Imagine a plan that reduces the cost of overcrowded prisons, lowers recidivism, creates a new form of human capital investment, and exemplifies societal goodwill. Five Berkeley Master of Financial Engineering (MFE) Program students did just that last fall with a proposal to offer financing and credit to former inmates who aim to become entrepreneurs and small business owners.
The plan, outlined in a paper titled "Valjean Financing: Credit for the Formerly Incarcerated," calls for lending money to qualified felons who have served their time and are looking for a second chance. Co-authors Ting Gao, Angelo Caraballo, Ruchit Duggal, David Cornejo Rodriguez, and Jay Yang, all MFE 12, say the plan also offers private investors new opportunities to invest in philanthropy at surprisingly low risk. And, after examining the data, the Valjean team predicts the program could save the government and taxpayers millions of dollars.
Gao first proposed the plan to his classmates in the Financial Innovation course taught by Haas Adjunct Professor John O'Brien. The primary assignment of the class is to combine imagination and financial engineering course-work to identify and develop solutions to important economic challenges.
Financial Engineering to Benefit Society
"Valjean Financing attacks a problem that we see in the U.S. and other countries. It is an ingenious way to involve the private sector and a perfect example of how financial engineering can be used for positive results," says O'Brien.
Indeed, Gao's idea stemmed from a startup contest that he entered in Singapore with a Chilean friend who was working on an entrepreneurial education program in Santiago to teach pre-release convicts basic business skills to enable them to start their own businesses and reintegrate better to the community. "After a few months in the Berkeley MFE Program, when we were prompted to come up with a financial innovation to solve real-world problems, this idea immediately flashed into my mind," he says. "I thought if there are numerous attempts globally to tackle this problem ... why can't we as financial engineers have a part to play as well?"
"We wanted to show financial engineering can benefit society," he adds.
The proposal is named after Jean Valjean of Les Misérables, who spends 19 years in prison after stealing a loaf of bread. Ultimately the act of a kindly bishop – from whom Valjean steals silver – leads Valjean to build a new life.
"This financing proposal offers us all a chance to reach beyond merely stating that we would like to help, because it will make it easy and fun to do so," says Caraballo. "After all, who doesn't want to help a Jean Valjean?"
Valjean Financing would provide personal credit regardless of one's criminal history. The plan calls for a selective qualification system that screens the applicant's conduct both before and during incarceration to determine eligibility.
Safeguards for all Involved
Valjean financing also would offer safeguards for both investors and the "Valjeans." For instance, performance-linked loans would improve the ability of a Valjean to make loan payments, especially during the tumultuous initial post-release period, and reduce the chance of investor sentiment going sour. The Valjean team continues to work on establishing a model that would assess an ex-inmate's fundability.
The loans would be awarded by a government or private intermediary that acts as an auctioneer. Private investors would compete for an individual's "Valjean Bond" by bidding on the interest rate, with the lowest rate winning. Participation of philanthropist investors could mean some rates are even negative.
The students say implementation of the plan would depend on the government's support and cooperation, access to protected data, a regulatory body responsible for periodic disbursements, investor buy-in, and scalability to allow the Valjean Financing Program to be easily replicated and function in multiple markets.