United States: Reconstruction Finance Corporation Emergency Lending to Financial Institutions, 1932–1933

The RFC was created through an act of Congress passed January 22, 1932 (U.S. Congress 1932b). The stated purpose of the RFC in the original act was “to provide emergency financing facilities for financial institutions, to aid in financing agriculture, commerce, and industry, and for other purposes” (U.S. Congress 1932b). The effects of the developing Great Depression, which were partially a result of overleverage and debt deflation, compelled many banks to restrict their lending to “reduce further exposure to declining asset values and accumulate loan loss reserves that could offset the capital depletion resulting from expected defaults” (Mason 2001b, 2). The resulting severe credit restrictions meant that many banks and industrial firms found it difficult if not impossible to acquire sufficient funding. Policy makers believed that if they could provide liquidity, “capacity utilization and therefore asset values would increase and general economic recovery would follow” (Mason 2001b, 2–3). The law also provided funding to farmers, who were having difficulty obtaining normal crop-funding loans (U.S. Congress 1932a, sec. 2).

In a speech delivered on December 11, 1931, President Hoover outlined the RFC’s role as a provider of emergency credit:

The RFC was closely modeled on the War Finance Corporation (WFC), a government-sponsored corporation created to give financial support to industries essential for World War I, and to banking institutions that aided these industries.^FNThe WFC, established in 1918, lasted until 1929, two years before the creation of the RFC. The WFC was created to ease the impact of newly issued war-finance federal government securities. Industrial “enterprises encountered difficulties in securing capital that would enable them to convert to war production” (Nash 1959, 457). Ebersole (1933, 467–68) says the RFC was so closely modeled on the WFC that “the only substantial innovations in the original Reconstruction Finance Corporation Act . . . were the greater volume of funds provided, and the inclusion of railroad financing.” For Eugene Meyer, former head of the WFC and member of the Board of Governors of the Federal Reserve, the WFC had “psychological value”: “The knowledge that funds were available in an emergency . . . gave a greater confidence to private finance” (Meyer 1931, 19).

At the time the act was passed, although the Federal Reserve could serve as LOLR for member banks, there was no federal agency that could make large loans to many depressed sectors of the economy or support state-chartered banks and banks in small rural areas that were not part of the Federal Reserve System but were in need of loans to manage daily operations (Gou et al. 2013). The RFC was intended to fill this gap; it was authorized to loan to a wide range of financial institutions, even those in receivership, and to accept as collateral any asset the board deemed acceptable, providing an outlet for illiquid assets (Gou et al. 2013).

Hoover enumerated the eight purposes of the proposed RFC in his memoir. Two related explicitly to financial institutions:

• to make loans to banks and financial institutions ‘which cannot otherwise secure credit where such advances will protect the credit structure and stimulate employment’ . . .  
• to make loans to closed banks upon their sound assets so as to enable them at least partially to pay out deposits to a multitude of families and small businesses who were in distress because their deposits were tied up pending liquidation or reorganization of these banks (Hoover 1952, 98).

Emergency lending to financial institutions and railways constituted the primary focus of the RFC prior to the bank holiday in 1933 and the introduction of the preferred-stock-purchase program in March 1933, the period on which this case is focused. Given banks’ large holdings of railway stocks, it was thought that stabilizing railway bonds was important to stabilizing financial institutions (See Appendix).

The RFC was significantly amended in July 1932 and again in March 1933 (see Key Design Decision No. 2). These amendments broadened the agency’s authority, and the nature of its operations changed in 1933 when Meyer resigned from its board and the Roosevelt administration pursued a wider range of stimulus activities using the RFC (Gou et al. 2013).

The RFC drew its legal authority from the Reconstruction Finance Corporation Act (RFC Act) (H. R. 7360), which Congress passed and President Hoover signed into law on January 22, 1932 (U.S. Congress 1932a). The RFC was created as a temporary corporation to be dissolved on January 1, 1942 (U.S. Congress 1932a, sec. 4). However, the RFC Act specified that its authority to make loans extended for only a year after the passage of the act; the president had the authority to “postpone such date of expiration for such additional period or periods as he may deem necessary, not to exceed two years” (U.S. Congress 1932a, sec. 5).

The RFC Act was amended by the Emergency Relief and Construction Act of 1932, passed on July 21, 1932, and signed into law on July 27, 1932, which expanded the RFC’s authority to make loans to “self-liquidating” projects (U.S. Congress 1932b). The RFC was further amended by the Emergency Bank Act—approved on March 9, 1933—which authorized the RFC to subscribe for preferred bank stock (Treasury 1959, 4). The Insurance Company Act of June 10, 1933, enabled the RFC to subscribe for preferred stock of insurance companies (Treasury 1959, 5).

Emergency lending to financial institutions and railways constituted its primary focus prior to the bank holiday and the introduction of the preferred-stock-purchase program in March 1933. Thereafter, the agency’s authority and its operations broadened, and under the Roosevelt administration it pursued a wider range of stimulus activities (Gou et al. 2013).

The RFC was created through a stand-alone act of Congress passed on January 22, 1932 (U.S. Congress 1932a). However, the federal government created a number of other agencies to respond to financial distress during the Great Depression, including the Federal Home Loan Banks (FHLBanks) in 1932 and the Home Owners’ Loan Corporation (HOLC) in 1933 (Wheelock 2008, 140). For more information on the FHLBanks’ operations during the Great Depression, see Leonard (2022).

A board of directors with seven members managed the operations of the RFC (U. S. Congress 1932, 2).  Under the original legislation, the board of directors was to be made up of the secretary of the Treasury, the governor of the Federal Reserve Board, the Farm Loan commissioner, and four other individuals appointed by the president and confirmed by the Senate (U. S. Congress 1932, 2). The board of directors was to be bipartisan, with no more than four members’ being appointed by one political party (Cho 1953, 11). On August 1, 1932, the Act was amended, removing the governor of the Federal Reserve Board and the Farm Loan Commission from the board and increasing the number of presidential appointees to six (U.S. Department of the Treasury 1959, 25). Board members served two-year terms and were paid salaries of $10,000 a year (U. S. Congress 1932, 2).

The RFC was an executive agency and a wholly owned government corporation. The RFC therefore had license to design its operations, within the scope of its authority, without further approval from Congress (Mason 2001b, 3).^FNResearch indicates that the board had discretion over collateral requirements, rates, and maturities, so long as loans were “fully and adequately secured” in the eyes of the RFC (U.S. Congress 1932a, sec. 5). The RFC was not subject to Civil Service hiring regulations, nor was it audited by the Congressional General Accounting Office (Mason 2001b, 3). As per section 15 of the RFC Act, the corporation submitted quarterly reports of its operations to Congress, which were also published in the Federal Reserve Bulletin (U.S. Congress 1932a, sec. 15).

Section seven of the Act provided that unused funds of the RFC could be deposited with the treasurer of the United States in an account established at the Federal Reserve. The Act also provided that the Federal Reserve and its system banks were authorized “to act as depositaries, custodians, and fiscal agents for the Reconstruction Finance Corporation in the general performance of its powers” (U.S. Congress 1932a, sec. 7).

The administration of the RFC was initially executed through regional offices housed within Federal Reserve banks (Ebersole 1933, 470).  The Fed lent to its member banks and accepted government securities as collateral; the RFC lent to banks and small and state-chartered banks, mortgage companies, and agricultural lenders, and it accepted collateral the Fed would not (Gou et al. 2013). Initially, RFC funds were disbursed through Federal Reserve Banks and district branches (RFC 1932, no. 1).

Eugene Meyer, the governor of the Federal Reserve Board and the chairman of the board of the RFC, stated that Federal Reserve banks lent “personnel and facilities” to aid the nascent RFC (Meyer 1932, 2). The regional RFC offices handled loan applications, with the exception of those concerning railroads, farm-loan banks, and federal intermediate credit banks, which were executed at the central Washington, DC, office (Ebersole 1933, 470).

Eventually, RFC field offices were established in principal cities throughout the country, with a main office in Washington, DC (Mason 2001b, 5). Like the former WFC, after which it was modeled, and from which many RFC staff members were recruited, the RFC had 33 field offices across the country (Olson 1988, 15). Field offices were authorized to extend loans up to $100,000, and only unusual loans required approval from the board of directors (Mason 2001b, 5). Field offices valued collateral and fixed collateral requirements for loans. So long as field offices turned a profit, they faced little intervention from the central RFC office in Washington (Mason 2000, 5–6).

This case study focuses on emergency loans to financial institutions between 1931 and 1933.^FNOver its long lifespan, the RFC’s authority grew to be broad, and to include lending to other types of corporations, and was later expanded to also include loans to finance infrastructure or industry, which is not the subject of this case study.  The RFC Act authorized the RFC to make loans and advances to a broad set of institutions, including many that were not eligible for Federal Reserve lending:

The RFC was authorized to lend to banks that were closed or in the process of liquidation. However, the RFC Act specified that no more than $200 million was to be allotted for such banks (U.S. Congress 1932a, sec. 5).

By July 30, 1932, the RFC had lent to banks throughout the country. Seventy percent of RFC bank loans were to banks in towns with populations of fewer than 5,000, and loans had been authorized to 20% of all banks in the country, covering 15 million of the country’s 40 million depositors (Mills 1932, 11). 

The RFC also provided emergency loans to railroad companies—and given the function of railroad bonds for bank-balance sheets, this lending had implications for bank solvency. See Appendix for more details.

In the original legislation creating the RFC, the corporation was to have a “capital stock of $500,000,000” subscribed by the US Treasury (U.S. Congress 1932a, sec. 2). However, most of the RFC’s financing came through borrowed funds. In the initial legislation, the RFC was authorized to have outstanding debt “at any one time in an amount aggregating not more than three times its subscribed capital” (U.S. Congress 1932a, sec. 9). This ratio was increased to six and three-fifths times its subscribed capital in the July 1932 act (U.S. Congress 1932b, sec. 9).

RFC obligations were marketed by the US Treasury, which had the authority to purchase or sell RFC notes or bonds (U.S. Congress 1932a, sec. 9). RFC obligations were unconditionally guaranteed by the US government and paid rates similar to other US-government liabilities with comparable maturities (Mason 2001b, 5).

Per section nine of the RFC Act, the RFC could issue up to three times its subscribed capital in debt, originally giving it a maximum program size of $2 billion (U.S. Congress 1932a, sec. 9). In July 1932, the RFC Act was amended to allow the RFC to have six and three-fifths times its subscribed capital as outstanding debt; this implied a maximum program size of $3.8 billion (U.S. Congress 1932b, sec. 9).

Section two of the Act specified that $50 million of the funded amount was to be allotted to the secretary of Agriculture “for the purpose of making loans or advances to farmers in the several States of the United States in cases where he finds that an emergency exists as a result of which farmers are unable to obtain loans for crop production” (U.S. Congress 1932a, sec. 2).^FNThe Act further provides that “such advances or loans shall be made upon such terms and conditions and subject to such regulations as the Secretary of Agriculture shall prescribe. A first lien on all crops growing, or to be planted and grown, shall, in the discretion of the Secretary of Agriculture, be deemed sufficient security for such loan or advance. All such loans or advances shall be made through such agencies as the Secretary of Agriculture may designate, and in such amounts as such agencies, with the approval of the Secretary of Agriculture, may determine” (U.S. Congress 1932a). Since our focus here is on loans to financial institutions and banks, we do not discuss the details of agriculture loans.

Section 5 of the original RFC Act also provided that not more than $200 million could be used for loans to closed banks (U.S. Congress 1932a, sec. 5).

During roughly its first year of operation, from February 2, 1932, through December 31, 1932, RFC credits totaled $2.3 billion, and advances totaled $1.6 billion (Ebersole 1933, 475). The RFC lent $1 billion to banks from January to March of 1933, at which point loans began to decrease, as many banks moved from the loan program to the new preferred-stock program (see graph below) (Mason 2001b).  Outstanding loans to financial institutions peaked at $718 million in December 1933 (see Figure 1).

Source: Mason 2001b, 38.

In the original legislation, loans to any one corporation and its subsidiaries and affiliates could not exceed 5% of the sum of (1) the RFC’s total authorized capital stock and bonds and (2) the aggregate amount of outstanding bonds of the corporation (U.S. Congress 1932a, sec. 5). On July 31, 1932, this limitation was lowered to 2.625% (U.S. Congress 1932b, sec. 5).

The RFC’s board initially set interest rates for loans to financial institutions at 6% (Mason 2001b, 8). Interest rates were lowered in mid-1932 5% and again in 1933 to 4% (Mason 2001b, 8). Despite these cuts, RFC rates remained above those at the Federal Reserve discount window, though both the discount window and the RFC had comparable collateral requirements (Mason 2001b, 8). The RFC deliberately priced its rates above those of the market in order to avoid crowding out private financing (Mason 2001b, 8).  However, it was criticized for these high rates and its strict collateral requirements, with some arguing that it had priced itself out of making loans to the small weak banks it was intended to help (Mason 2001b, 8).  With the introduction of the RFC’s preferred-stock program in March 1933, banks largely switched out of the RFC’s loan program (Mason 2001b, 9).

RFC loans were required to be “fully and adequately secured” (U.S. Congress 1932a, sec. 5), and the RFC Act provided the agency with broad authority to accept a diverse range of collateral (except for foreign securities):

The total value of outstanding advances “to any one corporation and its subsidiary or affiliated organizations” was not to exceed 5% of the RFC’s subscribed capital stock and issued bonds (U.S. Congress 1932a, sec. 5). This requirement was relaxed from 5% to 2.625% by the Emergency Relief and Construction Act of 1932 (U.S. Congress 1932b, sec. 5).

According to Anbil and Vossmeyer, despite its broad discretion, the RFC originally only accepted the collateral that met the standards of the Federal Reserve’s discount window: “gold, Treasury securities, and commercial, industrial, and agricultural paper” (Anbil and Vossmeyer 2017, 8).

According to Mason 1999, for the first six months of the RFC’s existence, collateral requirements were kept high at the discretion of the RFC’s chair, Eugene Meyer (Mason 2001a, 78). Meyer also served on the Federal Reserve’s board and worked to equalize collateral requirements and interest rates between the discount window and the RFC. Loans bore maturities of fewer than six months and were set at relatively high interest rates (6%). On July 21, 1932, Meyer was replaced as chair of the RFC’s board, at which point collateral requirements were lowered (Mason 2001a, 79).

Regional field offices had “the sole right to fix a valuation on the securities put up for collateral with each application” (Mason 2001b, 5). According to Olson (1972), the RFC initially accepted 80% of the market value of the highest-grade securities and no more than 50% of the market value of all other types of securities (Mason 2001b, 10).

Because of the subjectivity of the procedures used to value collateral, Olson considers the collateral requirements stringent and posits that they may have undermined the effectiveness of the loan program. Olson (1972, 177–78) argues:

Mason (2001a, 91) analyzes bank-level data to estimate the effect of RFC loans on bank-failure rates and finds that banks that took RFC loans had an increased risk of failure. As the RFC relaxed collateral requirements, beginning in July 1932 following Meyer’s Departure, the negative effects of its loans decreased (Mason 2001a, 79).

Under the original RFC Act, loans could be made with maturities not exceeding three years, though loans could be extended or renewed for up to five years (Treasury 1959, 51).

Despite having the authority to make loans of up to three years, the RFC’s board initially restricted loan durations to fewer than six months, though it frequently rolled over loans. This enabled the RFC to exert greater control over borrowers, including in the matter of executive compensation, a stipulation that some banks bristled at (Mason 2001b, 8). Short-term loans, with maturities of fewer than six months, made RFC loans initially comparable to the Fed’s discount window loans (Mason 2001a, 79).

Much of RFC lending to banks was on a short-term basis. Of the $1 billion it lent to banks prior to the March 1933 bank holiday, 70% went to banks that borrowed more than once and 15% to banks that borrowed more than five times (Mason 2001b, 10). See Figure 3 for a detailed breakdown of borrowing behavior.

Source: Mason 2001b, 43.

According to Mason (2001b, 1), the RFC evaluated the solvency and soundness of firms it lent to on the basis of “future market expectations,” which were often difficult or impossible to quantify. Beginning in 1933, the RFC could lend only to banks whose senior officers received reasonable salaries and that consented to keep their salaries reasonable throughout the duration of the loan (U.S. Congress 1933, sec. 4).

The RFC loans to financial institutions considered in this case had no impact on monetary policy; they did not change the monetary supply, as they were fully funded by the Treasury and the sale of Treasury bonds (Butkiewicz 1995, 198). Butkiewicz (1995, 198) argues that the RFC’s actions are an example of how banking policy, defined as sterilized lending to specific institutions, can provide economic relief in some conditions. To structurally separate the RFC’s fiscal activities from the Fed’s monetary functions, section nine of the RFC Act explicitly stated that RFC obligations “shall not be eligible for discount or purchase by any Federal Reserve Bank” (U.S. Congress 1932a).

The RFC’s “capital structure, government subscription, organization, [and] management” were directly modeled on those of the WFC, which was created in May 1918 to finance and organize the US government’s procurement of supplies for World War I (Todd 1992, 23; Ebersole 1933, 467). By 1931, the deepening Depression had convinced Meyer, the former managing director of the WFC, that President Hoover needed to re-establish the WFC (Nash 1959, 461). Hoover was initially interested in voluntary solutions. In his inaugural address in 1929, Hoover stated:

Prior to the creation of the RFC, Hoover had proposed a “voluntary” institution that would encourage a private solution to the developing banking crisis: the National Credit Corporation (NCC)(Ebersole 1933, 466). Created in October 1931, the NCC was a private credit pool organized to lend emergency advances for up to 120 days on government-security collateral (Todd 1992, 24).  By the end of 1932, the NCC had lent $144 million to 560 banks, but it had not materially eased the crisis (Ebersole 1933, 467).

In January 1932, the government created the RFC, styled after the WFC, to provide more firepower to address the continuing financial turmoil. Ebersole (1933, 467–68) says the RFC was so closely modeled on the WFC that “the only substantial innovations in the original Reconstruction Finance Corporation Act . . . were the greater volume of funds provided, and the inclusion of railroad financing.”

The NCC revealed that the banks and railroads needed not only liquidity but also, as the crisis deepened, an organization to assume “the risk of loss—and the losses” (Ebersole 1933, 467). By the end of 1932, President Hoover and the RFC board realized that the banks needed capital injections (Olson 1988, 37). The Emergency Bank Act of 1933 enabled the RFC to capitalize banks through preferred-stock subscriptions (Treasury 1959, 4). The bulk of the RFC’s support to the financial sector shifted to its capital-injection program, which was more successful at stabilizing the bank sector (see Lawson 2021).

President Hoover first indicated his intentions to create an “emergency Reconstruction corporation of the nature of the former War Finance Corporation” in a message to Congress on December 7, 1931 (Treasury 1959, 1).

Upon signing the act, Hoover stated that the RFC’s purpose was “to stop deflation in agriculture and industry and thus to increase employment by the restoration of men to their normal jobs” (Treasury 1959, 1). In his memoir, Hoover wrote that the purpose of RFC emergency lending was “to make loans to banks and financial institutions which cannot otherwise secure credit where such advances will protect the credit structure and stimulate employment” (Hoover 1952, 98).

The RFC published circulars that updated potential borrowers on the application process, collateral requirements, rates, and maturities (RFC 1932).

The RFC was originally required to “make and publish a report quarterly of its operations to the Congress stating the aggregate loans made to each of the classes of borrowers” and the assets and liabilities of the corporation, as per section 15 of the RFC Act (U.S. Congress 1932a, sec. 15). These reports included aggregate loans to each class of borrowers, number of borrowers by state, assets and liabilities of the RFC, and information on employees of the RFC (U.S. Congress 1932a, sec. 15). Quarterly reports were published in the Federal Reserve Bulletin (Board of Governors 1932, 225).

The Emergency Relief and Construction Act of July 21, 1932, amended the original legislation, requiring the RFC to report monthly on “its activities and expenditures . . . with a statement showing the names of the borrowers to whom loans and advances were made, and the amount and rate of interest involved in each case” (U.S. Congress 1932b, 8). The amendment was passed because of allegations of political favoritism in the RFC’s lending (Mason 2001b, 3). These allegations centered on an incident in Chicago wherein the RFC lent $90 million, the most in its history, to the Central Republic Bank, which closed several months later (Mason 2003, 107).^FNWhile contemporaries alleged political favoritism in the RFC’s lending, and indeed and federal legislators appealed directly to the RFC for loans, Mason (2003, 119) finds little evidence that “RFC assistance was distributed on the basis of anything more than economic conditions.”

President Hoover described the stipulation that the RFC publish the names of its borrowers as a “terribly dangerous clause” and considered vetoing the ERCA because of its inclusion in the bill (Hoover 1952, 110–11). However, he was assured by Senator Robinson that the disclosures would not be published to the broader public but rather be a “confidential communication to the clerks of the Senate and House” (Hoover 1952, 110). 

Following the passage of the Emergency Relief and Construction Act, which amended the original legislation to require that the RFC publish the names of borrowers, the “number and dollar value of bank loan applications received by the RFC dropped dramatically,” and RFC loan repayment accelerated. This was likely because banks were concerned to demonstrate financial soundness and avoid the stigma associated with the RFC (Butkiewicz 1995, 209). Butkiewicz (1995, 209) finds that the “publication of the list of loan recipients may have totally offset the initial effectiveness of the RFC’s lending activities.”

The RFC Act provided that upon expiration of the agency’s period for making loans, the Board was to liquidate its assets and wind down its operations. Any residual funds were to be deposited with the Treasury, the RFC was to be dissolved, and its capital stock was to be canceled and retired (U.S. Congress 1932a, sec. 13). If the board failed to complete the liquidation within 10 years, the obligation to do so would transfer to the Treasury, which would assume all responsibilities and duties of the board (U.S. Congress 1932a, sec. 14).

However, under the RFC Act, the executive branch was granted “broad executive powers . . . legislative authority can be supplanted by an executive order” (Mason 2003, 102). Thus the president could unilaterally change the RFC by executive order. It was in this way that President Hoover extended the RFC beyond its scheduled expiration on December 8, 1932, and Roosevelt extended it again on March 27, 1933 (Mason 2003, 102). At its outset, in 1932, the RFC was supposed to last 10 years, through January 22, 1942 (U.S. Congress 1932a, sec. 2). However, the RFC’s authorization was continually reauthorized while its powers were shifted and extended, and ultimately it was not disbanded until 1957 (Treasury 1959, 2).^FNLegislation enacted in 1940 extended the program to January 22, 1947 (Treasury 1959, 2). An act approved August 7, 1946 further extended the RFC to June 30, 1947, and an act approved June 30, 1947, extended it to June 30, 1948. Lastly, an act approved May 25, 1948, extended the program to June 30, 1956. By 1953, the RFC Liquidation Act had terminated the RFC’s lending powers and begun the process of winding down the corporation. By 1954, the secretary of the Treasury was exercising all duties previously handled by the administrator of the RFC, and the RFC was disbanded on June 30, 1957 (Treasury 1959, 2).