Could an idea imported from Britain help feds through tight financial times?

My colleague Jeff Liebman – a Kennedy School economist who had a senior position in the Office of Management and Budget for the first few years of the Obama administration – gave an interesting faculty seminar recently on work he has been doing on what are called (somewhat misleadingly in his view) "social impact bonds." This idea originated in the United Kingdom and has begun to spread to state governments in the US. I am wondering whether it conceivably might have some applicability in the federal government.

As Jeff pointed out in his presentation, "social impact bonds" are actually strict performance-based contracts with a twist. A contractor signs up for some performance objective over a period of years. If they achieve the performance objective, they are paid at a rate that will provide them a decent, but not huge, return on their investment. If they don’t achieve the objective, they are not paid.

So far, these contracts have been used almost exclusively for hard-to-solve social problems, such as reducing criminal recidivism or finding jobs for the hard-to-employ. So a contractor taking one of these jobs is signing up for a big risk of not getting paid.

Why would any contractor (mostly, in these cases, not-for-profits) sign up for this, given the risk and the relatively small profits even if successful?

This is the twist in "social impact bonds," and the reason for its name. Contractors do not take most of the risk themselves. Instead, the contractor's expenses, and a modest profit, are funded by foundations that are interested in solving the social problem the contract seeks to address. (The contractor is in effect borrowing money from the foundation and issuing a "bond.") The contractor typically gets some additional profit from the foundation if the performance objectives are met. For the foundation, this is an alternative to giving the non-profit a grant, which is unlikely to be as strongly performance-based. If the contractor fails, the foundation takes the loss.

The pool of capital for these efforts has more recently been expanded in two ways. Some private companies (such as Goldman Sachs) are investing in these as a pro bono investment that they at best hope maybe to break even on. More importantly, there are beginning to appear in the private market "shares" in these social impact bonds that wealthy people who would like to do some socially responsible investing are buying. (For states working on this arrangement for social programs, Jeff has set up a Harvard-based group that provides technical assistance to states and nonprofits going down this road.)

Like share-in-savings contracting, social impact bonds can be an especially attractive form of funding for organizations in tight budget times. (Share-in-savings can work in the absence of socially responsible investors because private firms receive a higher profit in exchange for the greater risk they take.) Listening to Jeff’s presentation, I wondered whether this could be used in the federal government.

I think most (but maybe not all) direct-delivery social programs are delivered by state and local government, not the federal government – though the Bureau of Prisons presumably also worries about re-offending, at least to some extent. But I was wondering whether there might be at least some situations where foundations or socially responsible investors might be willing to lend money to organizations that take on these challenges. One thought that came to mind might be wealthy immigrants who might be interested in investing in an IT application for Citizenship and Immigration Services at DHS.

Might there be some wealthy ex-military personnel (or just people who enthusiastically support national defense) who would be willing to invest in a risky Defense Department mission-related application? And how about using this for some performance-based research funding for the National Institutes of Health? (One thing to keep in mind is that these "bonds" are going to involve relatively limited amounts of money – don’t expect billion-dollar projects to be funded this way.)

Just some thoughts. In tight budget times, we need to become more creative. Reactions?