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5/17/2015

Smart Money, by Andrew Palmer - NYTimes.com

http://nti.m/1Jw0wen

SUNDAY OOK RVIW

Smart Mone, Andrew Palmer


FRANK PARTNOY

MAY 8, 2015

In 2012, The Economist published a 14-page special report on financial


innovation entitled Playing With Fire. It opened with the line Financial
innovation has a dreadful image these days. The goal: rehabilitate that image.
The reports author, Andrew Palmer, then the magazines finance editor,
attempted to shift focus away from the infamous subprime mortgage bets that
nearly brought down the financial system. Instead, he pointed to several new
deals bubbling up in unexpected corners of the markets. Palmer began in
Peterborough, England, site of the first-ever social-impact bond, a novel
and humanitarian transaction that sought to reduce recidivism among
prisoners.
Prison reform is not typically in the same paragraph as financial
derivatives, but Palmer argued that the Peterborough deal did what financial
innovation is supposed to do: match the needs of different people and
institutions, so that all can be better off. Investors in the Peterborough socialimpact bonds paid cash into a prisoner training program; in exchange, they
received a promise of future payments from Britains Ministry of Justice if the
prisoners committed fewer crimes than did other groups. The deal promised a
win-win-win: Prisoners would learn life skills and a trade, government would
spend less money on prisons, and investors would earn an attractive return.
Palmer raved about the tripartite deal: Here, surely, is a financial innovation
that even the industrys critics would agree is worth trying.

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5/17/2015

Smart Money, by Andrew Palmer - NYTimes.com

The Peterborough pilot program deserved more than a brief mention in a


magazine piece, and it now anchors the second half of Palmers fascinating
book. Palmer is a muscular, efficient writer; he relates in-person interviews
and statistical evidence with ease and humor. The chapter on social-impact
bonds tracks one man who, after being in and out of prisons for decades,
turned his initial work placement into a full-time job at a builders merchant.
He was in work, in accommodation, paying his own bills.... His life had
improved because of a dose of financial creativity.
There are now social-impact bonds that direct money to various social
needs: finding and supporting adoptive parents for hard-to-place children,
keeping children out of foster care, getting homeless rough sleepers off the
streets. With the first American social-impact bond, investors are financing a
rehabilitation program for adolescents at the Rikers Island correctional
facility, and will be paid back, with interest, if reduced recidivism goals are
met.
Palmer connects the Peterborough story to other ways finance can be a
force for good. Novel insurance-like policies help biotechnology firms raise
funds for risky clinical trials. Human-capital contracts enable college
students to obtain money for school without borrowing, by committing to pay
a fixed percentage of their income after they graduate. Online lenders, such as
Kabbage and OnDeck, use mathematical algorithms to assess the health of
small businesses, and provide capital when big banks will not.
The first half of the book is also provocative, but lacks the original
reporting of the second half and is smug in its sweeping, often unsupported
conclusions. The opening sentence of Chapter 1 promises much: The history
of financial innovation is also the story of human advance. But what follows is
lined with unsubstantiated assertions and cherry-picked history.
The rhetoric in the early pages reminded me of claims by Merton Miller, a
Nobel laureate economist at the University of Chicago, who was in many ways
the father of financial innovation. Miller praised complex financial
instruments, in large part because they helped institutions avoid the law. He
applauded bankers for cleverly avoiding government attempts to interfere with

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5/17/2015

Smart Money, by Andrew Palmer - NYTimes.com

markets. Yet Palmer does not address Millers arguments, or even cite him. It
is a material omission like a book on sonnets that does not mention
Shakespeare particularly because Palmers ultimate point is the opposite of
Millers: that financial innovation is beneficial because it addresses broad
social needs, not narrow private ones.
Fortunately, the second half of the book rehabilitates the first. Palmers
vignettes show how innovation can, and should, involve more than bankers
getting rich, playing games and dodging rules. Today, upstart companies are
nipping at the heels of the major banks, seeking to profit by doing good. That
is the right kind of smart money.
SMART MONEY
How High-Stakes Financial Innovation Is Reshaping Our World for the
Better
By Andrew Palmer
285 pp. Basic Books. $27.99.
Frank Partnoy, a law and finance professor at the University of San Diego, is the
author of Wait: The Art and Science of Delay.
A verion of thi review appear in print on Ma 10, 2015, on page R28 of the Sunda ook Review
with the headline: Societal ond.

2015 The New York Time Compan

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