Goldman Sachs Invests in Government and Expects to Be Paid Back

Is Wall Street the key to funding perennially cash-strapped social programs in the U.S.?

Goldman Sachs officials are proud, very proud, that their firm made the first investment ever in a public-private "pay for success" program.

In 2012, the financial giant entered an agreement with the city of New York to loan $10 million of start-up cash to establish a cognitive-behavioral-therapy program for juveniles incarcerated on Riker's Island. At the time, half of the adolescents who left New York City's Department of Correction returned within one year. The goal of the cognitive-therapy intervention was to reduce recidivism rates. The city pays back the loan with interest when recidivism rates drop, decreasing costs of jail time. If all goes well (and so far, it has), a successful reduction in reincarceration could net the Goldman's client investors millions of dollars in return.

Goldman Sachs' entrance into this kind of financing—most often known as social-impact bonds—could change the way both Wall Street and governments do business. "There's been value in everybody coming to the table ahead of time to identify the outcomes we're looking for," says Andi Phillips, vice president of the firm's Urban Investment Group. "How do we know we've achieved them--what drives payment?"

Over the last several years, Goldman Sachs has spearheaded three other social-impact bonds: a quality preschool expansion for at-risk 3- and 4-year-olds in Salt Lake City; a work and life-skills training program for young men leaving prison in Boston; and another preschool expansion in Chicago. All are based on the same pair of concepts—that upfront investments in evidence-based interventions for at-risk individuals can save lots of money down the line, and that there is no reason why a for-profit company shouldn't cash in on those savings.

The difficulty lies in quantifying the social bonuses of having fewer people in jail, fewer people committing crimes, and fewer kids needing remedial and special education services. That's also where the opportunity is.

"Our hope is that this type of financing grows. Our hope is that these types of investments will become more scalable over time, and that it really is an opportunity for the next generation of public-private partnerships," Phillips says.

As government budgets are squeezed tighter and funding even the most basic of services becomes more difficult, elected officials are usually disinclined to take the long view and factor in the longterm savings of a little bit of upfront investment.

Any attempt to provide benefits to Americans usually involves an accompanying initial cost that sometimes gives people pause. President Obama's attempt to provide health insurance for everyone is one example of this phenomenon, and early education is another. "In a movement, any sort of major push toward improving or increasing social programs, there is a point where you hit the money question," says Kris Perry, executive director of the First Five Years Fund.

Early education is a particularly sound investment, even though there isn't enough money to provide preschool for every 3- and 4-year-old in the country. University of Chicago economist James Heckman says the cost of educating youngsters before kindergarten gives returns of 7 to 10 percent per year, per child. From a purely economic perspective, early education is the very best government bang for the buck. The trouble is that it's hard for any single party to recoup that investment. (The quid pro quo here is important because American society has yet to decree that early education is a fundamental right and responsibility, as it has done for people ages 5 to 18.)

Nevertheless, Goldman Sachs' entered the world of early education with an experimental social-impact bond for expanded preschool in Salt Lake City. The funding helped a large urban school district add roughly 1,350 preschool slots for children who otherwise may not have received an early education. The expansion was largely targeted to help non-native English-speaking kids who qualifyed for free or reduced lunches because of their families' low incomes. The goal is to help prepare these student for kindergarten and to expose them to reading early on, so that "they're not lagging behind from the start," says Brenda Van Gorder, director of Pre-School Services for the Granite School District.

The results have been positive and conclusive so far, thanks to the social-impact bonds. Spending $1,500 per student to create additional preschool slots and give kids exposure to early-childhood education, decreases the number of students who later need expensive special education, Gorder says. "This [preschool] is like preventive medicine," she adds.

Goldman Sachs' social-impact bonds are too new to recount the profit yields. But the initial results are encouraging to the firm and its business partners. This may be a new way to look at doing business, in addition to a new way for local governments to fund services. "Increasingly, our clients across the board are interested in this crossover between investment and social impact," Phillips says.

Nancy Cook contributed to this article