrections officials have few budget reduction options other than eliminating the critical programs and services that change offender behavior and, in turn, improve public safety.”

Here's a February 8th story from the Londonist about a local government council spending more than £2m to house homeless families in hotels "because housing benefit cuts and a shortage of suitable properties have left them with nowhere else to go." 

“Westminster isn’t the only council placing families in B&B accommodation. In December we saw that several boroughs were breaking the law that’s supposed to limit these temporary placements to six weeks – but what else are they supposed to do? Councils have a statutory duty to house anyone who turns up and is homeless; benefit cuts have led to more people becoming homeless and councils are struggling to find anywhere else families can afford. And that’s leading to councils spending more on hotels than they were on housing benefit. This may be the very definition of a false economy.”

Massachusetts faces the identical problem.

SIBs don’t displace government funding or foundation grants.  They raise new money from new sources – private investors – who will only invest if they believe that prevention programs the government can’t afford will work, and produce the savings from which government can pay them back without additional appropriations.

It certainly remains to be seen whether social investing can be part of a more effective response to the new reality.  Mr. Pratt is correct when he says we have no results yet from any SIB project.  But, to be fair, the reasons we don’t are, first, they’re just getting underway, and, second, SIBs aren’t quick fixes for little problems.  Rather, they’re designed to scale what works over a long period of time. 

Which brings me to my second quarrel with Mr. Pratt’s imagined SIB “craze.”  He says that “the biggest SIB innovation is the transaction itself, and accompanying financial instruments and intermediaries, not the service method.”  In other words, there’s no there there:

“There are no proposed special service innovations for the work supported by the SIBs (they are understood to apply effective methods considered best practice in their field), but will get improved results through enhanced discipline by virtue of their participation in the SIB process and its restriction to only pay for results.  This high stakes carrot and stick approach is not unlike the expectations of results in the “No Child Left Behind” legislation, which had its own unintended consequences (including cheating scandals by pressured school administrators).”

Again, it’s perfectly fair to be skeptical about whether SIBs will produce better outcomes, but it's not fair to dismiss them by mischaracterizing how they work.  SIBs don’t just include “a dose of business incentive” that gullible funders who “view business managers as inherently more effective than nonprofit managers” accept as an article of faith.  I can assure Mr. Pratt that no one working to develop the new and still untested field of impact investing thinks, “after all – how hard can it be to run a nonprofit?” 

To the contrary, risk-averse investors are very conscious of the difficulty in running a social enterprise dependent on funding sources that Lucy Bernholz has described as “episodic, donor directed, temporal, fragmented, decentralized and disaggregated.”  Before social investors will buy SIBs, they want to know if, unlike philanthropy, their money is invested in a way that is steady, controlled by nonprofits, reliable, integrated, consolidated, and aggregated, will it enhance what nonprofits accomplish?  And the obvious answer to that question is:  not necessarily.  If we just add money without materially changing “the service method,” as Mr. Pratt claims, we’re unlikely to see better results.

Social investors know this and they don’t engage in wishful thinking that SIBs will magically work “through enhanced discipline by virtue of their participation in the SIB process and its restriction to only pay for results.”  The “market discipline” that we hope will come from private investment isn’t based on an ideological belief in the natural superiority of business.  Instead, the service innovations that we hope SIBs will engender (whose existence Mr. Pratt denies) is a direct result of the financial innovation that SIBs enable.  Why do I say that?

The business case for SIBs is that investors can accomplish their twin objectives of increasing the benefits of social programs and earning a modest financial return if and only if they apply the same due diligence to their social investments that they apply to their financial investments.  SIB investors won’t give us their money unless we convince them, using credible data, that the prevention programs work and can save government enough money to pay them back.  If not, the experiment ends.

Mr. Pratt makes the mistake of assuming that, because SIBs look for "evidence-based" programs delivered by nonprofits with track records of effective service delivery, they don't need any operational improvements.  As decades of research shows, programs that work well in some places at certain levels of operations often don't work nearly as well when they're transported to new places or expanded to reach more people.  When SIBs try to "scale what works," that's a very tall order requiring more than just adding money.

So, even if we can persuade  investors to buy SIBs, they will watch how we use it very carefully, just as they do with their long-term financial investments.  Interim performance metrics, such as enrollment rates, compliance with eligibility criteria and fidelity to the critical success factors of the intervention model, will be reported on a regular basis.  If the numbers don’t look right, the SIB intermediaries have time to make course corrections, and investors will expect them to do so.  All stakeholders, including the service providers, the intermediaries, the government agencies, and the measurement experts, will meet regularly to analyze progress and, through a collaborative governing process established in advance, decide how to get back on track. 

This is not the way most social services are delivered today.  Diligent selection of effective interventions and growth-ready providers, investing in managerial and organizational capacity, careful articulation of measurable outcomes, long-term planning, robust data collection with quality control, ongoing performance reviews, collaborative oversight, and independent verification of results might not be glamorous, but they are indeed “special service innovations for the work supported by the SIBs.”  

These kinds of best practices, some of which many nonprofits follow today as best they can with limited and unreliable funding, are indispensable with SIBs.  Without them, investors won't invest and the projects won't succeed.  There's a cause-and-effect relationship between the kind of money SIBs are designed to attract and the kinds of operational improvements needed under results-based contracts.

Mr. Pratt cites Donald T. Campbell for the “law” that “[t]he more any quantitative social indicator is used for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor.”  Campbell’s Law is certainly sound and counsels caution and humility in performance-based contracting. 

But Professor Campbell was not saying, as Mr. Pratt seems to argue, that performance measurement is a fool’s errand.  The professor wrote a paper in 1976 called, “Assessing the Impact of Planned Social Change,” which offered an observation to which all of us trying to advance social change can relate:  “It is a special characteristic of all modern societies that we consciously decide on and plan projects designed to improve our social systems.  It is our universal predicament that our projects do not always have their intended effects.  Very probably we all share in the experience that often we cannot tell whether the project had any impact at all, so complex is the flux of historical changes that would have been going anyway, and so many are the other projects that might be expected to modify the same indicators.”

In other words, impact assessment is absolutely essential but diabolically difficult.  It is neither a waste of time nor a sham designed to enrich investors.

Those of us working on social investment don’t think we’re smarter than those who aren’t, but we’re not selling snake oil, either.  We are well aware that impact investment would not be possible without the decades of social innovation that was nourished by philanthropy and sustained by taxpayers.  It is no criticism of either to acknowledge that we now face systemic challenges that traditional approaches haven't been able to overcome.  We have no intention of abandoning the vital work of the organizations that brought us this far, but we are exploring new approaches that might be able to pick up where they left off.  We don’t know if they’ll work yet, but we do know they'll fail without the help of organizations like Mr. Pratt's.  We understand there are risks inherent in bringing private capital into the mix, and we’re thinking hard about ways to manage those risks.  We expect to be judged by our performance.

SIBs are neither a quick fix nor a panacea.  There's nothing magical about them.  These are ideas worth considering and developing further, and healthy skepticism will force us to wrestle honestly with difficult questions.  Mr. Pratt says we should “closely examine and question the claims made for SIBs.”  Let’s do that.

Private Finance, Public Good: The Future for Children Bond

[You can download a PDF of this post here.]

At a time when we’re still suffering from the predations and gluttony of many on Wall Street, it can be hard to remember there was a time when financiers actually did something socially useful.  But we would not have the bounty most of us take for granted in technology, health care and energy without the foresight and courage of those who discovered those embryonic opportunities and raised the money to sustain and grow them.  The economic vitality of the United States since World War II would not have been possible without our singularly robust capital markets.

Still, much of the financial sector clearly lost its way, and the rest of us are still paying the price.  Nor have we really learned from our mistakes.  So while “financial engineering” isn’t intrinsically evil, it’s clearly capable of being grievously misused.

Many reasonable people fear that “social investment” (also called impact investment) will take us down the same road.  For example, after the Alberta College of Social Workers passed a motion on January 18th to oppose the use of social impact bonds in Alberta, Canada, spokeswoman Lori Sigurdson told the Edmonton Journal, “We don’t want some people to profit from the misery of others.”

This isn’t an illegitimate or trivial concern.  I happen to agree with Ms. Sigurdson that “[t]he primary responsibility of government is to be supporting vulnerable and marginalized people.”  Of course, the problem today is that government doesn’t fulfill that responsibility, and (as I write about in my book) hasn’t really done so for the last several decades.  The once-gloried social compact has become something of a bad news/bad news tale:  the safety net doesn’t work, and we can’t afford it.

The emergence of impact investing does not herald the selling out of the social sector.  I won’t say there aren’t risks we have to guard against.  The evolution of the microfinance industry, for example, provides a cautionary tale.  But this is truly a case where we don’t want to become so intransigent that we preemptively deny social entrepreneurs the means to grow that only private capital might be able to provide.

A case in point is the Future for Children Bond, announced today by Allia, an English charitable organization that describes itself as “The Social Profit Society.”  The Future for Children Bond is “the first public offering of a Social Impact Bond to retail investors.”  What does that mean and why is it a very big deal?

As Allia explains, social investment is simply “the provision of finance with the objective of achieving specific social outcomes and the expectation of receiving back at least the original amount invested.”  The words “objective” and “expectation” signal that uncertainty is involved, while “at least” suggests the prospect of a positive reward beyond merely breaking even.

Readers of this blog know what a Social Impact Bond (SIB) is, and newcomers can find a great New York Times article here.  Inherent in most formulations of the SIB concept is the possibility that investors could lose some or all of their initial investment, an unwelcome prospect known as “loss of principal.”

Like all social investors, SIB investors hope that won’t happen, and that the worst outcome would be that they “only” get their money back.  In the basic SIB model, investors break even if the project they support hits the agreed social outcome target (say, a 10% reduction if prisoner recidivism), and they earn a profit (“a return”) if they exceed the target.  If they fall short, they stand to lose some or all of their principal depending on how the SIB contract is written and how close they get to the agreed results.  The idea is to encourage social investors to support innovative programs that might produce superior results, and to accept a certain amount of risk that they might not.

Of course, most impact investors are also philanthropists.  They give money away with no expectation of getting any of it back.  But the supply of philanthropy isn’t unlimited.  If we want civic-minded affluent people to make a lot more money available for social purposes, they need to know they’ll eventually get it back.  Philanthropy is disposable, social investment is recyclable.

Finance is socially useful when it supercharges economic output, which is why it’s entirely reasonable for conservatives to say that “the best social program is a job.”  While the nonprofit sector does produce millions of jobs and generates billions of dollars of economic value, philanthropy is designed, in large measure, to address market failure.  Finance is designed to amplify market success.

The Future for Children Bond exemplifies financial innovation for social good at its best.  If offers some inspired improvements over the simple SIB model that should make it much more attractive to investors and, therefore, a potentially much more powerful way to expand social programs that clearly work and that children and families desperately need.

I’m going to explain in some detail what makes them more attractive and why they have greater growth potential.  You might want to get yourself a nice cup of hot chocolate and a comfy chair.  This will take a while.

Why Future for Children Bonds Are Attractive Social Investments, Part I:  “Security Trumps Returns”

No one’s going to get rich investing in SIBs.  At this point, we don’t even know if they work, and, if they do, the returns are likely to be modest.  (Another lame SIB joke:  “The risks are high, but at least the returns are lousy.”)  SIBs won’t get your blood racing unless you’re an investor who’s motivated by the possibility of producing much better social outcomes.  As Cathy Clark, Jed Emerson and Ben Thornley recently wrote, social investors might well consider “low single-digit financial returns with clear social outcomes” to be “[e]xceptional returns.”  We’re lucky to have such civic-minded investors.

The really challenging part of getting SIBs right is managing the risks, or, in financial lingo, “reducing the downside.”  Social investors aren’t looking for huge profits, they’re looking for modest profits they think they will actually see.  As Steve Godeke and Lyel Resner recently observed, “security trumps returns.”  Katie Hill, an advisor to the City of London Corporation agrees:  “protection of the downside is more important than potentially high upside.”

SIBs have downside risk because investors get their principal back only if they invest in charities that achieve results established in the SIB contract with government.  In the world’s first SIB, recidivism rates for Peterborough prison must be at least 7.5% lower than rates for comparable ex-offenders released from ten other English prisons.  In the first US SIB, juvenile recidivism at Rikers Island jail must be reduced by at least 10%.  If Peterborough rates are only 7.4% lower, the investors lose their entire principal.  If Rikers Island recidivism falls by at least 8.5%, investors lose half of their principal; if not, they lose everything.

That’s a lot of downside risk.  As I explained in the latest issue of the Social Impact Bond Tribune, SIB developers are exploring a variety of ways to try to reduce that risk.  In the case of the Future for Children Bond, Allia has come up with a particularly clever approach.

How The Future for Children Bond Works

When you buy a Future for Children Bond, you’re actually making two social investments at once, with very different levels of risk.  The first one is an honest-to-goodness bond, a fixed-rate loan to Places for People Homes, “a Moody’s Aa rated housing provider that builds, sells and rents homes and provides services and support to those who live in them.”  Moody’s Investors Service says “[o]bligations rated Aa are judged to be of high quality and are subject to very low credit risk.”

The second part of the Future for Children Bond is a SIB offered by the Essex County Council to provide services to troubled families whose children are considered to be “at risk” of being placed “in care,” that is, removed from their homes to protect them from potential child abuse and neglect.  (In the US, we call these “child welfare” services.)

Essex County is a study in contrasts, with some of England’s wealthiest and poorest communities.  All but one of its 18 Members of Parliament belong to the Conservative Party.  When it comes to children in care, Essex faces some formidable challenges:

• “High numbers of children in care;
• Predominance of high cost residential placements;
• Higher proportion of older adolescents with behavioural issues;
• Poor parenting support in particular around managing behaviour;
• Under developed early intervention and family support services;
• Lack of higher level intensive interventions and limited resources to establish them; and
• Vicious circle, wrong service offer, young people in care unnecessarily, pressure on budgets, reducing available investment.”

Roger Bullen, the Head of Joint Working at Essex County Council, has a simple goal for changing the system for children on the edge of care: “Fix it, and fix it forever.”

The Future for Children Bond funds two social investments in order to separate the risk and return features of the bond:  the loan to Places for People Homes protects the principal amount and the Essex County SIB provides the potential return.  For every £1,000 invested in the Future for Children Bond, £780 goes to Places for People Homes, £200 goes to the Essex County SIB, and £20 (2%) goes to Allia to cover its costs.

At the end of the eight-year term of the Bond, Places for People Homes will repay £1,000 for the £780 loan, an interest rate of 3.2%.  As this is a very safe loan, the likelihood that investors will get back their entire principal is extremely high.  So the worst expected financial outcome for the Future for Children Bond is that the investors break even (leaving aside inflation and the time value of money).  Allia’s statement that the “[m]inimum return to investors will be 100% of funds invested” is not one that most SIBs can make.

A “not-for-dividend” organization, Places for People,  is “one of the largest property management, development and regeneration companies in the UK.”  It manages more than 83,000 homes and has “a long track record of successful development, from large-scale regeneration projects to the creation of whole new communities and manage[s] these projects so they remain sustainable into the future.”  In 2012, Places for People earned a Platinum award in the Corporate Responsibility Index, recognizing it as one of the most ethical businesses in the UK.

That’s the first part of what makes Future for Children Bonds so attractive.  The odds of losing any of the principal are negligible, and the loan proceeds are put to very good use for eight years.  For social investors who just need to make sure they get their original investment back and do some good along the way, the Bond should be a no-brainer.

Why Future for Children Bonds Are Attractive Social Investments, Part II:  Getting More Than Just Your Money Back

But there are two more features that make the Bond an attractive social investment.  The first is the possibility of making a modest profit on the investment.  The second is the possibility of making really effective social services much more widely available to kids who really need them.  Let’s get the profit part out of the way first.

Like most SIBs, the underlying concept is that “an ounce of prevention is worth a pound of cure.”  As Allia explains, “[t]he Essex SIB will fund a programme of ... intensive support to approximately 380 children and their families. The target is to divert around 100 young people from entering care by providing support to them in their home. The success of the SIB will be measured by the reduction in days spent in care by these children, as well as improved school outcomes, wellbeing and reduced reoffending.  If the programme is successful in reducing the amount of time children need to spend in care, it will result in cost savings for Essex County Council, which can be used to provide a return to the investors in the SIB.”

This might be a good time to replenish your cocoa, as I’m going to take a rather deep look at this simple explanation.  The parties behind the Future for Children Bond have tapped into something truly significant.

Taking children at risk of abuse and neglect away from their families is an emergency measure that, unfortunately, produces its own adverse consequences.  “When it is clearly unsafe for a child to remain in his or her home, foster care provides a temporary safe haven. However, for too many children, foster care becomes long-term and unstable. Research demonstrates that children who have been in foster care for lengthy periods of time do not fare as well as their peers, especially in the areas of education, employment, mental health and teen pregnancy. Factors such as the number of changes in foster families, changes in schools and separation from siblings often harm a child’s behavioral and social functioning.”  Casey Family Programs, “Ensuring Safe, Nurturing and Permanent Families for Children” (May 2010).

In the US, about one-quarter of the 424,000 children currently in foster care have been there for more than three years.  That’s far too long.  In the UK, there are currently more than 67,000 children in care, with around 1,500 children in Essex County.  The SIB targets one particular group:

“The largest group being looked after is adolescents. They often enter care because of multiple and complex behaviour problems which lead to aggression, antisocial behaviour, parental loss of control, family breakdown, and ultimately an inability or lack of desire to continue living with their birth family.  Young people who enter care in their teenage years are likely to spend more than 80% of their remaining childhood in care.  The life chances of these children are typically bleak:  half of looked after children obtain fewer than five GCSEs [a UK academic qualification] or equivalent compared to the national figure of 10%; one in three previously looked after children is not in education, employment or training at age 19; one in four of all prisoners has been in care, compared with 2% of the population overall.”

Beyond the traumatic social impacts of children languishing in foster care or residential placements, “[s]tate care is also expensive, costing up to £180,000 [about $283,000] a year for a child in residential care.”  Total projected spending in the UK for foster care alone is about £2.4 billion  (about $3.8 billion) per year, and the US spends about $29.4 billion (about £18.7 billion) per year for child welfare programs.

That’s a lot of money.

But child abuse and neglect is also a problem we know how to prevent to a much greater extent than we currently do.  The funds raised by the Essex SIB will be used to provide Multi-Systemic Therapy (MST), a comprehensive approach that “blends the best clinical treatments—cognitive behavioral therapy, behavior management training, family therapies and community psychology.”  For anyone worried that SIBs will favor investors by avoiding hard cases, MST works with “the toughest offenders ages 12 through 17 who have a very long history of arrests.”

Dr. Scott Henggeler developed MST in the mid-1970s when he was getting his Ph.D. at the University of Virginia.  After working with some of the state’s most antisocial teenagers and making little progress, he decided to visit the adolescents in their homes. “It took me 15 to 20 seconds to realize how incredibly stupid my brilliant treatment plans were.”

MST is “an intensive family- and community-based treatment program that focuses on addressing all environmental systems that impact chronic and violent juvenile offenders – their homes and families, schools and teachers, neighborhoods and friends. MST recognizes that each system plays a critical role in a youth’s world and each system requires attention when effective change is needed to improve the quality of life for youth and their families.”

Now, MST is not your average social program.  It’s used in 34 states and 14 countries to treat more than 23,000 youth and their families every year.  Rigorous research involving more than 5,200 families, including 20 randomized control trials, shows that MST reduces out-of-home placements by 47-64%.  A 14-year follow-up study by the Missouri Delinquency Project showed youths who received MST had up to 54% fewer re-arrests, 57% fewer days of incarceration, 68% fewer drug-related arrests, and 43% fewer days on adult probation.

In fact, MST has consistently demonstrated positive outcomes with chronic juvenile offenders for more than 30 years.  It has been endorsed by Blueprints for Violence Prevention, the Office of the Surgeon General, the Coalition for Evidence-Based Policy, SAMHSA's National Registry of Evidence-based Programs and Practices (NREPP), and the Washington State Institute for Public Policy, among others.

In order to achieve these results, MST Services, Inc. was founded to disseminate the intervention in compliance with a long list of specific practices that are critical to its success.  In 1996, the Medical University of South Carolina licensed MST Services to train therapists and provide them and their supervisors with support, resources and ongoing coaching, including budgeting and business planning, hiring, record-keeping, reducing staff attrition, quality assurance, and marketing and public relations.  You can’t provide “MST®” – and that’s the only kind of MST there is – without signing up for the complete package.

This is why the Essex County Council knows that MST will work.  And the Council knows it will save money because MST has also been the subject of exceptionally thorough cost-benefit analysis. The Washington State Institute for Public Policy estimates the net direct cost of MST to be about $4,743 (a little more than £3,000) per participant, and found that “taxpayers gain approximately $31,661 [just over £20,000] in subsequent criminal justice cost savings for each program participant.”  Every dollar spent on MST saves $6.68, and every pound saves £4.25.

In short:  the current governmental response to reports of child abuse and neglect is ineffectual and prohibitively expensive.  With MST, we have a highly-effective, low-cost way to prevent an array of devastating social problems afflicting one of our most vulnerable populations, older teenagers at risk of being placed in long-term foster care or residential facilities.  

At about this point, you’re probably wondering why government doesn’t just pay for MST directly.  There are a number of messy and confusing explanations, but the short answer is there’s little or nothing left for MST after government pays for emergency care and residential placements.  Even though government could provide better care at lower cost using MST, it can’t take money away from acute care to pay for prevention because prevention takes time to work and, in any event, it won’t completely eliminate the need for emergency services and out-of-home placements.

As the US Department of Health and Human Services said in 2011, “there is often a struggle encountered with successfully scaling up selected evidence based interventions while converting the old services array to new evidence-supported services.”  Government can’t pay for both at the same time, so it needs to use someone else’s money to bridge the gap.  That’s where private investors come into the picture.  Let’s turn next to what gives the Future for Children Bond much greater power to expand MST.

Why Private Investment in Future for Children Bonds Can Expand MST in Ways That Government Spending and Philanthropy Can’t

Allia calls the Future for Children Bond a “capital plus” bond which “combines a low-risk ethical investment into affordable housing (Places for People Homes) to provide the funds to repay capital to investors, with a high-risk investment into the social impact bond with the aim of delivering a high social impact and providing an additional variable return.”  Allia is starting out rather modestly, seeking to raise just £3.1 million, but once this gets rolling, I think the demand will outstrip the supply.

Would this be an opportune time for me to mention that I don’t make any money from Future for Children Bonds?

I have to begin with some tedious terminology that will sound crass and cynical to many ears.  Please bear with me while I try to convince you that they have the potential to accomplish things that nicer-sounding words like “grant” and “social compact” can’t.  

“Monetization” means extracting a financial benefit from a nonfinancial activity.  When preventing a problem saves money, the savings become available for other uses.  So SIBs monetize future government savings (we hope) by reducing the demand for more expensive government programs.

“Financialization” means, at least in this case, making the opportunity to monetize an activity into something that others can invest in.  So a SIB isn’t just a way to pay for prevention programs, it’s a financial instrument that investors can buy so they can share in any returns that result from monetizing future government savings.

So the first step in raising more money for MST (or, indeed, for any SIB), monetization, is making something that doesn’t have financial value into something that does, and the second step, financialization (or securitization), involves creating an investment vehicle that can raise capital from lots of investors who want to fund the monetizing activity.

It’s common for reasonable and dedicated people involved in charity to think that this turns an activity that shouldn’t be about money – helping children at risk – into something that’s just about money – investing.  But SIBs and other social investments don’t make money more important than helping people.  Instead, the only way they make any money for investors at all is if they do help people.  If they don’t, the investors won’t get paid and that’ll be the end of this grand experiment.

Social investing will definitely be a major change in how we fund social programs, and there’s no question it rubs some people the wrong way.  All I can say is that the way we used to address these kinds of problems no longer works, and the problems are only getting bigger and uglier.  Impact investment might work a lot better.

Future for Children Bonds provide a small financial incentive for investors to pay for more MST, which could reduce the number of children taken from their homes and save government a lot of money.  Monetization creates an entirely new source of funding that doesn’t compete with limited government budgets or donations.

The 380 kids who will benefit from the initial £3.1M bond sale represents a good start on the 1,500 children-in-care in Essex County, but it barely scratches the surface of the 67,000 in the UK.  If the Essex County SIB works, there’s no reason why other bonds couldn’t be offered in other counties.  By financializing the investment opportunity, MST can be expanded, and there’s an enormous untapped supply of capital available for low-risk investments that produce reliable social benefits.

When Paying Retail is a Good Thing

Allia’s bond has one more trick up its sleeve, and it’s a beaut.  

As we’ve learned the hard way, securities can be dangerous, so they need to be regulated.  Different kinds of securities need different levels of regulations, which have the general purpose of informing investors of the risks inherent in any particular instrument, known as “disclosure.”  Different kinds of investors need different kinds and amounts of disclosure, often based on how sophisticated the prospective investors are likely to be.  Professional investors need less disclosure because they have other sources of information; the general public needs more disclosure because they can’t understand and don’t even read fine print.  Some investments are simply too complicated to explain to amateurs, so they can’t be sold to the public.

SIBs are an untested and unconventional financial instrument with uncertainty and risk at every link in the value chain:  private investment => prevention => government savings => repayment of principal plus return.  At this point, they’re essentially unregulated, so only professional investors can buy them, which limits their growth potential.  If and when we understand the risks better, SIBs should be able to be sold with adequate disclosures so they can raise more money to expand more programs like MST, which will take billions of dollars to serve every family that needs it.

But Allia took this dilemma head on.  First, recall that 78% of the proceeds from the Future for Children Bond is invested in a very safe and very ordinary bond, which is used to repay investors 100% of their principal.  Second, the SIB only gets 20% of the proceeds (Allia gets 2%), which goes toward profit if and only if the MST services save Essex County an agreed amount of money.  Allia tells investors up front they might get absolutely no return from the SIB portion of the bond.

Voilà:  investors now understand their risks.

Allia adds one more feature:  Future for Children Bonds can only be purchased through financial advisors licensed by the British Financial Services Authority, the counterpart of the US Securities and Exchange Commission.  These registered advisors now have a financial incentive to tell their clients about these Bonds.  Taken together, these three features make the Future for Children Bond the first SIB that can be sold to “retail,” i.e., nonprofessional investors like you and me.

Well, not me, because the minimum investment size is £15,000, or $23,578.50, which I don’t happen to have on me at the moment.  (Would you take a post-dated, third-party check?  Doesn’t matter.  I don’t have one of those either.)

But £15,000 is way below the minimum “subscription” amount for securities that can only be purchased by “accredited” investors, which run into the hundreds of thousands or even millions of dollars.  The SEC defines an accredited investor as an individual with an income of more than $200,000 per year, or a couple with joint income of $300,000, in each of the last two years, or anyone with a net worth exceeding $1 million.

By designing the Future for Children Bond as a retail investment product, Allia is opening a completely new frontier for social investment.  If things go as planned, someday investments like this will become something that virtually anyone can invest in as part of your regular portfolio or your retirement account at work.  Mutual funds, pension funds and even foundation endowments could include SIBs.  That’s why impact investment has the potential to raise tens or hundreds of billions of new money for effective social innovations like MST.

Okay, we’re almost done.  I’ve tried here to explain the Future for Children Bond and its significance in terms that anyone can understand.  If I’ve been successful in simplifying something pretty arcane, I hope that no one draws the conclusion that there’s no rocket science in this particular innovation.  I have a Master’s degree in economics and a law degree, I’ve worked in government, business and nonprofits, and I could never have invented this thing.

With apologies in advance to everyone I’m leaving out, many of the brilliant people who did come up with this hale from the very same financial services industry and related corporate enterprises that brought the world to its knees beginning in late 2008:

• Tim Jones, CEO, Allia:  “Tim’s 35-year career spans financial services, SME start-up and social entrepreneurship. He has worked in North America, the Gulf and Europe – posts included Head of Marketing at FTSE Top 30 company Royal Insurance, and Managing Director, Europe, at Direct Marketing Corporation of America. He subsequently spent 12 years building, and successfully exiting, two enterprise start-ups – Fraser-Milne and STD Belgrade – before taking on Allia in 2002.”
• David Hutchison, CEO, Social Finance, Ltd. (UK):  “This follows a 25 year career at Dresdner Kleinwort where he was most recently Head of UK Investment Banking and a member of the Global Banking Operating Committee, coordinating the bank’s activities in the UK across the full range of investment banking products, M&A, debt and equity raising and derivatives marketing.”
• David Cowans, Group Chief Executive, Places for People:  “David has led the transformation of Places for People from a traditional Housing Association into a diverse business [with assets in excess of £3.1 billion] which provides a range of products and services to build and manage communities that can prosper and be sustainable in the long term. This includes regeneration services, financial services, affordable childcare, care and support services and a range of options to enable people to access a home whether through outright sale, affordable rent or sale or market rent.”

Of course, not everyone involved is a former banker or business executive:

• Children’s Support Services Limited (CSSL) is a newly-formed company set up by Social Finance to manage the outcomes contract with Essex County Council.   One of CSSL’s Directors, Lisa Barclay, is a Director at Social Finance who started her career as a public policy advisor focusing on Treasury, Transport and Employment policy areas and was a Special Advisor at the Department for Education and Employment.
• Tom Jefford, another CSSL Director, is the Head of Youth Support Services at Cambridgeshire County Council and has worked with MST Services for the last 10 years and is in the third year of a 4-year trial of MST for child abuse and neglect.
• The primary service provider is Action for Children, a charity that dates back to 1869 and is the largest single voluntary sector provider of services for looked-after children in the UK.  Clare Tickell, chief executive of Action for Children, whom Third Sector voted the “Most Admired Chief Executive” in 2008, “joined the charity in January 2005 after 16 years leading voluntary sector organisations.”

Not exactly Gordon Gekko.

I’ll close (finally!) with a personal observation.  On May 14, 2012, the Administration on Children, Youth and Families of the U.S. Department of Health and Human Services issued an “information memorandum” on “Child Welfare Waiver Demonstration Projects.”  The objective was essentially the same as the Future for Children Bond:  “there is a growing body of evidence suggesting that there are promising and effective approaches to improve outcomes for children and families in which abuse and/or neglect has taken place or is likely to take place. However, such approaches are utilized too rarely by many child welfare agencies. Our goal in facilitating innovation and experimentation in child welfare programs through waiver demonstrations is to improve outcomes for children and, thus, we encourage States to consider whether funding flexibility and improvements in the service strategies for children both at risk of foster care placement and those already placed outside the home could lead to better outcomes for children.”

With commendable prodding and support from the Office of Management and Budget, HHS included SIBs as one of the flexible funding mechanisms it wanted to promote:  “The proposed arrangements could take many forms and utilizing funding from non-Federal sources, including the philanthropic community and social impact bonds, is encouraged. For example, a state could condition provider payments, or bonuses paid from a foundation partner, on measurable improvement in child well-being outcomes or increased numbers of successful adoptions among the longest waiting children in foster care.”

As far as I know (and for reasons that I won’t go into here), no states applied to HHS for a spending waiver to use SIBs to keep at-risk kids from being taken away from their families.  Now that the UK has once again led the way by developing this brilliant social investment strategy as a promising approach for expanding proven prevention programs like MST, it’s time for government, foundations, social service agencies, and advocates in the US to take a close look.  This is one kind of financial engineering that can do an awful lot of public good.