Reconstruction Finance Corporation (RFC)

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RECONSTRUCTION FINANCE CORPORATION (RFC)

In searching for the causes of the Great Depression, historians regularly cite protective tariffs and their impact on foreign trade, gross agricultural overproduction, speculative mania on Wall Street, and inequitable distributions of national income, but the most significant factor may well have been the instability in the money markets during the 1920s. Intense competition, inadequate capital reserves, real-estate speculation, and inadequately secured loans (especially to farmers) eroded bank assets and brought about the failure of more than five thousand banks between 1920 and 1930. In addition, banks and insurance companies had long invested in railroad bonds, but early in the 1930s, many railroads began defaulting on interest payments. Deeply in debt, burdened by heavy fixed costs, and suffering declines in freight revenues because of competition from long-haul trucks, dozens of major railroads faced bankruptcy. Their plight pulled thousands of banks toward the same fate. Another 1,357 American banks went belly up in 1930. International problems then finished the job. In May 1931 Austria's largest bank declared bankruptcy, and four months later the Bank of England abandoned the gold standard, sending American money markets into a state of panic.

To prevent a complete financial meltdown on Wall Street—and Main Street—that would doom his reelection chances, President Herbert Hoover acted, turning first to the private sector. Working with a number of prominent bankers, he established the National Credit Corporation (NCC), hoping to accumulate up to $500 million for loans to troubled banks. In October and November 1931, however, the NCC loaned out a paltry $10 million, hardly enough to rescue the banking system. Reluctantly, Hoover turned to the federal government. Modeling his plan on the War Finance Corporation of World War I, in January 1931 Hoover proposed and Congress established the Reconstruction Finance Corporation (RFC), endowing it with an initial capital of $500 million and the ability to borrow another $1.5 billion to make loans to banks, mutual savings banks, insurance companies, credit unions, railroads, and savings, building, and loan associations. Determined to avoid political controversy, Hoover gave the RFC a bipartisan board that included Charles G. Dawes, a prominent Chicago banker and former Republican vice president of the United States, and Jesse Jones, a wealthy Houston banker and a power broker in the Texas Democratic Party.

The RFC went to work immediately, but it soon generated bitter political controversy. When the Central Republic Bank of Chicago (of which Charles Dawes had only recently been president) hurtled toward bankruptcy in the spring of 1932, the RFC sprang for a loan of $90 million. The money staved off bankruptcy and prevented a regional financial crisis, but it smacked of corruption, and Democratic politicians pounced on it. The fact that the Hoover administration was so stingy in providing work relief for the unemployed only exacerbated the controversy. While poor people in Chicago starved, so the critique went, Charles Dawes and his minions filled their pockets with federal money. A $19 million loan to the Missouri Pacific railroad precipitated almost as much controversy. Long known for its dishonesty and financial slights-of-hand, the Missouri Pacific enjoyed a particularly stained financial reputation, but the Hoover administration insisted that had the Missouri Pacific defaulted, hundreds of banks and insurance companies would have been drawn into its whirlpool of bankruptcy.

To blunt the controversy, Hoover joined hands with Republican moderates and Democratic liberals in Congress to expand RFC authority. In July 1932, the Emergency Relief and Construction Act authorized the RFC to make up to $300 million in loans to state and local governments to assist them in providing relief to the unemployed, and $1.5 billion in loans to state and local governments to put people to work building such self-liquidating public works as toll roads, bridges, and sewage and water systems. The act also gave the RFC power to extend loans to financial institutions to assist farmers in storing and marketing agricultural goods. But the effort proved to be too little, too late. The $300 million in relief was only the proverbial drop in the bucket compared to total need, and the public works construction projects took too long to get underway. President Hoover's political fortunes continued to sink.

Although the RFC made nearly $2 billion in bank loans in 1932, instability continued to plague the money markets, with hundreds of banks failing every month, more and more railroads going into default, and commercial loans drying up. In the winter of 1932 to 1933, the RFC's shortcomings came into bold relief. The governors of Idaho, Nevada, Iowa, Louisiana, and Oregon all had to declare statewide banking holidays to stop panicstricken depositors from making runs on banks, and in March 1933 newly-inaugurated President Franklin D. Roosevelt declared a nationwide bank holiday. The nation's financial system had collapsed, even with $2 billion in RFC loans.

Despite its shortcomings, the RFC was about to undergo a geometric expansion in its power and scope. During the famous First Hundred Days of the Roosevelt administration, the RFC became the heart and soul of the New Deal. Congress established the Federal Emergency Relief Administration to take over and expand the RFC's program of relief loans to state and local governments. The new Public Works Administration assumed responsibility for the RFC public works construction program. The Commodity Credit Corporation took over the RFC loan program to assist farmers in storing and marketing crops. The Emergency Banking Act of 1933, which Congress passed at the outset of the nationwide bank holiday, authorized the RFC to make direct loans to private businesses and to purchase preferred stock in private banks. Within a few years, the RFC owned $1.3 billion in stock and exercised voting rights in 6,200 private commercial banks. Because the money came in the form of investment capital, not loans that had to be repaid in six months, the RFC stock purchases proved to be a godsend. With the RFC, the Banking Act of 1933, and establishment of the Federal Deposit Insurance Corporation, the money markets began to settle down. Bank failures plummeted, and commercial loans, the life blood of an economy, slowly began to increase.

Finally, because the RFC enjoyed a constant flow of capital through loan repayments, it became a source of money almost external to Congress, which President Roosevelt and other New Dealers frequently exploited. By 1937, Jesse Jones headed an RFC empire that included direct control or profound financial influence over the Federal Emergency Relief Administration, the Public Works Administration, the Works Progress Administration, the Commodity Credit Corporation, the RFC Mortgage Company, the Rural Electrification Administration, the Federal Security Administration, the Federal Housing Administration, the Home Owners' Loan Corporation, the Resettlement Administration, the Federal Farm Mortgage Association, the Farm Credit Administration, the Tennessee Valley Authority, the Electric Farm and Home Authority, the Disaster Loan Agency, the Export-Import Bank, and the Federal National Mortgage Association. In 1939, Congress established the Federal Loan Agency to supervise the federal government's vast financial establishment, and President Roosevelt named Jesse Jones to head the new agency. By that time, the RFC and its subsidiaries had made loans in excess of $8 billion, prompting some journalists to refer to the agency as the "Fourth Branch of Government."

Two years later the entrance of the United States into World War II brought extraordinary new powers to the RFC. The economy needed to make, as soon as possible, the transition from Depression to wartime production, and Jesse Jones and the RFC assumed a central role in that effort. A host of new government corporations—all included under the financial umbrella of the RFC—mushroomed to transform the economy; they included the Defense Plant Corporation, the Defense Supplies Corporation, the Metals Reserve Company, the Defense Homes Corporation, the Petroleum Reserves Corporation, the Rubber Reserve Company, the United States Commercial Company, the War Assets Corporation, and the Smaller War Plants Corporation. By the end of World War II, the RFC's total loan volume, to fight the war and the Depression, exceeded $50 billion, making it by far the largest and most powerful federal agency in American history. After the war, however, during the reconversion effort, the RFC lost political traction. In 1953, Congress passed the RFC Liquidation Act, transferring the RFC's loan-making power to the new Small Business Administration. Four years later, in 1957, Congress dissolved the RFC.

Because of the New Deal's profound impact on American public policy, historians and politicians have spent seventy years debating its meaning and its merits, arguing about whether it was essentially liberal or conservative or radical. But it seems clear that the RFC—by far the most influential of New Deal agencies—was an institution designed to save capitalism from the ravages of the Great Depression. Through the RFC, Roosevelt and the New Deal handed over $10 billion to tens of thousands of private businesses, keeping them afloat when they would otherwise have gone under and deadening the voices of those who saw in socialism a solution to the country's economic mess.