What prisons can learn from Goldman Sachs

Riker’s Island penitentiary

FORTUNE — In the U.S., we call them correctional facilities, but what do they correct? Correction implies a fix, something made better, improved. A third of all individuals incarcerated in America (who account for a quarter of all prisoners in the world) have returned to prison after a violation of their parole or probation.

One might assume that the type of people who end up in prison are simply bad and cannot be made better, but more than half of the prison population is there for nonviolent crimes or drug charges. More than 68 million Americans have a criminal record. That’s a quarter of the country.

As the prison population has swelled, so has the prison budget. In 1980, the U.S. spent $6.9 billion a year on its prison system; today, it is $80 billion. If you include the entire system of mass incarceration — judicial, legal, police — we spend an estimated $260 billion per year on on so-called corrections.

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The costs of incarceration on an individual scale range from $21,000 a year (in a federal, minimum security prison) to a little more than $47,000 per year in California. Those who end up back in prison — which is about half of all of those in prison at the moment — are often there for maddeningly minor parole infractions. If you don’t pay the $30 a month for your parole, you go back to prison; if you don’t have a reliable address after 30 days, you go back to prison; if you miss a meeting with your parole officer, you go back to prison. In Mississippi, nearly one-third of all prison admissions are for nonviolent parolees who return because of such “technical violations.” Until recent reforms, nearly two-thirds of those in California’s system were there for the same sort of infractions. Ours is a system that has a talent for keeping people in the system.

Bryan Stevenson, a lawyer and founder and executive director of the Equal Justice Initiative (EJI), tells the story of one such recently released prisoner, an elderly man “who just didn’t have anyplace to go. He was 71, and he had absolutely no one.” He was homeless, he did not have a reliable address, and so 30 days after his release he would have been charged with a technical violation and reincarcerated. Stevenson’s Alabama-based organization stepped in, provided shelter and — crucially — enough time for the man to land a job (not easy, being elderly and having a criminal record) so he could put the money toward a roof over his head, and the $30-a-month required for his parole. It didn’t take long, just 90 days, and it didn’t cost EJI much to prop him up a bit to keep him from falling back. Financially speaking, this is a tiny part of Stevenson’s non-profit — he estimates they spend “less than $5,000 providing some services: driving people to meet their parole officer, finding a shelter, getting a Post Office box …” And yet, for just $5,000, he estimates they keep about 100 people from reentering prison each year.

“This is very simple stuff,” Stevenson says, “But this is a system indifferent to any consequence — it’s just acculturated to sending people back to prison.” Indeed, probation officers are often paid by counties, while prisons are most often state systems. When a probation officer sends one of his charges back to prison, he reduces his workload and saves money for the county, only to transfer costs to the state, drastically increasing costs overall. With such perverse incentives in place, it’s little surprise that the American prison system has become the largest and most expensive in the history of the world.

There’s a better way. Instead of encouraging incarceration, incentivize performance. How might the performance of the department of corrections be measured? By recidivism. A drop in reincarceration would offer evidence that well-performing prisons are not places that breed more criminals but provide rehabilitation instead.

Such performance incentives already exist. They are called “social impact bonds.” The first, issued in 2012 by Goldman Sachs (GS), is underway in New York City for $9.6 million. The money is going toward a four-year program to reduce reincarcation of juveniles at Riker’s Island prison. Goldman Sachs has a vested interest in the success of this program. If participants stop returning to jail at a rate of 10% or greater, Goldman will earn $2.1 million. If the recidivism rate rises above 10% over four years, Goldman stands to lose $2.4 million. In a recent report, the Brennan Center for Justice at NYU School of Law calls this a “bet on success … instead of using the typical model of privatization, in which private prisons generally bet on failure (i.e. the more prisoners, the better).”

What if this idea grew into something greater than an experiment between a jail and a bank? What if states — which control most of the U.S. prison system — introduced performance bonuses that rewarded successful jails?

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Stevenson spends a lot of time in prisons, and he says he believes this idea could be transformative — the further you take it, the more powerful it becomes. “What if you personalize it?” he asks. “What if individual officers, and administrators, personally benefitted by reducing recidivism rates? If you created the right kind of bonus, something that was really meaningful, it would just be fascinating to see how quickly things would change. Guards would be desperate to get educational facilities, they’d want classes, drug treatment, safe environments. Their interests would align with the prisoners’ — they’d care if people came out. They’d care about who shouldn’t come out. It would have an impact on how they think about their work, their life. And you — we, taxpayers, the system — wouldn’t be spending new money, you’d just reallocate.

“I think everyone involved would much prefer going to work and not hating everybody, but feel like they’re contributing to something that’s making people better.” And we’d be that much closer to having a department of corrections that’s actually correct.

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