posted August 03, 2012 03:25 PM            

Goldman Sachs (GS) is offering $9.6 million in funding to help New York City keep Rikers Island jail inmates from ending up back behind bars after they’re released. This isn’t a regular donation, though—it’s a new type of investment called a “social impact bond,” designed to use market incentives to encourage private funding for public problems.

The Rikers project is the first social impact bond in the U.S., but the idea has origins in the U.K. In 2010 a British do-good investment bank called Social Finance issued the first social impact bond. The bank lined up 17 investors—mostly foundations and charitable trusts—to support an $8 million program to rehabilitate 3,000 men released from a prison in Peterborough, a London suburb. The program set the goal of reducing the recidivism rate for the men by at least 7.5 percent over six years as compared with a control group at other prisons.

Social impact bonds require investors to front the money for nonprofits to provide social services, and if the nonprofits don’t meet the goal, the government doesn’t lose a penny—and the investors won’t recoup all their funds. If the Peterborough program meets or surpasses the goal, the government (with some help from Britain’s lottery fund) will repay investors the original capital as well as a return, as much as 13 percent per year over an eight-year period.

If MDRC, the New York group spearheading the Rikers program, succeeds in helping lower the prisoners’ recidivism rate 10 percent over four years, the city’s Department of Correction will give the nonprofit the money it needs to repay Goldman Sachs for the loan. Should MDRC double that goal, Goldman could stand to make an additional $1.1 million (PDF). Uniquely in this case, New York City Mayor Michael Bloomberg’s private foundation is providing a $7.2 million guarantee on the loan. (The mayor is founder and majority owner of Bloomberg LP, the parent of Bloomberg Businessweek.)

The New York Times looked at the British case in June, reporting that One Service, the nonprofit coordinating the program, “meets everyone in Peterborough at the prison gate, even the prisoners who didn’t sign up for the service. They go to breakfast—usually at McDonald’s (MCD), at the men’s request—and then to the office.” The goal is to then persuade the inmates to take advantage of One Service’s offerings, including mentors, job training, housing, and drug rehab.

In describing the program (PDF), Social Finance explains that the bond tried to solve a funding conundrum—while rehabilitating inmates cuts down government costs in the long run, the programs cost money in the short term. And politics often inhibit that type of big-picture thinking—particularly in times of austerity—which is why this gap investment from the private sector appeals to officials.

New York City isn’t the only U.S. government to explore social impact bonds. Massachusetts just signed up two nonprofit partners to apply the technique to work with juvenile criminals and the homeless, a step it needs to take before lining up investors, and other countries as well as states and cities in the U.S. are trying to get projects going. This is all before there’s any solid data to judge the Peterborough program. It’s first full evaluation comes in 2014, when we’ll get a real sense of just how much “social impact” the bonds can have.

Weise is a reporter for Bloomberg Businessweek.
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