Using derivative logic to speculate on the future of the social investment market

ABSTRACT

This article pries open the black box of the social impact bond (SIB), the novel financial instrument at the heart of social investment. We discover that concrete information is currently limited and our method is thus more speculative. We address the obfuscation of the nomenclature of the instrument and explore the mechanics of SIBs to suggest that they are not simple bonds but rather also bear properties akin to those associated with derivative contracts. We speculate on possible developments of the market in these bonds by considering the history of some previous financial innovations, namely, collateralized debt obligations (CDOs) underpinned by microfinance loans and the short-lived policy analysis market. Our discussion leads us to reevaluate Goodhart’s law and the ways in which it operates in relation to SIBs. We conclude by suggesting that SIBs' inherent indifference to the underlying state of the world renders them ultimately unlikely to delivery improvements in public services.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Two decades earlier, New Zealand economist Ronnie Horesh had proposed “social policy bonds”; these share many features with SIBs but also some important differences, as explained by Horesh (2015), who “do[es]n’t like” the latter. For a longer history of social investment, see Harvie (forthcoming).

2. Other proponents of the social investment market have also developed accounting tools and algorithms that seek to quantify expected outcomes and otherwise rationalize the construction of SIBs. For example, the Global Impact Investing Network oversees a “catalog” of social, environmental, and financial performance metrics called IRIS (see https://iris.thegiin.org/).

3. A fiscal cost here is a cost to the public purse, such as delivery of police response. An economic cost is the cost to the local economy, such as lost production. The social cost is the additional wider financial implications to society as a whole of the matter at hand. The database is available here: http://www.neweconomymanchester.com/our-work/research-evaluation-cost-benefit-analysis/cost-benefit-analysis/unit-cost-database.

4. Our use of somewhat cynical language to describe CDOs is both deliberate and far from constrained to avowedly critically oriented commentary, as the ubiquity of the term toxic assets in international press from 2008 onward attests. CDOs have, of course, been used to “pool” all types of debt. But their increasing ubiquity should not lead us to assume that they are therefore benign, as the similarly increasing ubiquity of the notion of toxic assets reminds us. Indeed, we would contend that their association with the subprime crisis is not necessarily a particularly aberrant instance of their use. There are several characteristics of securitization—the process through which a CDO is created—that are germane to our discussion and that, we suggest, apply to both the U.S. mortgage market and, potentially, the social investment market. First, securitization involves a further separation between the “performance” of some underlying activity or asset and the actors who benefit financially from this performance. This creates principal–agent problems related to the monitoring of this underlying performance—or portfolio of performances. Second, an often implicit assumption associated with the CDO is that the performances of the underlying activities or assets are uncorrelated. This assumption clearly proved to be false in the case of subprime mortgages and we suspect that it is similarly ungrounded in the case of the social problems that SIBs are designed to address. Finally, and more generally, securitization further shifts risks onto society’s most vulnerable: households, especially poor households, in the case of mortgages, which become the “shock absorbers of last resort” (International Monetary Fund, as cited by Bryan, Martin, & Rafferty, 2009, p. 468); the users of social services—victims of domestic violence, the homeless, etc.—in the case of the social investment market. (See Bryan et al., 2009, for an insightful critique of securitization.)

5. See Hina, Khan, and Lightfoot (2009) for more details.

6. Or, as is more likely, justify the defunding of social care initiatives (Dowling, 2016).

7. See Robin Hanson’s “Policy Analysis Market (and FutureMAP) Archive” for considerably more detail on this curious beast (http://mason.gmu.edu/~rhanson/policyanalysismarket.html).

8. Causality is not one-way: the value of the “underlying” may change in response to change in the value of its “derivative” variable.

Additional information

Notes on contributors

Simon Lilley

Simon Lilley is Professor of Information and Organisation and Head of the Management and Organisation Division of the University of Leicester School of Business, where he is currently Director of the Centre for Philosophy and Political Economy.

David Harvie

David Harvie is a member of the Centre for Philosophy and Political Economy at the University of Leicester. Most of his writing is available on academia.edu and ResearchGate.net.

Geoff Lightfoot

Geoff Lightfoot is also a member of the Centre for Philosophy and Political Economy at the University of Leicester, where he is Associate Professor of Accounting and Entrepreneurship.

Kenneth Weir

Kenneth Weir is Lecturer in Accounting at the University of Leicester, where he is also a member of its Centre for Philosophy and Political Economy. His recent research explores the links between value, accounting, and finance, specifically how these links are shaped within the social context of accounting.