The Great Depression: Reconstruction Finance Corporation 1932-1941

Historic Events for Students: The Great Depression. Editor: Richard C Hanes & Sharon M Hanes. Volume 1. Detroit: Gale, 2002.

Introduction

A common misconception about the Great Depression was that it was immediately caused by the stock market crash on “Black Thursday,” October 24, 1929, followed by a sudden collapse of the economy. Signs of weakness in the banking system, however, had been evident throughout the 1920s and by the crash there had already been a decade-long economic depression in agriculture. Although the historical moment of the great crash was firmly fixed in the collective memory of most Americans of that generation, it became undeniably evident that something more extensive was seriously wrong with the economy. The market had given ominous signs before that date, but investors easily dismissed grim warnings. They spoke of the natural adjustment of prices after a decade of inflated stock prices that would ultimately strengthen the economy. Despite the positive outlook, used to instill confidence in the market before “black Thursday,” such cheerful exhortations had little meaning afterwards. The date marked an interval of bewilderment and economic disorder that would continue for several weeks and then months.

The crash of the stock market did not initiate a sudden collapse of the American economy, rather the economy looked relatively unchanged for several weeks. Ongoing speculation built as to what impact such a large fall in stock prices would have on related markets, industry, and employment. Nobody really knew what was happening to the nation economically, but mounting apprehension led quickly to fear and uncertainty. The confusion was compounded by the fact that very few sources of economic data were available. The Federal Reserve, a system of federal banks that hold money reserves for other banks in their region, produced a monthly bulletin on the state of finance, as did several private banks. But piecing together available information was difficult and would have been incomplete. The little information that was readily available showed declines occurring in production in key industries such as steel, automobiles, and rubber. By spring of 1930 there was still no evidence of improvement in these industries. It soon became clear to state relief agencies that unemployment continued to rise while wages and prices kept falling. To make matters worse, the stock market closed out April 1930 with another series of losses. To many observers, it appeared deeper economic forces were at work than simply a crash on the stock exchange, however enormous that might have been.

On May 1, 1930, newly elected President Herbert Hoover (served 1929-1933) addressed the delegates of the annual meeting of the U.S. Chamber of Commerce in Washington. Hoover asserted that U.S. history had shown that such economic downturns happened periodically, but he was sure the worst was over and recovery would be rapid. Hoover was overly optimistic because the crash of October 1929 was less obviously being followed by a more gradual but much larger fall in stock values and the economy.

With the Great Depression lingering on, Hoover began taking more aggressive action in October 1931. Pushing his reliance on voluntary action by industry, he created the National Credit Corporation (NCC). This private corporation made up of leading banks would increase the availability of loans to other corporations so that they could continue to operate without dismissing more employees. The NCC quickly proved ineffective, however, partly because of stiff requirements imposed on corporations seeking to qualify for loans. It was then that Hoover took what at the time was bold action, creating a new federal organization, the Reconstruction Finance Corporation where government assumed a more active role in spurring the economy. Though the RFC would also prove ineffective at first in the face of massive economic problems brought by the Depression, the organization would see new life under President Franklin Delano Roosevelt (served 1933-1945) as part of the New Deal, a vast array of federal social and economic programs designed to combat the effects of the Depression.

Issue Summary

A Volunteer Approach to Recovery

As the nation’s economy continued to struggle for several months after the stock market crash, President Hoover took vigorous action by employing a method that had been effective while he was Secretary of Commerce. He organized a conference of business and government officials in early 1930 to address ways of preventing the economy from backsliding further. Before the conference delegates he pledged to spend $2 billion in construction in 1930, to speed up approval of public works projects, and to consider a proposed tax cut. It was a plan intended to restore public confidence in the business community. In the State of the Union Address in December 1930, Hoover informed the joint sessions of Congress that there would be enough of a tax surplus that year to offset tax cuts. On December 5, 1930, Congress passed the tax cut bill and nearly $2.5 billion was earmarked for public works that would create 600,000 jobs. Several additional conferences of particular industries secured agreements to maintain wages and avoid strikes or lockouts. The Federal Farm Board moved to support the prices of cotton and wheat, commodities that had sharply declined. Hoover had seized the spotlight and appeared to be an active chief executive attempting to bring the full authority of the federal government to combat the depression.

The difficulty was that nearly everyone underestimated the depth of the economic decline. By June 1930 the depression did not look much worse than the recession of 1921. Hoover believed the economy would bounce back quickly as it had then. In fact the depression in 1930 may have been comparable to other downturns in the late nineteenth and early twentieth centuries, but it was also rapidly getting worse. The estimates of unemployment by the Department of Labor, just under 2.3 million in 1930, contrasted sharply with that of state estimates that were much higher. The National Unemployment League concluded the figure was actually closer to 6.6 million by mid-year. The president’s efforts to assure business of certain recovery did instill enough pressure to maintain wage, price, and employment levels in 1930, but corporations maintained wage levels only at the expense of laying more people off. Finally in September 1931 U.S. Steel was compelled to cut wages by 10 percent. Within days other industries followed suit.

Spending on public works did increase, but the small number of workers employed on projects and the construction generated did not come close to offsetting the construction losses in the private sector. In the meantime unemployment was increasing every month, and state and municipal relief rolls were growing. Even the cities with the most generous public assistance for the unemployed, Detroit and Boston, could not help more than a third of unemployed families. Breadlines became a common sight in cities across the country.

Hoover’s political philosophy upheld the traditional virtue of individualism but also recognized that economic realities of the market and the modern industrial state could easily erode individual liberty. He envisioned an economic system that would be a blend of individual entrepreneurs and a shared technological approach. This could be accomplished, he believed, through the promotion of private associations that represented various trade, labor, and manufacturing interests. Examples of associations, such as the United States Chamber of Commerce, the National Association of Manufacturers, and the American Farm Bureau, had already grown in response to U.S. industrialization. Hoover believed that industrial associations, through voluntary action, were the most able representatives of industrial interests. They could exert pressure on their members and they shared a common, national goal with their competitors, that of increasing productivity and reducing the effects of wasteful competition. A network of associations held out the promise of a self-regulating business commonwealth. Industries would promulgate ethical codes of conduct and professional standards and engage in cooperative problem solving.

The role of the federal government in such a system would be to set objectives for national planning, encourage the creation of trade associations, farm cooperatives, labor unions and professional organizations, assist in research and development, and provide business with reliable economic data. Hoover’s faith in the benefits of coordinating voluntary action in the private sector, based on his political philosophy and his pre-presidential experience, led him to develop his first significant program to combat the depression. It would prove a discouraging failure.

Throughout 1930 Hoover did his best to persuade business not to decrease wages or prices. If more money was needed to offset losses in a firm, Hoover reasoned, then credit must be readily available. One of the problems with this approach was that the financial crisis worsened in 1931 when Britain changed the value of its currency to solve its own problems created by the Depression. The change immediately put great pressure on Wall Street and the U.S. dollar. The public, alarmed by possible changes in U.S. currency, was demanding their bank deposits in cash. Many regional banks did not have enough liquid assets, or money on hand, to give clients their deposits and to lend credit at low interest rates as Hoover was encouraging. Banks were increasingly addressing their own problems by calling in loans and refusing to lend money for fear of facing collapse. As a result there was a significant decrease in the availability of credit for business, as opposed to an increase.

To meet the emergency, President Hoover summoned Eugene Meyer, chairman of the Federal Reserve Board to the White House on September 8, 1931. The president presented a plan in which a voluntary, cooperative effort among bankers, heavily encouraged by the federal government, would establish a private credit corporation to assist troubled banks. He believed the public would then be calmed and would stop demanding their deposits. At a meeting of the Federal Reserve Advisory Council seven days later, the president called on bankers to create a $500 million credit pool. The money lent to weak banks would prevent their collapse until public confidence was restored. Privately Meyer was skeptical that this would be enough, but both the president and the Federal Reserve chairman shared the assumption that economic growth would not resume until commercial banks started making more loans to business and industry. Both believed that through discipline, banks could increase their commercial loans. Meyer, however, did not share the president’s faith in the willingness of the financial community to contribute the necessary $500 million. Instead Meyer thought it would be better to revive the model of the War Finance Corporation (WFC), which had undertaken a similar endeavor during World War I. The federal government would underwrite private banking. Hoover, however, was not supportive of such drastic federal intervention in the peacetime economy. It would require a special session of Congress, would probably frighten the public into thinking the situation was more serious and, in the opinion of the president, it would not in the end be necessary. Since it was in the long-term best interest of the financial community to cooperate with the plan, Hoover believed the bankers would surely respond to the proposal.

Both Hoover and the Federal Reserve placed much of the blame for the Depression on the decline in commercial credit at a time when the business cycle was in a downturn and needed the credit. Statistical data showed a definite lack of commercial credit and the administration believed it was because banks were unwilling to lend. There were, however, deeper reasons for the decline in credit that were not fully understood by the administration. An erroneous assumption was that business and consumers desperately wanted and needed commercial credit. In actual fact it was not so much that banks were unwilling to make commercial loans, but a decline in demand for commercial credit was occurring.

Several factors explain the decline. First, most businesses were frightened of borrowing at this time. What if they could not afford to repay it? With the economy in decline, the financial prospects of a corporation often did not present adequate security to ensure repayment of a loan. Overall the administration was doing little to actually stimulate demand. Second, throughout the 1920s, the larger corporations had tended to finance expansion with new securities issues (by issuing and selling more stock) or simply by surplus profits. In the boom economy of the 1920s, the larger corporations often did not have to acquire commercial loans for expansion. The administration was unaware of these developments because they had assumed that bank lending was more involved in the economic boom of the 1920s.

The Ill-Fated NCC

On October 4, 1931, in Secretary of the Treasury Andrew Mellon’s Washington apartment, Hoover presented his proposals to the bankers. The president offered both the carrot and the stick. In exchange for forming an association, Hoover promised to push a bill through Congress to relax eligibility requirements for the Federal Reserve System. Banks could enjoy benefits more easily, and if they did not cooperate, the president threatened the creation of a federal credit agency. Ironically, several prominent New York bankers had met the week before and concluded that only a revival of the WFC would end the crisis. At the meeting the bankers praised the president’s initiative but then requested he pledge to revive the WFC if the private association failed to stabilize the economy. Somewhat surprised at the willingness of the bankers to embrace federal intervention, Hoover agreed. Two days later the plan was warmly received at a bipartisan meeting of several Congressmen. Most state and local banks welcomed the proposal and the financial community responded favorably. Privately, however, some of the larger banks expressed their misgivings.

The banking community began immediately to organize. The governor of the Federal Reserve Bank of New York, George Harrison, brought together a committee of leading New York bankers to formulate plans for the credit corporation. Under the leadership of Mortimer Buckner, chairman of the New York Trust Company, the committee soon received a pledge of $150 million from the member banks of the New York Clearing House Association. On October 13 Buckner announced the formal organization of the National Credit Corporation (NCC). Its by-laws authorized up to $1 billion in government bonds of which the membership banks would provide $500 million. Any bank subscribing a certain amount to the association could join. Mortimer Buckner was named president and George M. Reynolds, chairman of the Continental Illinois Bank and Trust Company, was named chairman of the board. The NCC divided the member banks into a series of smaller associations. Any member bank could apply for a loan to the local association and once the loan was approved, the national office would forward the money after review.

The newly formed organization was off at a snail’s pace. From the beginning the NCC officers were not eager to make loans, and during the last week of October, Hoover and Undersecretary of the Treasury Ogden Mills demanded the leaders of the NCC to quit procrastinating. Despite early delays, however, the NCC seemed initially to have a positive effect. Bank failures in October and the first half of November dropped following the announcement of the NCC’s establishment, and there was reason to believe the association would be a success. But the slight economic upturn only led the NCC leadership to hope the agency could be dissolved without making any loans.

Severe collateral requirements of borrowing banks were put in place if loans should become necessary. The NCC did not accept real estate or agricultural deeds as collateral at all, and U.S. government securities were appraised at only 75 percent of their value. When bank failures increased dramatically at the end of November, the regulations of the NCC discontinued its assistance to many banks. Banks verging on failure were often unable to qualify for a loan, and the more solid banks wanted to avoid involvement in the scheme if it became involved with failing banks. Ironically because of the strict collateral requirements, only banks in good condition could get loans. By December 1931 the NCC had only loaned $10 million. Yet even if the $500 million had been distributed freely, it probably was not enough to end the bank failures.

A Stronger Federal Role Proposed

Late in November many small banks throughout the country began demanding replacement of the NCC with a government agency. President Hoover, realizing that most banks would not act beyond their own self-interest, had no choice but to abandon the program. On December 7, 1931, the president submitted to Congress a proposal for the revival of the War Finance Corporation. It was not a step he wanted to take, but he fulfilled his promise to enact a federal program in the event that the private association failed. For the rest of his life an embittered Hoover would criticize the bankers for being self-serving during the time of a national crisis.

President Hoover now asked Congress for comprehensive legislation aimed at stimulating economic recovery. It was a plan very much in line with his belief that the expansion of commercial credit would end the depression. The president called for an appropriation of $125 million to strengthen the Federal banks to enable them to make loans to farmers and rural banks in the hope of assisting the agricultural economy. He also asked for the establishment of a new system of federal home loan banks to grant loans to building and loan associations. This would encourage mortgage lenders to increase home loans and stimulate the construction industry. Believing that the release of funds tied up in closed banks would stimulate consumer purchasing power, Hoover also formulated a plan for the early distribution of personal savings deposits that were tied up in closed banks. The president again urged Congress to reduce the eligibility requirements for banks to join the Federal Reserve System. As the most important part of his legislative agenda, the president requested funding for a program that would reestablish the old WFC by creating the Reconstruction Finance Corporation (RFC). The RFC would take over where the NCC had failed. It would offer government credit at low interest to financial institutions in trouble. Hoover explained that the RFC would be able to supply the necessary funds to inject fresh capital into the money markets and increase the number of commercial loans. Privately he hoped that once the fear afflicting so many bankers was somewhat lessened, then banks would increase their lending and the RFC could be dismantled.

The approach expressed the prevailing view of many economists of the day who considered the availability of bank credit to be the essential ingredient to national economic recovery. The theory was that by ending bank closures, the RFC would relieve the fear of banks to grant commercial loans. Business would then be able to acquire capital and increase their investment in equipment, inventory, and payrolls. Unemployment would decline, wages would increase, and consumers would have considerable purchasing power. This purchasing power would then stimulate a national recovery.

Hoover implored Congress to act quickly. The Bank of America chain in California was on the verge of collapse and others would undoubtedly follow. Debate over the bill raised several concerns in the largely Democratic Congress. For example it looked like a huge bailout for irresponsible bank lenders. The bill, however, was finally passed on January 22, 1932. Many progressive Republicans and liberal Democrats were skeptical of the economic theory behind the RFC. Senator Robert F. Wagner of New York, for example, urged that federal money be spent directly on unemployment relief and public works. He supported the bill, however, despite his objections to its approach. There simply were no other alternatives being introduced in Congress.

There were a few minor amendments added by Congress prior to passage of the RFC bill. Senator Carter Glass of Virginia insisted on increasing the five directors of the RFC to seven with only four coming from the same party. Both Senator Glass and Senator Robert La Follette of Wisconsin opposed a clause in the bill permitting the RFC to loan to “bona fide institutions” on the basis that it was too vague. This is exactly what the administration wanted, but Carter and La Follette insisted that it gave the administration too much power. They preferred limiting the RFC’s lending authority to a specific list of financial institutions. They also wanted to make sure that the RFC did not assist the NCC. This, the two Senators believed, was an issue that could be handled by the private bankers. Hoover relented, knowing that both amendments would not substantially change his proposal.

There was also substantial support for an amendment introduced by Senator Royal Copeland of New York to allow the RFC to issue loans to municipalities (city governments). This was a radical departure from the administration’s recovery plans. Pouring money into relief loans to cities, Hoover believed, would merely postpone the revitalization of banks and corporations. The president was not dogmatically opposed to unemployment relief and public works programs but he did think they would not be needed once the credit machinery of the country was reestablished. The Copeland amendment would, in Hoover’s opinion, only detract from the assets of the RFC.

The president was not willing to compromise on this issue and was successfully able to organize a coalition of Republicans and southern Democrats to defeat the amendment in the Senate. The Reconstruction Finance Corporation bill then moved quickly through Congress. The House passed it with 335 to 55 in favor and the Senate with 63 to 8 in favor. Generally, there was broad support for the bill across party lines. The statute required that the RFC would be discontinued on January 1, 1933 unless by executive order it was extended until January 1, 1934.

The RFC Begins Operation

The Reconstruction Finance Corporation Act provided for direct federal assistance to the entire money market in the United States by underwriting loans to commercial banks, savings banks, insurance companies, trust companies, building and loan associations, mortgage banks, credit unions, Federal land banks, joint stock land banks, agricultural credit corporations, livestock credit companies, and receivers of closed banks and railroads. Its scope was unprecedented and, in addition to the $500 million initially subscribed by the federal government, the RFC was authorized to sell bonds to obtain an additional $1.5 billion. Of the original funding from Congress, the RFC allotted $200 million to crop loans to help the agricultural industry.

The men Hoover selected to chair the RFC board were prominent bankers and businessmen. As chairman Hoover appointed Eugene Meyer, a loyal Republican originally from California who served as chairman of the Federal Reserve under Hoover. He was a cautious banker, politically conservative, and well connected to the New York banking community. Two additional ex-officio positions on the Board were reserved. Ogden Mills became an ex-officio member of the RFC board of directors due to his position as the new secretary of the Treasury. H. Paul Bestor served as the other ex-officio member, having previously presided over the Federal Farm Loan Board. Former Vice-President of the United States Charles G. Dawes was appointed president of the agency. Meyer, Mills, Bestor, and Dawes, all Republicans, completed the number eligible to serve on the board from the Republican Party. Hoover next appointed three Democrats. At the recommendation of Senator Joseph Robinson, Hoover named Harvey C. Couch, a southern Democrat from Arkansas who had become a prominent leader in the Southeast and served on the boards of several banks and railroads. Jesse H. Jones, a banker from Texas, was the second Democratic appointee and finally, to provide regional balance Hoover settled on westerner Wilson McCarthy. McCarthy was a conservative banker and lawyer from Salt Lake City who was an expert on agricultural finance. The eminent qualifications of all seven nominees ensured a quick confirmation by the Senate in the first week of February.

The headquarters of the RFC were moved to the old Department of Commerce Building on the corner of Nineteenth Street and Pennsylvania Avenue in Washington, DC. Hoover and Meyer quickly staffed the new agency. An organizational framework was adopted that nearly duplicated the old WFC. In fact many of the personnel had once worked for the wartime agency. By the end of February Meyer had hired over six hundred people to staff both the Washington headquarters and 33 regional offices.

The RFC began making dozens of loans a day. Perhaps most extraordinary was the unprecedented independence of the agency from both Congress and the U.S. director of the budget. Although the RFC had to issue monthly and quarterly reports to Congress, it did not have to provide the names of borrowers or the amounts of loans. Nor would the agency need to subject itself to congressional scrutiny for additional funding. In theory the RFC could operate indefinitely on the original allocation of Congress.

Without question the creation of the RFC brought temporary confidence to the economy. Many of the problems and assumptions that beset the National Credit Association came to the fore, however, as the operation of the RFC was underway. In large part due to the background of the directors, each wanted to end the crisis with a minimum of expense to the government, and as a result the agency proceeded cautiously. The directors insisted that all loans be repaid promptly and strict collateral requirements approximating those of the NCC were implemented. Only 80 percent of the market value of securities (stocks) was accepted and only 50 percent of the market value of other bank assets. Increased collateral could also be demanded if there were future declines in the value of the collateral such as securities. Thus a bank accepting an RFC loan usually had to deposit its most liquid assets at a fraction of their value. In addition there was a six-month maturation date (waiting period) for the initial batch of loans. This meant that in practice many banks could not be helped before they collapsed. Another obstacle was the interest rate of the loans themselves. To prevent unfair competition with private institutions, the RFC set the interest rates higher than the prevailing private levels. This made the loans expensive and eventually limited the agency’s effectiveness.

Hoover believed that the very existence of the RFC, by assuring the public that the federal government was prepared to make loans to sound banks, would be enough to restore confidence. But the administration underestimated the skepticism of the public in the face of numerous bank failures. A fundamental structural problem was that the RFC could only make secured loans to banks. This meant that banks could only borrow what they could match in their assets. But the value of many assets was declining during the Depression, and the value of securities, land values, and mortgages were generally in decline or, in the case of outstanding loans, simply frozen and not being paid. Banks either needed more capital or longer-term loans of three to five years, neither of which were provided by the RFC. By law all loans had to be strictly secured with collateral below market level, and since the agency was only to be in existence for another year, long-term loans were not possible. The short-term maturity dates of the loans often forced many banks to repay the loans well before they had become solvent (in good financial condition), thus imposing additional hardship.

Despite these problems the first month of the RFC was the high point of the Hoover administration, with the arrival of thousands of applications from banks. For a brief period the well-publicized loans that appeared to save banks from imminent collapse inspired confidence in the financial community. In fact the administration did avert some serious crises. Fifteen million dollars was immediately loaned to the Transamerica Corporation in San Francisco to save the Bank of America. Seven million dollars was loaned to the East Tennessee National Bank of Knoxville to the relief of depositors throughout the state. In February alone the RFC authorized more than $45 million to banks and trust companies, while another $25 million went to several railroads. Special funds that had been set aside for crop loans were also issued. By the end of March Secretary of Agriculture Arthur Hyde had loaned nearly $40 million to over 200,000 farmers and the RFC had issued 974 loans totaling over $238 million. These loans went predominantly to banks and railroads in addition to $18 million to savings and loans associations.

The RFC Runs Into Problems

Bank closings in March 1932 began to decrease. Only 45 banks failed in March as compared to 334 in January and 125 in February. Morale improved in the administration and it looked as if the increase in commercial lending would revive industrial production and employment. But the first signs of political trouble had already appeared as a controversy developed over the dispensing of a railroad loan. Early in March the RFC agreed to lend the Missouri-Pacific Railroad $12,800,000. One of the objectives of the RFC was to end the wave of railroad bankruptcies that had begun the previous year. Railroad bonds during the 1920s formed a substantial part of stock holdings of many commercial lenders including savings and life insurance banks. Strengthening railroad bonds would strengthen thousands of commercial banks but it would also require a substantial amount of loan money.

The Interstate Commerce Commission (ICC), which had approval authority over loans to interstate railroads, was reluctant to authorize the Missouri-Pacific loan. This was because nearly $6 million of it would be turned over to J.P. Morgan and Company, Kuhn, Loeb and Company, and the Guaranty Trust Company of New York as payment on earlier loans. Joseph B. Eastman, head of the ICC, insisted that prior obligations on private loans had to be settled before the RFC would lend to railroads. Meyer resented the interference. To him the ICC did not understand that although much of the loan money would return to investment banks on Wall Street, the underlying purpose of the loan was to strengthen railroad bonds. Therefore Meyer went ahead with the loan but it was not without political fallout.

The Missouri-Pacific loan became an explosive issue in the Senate. Progressive Republicans, particularly Senators James Couzens of Michigan, William Borah of Idaho, and Robert La Follette of Wisconsin, all of whom were increasingly outspoken critics of the administration, attacked the RFC’s policies. They charged that the RFC railroad loans were to assist the railroads with their long-term credit obligations. There was nothing in the law creating RFC that allowed for the wholesale assumption of debts by the railroads. Politically, the controversy was a turning point for many progressive Republicans already on the verge of defecting from Hoover’s support and support of Republican Party candidates in general. Several, most notably Senator George Norris of Nebraska, committed themselves to Franklin Roosevelt in the next general election.

The Missouri-Pacific loan controversy provided an ideal opportunity for the progressive left of the Republican Party to disassociate themselves from Hoover. The growing criticism in Congress also widened differences on the RFC board. Meyer, Mill, and Bestor favored a policy of loaning to banks to revive the bond market and restore strength to the assets of banks. Dawes, Jones, Couch, and McCarthy struck middle ground between the progressives in the Senate and the more conservative board members. They accepted the Meyer’s approach to recovery but felt that before railroad loans were made, banks that held their loans must show good faith by extending the time that railroads had to pay back their borrowed money. Personal relationships on the board also began deteriorating. While Dawes, a Republican appointee, was relatively independent, he joined Jones, Couch, and McCarthy in resenting the dominance of Meyer. He also resented the perceived favoritism that Mills, Meyer, and Bestor had for the eastern banking community at the expense of farmers and rural and Western banks. Since Meyer retained the ear of the president, however, Dawes and the Democratic appointees on the board often felt left out.

Banks, joined by the Federal Reserve, began to criticize the RFC as well. By the end of May 1932 the RFC had purchased over $500 million in government securities, also known as bonds, yet commercial loans remained depressed. In general banks were fearful of another crisis looming and were reluctant to issue more loans. It was clear to them that the RFC had not stimulated recovery. Hoover assumed that bankers did not yet feel secure enough to use their excess reserves for loans, but he was growing increasingly impatient with the banking community. He was also growing impatient with Meyer who continued to promise to Hoover that bankers would respond to RFC loans by increasing their business loans. It simply was not happening. Hoover did believe that the RFC had succeeded in stabilizing the financial system even if it had not brought about recovery. Nevertheless, he began looking for an alternative. He concluded that Eugene Meyer had to be replaced as chairman of the RFC and he once again entertained voluntary schemes. One such project, undertaken by the Federal Reserve Bank of New York, had established a committee to coordinate private credit supplies with business demands. The president urged the Federal Reserve to establish similar programs in each of its twelve districts. It was an indirect admission that the RFC was failing.

On June 6, 1932, Charles Dawes resigned as president of the RFC. At the same time, word spread of a new financial crisis. A series of small banks began failing in Chicago and northern Illinois, undermining depositor confidence in the Midwest. The Central Republic Bank and Trust Company of Chicago, one of the city’s largest financial institutions, was also in a precarious situation. If the Central Republic Bank closed, it was conceivable that nearly every bank in Chicago would also have to close. This in turn would suspend the commodities market. If this happened, there would be a chain reaction of bank collapses all over the country. Given that bank failures had increased to 151 in June, the highest since January, Hoover was alarmed. If Central Republic bank was not saved, it was conceivable the entire U.S. banking system might fall with it. On June 27 the RFC loaned $90 million to Central Republic Bank. The loan averted at least temporarily a national banking collapse, at least for the time being, but like the Missouri-Pacific loan, it was not without a political backlash. Early in June the city of Chicago had sent a delegation to Washington to request a loan of $70 million to pay teachers and municipal employees. The RFC was not empowered to make such loans to municipalities and was forced to turn the delegation down. Almost simultaneously with the denial came news of the Central Republic Bank bailout.

The Hoover administration was accused of refusing to assist in paying the salaries of thousands of impoverished workers in Chicago while willing to give one bank $90 million. The loan also brought renewed criticism by small banks that argued that the RFC channeled its resources to the largest financial institutions. Critics neglected to recognize that in 1932, one percent of the banks controlled 40 percent of the deposits. As a result, loans to these larger banks, even though smaller in number, accounted for a larger amount of total funds loaned. The RFC defended the practice of strategically assessing where loans were most in need in order to shore up the money markets and increase the volume of commercial lending. Consistent with this theory was the suggestion that direct loans for relief would be futile or counterproductive, a point which the RFC leadership and the administration continued to make.

By late 1932 this “trickle-down” theory of recovery had few adherents among the liberal Democrats and progressive Republicans, a great deal of skepticism toward it in the banking community, and increasing distrust of it among the public who began to question the assumptions upon which the RFC was founded. The administration and the RFC board continued to insist that direct payments for employment relief or public works to stimulate economic recovery would only be counterproductive or even damaging. But to the general public, it was a policy increasingly viewed as a hard-hearted refusal to recognize the plight of the unemployed.

The reluctance of the administration to assist the “Forgotten Man” at the expense of banks, railroads, and corporations, as New York’s Governor Franklin Roosevelt depicted the administration’s priorities in a speech given on April 8 after the Missouri-Pacific controversy surfaced, was a view increasingly accepted by popular opinion. This perception became dramatically magnified in the summer of 1932. President Hoover mishandled a grass-roots movement of World War I veterans who sought approval of a plan to provide direct relief to war veterans. In an administration that had confronted one crisis after another, the resulting Bonus Army controversy would become one of the most alarming political events to beset the struggling presidency.

The Bonus Army Disaster

In the summer of 1932 a ragged multitude of veterans of World War I and their families appeared at the nation’s capital to request a service bonus promised to be dispersed by 1945. The veterans, the majority of whom were unemployed and homeless, had arrived with the intention of petitioning Congress to award them the bonus 13 years ahead of its scheduled date. They became known as the “Bonus Army.” Earlier in 1924 Congress passed legislation authorizing the payment of “bonuses” to veterans of the war, $1 a day for each day of service in the United States, $1.25 for each day overseas. The money was to be placed in an endowment fund until 1945 and after interest each veteran would receive an average of a thousand dollars. But in 1929 legislation was introduced to provide for immediate payment to the veterans. President Hoover was opposed to the idea and the bill got nowhere in Congress. With many veterans out of work due to the Depression a compromise bill was introduced in Congress in February 1931, but Hoover vetoed it.

In May 1932 the veterans began to organize a march across the country that would descend on Washington, DC, by the summer to lobby Congress to pass a new bonus bill. The resulting “Bonus Expeditionary Force,” as the veterans called themselves, marched into Washington. At the march’s peak, there were as many as 20,000 men, women, and children, with some estimates as high as 25,000, living in 27 camps in and around the District of Columbia. All had arrived expecting that their presence would persuade Congress firsthand to pass the bonus bill.

Their reception was initially friendly with the city providing the army with food, donated tents, and help to set up barracks. On June 15 the House passed the resurrected bonus bill by a vote of 209 to 176 but two days later the Senate defeated the bill 62 to 18. In defiance some of the Bonus Army stayed in Washington although the number of men gradually declined to somewhere between eight and ten thousand by late July. Small demonstrations began to erupt, and when police efforts to remove the remaining veterans led to violent street battles Hoover decided to send in U.S. army troops. General Douglas MacArthur, chief of staff of the Army, proceeded to the scene of the disorder with troops, cavalry, and six tanks proceeding along Pennsylvania Avenue. As the troops advanced the cavalry drew their sabers and the crowd scattered. Bonus marchers in the abandoned buildings were routed with tear gas and bayonets and the marchers retreated. Hoover was aghast as MacArthur sent his troops into the camps. Tear gas was fired scattering veterans, spectators, and passers-by alike. In a move that served only to heighten the panic, MacArthur gave the order to set the tents and shacks on fire. The blaze spread quickly and as marchers moved hurried and confused to gather what little belongings they had, it was possible to look up to see the dome of the Capitol outlined against the flames.

The “Battle of Washington,” as the event was soon labeled in the sensational press, was splashed across newspaper headlines. The country saw photographs of the marchers, disheveled and weary, fleeing before soldiers with bayonets. They saw troops stamping through the smoking debris of the former camps and resisters, still weeping from tear gas, hauled to police wagons. The photographs of U.S. soldiers attacking veterans were, to many Americans, incredulous images.

A Wounded Administration Watches as the Banking System Crumbles

The day after the attack on the Bonus Army, Hoover informed the press that a challenge to the government of the United States had been met swiftly and firmly. The country was dumbfounded. At Hyde Park the next day, Governor Roosevelt privately confided to his advisor Rexford Tugwell that any chance Hoover had of being reelected was gone. Writer Sherwood Anderson, in an open letter to the president, wrote that the Bonus Marchers had in essence demanded so little from their government. Why, he asked, could Hoover not have gone and talked to the men?

For the man who had entered the White House with such extraordinary personal achievements, a politician billed as the modern technocratic statesman who would bring business efficiency to the art of government, Hoover was now pictured as helpless and inept. Not only did he fail to deal with the economic catastrophe, the administration’s perceived inability in the face of the Depression was firmly and symbolically affirmed by the way the Bonus Army was mis-handled. The political debacle somehow seemed a key reflection of the Hoover presidency. Events seemed to slip out of the administration’s grasp, and the complacency and dominance that characterized the Republican Party during the 1920s was clearly at an end.

In the fall of 1932 the administration’s popularity had plummeted to perhaps the lowest any sitting president has endured. The Bonus Army fiasco and the dire state of economic affairs left Republicans with little to campaign on in the general election in November. Democrats focused mostly on the banking system and targeted the RFC to a devastating effect. To the surprise of no one, the Democratic candidate Franklin D. Roosevelt won by a landslide, taking with him enough Democrats to form a House and Senate majority, however, Hoover still had five more months in office. The new administration would not enter the White House until March (this delay was subsequently changed by Constitutional Amendment so that a president now begins his or her term in January). During that time Hoover sought to secure commitments from Roosevelt to maintain the administration’s policies on a balanced budget, but Roosevelt remained noncommittal.

Hoover also arrived at the bitter conclusion that banks were using RFC loans to turn their own assets into cash rather than loosen credit for loans to businesses. In November 1932 the president threatened the banking community by proposing to give direct loans to business, but by the end of the year there was evidence of extremely serious financial instability of the banking system. As a state of crisis increased the RFC reverted to its original goal of preventing bank collapses. The first wave of bank closures occurred in Iowa in the last weeks of December. Several important Iowa banks closed and the governor of Iowa was forced to declare a moratorium, meaning a temporary halt, on banking on January 20, 1933. At the same time banks in Tennessee were on the verge of failure. The RFC was considering a $13 million loan to the Bank of America and Trust Company of Memphis to save it. Grave situations also developed in Kansas and Missouri, and late in February the Hibernia Bank and Trust Company of New Orleans, a key financial institution in the South, was on the brink of collapsing.

Senator Huey Long appealed directly to the RFC board for a $20 million loan. In January alone the number of bank suspensions across the country climbed to 242, the highest yet.

Panic by depositors now became widespread in many parts of the country. In mid-February, the two largest banks in Detroit closed due to depositor withdrawal. Both banks, the Guardian Detroit Union Group (known as the Union Guardian Trust) and the Detroit Banker’s Company, controlled dozens of banks throughout Michigan. The administration was convinced that if both banks failed, a chain reaction would occur throughout the state and then the country. The RFC concluded that $50 million was needed to save the Union Guardian Trust but that it could only loan $36 million. The RFC board therefore expected Union Guardian to raise the rest. The Ford Motor Company agreed to a $7.5 million deposit and Chrysler and General Motors each pledged $1 million. Hoover personally appealed to executives of Chrysler and General Motors to raise more but they were reluctant to do so. The Ford Motor Company, their rival, was a major stockholder in Union Guardian Trust. They did not want to bail out their competitor.

Hoover then asked Edsel Ford to commit more money but he refused to do so. The elder Henry Ford was disgusted with his rivals and felt they were forcing him to save the entire financial system of the state. Foreseeing collapse, he then threatened to withdraw $25 million from the Detroit Banker’s Company and the First National Bank of Detroit. The RFC was unwilling to save these latter two banks since they were considered a hopeless cause. On February 13, 1933, the Union Guardian Trust and the First National Bank of Detroit closed. They were immediately followed by closures all over the state and on the same day Governor Comstock of Michigan declared an eight-day moratorium on all banking activities. Panicked depositors withdrew funds from thousands of banks across the country, and the RFC was unable to cope with such massive drains. State after state restricted withdrawals or declared a banking holiday. On the first and second day of March banking holidays were declared in Arizona, California, Georgia, Idaho, Kentucky, Minnesota, Mississippi, Nevada, New Mexico, Oklahoma, Oregon, Tennessee, Texas, Utah, Washington, and Wisconsin. On inauguration morning, March 4, 1933, the governors of New York and Illinois closed the banks of New York City and Chicago. The day Franklin Roosevelt took the oath of office, the entire banking system of the United States had collapsed.

Roosevelt Continues the RFC

The RFC had completely failed to bring about economic recovery in 1932 but the new administration would attempt to breathe new life into the moribund agency. At first Roosevelt wanted a fresh start on the board membership but decided to appoint Jesse Jones, the dominant Democrat on the existing board, to be chairman. Unlike Hoover and Meyer, Jones did not envision the RFC as only a temporary agency. He had a much broader conception of the RFC’s potential and was prepared to provide the banking system with massive amounts of funds. Jones thought big and had the energy and the domineering will to back up his plans.

The Emergency Banking Act of 1933 gave the RFC expanded authority, and Title III of the act authorized the RFC to purchase stock of banks and trust companies. This would provide them with long-term investment funds and relieve them of their short-term debts to the RFC. It allowed the RFC to make loans that were for a longer term and less expensive. Franklin W. Fort, head of the Federal Home Loan Bank during the Hoover administration originally introduced the proposal. Hoover initially found the idea too extreme, but by February 1933 he conceded it would be necessary. Hoover had Fort, Ogden Mills, and Undersecretary of the Treasury Arthur Ballentine draft a plan to be given to Roosevelt’s economic advisors. The bill went to Congress on March 9 and President Roosevelt signed it the same day.

In early 1934 Congress appropriated an additional $850 million to the RFC. As a result the Jones was able to make an immense number of loans. By 1936 for example the RFC issued over $8 billion in loans. It had already received payments totaling $3.2 billion of which $294 million was in interest, with loans in every congressional district. Jones’ leadership also broadened the scope of the RFC. Already under the authority of the Emergency Relief and Construction Act of 1932, the RFC had authority to provide $300 million in loans to state agencies for relief payments. In 1933 Roosevelt established the Federal Emergency Relief Administration (FERA) and appointed Harry Hopkins to head it. Hopkins drew from the personnel of the RFC Emergency Relief Division to staff the FERA. Instead of working with only $300 million, however, the RFC provided $1.5 billion to finance relief grants between 1933 and 1935. Under Hoover the RFC had set aside $1.5 billion to finance large-scale public works but the division had only loaned $20 million by the time Hoover left office in March 1933. Roosevelt had the new Public Works Administration (PWA) take over the RFC’s construction projects. The RFC then assisted the PWA by purchasing construction bonds that the PWA accepted from counties and municipalities. By 1936 the RFC had purchased over $700 million in PWA bonds, thereby underwriting a host of public works projects undertaken by the agency.

It was an ingenious administrative maneuver. Not only did the agency have a revolving credit fund from which it could issue credit to a greater number of financial institutions at a lower interest for longer maturation periods on the loans, it was also financing New Deal agencies. In essence the RFC was transformed into the bank of the New Deal. Moreover, the independence of the agency and its huge reserves gave Roosevelt the power to appropriate enormous funds without congressional authorization. For almost every New Deal program, there was some RFC funding behind it. For example a total of $200 million was supplied to the Home Owner’s Loan Corporation (HOLC); $40 million to the Farm Credit Administration; $44 million to the Regional Agricultural Credit Corporation; $55 million to the Federal Farm Mortgage Corporation; $83 million to the Federal Housing Administration (FHA); $246 million to the Rural Electrification Administration (REA), and $175 million to the Resettlement Administration (RA).

When the Works Projects Administration (WPA) was established in 1935, it immediately received $1 billion from the RFC. Largely due to the able leadership of Jesse Jones the RFC expanded in size and operated with enormous flexibility. When local business leaders from Los Angeles requested assistance after a 1933 earthquake, the RFC devised short-term loans for rebuilding. Similarly farmers were issued short-term loans for immediate short-term needs. Perhaps most revealing of the contrast with the Hoover administration, Roosevelt had the RFC extend a loan of $22.3 million to the Chicago Board of Education shortly after he took office. It was exactly the type of loan Hoover had denied on the grounds that it was beyond the authority of the agency.

But Roosevelt shared a common objective of his predecessor. Of paramount importance to the administration was restoring public confidence in the banking system as quickly as possible. The bank holiday Roosevelt declared on March 6 and then extended as part of the Emergency Banking Act on March 9 closed all banks between March 4 and March 13. The Roosevelt administration shared the belief that bank reconstruction required commercial credit but it was clear that short-term loans to banks and railroads would not be adequate. The new plan was simple. Federal inspectors would guarantee the financial integrity of each individual bank. The president would then assure the public that no bank would be reopened unless it was sound. The key to the operation was speed. If the public grew skeptical as a result of delay then the plan would fail. Teams of examiners from the RFC, the Federal Reserve Banks, and the Treasury Department went to work right away. National banks whose financial condition was relatively sound received a license to reopen by the president. Those banks that could not fully return deposits or credit were handed over to others who could then reorganize them with the assistance of RFC loans under Title II of the Act. Although the federal government had no authority to regulate state-chartered banks, state banking authorities generally complied with the same licensing process. On the evening of March 12, Roosevelt addressed the country in a fireside chat. He explained the nature of the banking crisis, how it had occurred, and what the federal government was doing to fix it. He then assured the public that all reopened banks would be sound, and the next day the first openings began. To the astonishment of Wall Street there was no panic. By March 15 nearly 70 percent of the banks had reopened. Depositors began returning money and by the end of the month over $1 billion had flowed back into the banks. In one of the greatest public relations campaigns of all time, Roosevelt restored the banking system.

The bank holiday gave the RFC, which was instrumental in the examination process, a firsthand look at the state of the nation’s financial system. For the new board it was also an opportunity to evaluate the money markets and reconsider policy. The RFC under the Hoover administration had kept interest rates on loans at 6 to 7 percent, generally above prevailing rates. Jesse Jones decided that he would lower interest rates, beginning by a half percent, and relax the collateral requirements. Later, he reduced the interest rates to three to four percent. The RFC also had to manage the 4,215 unlicensed banks being temporarily held by others. About 1,100 were simply liquidated in 1933 because their assets were so badly eroded that nothing could save them. The remaining 3,100 banks were handled by the RFC through several strategies. Sometimes the RFC would liquidate the bank and merge all of its assets with another bank. At the urging of President Roosevelt, Jones later directed the RFC to loan directly to closed banks. This was handled under the Deposit Liquidation Board, a division created especially for this procedure and continued until early 1936.

The RFC continued to assist banks until Congress passed the Federal Deposit Insurance Corporation (FDIC) on June 1, 1934. Banks that joined the FDIC would have their deposits insured by the federal government up to a certain amount. In the meantime the RFC assisted closed banks in meeting the requirements of the FDIC. Jones created a Non-Member Preferred Stock Board to purchase the stock and capital of banks in order to make them financially solvent. The program was enormous and by September 1934 the RFC actually owned stock in half the nation’s banks. But the RFC program was also a phenomenal success, and banks poured into the FDIC and by the end of the year over 14,000 banks had joined. In 1935 bank failures dropped to only 32. Never again would the United States experience the wave of bank failures that the country endured in 1932.

The RFC Continues Through the Depression

The RFC under the New Deal had returned stability to the banking system and ended the cycles of panic and bank collapse. One old problem still remained though. Repairing the banking system had not led to the increase in commercial lending that the early New Dealers, like the Hoover administration before them, believed would be necessary for economic recovery. For some unknown reason banks were not making commercial loans. Instead they were investing their funds in safer government securities. The relationship between industrial production and availability of credit was little understood. The prevailing view, at least in 1933 and 1934, was that more commercial credit had to be made available to stimulate recovery. The success of the New Deal agricultural program and the National Recovery Act depended on it. Business would need working capital loans, mortgage money would have to be made available to finance construction, farmers needed loans for paying mortgages on their land, and cities needed help in meeting their expenses. Any attempt to coerce the private sector had already proven nearly impossible for banks to supply more credit. It seemed there was little choice but for the government to make the loans directly. The New Deal did exactly this and embarked on a series of programs that would bring about a credit revolution.

Roosevelt approached the credit crisis by expanding the role of the RFC to make even lower-interest loans (three to four percent) to insurance companies, joint stock and land banks, livestock credit corporations, and agricultural credit corporations. An extension of the RFC’s authority passed on January 31,1935, allowed the agency to purchase railroad securities directly. The RFC was thus able to underwrite millions of dollars in bonds to railroad companies. The RFC could also purchase municipal bonds to help cities refinance their debt. As part of the overall plan to loosen credit, bankruptcy laws were also drafted to allow municipalities greater latitude in refinancing and reorganizing before filing for bankruptcy. Through the Frazier-Lemke Act of 1934 farmers were allowed to repurchase their land at an interest rate of one percent over six years or to retain possession of the land for five years without foreclosure. Finally with the capital support of the RFC a number of agencies were created to issue credit directly to farmers, businesses, and homeowners.

The farm credit programs were consolidated in the Farm Credit Administration (FCA), which made loans exceeding $500,000 to national farm cooperatives. It also created the Production Credit Association that loaned to 10 or more farmers or to loan associations that could loan to individual farmers. The RFC supplied the FCA with $1.16 billion. In eighteen months more than 20 percent of all farm mortgages in the United States were directly refinanced by the administration. Roosevelt also created the Commodity Credit Corporation by executive order on October 16, 1933. It allowed farmers to hold their crops off the market until seasonal surpluses disappeared thereby driving prices down. The New Deal also revived real estate markets and the construction industry through the Home Owner’s Loan Corporation (HOLC), capitalized with over $200 million from the RFC and the right to issue up to $2 billion in bonds. The bonds would then be exchanged for a single first mortgage. By 1940 the Farm Credit Administration loaned $6.87 billion and refinanced nearly a third of all farm mortgages in the United States. The Commodity Credit Corporation loaned hundreds of millions to farmers and the Home Owner’s Loan Corporation refinanced more than 20 percent of mortgaged homes in the country, making home ownership more affordable. Lastly to supervise the vast government credit machinery, President Roosevelt created the Federal Loan Agency and appointed Jesse Jones to direct its efforts.

Contributing Forces

War Finance Corporation

The model of the Reconstruction Finance Corporation (RFC) was borrowed directly from the War Finance Corporation (WFC) of World War I, the most successful of the wartime economic coordination agencies. Created by an act of Congress on April 5, 1917, the WFC followed the establishment of several other wartime federal agencies including the War Industries Board, the Food Administration, the Fuel Administration, the U.S. Shipping Board, and the U.S. Railroad Administration. William Gibbs McAdoo headed the WFC. By the end of 1919 the WFC had made direct loans totaling $306.5 million to public utilities, banks, building and loan associations, and railroads. After the war Congress was concerned about boosting domestic production of goods to avoid a severe post-war recession. It authorized the WFC to make export loans. The agency was found to be very useful and Congress did not want it discontinued. In 1921 the role of the WFC was further expanded with the passage of the Agricultural Credits Act. The act provided the agency with an additional $300 million and authorized the WFC to make loans to farmers needing intermediate credit. The agency finally came to an end in 1924 when the creation of the Federal Intermediate Bank System began to assume the responsibilities of the WFC. Over the next six years the government began liquidating the assets of the WFC.

When Hoover created the RFC in January 1932, he not only had the wartime agency in mind as a model, he nearly replicated the WFC. Eugene Meyer, member of the WFC board, was appointed chair of the RFC board. Both agencies had eight divisions, including auditing, legal, treasury, secretarial, agency, examining, statistical, and railroad) and both had 33 regional offices. The legal and examining divisions of the RFC were almost entirely made up of former WFC staff. Yet although both agencies were essentially designed to undertake the same purpose, the economic problems they confronted were actually quite different. The wartime agencies established by President Woodrow Wilson’s (served 1913-1921) administration were in response to pressure to supply the Allies with unlimited war materials. Direct government intervention in the economy through regulations and subsidies during the war occurred at a time when there was urgency to increase industrial production without the hazards competition. In 1917 there were not the same underlying weaknesses in the nation’s financial structure as there were in 1932.

Department of Commerce

With his popularity rising, already in 1920 there were calls for Herbert Hoover to run for president. Hoover however was more interested in applying the new scientific business practices to American industry in a different capacity. For the next eight years, as secretary of commerce under the Harding and Coolidge administrations, Hoover would bring his international business experience to transform the Department. It became a modern organization able to confront what Hoover deemed the most pressing economic problem of American industry: the elimination of waste and the increase of productivity. This, he believed after studying the economic slumps of the nineteenth century, was the only practical way to reduce the burdens of debt left by World War I.

Hoover perceived his role as secretary of commerce as one of organizing and directing business, industry, engineers and workers in new methods of scientific management and economics. In this he thoroughly succeeded and the accomplishments of the Department of Commerce during these years was unprecedented. The most immediate improvement came with the development of superior equipment and methods of railway transportation and the establishment of uniform methods of packing and storage. These actions reduced damage claims by millions of dollars a year. Committees were set up between shippers and railway operators to better handle traffic. A mediation board, subsequently formally recognized in the Railway Mediation Act, reduced railroad strikes. The Department made many regional studies of technical problems involved in the expansion and conversion of factories to electrical power. A move to standardize manufactured products was undertaken. The measurements of nuts, bolts, pipes and other construction materials, for example, previously unique to each manufacturer were given uniform specifications. This was a great leap forward.

By standardizing sizes and measurements, manufacturers could now engage more fully in mass production. Inventories carried by consumers were reduced and competition was enhanced. The Department also set up commercial arbitration boards to reduce the expense of litigation. Commissions were organized to study the problems of the oil and coal industries. Studies were undertaken of business cycles and improvements were made in traffic safety regulations. Hoover also worked to eliminate the 12-hour day in the steel industry and embraced various schemes of worker representation. He even turned his attention to agriculture after the Mississippi River flood of 1927. He advocated strategies to enable sharecroppers and tenant farmers to own their own land. By the time Hoover became President of the United States in 1929, his reputation as an international businessman, humanitarian, and successful government administrator was undisputed. He appeared on the American political stage as a new type of character, that of the great statesman-engineer who could bring modern, scientific methods to improve government and industry. It was widely believed that if anyone could apply modern economic knowledge and methods to reversing the economic decline, it was Hoover.

Growth of the U.S. Banking System

After World War I over 50,000 financial institutions existed across the country. Most were commercial banks and the rest were savings banks, building and loan associations, industrial banks, credit unions, and finance companies. State bank authorities granted charters liberally and most had little cash on hand. Rural and small town banks failed throughout the 1920s as a result of the ongoing agricultural depression during the decade. In addition the growth of large chain stores and mail order houses like Sears Roebuck closed many smaller businesses that had been the clientele of rural banks. Between 1921 and 1929 one quarter of all rural and small town banks failed. With the boom in the stock market, banks tended to put their assets into securities instead of government bonds. There were simply higher returns on stocks, corporate bonds, and mortgages. In fact investment by banks in stocks and bonds was encouraged by several policies of the Federal Reserve Board during the 1920s—a practice that Hoover, as Secretary of Commerce, criticized. Additionally as corporate profits increased during the decade the need for commercial loans declined. It was more economical for businesses to sell stocks and bonds than to secure bank loans. Thus the volume of loans declined putting commercial banks in a precarious position since most were undercapitalized anyway. In 1918 short-term commercial loans comprised the bulk of a bank’s assets. In 1929 those assets were either speculative investments or loans such as real estate whose worth was based on ever changing market values. Many banks also had railroad bonds, which were blue chip investments for banks in 1917. During the 1920s, however, their value declined due to competition from trucking carriers to the point of becoming unmarketable by 1932.

In a period of economic growth like the 1920s, stocks, bonds, and real estate were the assets to own for they could be easily sold on the booming stock exchanges. But if for some reason the market declined, the value of those assets would deflate rapidly and banks would lose their capital very quickly. It seemed an impossible scenario in the 1920s, but there were warnings. So many stocks were overrated and railroad bond values steadily declined. When the market crashed, there were even steeper declines in the prices of commodities, land, and securities. Banks could not convert their investments to cash to pay off panicking depositors demanding their money back. With thousands of banks trying to convert securities into cash, the stock market declined further into a vicious cycle. Business activity then declined, followed by bankruptcies, which reduced the ability of businesses to make loan payments. The collapse of thousands of rural banks led to a chain reaction of closures throughout the country. The failure of several key European banks in 1931 only made matters worse. By the time Hoover instituted the RFC in January 1932 the economy looked very different than it had in 1917.

Impact

By the late 1930s, as the administration began preparing for the possibility of war, the recovery effort of the RFC gave way to defense. It was estimated that the increase in government spending and the enormous defense contracts necessary in time of war would require more credit than private capital could provide. On June 25, 1940, Congress passed legislation allowing the RFC to negotiate its own flexible interest rates, collateral security, and payment considerations. Jones began changing the focus of the RFC from recovery to defense. In June 1940 he formed a Rubber Reserve Company to stockpile rubber and end dependency on Japanese controlled supplies in Southeast Asia. He also established a Metals Reserve Company and the Defense Plant Corporation to finance new plant construction for war industries. In August the Defense Supplies Corporation was set up to acquire critical industrial materials. In October 1940 Jones established the Defense Homes Corporation to loan money for the construction of new homes for workers in defense plants. A week after the attack on Pearl Harbor on December 7, 1941, Jones established the War Damage Corporation to assist insurance companies in underwriting business losses due to war. Later in 1943 the Petroleum Reserve Company was created to stockpile oil and gasoline.

It was World War II that would bring the RFC full circle to its origins as a wartime agency. Between 1941 and 1945 the RFC and its subsidiaries advanced $37 billion dollars. Many of the reserves and plants built and managed by the RFC would be turned over to private industry after the war. It was the most massive government investment in the economy up to that time and it ended the Depression. Eventually, the agency was discontinued in 1953 when President Dwight D. Eisenhower (served 1953-1961) reorganized it into the Small Business Administration.

Perhaps the largest impact of all stemming from the RFC was the influence on the U.S. loan system. By the end of World War II, the federal credit system was permanently underwriting money markets, mortgages, construction, crops, and utilities and continued doing so into the twenty-first century. There is little doubt that the RFC laid the groundwork for the state-sponsored capitalism of the post New Deal era.

Perspectives

Government

Establishment of the Reconstruction Finance Corporation was undoubtedly a departure from the policies of former administrations. Never before in peacetime had the federal government became so directly involved in private sector economics. Gone forever were the days when a group of Wall Street bankers would rescue the financial markets during a crash by underwriting massive loans or purchasing stock. The federal government now assumed this responsibility. President Hoover was uncomfortable with this new alliance between the financial community and government but he always viewed the agency as temporary. Comparing the severe economic crisis to war offered at least some psychological comfort to both him and others believing in limited government roles that both events required extraordinary measures that were temporary. Indeed Hoover believed that the Depression was in fact an outgrowth of World War I, perhaps the final phase of the drain on national resources that the war had demanded. A return to prosperity would end the need for such enormous federal involvement in the economy.

Although Hoover may have been committed to government intervention as a last resort, he was also keenly ambivalent about its potential danger. Local committees of the RFC regional offices consisted of local bankers empowered with the enormous authority of the federal government. This power had potential for abuse. For a believer in voluntarism and limited government, the RFC was contrary to Hoover’s political philosophy. He was profoundly uneasy about the presence of the federal government in the local economies of cities and counties across the nation.

Public

Surprisingly the RFC also demonstrated that beliefs about the traditional opposition of government and business to federal action were not necessarily accurate. In times of national crisis at least, cooperation was essential between private business and the federal government. It was in a relatively short period of time following the 1929 stock market crash that the financial community generally came to accept the need of federal assistance in the private sector.

The support for RFC activity grew much more by 1933. The expansion of the power of the RFC during the Roosevelt administration was the direct result of the knowledge and experience gained during the Hoover years. The New Deal credit revolution grew out of the inability of either the Hoover or Roosevelt administrations to bring commercial lending by banks back to 1920s levels. Economists did not fully understand the relationship between credit and industrial development until the late 1930s and World War II when early economic ideas of the supply of credit functioning as a stimulant for growth were abandoned in favor of Keynesian models favoring large government spending directly into the economy. Nevertheless the RFC not only rebuilt the banking system but also prevented its total collapse. It also made possible numerous New Deal credit programs.

One of the ongoing historical debates about the Hoover administration centers on the question of whether the Hoover presidency marked the end of the old order or the beginning of the new. It is a debate that has provided much material over the years to political commentators and politicians to advance views on both the left and the right and has been applied as a basis of appraisal for subsequent administrations throughout the twentieth century. On the one hand Hoover’s policies to fight the Great Depression, particularly the RFC, were unprecedented innovations. Past presidents tended to deal with economic downturns by waiting them out. Hoover, however, was the first president to offer federal leadership in mobilizing resources to meet the problem of the depression. Unlike his predecessors, Hoover responded immediately by holding a series of meetings with business and labor leaders to win support for his program. He eased tight credit by having the Federal Reserve lower interest rates and encouraged private charity to assist the unemployed. As the depression worsened, Hoover created the Reconstruction Finance Corporation and together with the Emergency Relief Construction Act in July 1932, these measures constituted a comprehensive anti-depression program.

Conservative commentators have argued that Hoover actually checked the forces of the Great Depression several times but that events continued to intervene that made the Depression worse. The election of Roosevelt, with his campaign talk of monetary experimentation, only served to undermine the confidence of business in the winter 1932. But most important, Hoover devised a recovery program without compromising the integrity of the American individualist tradition. The drastic innovations of the Roosevelt administration, according to this view, destroyed a venerable American system that remained intact during the Hoover years.

Liberals, on the other hand, welcomed Roosevelt’s broad conception of presidential powers and his willingness to experiment. To the left Hoover has been portrayed as a pitiful or tragic figure, inept in politics, stuck in nineteenth century economic theory, and incapable of understanding the defects of the modern economic system. Hoover proclaimed his administration’s success in the face of overwhelming evidence of the economic Depression. He resisted instituting programs on the scale necessary to combat the depression and was unwilling to enlarge the power of the federal government to meet the crisis. Both groups have generally conceived of Hoover and Roosevelt as polar opposites in both political philosophy and temperament and ability. The role of RFC was in the center of these debates.

Of course the truth probably lies somewhere in the middle. Historians generally acknowledged that Hoover’s policies for dealing with the Great Depression not only drew from past precedent, such as the Home Loan Banks and the Federal Farm Board, but he also introduced innovations like the Reconstruction Finance Corporation. Yet, fundamentally Hoover believed that the federal government’s proper role was to coordinate voluntary action. He was uncomfortable with federal power expanding beyond this role. As a result, the scope and effectiveness of his anti-depression policies were limited. By insisting on public works projects that were self-liquidating, balanced budgets, higher RFC loan rates than the prevailing market value, and a fundamental belief that primary responsibility for reviving the economy must come from the private sector, Hoover put many limitations on federal intervention. Hoover, it seems, had a very different view of the American system, emphasizing voluntary organizations and state and local government, than the federal behemoth that later emerged. The question that later perplexed many students of the modern United States political and economic system was whether this development was inevitable. Undoubtedly Hoover contributed to government policies for dealing with economic downturns but his program seemed modest in comparison to the New Deal.

Notable People

Charles Gates Dawes (1865-1951)

Dawes was born in Marietta, Ohio on August 27, 1865, the son of Civil War General Rufus R. Dawes and Mary Beman Gates. After graduating from the Cincinnati Law School in 1886 Dawes practiced in Lincoln, Nebraska, until 1894. He won much local acclaim for attacking the unfair rate prices of railroads. While practicing law he also worked as a bank director in Lincoln and wrote a book on banking. He acquired stock in gaslight and coke companies in Wisconsin and Illinois and soon made a small fortune. In 1895 he moved to Chicago and became involved in the Republican Party.

After managing William McKinley’s (served 1897-1901) presidential campaign of 1896 in Illinois and was rewarded with an appointment as comptroller of the currency. In 1902 he organized the Central Trust Company of Illinois and became its president. He became a recognized expert on the relation of currency to banks and municipal bonds. When the United States entered World War I Dawes became the general purchasing agent of the American Expeditionary Forces. His job was to procure supplies, eliminate waste, and keep prices low. When the war ended Dawes had earned the rank of brigadier general.

In 1921 President William Harding (served 1921-1923) appointed Dawes the first director of the budget. In 1924 Dawes was sent to Paris where he joined European representatives to attempt to solve the problem of collecting German war reparations (payments to victorious European nations for their damages). Under the plan that would bear his name, the German currency was stabilized by a loan of $800 million gold marks from abroad. The Dawes Plan temporarily saved Germany from the burden of the terrible war debt. It was a phenomenal diplomatic accomplishment and for it Charles Dawes became a co-winner of the Nobel Peace Prize in 1925.

In 1924 Dawes was elected Vice President on the Republican ticket with Calvin Coolidge. After serving as ambassador to Britain since 1929, in 1932 Hoover appointed Dawes to be chairman of the Reconstruction Finance Corporation. Throughout his tenure on the board Dawes never permitted the RFC to make loans to his own bank until after he left government service. He was also reluctant to underwrite completely the bank debts that railroads had accumulated with Wall Street banks and often sided with his Democratic colleagues on the board. In fact he tended to remain politically independent and often mediated between factions in the RFC. Nevertheless when the Central Republic Bank of Chicago looked as if it were on the brink of collapse, Dawes devised a plan to save it though it involved underwriting much of the bank’s debts. The “Dawes Loan,” as it came to be called, generated a great deal of controversy. The Hoover administration was seen as only assisting large financial institutions, while Dawes felt that if Central Republic collapsed, it would cause a chain reaction. The loan was issued and it did save the bank for two months, long enough to shore up smaller banks under its control. After many difficulties with managing the RFC board and concerned about managing his own bank, Dawes resigned as president of the RFC on June 6, 1932. For the rest of his life he remained active in business.

Eugene Isaac Meyer (1875-1959)

Meyer was born on October 31, 1875, in Los Angeles where he grew up before his family moved to New York. His father accepted a partnership in the prestigious banking firm of Lazard Freres, which specialized in international trade. After graduating from Meyer following his father’s footsteps into the world of high finance. From investments in the stock market Meyer became a millionaire almost overnight. In the stock market crisis of 1901, he bought cheap stock as panicked sellers dumped their declining securities. The crash was short-lived, prices rebounded and Meyers made a fortune. By the time he was 40 Meyer’s net worth was about $60 million. He was one of the major organizers of the Allied Chemical Company and as a financier he developed expertise on the copper mining and automobile industry. He married in 1910 and had five children including one of whom was Katherine Meyer Graham, who later managed his communications empire including the Washington Post and Newsweek.

In 1918 President Woodrow Wilson appointed Meyer to be director of the War Finance Corporation. Meyer continued in this position after the war assisting farmers dealing with the post-war recession in agriculture. Largely because of this experience, President Calvin Coolidge (served 1923-1929) appointed Meyer to be director of the Farm Loan Board in 1927. In 1929 President Hoover then appointed Meyer governor of the Federal Reserve.

Meyer was regarded as a cautious banker, politically conservative and someone with strong links to the New York banking community. Because of his political philosophy and experience, Hoover wanted Meyer to be chairman of the board of the newly formed Reconstruction Finance Corporation, which Meyer accepted. He continued to function as chairman of the board until the very end of the Hoover administration. Throughout this time, Meyer remained conservative in his approach to the lending practices of the RFC while Hoover gradually moved toward supporting a more flexible arrangement. By the end of the Hoover presidency, Meyer had taken much of the blame for the RFC’s failure to stimulate recovery and Hoover asked for his resignation in July 1932.

After leaving public service Meyer began a new career in publishing. In 1933 he bought the struggling Washington Postand turned the paper into a highly regarded institution. In 1946 at the urging of President Harry Truman (served 1945-1953), Meyer was appointed the first president of the World Bank. It was a job he did not particularly enjoy, however, and once the bank was formed, Meyer resigned and returned to his communications group, becoming chairman of the Washington Post.

Ogden Livingston Mills (1884-1937)

Mills was born into a socially prominent New York family in Newport Rhode Island. After attending Harvard Law School he began a law practice in New York City. Mills first became active in the Republican Party in 1911 and was elected to the New York State Senate in 1914. When war broke out, Mills secured a commission as a captain in the American Expeditionary Forces in France. Upon returning, Mills successfully won a seat to the U.S. House of Representatives in 1921 where he served three terms until 1927.

After an unsuccessful run in the 1926 New York gubernatorial race, President Coolidge appointed Mills undersecretary of the Treasury in 1927 upon the recommendation of Treasury Secretary Andrew W. Mellon. To Mills fell much of the responsibility of representing the Treasury Department before Congress. When Hoover came into office, Mills continued as undersecretary of the Treasury and became actively involved in the early dominant issue of the Hoover Treasury Department, post-World War I reconstruction in Europe. Hoover promoted Mills to secretary of the Treasury on February 13, 1932. Mills continued the conservative economic policies of his predecessor, Mellon, and recommended a drastic reduction in government spending and a tax increase that would balance the budget by 1934. Mills was a staunch economic conservative who believed in a strictly balanced budget. His proposals in the final months of the Hoover administration fell on deaf ears in Congress and he was able to accomplish little. Nevertheless Mills did exert influence on President Hoover’s economic views and as secretary of the Treasury was an ex-officio member of the Reconstruction Finance Corporation board.

Mills left the Treasury Department and government service when Roosevelt came into office on March 4, 1933. He continued to be active in business and politics and criticized the New Deal’s “easy money” policies. His views were published in two books, What of Tomorrow (1935) and The Seventeen Million (1937), in which he attacked New Deal politics and defended Hoover.

Jesse Holman Jones (1874-1956)

Jesse H. Jones, facetiously referred to as the “Czar” of the Reconstruction Finance Corporation, was born in Robertson County, Tennessee. His family moved to Dallas when he was young and he graduated from Hill’s Business College in 1891. Jones went to work in his uncle’s timber company and within a short time had risen to general management and purchased his own firm. In 1903 he entered real estate and construction, then he went into banking two years later and finally newspaper publishing in 1908. He became one of the largest real estate developers in the Houston area. Known as “Mr. Houston,” Jones owned over 50 major buildings in the city alone. In 1912, he became president and later chairman of the Texas Commerce Bank. Jones also invested wisely in a small oil and refining company known as Humble Oil and Refining, which later became Exxon Corporation. He was the sole owner of the Houston Chronicle and briefly owned the Houston Post before selling it. By 1929 Jones was a self-made multi-millionaire.

In addition to the many business interests, Jesse Jones became involved in the Democratic Party. He served as chairman of the Houston Harbor Board between 1913 and 1917, which developed a canal in 1914 that turned the city into a major seaport. In 1917, President Wilson appointed Jones to be director general of Military Relief in the American Red Cross. When the war ended, Jones was instrumental in forming the international League of Red Cross Societies. He also developed a close friendship with President Woodrow Wilson whom he greatly admired. Much later in life Jones would establish the Woodrow Wilson school of Foreign Affairs at the University of Virginia and he would also serve as the president and treasurer of the Woodrow Wilson Foundation.

Hoover appointed Jones as one of the Democratic members of the Reconstruction Finance Corporation board. When Roosevelt came to office, he appointed Jones chairman of the RFC. During his chairmanship from 1933 to 1945, Jones made over $50 billion in loans, the vast majority of which were repaid to the government with interest. As an administrator Jones was a true businessman and gave little consideration to political philosophy. Nevertheless Jones despised the Wall Street establishment for what he viewed as its conservatism and narrow-minded policies that stifled business development in the South and West. Everyone in Washington recognized the tremendous power he exerted over the Reconstruction Finance Corporation. In part this was due to the force of is own domineering personality. He was physically large and tall and always wore double-breasted suits. Jones knew how to move in the world of politics. He was always friendly with the Congressman that would appear at his office to discuss pending loan applications in their district. When he was not in his office, he was paying social visits to congressional offices on the hill. Jones had an uncanny ability to form close relationships with powerful figures in the New Deal including Harry Hopkins and Harold Ickes.

Believing there was nobody else with the experience and knowledge to handle the job, Roosevelt appointed Jones head of the newly created Federal Loan Agency in 1939 in addition to his responsibilities with the RFC. From 1940-1945, he also served as secretary of commerce. He devoted much of his later life to philanthropic work and founded the Houston Endowment, Inc., which built many community facilities, endowed academic chairs, and provided thousands of scholarships. In his honor the graduate school of Administration at Rice University was named after him.

Primary Sources

President Hoover Proposes the RFC

On December 8, 1931, President Herbert Hoover delivered the State of the Union address to a joint session of Congress, including members of both the Senate and House of Representatives. In the address the president covered a range of topics important to the nation at the time. Prominent among them was the lingering Great Depression which would not seem to go away as some, including Hoover, had thought it would do on its own. The address greatly reflects Hoover’s ideas about the proper role of government in the nation. Hoover proposes the Reconstruction Finance Corporation as a primary avenue for federal action to combat the Depression (Hoover, 1976, pp. 580-597).

“It is my duty under the Constitution to transmit to the Congress information on the state of the Union and to recommend for its consideration necessary and expedient measures …

Our national concern has been to meet the emergencies it has created for us and to lay the foundations for recovery.

If we lift our vision beyond these immediate emergencies we find fundamental national gains even amid depression. In meeting the problems of this difficult period, we have witnessed a remarkable development of the sense of cooperation in the community. For the first time in the history of our major economic depressions there has been a notable absence of public disorders and industrial conflict. Above all there is an enlargement of social and spiritual responsibility among the people. The strains and stresses upon business have resulted in close application …

Business depressions have been recurrent in the life of our country and are but transitory (temporary). The Nation has emerged from each of them with increased strength and virility because of the enlightenment they have brought, the readjustments and the larger understanding of the realities and obligations of life and work which come from them …

In order that the public may be absolutely assured and that the Government may be in position to meet any public necessity, I recommend that an emergency Reconstruction Corporation of the nature of the former War Finance Corporation should be established. It may not be necessary to use such an instrumentality very extensively. The very existence of such a bulwark will strengthen confidence. The Treasury should be authorized to subscribe a reasonable capital to it, and it should be given authority to issue its own debentures. It should be placed in liquidation at the end of two years. Its purpose is that by strengthening the weak spots to thus liberate the full strength of the Nation’s resources. It should be in position to facilitate exports by American agencies; make advances to agricultural credit agencies where necessary to protect and aid the agricultural industry; to make temporary advances upon proper securities to established industries, railways, and financial institutions which can not otherwise secure credit, and where such advances will protect the credit structure and stimulate employment …

It is inevitable that in these times much of the legislation proposed to the Congress and many of the recommendations of the Executive must be designed to meet emergencies. In reaching solutions we must not jeopardize those principles which we have found to be the basis of the growth of the Nation …

It is the duty of the National Government to insist that both the local governments and the individual shall assume and bear these responsibilities as a fundamental of preserving the very basis of our freedom.

Many vital changes and movements of vast proportions are taking place in the economic world. The effect of these changes upon the future can not be seen clearly as yet. Of his, however, we are sure: Our system, based upon the ideals of individual initiative and of equality of opportunity, is not an artificial thin. Rather it is the outgrowth of the experience of America, and expresses the faith and spirit of our people. It has carried us in a century and a half to leadership of the economic world. If our economic system does not match our highest expectations at all times, it does not require revolutionary action to bring it into accord with any necessity that experience may prove. It has successfully adjusted itself to changing conditions in the past. It has successfully adjusted itself to changing conditions in the past. It will do so again. The mobility of our institutions, the richness of resources, and the abilities of our people enable us to meet them unafraid.

The RFC Begins

On January 22, 1932, President Herbert Hoover signed the Reconstruction Finance Corporation Act. The act was in response to Hoover’s request for federal action to provide financial support for the nation’s businesses struggling to survive the economic hardships of the Great Depression (Hoover, 1977, pp. 29-30).

“I have signed the Reconstruction Finance Corporation Act.

It brings into being a powerful organization with adequate resources, able to strengthen weaknesses that may develop in our credit, banking, and railway structure, in order to permit business and industry to carry on normal activities free from the fear of unexpected shocks and retarding influences.

Its purpose is to stop deflation in agriculture and industry and thus to increase employment by the restoration of men to their normal jobs. It is not created for the aid of big industries or big banks. Such institutions are amply able to take care of themselves. It is created for the support of the smaller banks and financial institutions, and through rendering their resources liquid to give renewed support to business, industry, and agriculture. It should give opportunity to mobilize the gigantic strength of our country for recovery.

Suggested Research Topics

  1. What was the Hoover administration’s “trickle-down” theory of economic recovery? Was it fundamentally sound? Under what circumstances might it have been more effective? If commercial lending had recovered, do you think the rest of economy has recovered as well?
  2. How much were the Hoover administration’s policies limited by a lack of understanding of the economic forces affecting the country?
  3. “A civilized nation is one in which there exists an orderly transfer of power.” Was there an orderly transfer of power between the Hoover administration and the Roosevelt administration? If the peaceful transfer of power through an election was not available to Americans in the fall of 1932, might there have been greater appeal for a revolution?
  4. Was the level of spending by the RFC during World War II simply inconceivable during the 1930s or did it take until the late 1930s to understand spending was necessary to bring the country out of depression?
  5. In what ways was the RFC a radical departure from previous public policy? Could a RFC exist today? Would it be necessary? Would it be a dangerous concentration of power? What about international repercussions?