Opinion: City Places Investors Ahead of Kids With Social Impact Bonds

If there’s one thing we know about Wall Street, it’s that most Wall Street firms are not in the business of philanthropy.

Yet the city is about to enter into a $30 million agreement with several Wall Street lenders to finance an early education program that from all appearances will allow banks to profit off the educational success of children with almost no risk to their own bottom lines.

And, once again, the city is about to enter into a complex, long-term financial transition with millions of dollars at stake with almost no debate, little understanding of how the program works and no third party to weigh in on the potential risk and rewards.

Even worse, the program looks from some angles to be little more than a mechanism to transfer public dollars to private lenders while using children as collateral.

The Emanuel administration says the program, known as “social impact bonds”, is an innovative way to cover the costs of enrolling more than 2,600 children in an already-existing Chicago Public Schools preschool program.

Instead of simply finding the money in the city budget to expand the program and keep the benefits for itself, however, the city has turned to lenders such as Goldman Sachs, Northern Trust and the Pritzker Family Foundation to provide the upfront money, with promises of substantial profits for the lenders down the road if the program goes as planned.

At issue is the question of whether children do better later in their academic careers if they receive critical early childhood education. The financing will pay for 2,600 additional slots in Chicago’s well-regarded Child-Parent Centers that currently provide preschool, support services and require strong parent engagement.

In short, the city receives $17 million to enroll the kids now and promises to pay as much as $30 million back in expected “savings” in years to come should all the children meet a series of educational and performance goals.

According to an analysis by Chicago Catalyst, the deal “relies on a complicated formula that poses little risk to investors … largely due to the proven track record of the project’s chosen preschool program.” Catalyst also found that CPS will pay about $21.5 million over 16 years of “savings” from kids using fewer special education services. However, if the program is more successful than expected, CPS could pay up to $30 million to the lenders.

The city is also expected to pay $4.4 million more in “success payments” based on children’s kindergarten readiness and third-grade literacy. CPS is also on the hook for a series of other payments, fees and expected returns.

In return, lenders have built into the contract the ability to minimize their upfront risk in return for the loans. Under questioning from aldermen at a Monday City Council Finance Committee hearing where the proposal was passed for consideration by the full Council, Chicago’s Chief Financial Officer Lois Scott said CPS will first be required to do a feasibility study to prove it can generate enough money to pay investors back.

Beyond the project’s expected risks or rewards, however, lies the bigger question of exactly how the city authorizes such programs. Much like the notorious parking meter deal, the less well-known Chicago Infrastructure Trust or plans earlier this year to issue $1.9 billion in new bonds, the social impact bond deal requires both substantial review and a fundamental understanding of complex financial transactions to ensure the city is getting the best deal possible.

However, much like any number of other complex financial transactions the city engages in, aldermen had less than a month to review and understand the more than 200 pages of contracts and agreements that govern the deal. As well, the Council’s much heralded reform designed to provide insight into such transactions—the Council Office of Financial Analysis—remains in limbo more than a year after being created due to a fight over who should lead it.

Further, the only public debate over the issue was at Monday’s Council Finance Committee hearing, where less than half of the committee’s 35 members appeared and only four—Toni Foulkes (15), Lona Lane (18) and Willie Cochran (20) and Scott Waguespack (32)—voted against the measure.

As a result, the contract was transmitted to Council in early October and will be voted on—and approved—less than a month later at Wednesday’s full Council meeting.

“[Preschool programs] been proven to work for decades,” said Waguespack at Monday’s hearing. “It reminds me of the parking meter deal. The same type of people came in and said it was a high-risk asset [when] it was a low-risk asset ...We lost billions of dollars. We’re not gonna lose billions here. But, taxpayers under this scheme are gonna pay a lot more than if we just went out and re-allocated resources we already have.”

Of course, that’s just how it is when Wall Street comes knocking on Chicago’s door. Whatever big banks and financial institutions say is taken as gospel, and the city bends over backward to make sure such deals are rushed through before any effects on the future are really understood.

Only this time, it’s children that are being used as an excuse to make sure Wall Street get what it wants. 

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