Andrew Allentuck was kind enough to quote me in his October, 2014, piece Product shelf now includes green bonds:
In January 2014, the Commonwealth of Massachusetts issued a green bond called the Juvenile Justice Pay for Success Initiative. That US$9-million issue – and companion issues from Bank of America in negotiation at time of writing – are designed to provide funds to deter young criminals from committing more crimes.
Each person the program keeps out of jail for a year saves Massachusetts US$12,500 a year, according to a Bloomberg LP report. The state would win, social service agencies would win and the deterred criminals presumably would win. It’s all good economics designed to capture and monetize external matters, but there’s a critical flaw in the plan: those who are to be deterred have no direct interest in paying the bondholders.
It’s early in the life of these bonds and, so far, there have been no defaults. But bonds with an iffy payment mechanism need justification beyond yield to maturity.
These “stay out of jail” bonds were priced with huge payoffs if they work – and, of course, big losses if they don’t. In August 2012, the State of New York issued a US$9.6-million “social impact bond” designed to reduce recidivism. The investor, Goldman Sachs Group Inc. in this case, will receive US$9.6 million. But if recidivism were to drop by more than 10%, Goldman would get a payoff of up to US$2.1 million. If recidivism does not drop by at least that much, Goldman could lose as much as US$2.4 million.
The balance point is a change of plus or minus 10% in the recidivism rate of a defined set of convicted felons. “The risk is great,” says James Hymas, president Hymas Investment Management Inc. in Toronto. “And this is really equity in bond clothing.”