The New Deal and Recovery, Part 28: A New Deal for Housing

Because this series is about the New Deal’s contributions to economic recovery, it’s essential that we recognize the difference, as Roosevelt himself did, between recovery on one hand and relief and reform on the other. A New Deal policy that undoubtedly offered relief to those harmed by the depression, or one that achieved reforms with indisputable long-run benefits, might not have made the depression any shorter, and might even have lengthened it.

But some New Deal policies that had relief or reform as their most obvious aim could also hasten recovery. Any policy that meant more federal spending, and deficit spending especially, might do so simply by boosting aggregate demand, though Roosevelt himself wouldn’t have thought so until well into his second term. Nor was this the only possible way in which the lines separating the R’s could become blurred.

None of the Roosevelt Administration’s 100-day initiatives illustrates this point better than the creation, on June 13, 1933, of the Home Owners’ Loan Corporation (HOLC), a relatively small and little-known New Deal agency that was only active for just over two years and was wound-up altogether in 1951. In recommending the HOLC bill to Congress two months earlier, President Roosevelt explained that its immediate purpose was “to protect small home owners from foreclosure and to relieve them of a portion of the burden of excessive interest and principal payments incurred during the period of higher values and higher earning power.” But he first let Congress know that he considered the legislation an “urgently necessary step in the program to promote economic recovery.”

The HOLC has been called “one of the great success stories of the New Deal” (Carrozzo 2008, 22), and this opinion is widely shared. Nor is it difficult to see why: during its brief life, the Corporation refinanced mortgage loans for a million homeowners, sparing many the extreme hardships of foreclosure. Lenders benefited as well by trading their delinquent mortgages for the Corporation’s bonds. Yet instead of operating at a loss, the HOLC appeared to turn a tidy profit of $14 million!

In short, no other New Deal program seemed to deliver more obvious benefits at so little cost. But as we’ll see, although the relief the HOLC offered homeowners was palpable, it was mortgage lenders who benefited most from the bargains it struck. That this was so was a reflection of the HOLC’s overarching purpose of promoting recovery. Even so, the Corporation’s contribution to ending the Depression has proven difficult to pin down, and many say that its endeavors had far-reaching long-run consequences that were anything but benign.

Up, Up and Away…

To understand the severity of the Great Depression mortgage crisis, it’s necessary to step back in time to consider the housing boom of the 1920s, and the nature of the mortgage loans that financed a large part of it.

“In a decade of almost steady growth,” Eugene White (2014, 117-18) says, “the behavior of residential construction stands out.” Whereas the better-known boom of the first decade of the 2000s witnessed the construction of 1.3 million new homes, that of the 1920s, when the population was little more than a third as great, witnessed twice that number. For four years starting in 1924, residential construction accounted for more than 8 percent of the nation’s GNP (Field 1992, 785); and during 1925 and 1926 alone, the amount invested in new houses—almost $10 billion—was about equal to the value of new securities purchased in the peak stock market years of 1928 and 1929.

To some extent, the housing boom of the 20s was just the economy’s way of making up for the “crowding-out” of residential construction during WWI, when the government’s heavy borrowing left little aside for the financing of new homes. But according to White (ibid., 125), there was more to the boom than that. As happened during the 2000s, easy Fed policy, lax underwriting standards, equally lax bank supervision, and a roaring but heedless market for securitized mortgages, all played their part, by making it easier than ever for people to buy homes on credit.

…in Not-So-Beautiful Balloons

“Mortgages,” White (ibid., 134, 138) explains, “supplied over $2 billion of the $3.3 billion in financing for 1926,” which was about twice the 1922 level; and almost all of them were short-term, non-amortized mortgages, a type seldom seen either before the First World War or since the Second. Most commercial bank mortgages had terms of 5 years or less, at interest rates of 8 percent or more. Borrowers made interest-only payments until the loans matured, when a final, “balloon” payment, consisting of the loan principal, fell due; and because many were in no position to make that large payment so soon after taking out their loans, refinancing at least once, and often several times, was common.

But by far the most important institutional mortgage lenders in those days were parvenu building and loan associations (B&Ls). These were typically small, local institutions, mutually owned by their members and funded by members’ dues, that is, by their weekly or monthly purchases of association shares (Fishback et al. 2013, 12). B&Ls first rose to prominence during the last decades of the 19th century, thanks in part to relatively strict limits on mortgage lending by commercial banks: until 1914, national banks weren’t supposed to offer mortgages at all[1]; and the mortgages they offered afterwards, as well as those to be had from state banks, featured not only short terms but hefty minimum down payments (Price and Walter 2019, 2).

But the rise of B&Ls before 1900 was nothing compared to what came afterwards. Between 1910 and 1929, their numbers more than doubled, from 5,869 to 12,342, while their assets quadrupled. When the stock market crashed in October 1929, roughly one American in ten was a B&L member; and even in 1930, as the economy was starting to spiral downward, B&Ls were writing 1,000 mortgages a day, and accounting for as much outstanding residential mortgage credit as commercial banks, life insurance companies, and mutual savings banks combined (Mason 2004, 61; Rose 2011, 1076).

Although it resembled other mortgages in being non-amortizing, the standard B&L mortgage had a somewhat longer term—usually between 5 and 10 years. And instead of ending with a balloon payment equal to the loan principal, it allowed borrowers’ share accounts to serve as sinking funds for their loans. When the value of a borrower’s shares, augmented by occasional dividends, reached that of the loan principal, the loan was considered paid. Share accumulations beyond that were the homeowner’s, free and clear.

Thus, like those who took out interest-only mortgages with balloon payments, and unlike today’s holders of amortized mortgage loans, B&L borrowers owed the entire principal of their loans for the loans’ full life. It follows that, if a member defaulted, he or she “lost not only the house but also the accumulated value in the sinking fund” (Fishback et al. 2013, 14-15). Even so, as long as the value of a B&L’s shares stayed the same or rose, these were attractive terms. Borrowers could then avoid having to come up with lump-sum balloon payments, while enjoying a share in their association’s profits. And so they did throughout the 1920s. Only if share prices fell could things possibly turn sour.

That Sinking Feeling

It’s tempting, with the aid of 20/20 hindsight, including knowledge of just how much mortgage-financed home buying went on during the 1920s, to suppose that B&Ls and other mortgage lenders that came to grief afterwards did so because they’d lent recklessly. It’s tempting; but it’s hardly fair, for had it not been for the unprecedented severity of the downturn, most of their loans would have performed well, and their capital would have sufficed to protect them against those that didn’t.

In fact, two things had to go terribly wrong to cause the U.S. mortgage industry to suffer as it did. One was a collapse in house values; the other was a collapse in household income and wealth. Had house prices remained stable, those who could not afford to keep paying their loans at least had the option of selling their properties at prices that would allow them to pay their debts; and if they didn’t, their lenders might make themselves whole by foreclosing. If, on the other hand, house prices fell dramatically, but their owners’ earnings didn’t, though owners would suffer a loss of equity, they could still go on paying off their debts (Wheelock 2008, 1378).

The Great Depression was great in part because, in the United States at least, it managed to pull this “double trigger,” dealing a mortal blow to mortgage lenders by making it impossible for vast numbers of their clients to continue paying off their loans (Fishback et al. 2013, 19). Between 1929 and 1933, house prices fell by a third, while the unemployment rate rose to 25 percent. In 1932, roughly 273,000 people lost their homes, as compared to only 6,000 in 1926. Yet the bottom still hadn’t been reached. By the time of Roosevelt’s inauguration, with roughly a third of all U.S. mortgages in default, and twice as many in arrears, lenders were foreclosing on 1000 loans every day.

This explosion of foreclosures was more than enough not just to ruin many mortgage lenders but to put paid to private firms that insured their loans (White 2014, 141). And the rot was tragically self-reinforcing: as mortgage credit dried up, borrowers facing balloon payments they couldn’t afford would find it impossible to refinance. So more borrowers would default, and more lenders would fail, in a vicious downward spiral. Finally, homeowners who managed somehow to keep up with their payments were paying with dollars worth a third more than their value in 1929 (Fishback et al. 2013, 29).

A similar negative feedback loop was tearing apart building and loan associations, which were all the more vulnerable by virtue of having mortgage lending as their bread and butter. Although their member-borrowers didn’t face balloon payments, so long as many failed to make payments, because they lost their jobs or were earning much less, all their members saw their share values dwindle, and their hopes of paying off their loans go up in smoke. When their B&L’s failed, they were wiped out altogether, and by 1933, almost 2000 of the nation’s 13,000-odd B&Ls had done so (ibid., 30).[2]

Nor was the damage limited to homeowners and real estate lenders. The troubles of the mortgage industry contributed to the overall collapse in spending on residential construction, which (assessed in inflation-adjusted terms) would take almost a quarter-century to return to its 1926 peak (Field 1992, 787). As construction fell to a mere trickle, hundreds of thousands of workers joined the ranks of the unemployed and, in many cases, those of mortgage deadbeats: all told, between a quarter and a third of workers unemployed during the depths of the Depression came from the building trades. So the number of foreclosures also grew, adding that many more housing units to an already severe glut.

Yet hundreds of thousands of nonperforming mortgages were still on lenders’ books, thanks to state foreclosure moratoriums, or to some combination of lenders’ voluntary forbearance and their unwillingness to take possession of more unsaleable real estate. These were, however, mere stays of execution: barring some other intervention, the mortgage pipers would have to be paid, and that many more delinquent homeowners would come home to find their locks changed and their belongings on the street.

A White Knight for Homeowners

Homeowners’ and mortgage lenders’ desperate straits cried out for some sort of remedy. The Federal Home Loan Bank Act, passed in July 1932, was supposed to have helped. Besides granting credit to illiquid B&Ls, much as Federal Reserve Banks granted it to commercial banks, the new Home Loan Banks could also lend directly to distressed homeowners. However, their terms were so conservative that of the 41,000 applications they received, only three were approved! (Carrozzo 2008, 9). The Federal Home Loan Bank Board (FHLBB) itself recognized the need for an alternative. So when Roosevelt proposed a new agency, to be overseen by the FHLBB, but with the specific aim of giving distressed homeowners a real break, while helping mortgage lenders as well, the House approved it with a whopping 383–4 majority, and it breezed through the Senate on a voice vote.

The HOLC’s plan was ingenious in its simplicity. The Corporation would invite distressed mortgage holders to apply to it for amortized 15-year mortgages, for which it charged a below-market rate of 4.5 or 5 percent. Once it accepted an application, which it did provided it was convinced that the prospective borrower was both capable of making the lower payments and in need of help, the Corporation would contact the lender holding the original mortgage, offering to swap its own bonds, paying 4 percent interest, for it. Although 4 percent wasn’t much, it was a good return compared to what the mortgages in question were actually earning, which was typically nothing at all; it was also likely to be a better deal than what lenders could expect to earn by foreclosing on delinquent properties and then renting or selling them. If the HOLC’s offer was accepted, it would proceed to refinance the loan, charging just $35 in closing costs. Thus most HOLC loans were actually financed by the private-market lenders whose own loans they own replaced.

But for all its simplicity, the HOLC’s plan was no perpetual motion machine: what ultimately kept it humming—and the reason why no private-market effort could have matched it—was the backing it got from the federal government. That backing consisted, not only of the $200 million in starting capital the HOLC received from the Treasury, but of the fact that the federal government guaranteed, first the interest on the Corporation’s bonds and, starting in April 1934, the principal as well. That made those bonds as safe as Treasury securities (Fishback et al. 2013, 112). This meant that holders of HOLC bonds didn’t have to worry that, by being too generous in its lending, the Corporation could itself go bankrupt.

Thanks to those guarantees, the HOLC’s offers were eagerly swooped up. Between June 13, 1933 and June 27, 1935, when it stopped accepting them, it received applications from almost two million homeowners, and by 1936 it had refinanced a million of their mortgages. Most of the homeowners it helped were two years or more in arrears not only on their loan payments but also on their property taxes, which their HOLC loans also covered. It’s therefore likely that, had it not been for the HOLC, they would have lost their homes, doubling the number of foreclosures. That the HOLC wasn’t being too strict in deciding who to help is evident enough from the fact that it ultimately had to foreclose on some 200,000 of its own clients, despite making every effort to avoid doing so. The chart below, reproduced from Fishback et al. (2013, 22) shows the progress of private and HOLC foreclosures.

Four-fifths of those who received HOLC loans were, on the other hand, able to stay in their homes for good thanks to them; and there can be no gainsaying the tremendous value of that deliverance. “The contributions of the HOLC,” Peter Carrozzo (2008, 22) writes, “were very real.” Thanks to it,

[o]ne million families were not afraid to receive their mail each day for fear off the eviction notice; one million families did not suffer the humiliation of carrying furniture and belongings out of their homes as neighbors watched; one million families were not forced to remove to a different neighborhood, into cramped houses with relatives and to transfer children to new schools; one million families did not have their credit destroyed and a sense of utter failure… .

And a Bailout for Lenders

It would be a mistake, though, to treat homeowners as the HOLC’s sole, or even its main, beneficiaries. In fact, as Jonathan Rose (2011, 1074) points out, it was, in important respects, not a borrowers’ program but “a lenders’ program.” For that reason, the HOLC put less emphasis on achieving principle reductions for borrowers than on offering their lenders generous prices for their mortgages, which it did by appraising mortgaged properties very generously. This made it a lot easier for lenders to take part in the program, while also boosting the number of qualified loan applicants. But it also reduced the number of distressed borrowers whose high loan-to-value ratios would otherwise have inspired HOLC efforts to get lenders to agree to “haircuts” on amounts they were owed

Why did the HOLC take this approach? The explanation resides in its double-barrelled purpose. Had relief been the Corporation’s sole aim, it might have preferred to devote more effort toward reducing distressed homeowners’ debt burdens by striking harder bargains with their lenders. But because it was supposed not only to offer relief but to stimulate recovery, it chose instead to increase the relief it offered lenders by, in effect, boosting their capital, much as the RFC boosted the capital of commercial banks. The hope was that doing so would help revive investment in the real estate market.[3] “HOLC officials,” Rose (2011, 1095) says,

appear to have been more concerned with the course of the housing market than with the availability of principle reductions. The most likely rationale was that even if borrowers debts remained high, a strong housing recovery would allow borrowers to gain equity in their properties, and so the HOLC took as its mission to support such a recovery by increasing the size of the program.

But just how did the U.S. housing market respond to the HOLC’s support? Most assessments of the Corporation’s success refer only to the relief it offered homeowners, neglecting its overriding, macroeconomic purpose. Nor is it hard to see why. As David Wheelock (2008, 144) notes, “It is difficult to determine the extent to which the HOLC contributed to a rebound in the housing market, let alone to the macroeconomic recovery.” Wheeler himself claims that, by taking one-million bad loans off of private lenders’ books, the Corporation must have helped revive private mortgage lending. But the extent to which it did is anything but unclear.

A student publication (Hanes and Hanes 2002, 101) says that

By February 1939, the HOLC had refinanced 992,531 loans totaling over $3 billion. The refinanced loans not only halted countless foreclosures but reduced delinquent property taxes. This permitted communities to meet their payrolls for school, police, and other services. Millions were also spent on repair and remodeling of homes. Thousands of men gained employment in the building trade. Thousands more jobs were stimulated in the manufacture, transportation, and sale of construction materials.

But while they all credit the HOLC with avoiding reducing foreclosures, economic historians are not so sure its undertakings led to any substantial change in residential repairs or new construction. In a 2011 study, Charles Courtemanch and Kenneth Snowden (2011) recognize that the HOLC’s “primary goal was to break the cycle of foreclosure, forced property sales and decreases in home values.” They also uncover evidence that HOLC refinancing did indeed  “cut short” the vicious cycle of debt deflation of the early 1930s by boosting both home values and homeownership rates (ibid, 309). But they find no evidence that it stimulated new home construction (ibid., 335). In another study published that same year, using data from 2800 U.S. counties, Price Fishback and his coauthors (Fishback et al. 2011) find evidence that the program stimulated both home sales and home and apartment construction, but only after setting data for counties with 50,000 inhabitants or more aside. When bigger counties are included—as seems more appropriate for assessing the program’s overall effects—the HOLC doesn’t appear to have made any difference. Finally, although it’s certainly true that the HOLC spent money repairing homes it foreclosed upon, private lenders did so as well, for the same reason, to wit: to profit as much as possible from the properties they took possession of.


Whatever the HOLC’s macroeconomic achievements, if it’s really true that, instead of costing taxpayers anything, its refinancing efforts actually helped fill the Treasury’s coffers. And that’s what most assessments of those efforts suppose. Peter Carrozzo (2008, 23), for example, says that “[u]pon congressionally-ordered liquidation in 1951 and a final accounting, the HOLC ultimately turned a slight profit.” In his history of the Corporation, C. Lowell Harriss (1951, 159-62) put that profit at $14 million, apparently by simply subtracting its cumulative capital loss of $338 million from its total operating income of $352 million (Wheelock 2008, 144).

But Harriss’s figure is wrong. According to Fishback and his co-authors (2013, 112-114), if the HOLC’s loan financing activities are considered apart from its other undertakings, and account is taken of all its interest expenses, including the foregone interest on the Treasury’s $200 million investment in it, it actually lost $53 million, or about 1.8% of the $3 billion it lent. Considering the relief those loans provided, this was still a good deal. But if one instead treats economic recovery as the goal of the HOLC refinancing efforts, while relying on econometric assessments of its loans’ macroeconomic consequences, those 53 million dollars look more like money poured down a drain.

There is, furthermore, an important sense in which the HOLC placed a much greater burden on taxpayers than that $53 million figure itself suggests. Thanks to government guarantees, the  HOLC was able to borrow for between one and two percentage points less than it would have otherwise have had to pay to acquire all the mortgages it acquired. But because those guarantees put taxpayers on the hook for any substantial losses the Corporation incurred, they amounted to a taxpayer-financed subsidy. Had it not been for this subsidy, and assuming it operated on the same scale, the HOLC’s total losses would have been several hundred million dollars greater (ibid., 2013, 119).

In the event, the gamble the HOLC took with taxpayers’ money paid off: the federal government never had to make good on its bonds (ibid., 119). But things might have turned out much differently. If, instead of staying open until 1951, the HOLC had been liquidated in 1938, it would almost certainly have ended up insolvent, and taxpayers would have been on the hook for substantial losses. On the other hand, as Lowell Harriss (1951, 124) points out, had it waited a few more years to dispose of its properties, instead of selling most before the war started, and the rest by 1944, it really would have turned a tidy profit.[4]

Seeing Red

Many also claim that the HOLC’s activities had costly unintended consequences—consequences that now cast a dark shadow over its more immediate and admirable accomplishments. The Corporation stands accused of having invented, employed, and institutionalized the discriminatory lending practice that has since come to be known as “redlining.”

The now-conventional story goes as follows: having been charged by the FHLBB with surveying real-estate risk levels in most larger U.S. cities, the HOLC complied by producing detailed reports on each, together with “security maps” (like the one for Atlanta shown below) for many. Those maps assigned letter grades—A, B, C, and D—to different neighborhoods, while coloring them green, blue, yellow, and red, respectively. Neighborhoods considered likely to appreciate were graded A and colored green; those that had “reached their peak” were graded B and colored blue; those understood to be declining were graded C and colored yellow; and those seen as already fallen, and therefore particularly “hazardous,” were graded D and colored red. Predominantly African American neighborhoods were unfailingly among those colored red.

By basing its own lending on these maps (the story continues), the HOLC systematically discriminated against African American homeowners.[5] Worse still, it shared the maps with both private mortgage lenders and the Federal Housing Authority (FHA), which began insuring private mortgages in August 1934, causing them to discriminate against red-zoned African American communities as well.[6] Of course, discrimination and segregation had been rampant long before the New Deal. But redlining reinforced it by making a property’s proximity to minority households a reason for refusing to mortgage it (Faber 2020, 744). Relatively affluent whites, who received almost all FHA-insured loans, were given yet another reason to avoid buying property in predominantly minority neighborhoods, as well as a new, powerful reason to adopt restrictive covenants aimed at keeping African Americans out of white ones. Jacob Faber (ibid, 742 and 763) estimates that, thanks to such discrimination, by 1960 billions had been “funneled…away from poor, urban communities of color, and toward more affluent and suburban white communities,” and roughly two million more African Americans were living in highly segregated city neighborhoods than would have lived in them otherwise.


Like most widely believed but nonetheless misleading stories, the one blaming the HOLC for subsequent racial discrimination contains a large element of truth. The HOLC did create those multicolored maps; and it did share at least a few copies with the FHA. Furthermore the FHA did methodically and cold-bloodedly discriminate against African Americans; and by doing so encouraged many private lenders to follow its lead. Finally, discrimination played a very large part in perpetuating and intensifying racial segregation.

Where the popular account goes wrong is in blaming the HOLC for what happened. Thanks to more recent research by Amy Hillier, Price Fishback, and others, it appears the agency was mostly if not entirely innocent of the charges laid against it.

First of all, the HOLC didn’t invent discriminatory lending practices. According to Hillier (2003, 398), mortgage companies had long been systematically discriminating against African American neighborhoods when the HOLC was established. More importantly, despite the prevalence of discriminatory lending, the HOLC itself didn’t practice it. On the contrary: it vowed not to put residents of poorer, minority neighborhoods at a disadvantage, and the numerous mortgages it purchased from them leave no doubt that it kept that promise.

As for those notorious multicolor maps, HOLC staff couldn’t possibly have made much use of them in deciding which mortgages the Corporation should purchase, for the simple reason that the maps weren’t drawn until after the HOLC did most of its lending. Like other materials the Corporation produced as part of the FHLBB’s City Survey Program, which was launched in August 1935, the maps weren’t intended to guide its mortgage purchases. Instead, their purpose was to help it “gaug[e] the risks of the enormous portfolio of loans it had already accumulated, and in managing the resale of its foreclose real estate holdings” (Fishback et al, 2022, 3).

The possibility remains that other lenders and government agencies, and the FHA in particular, based their own mortgage approval practices on the HOLC’s security maps. But the evidence for this is extremely slim. The FHLBB treated all City Survey Program materials, including the maps, as highly confidential, precisely because it feared others might interpret and use them in ways “which were not intended” (Hillier 2003, 399). Private lenders never got any copies; and HOLC staff were repeatedly told to keep their own copies to themselves.

The FHLBB did, however, supply security maps to “a handful of government agencies,” including the Federal Housing Authority.  But there’s no evidence that the FHA based its own assessment of mortgages’ riskiness, or its willingness to insure them, on those maps. Instead, it had begun developing its own risk rating system, using block-level information and maps based upon the same, eight months before the start of the FHLBB’s City Survey Program. Alas for the HOLC, and to the enduring confusion of many subsequent scholars, it happened to use the very same letter grading system found on the HOLC’s maps.

If circumstantial evidence can also be thrown on the scales in assessing the HOLC’s culpability, that evidence also tends to exonerate it, while making the FHA look as guilty as a cat in a goldfish bowl. The HOLC was charged with keeping distressed mortgage holders in their homes, and it could hardly have done so without making risky loans. Although it did indeed screen-out applicants it considered unqualified, either because they didn’t need its help or because their circumstances made them unlikely to avoid defaulting even on its more generous loans, it had no reason to discriminate against particular neighborhoods or minorities. The FHA, in contrast, was supposed to play it safe. Its goal was reviving the construction of new homes, almost all of which were destined to be sold to relatively affluent, white home buyers, by insuring “economically sound” mortgages only. That meant not insuring mortgages in predominantly African American neighborhoods. It also meant not insuring mortgages—including ones for African Americans seeking to move into mostly white neighborhoods—that reduced the value of others the FHA had insured.

Far from making a secret of its discriminatory practices, the FHA recommended them in early editions of the manuals it supplied to its underwriting staff.  Section 920 of the 1938 version, for instance, explains to them that, while

[i]t is not the policy of the Federal Housing Administration to exclude entire cities and towns from the benefits of mutual mortgage insurance…it may be that within certain communities where present day and expected future stability is exceedingly low, only certain favored locations which surpass the general average of the town or community may prove acceptable for insurance. The rating ascribed shall apply to all locations situated in the area rated (my emphasis).

Later in the same manual (§931), the FHA’s underwriters are reminded that

[p]roperties must remain desirable to their present owners if a satisfactory lending experience is to be expected. A change in class of occupancy is frequently accompanied by a decline in the values and seriously affects the continued desirability of the properties to their original owners. Mortgage risk is greater in such neighborhoods.

Should such statements seem too vague to be taken as proof that the FHA understood that its rules amounted to a policy of discriminating against African Americans, we may call on Homer Hoyt, the FHA’s Principal Housing Economist, to dispel any doubt. In another FHA publication, he observes that “the presence of even one nonwhite person in a block otherwise populated by whites may initiate a period of transition” (Hoyt 1939, 54; quoted in Fishback et al., 2022, 3).

Finally, unlike the HOLC maps, many of which are still available, the last copies of the FHA’s security maps were deliberately destroyed by one of its staff members soon after it was served notice, in 1969, of a class action suit brought against it for discrimination (Sagalyn 1980, 16; Fishback et al. 2022). In a court of law, this would qualify as evidence of “consciousness of guilt.” Because such evidence is also circumstantial, a judge might advise jurors to infer nothing from it. Nothing, that is, that isn’t reasonable, given other evidence.

Continue Reading The New Deal and Recovery:


[1] But see Keehn and Smiley (1977, 475), who draw attention to “the numerous methods that national banks used to grant loans secured by mortgages and real estate” despite the prohibition.

[2] Delinquent loans weren’t the only reason B&Ls were dropping like flies. Another was competition from postal savings banks. According to Sebastian Fleitas, Matthew Jaremski, and Steven Sprick Schuster (2023, 16), during the Depression the postal savings banks, deposits at which were fully insured, “stripped funds from B&Ls.” They claim that, had it not been for competition from their government-run rivals, “B&Ls would have maintained a significantly larger number of investors and may have been able to expand lending during the period” (ibid., 16). See also O’Hara and Easley (1979).

[3] Rose (2011, 1094) claims to “find little support” for the claim “that HOLC officials set out to indirectly recapitalize mortgage lenders,” while proposing instead that their goal was “increasing [lenders’] participation.” I frankly cannot see any reason for his treating these as alternative hypotheses: whether HOLC officials thought in terms of recapitalizing lenders or not, it was only by offering to do so, at least implicitly, that they succeeded in gaining their cooperation.

[4] According to a consistent index constructed by Jonathan Rose (2022, 917), using data from repeat Baltimore home sales, between 1939 and 1945 house prices more than doubled, even surpassing their mid-1920s peak. Rose finds, furthermore, that the same price data “show no meaningful recovery until the onset of World War II.” There is therefore no reason to assume that the HOLC’s activities themselves played a part in boosting Baltimore house prices.

[5] Although the conventional story’s locus classicus is Jackson (1980; see also idem. 1985, 197-203), Kenneth Jackson’s own telling of it recognizes that the HOLC did not itself discriminate against minorities or poor neighborhoods, whereas many subsequent tellings do not. Namrata Singh (2022), for example, writes that the HOLC “directly and explicitly biased its decisions on the basis of a neighborhood’s racial composition” and that it “discriminated against black populations the most blatantly, but also considered Jewish, Catholic, and many immigrant populations, particularly those from Asia and Southern Europe, to be undesirable and high risk.”

[6] The FHA, one of several results of the June 27, 1934 National Housing Act, was the New Deal’s other, major housing market initiative. Apart from discussing its part in institutionalizing redlining, I pass over it because I share the consensus view of economists, succinctly stated by  Alexander Field (1992,  794), that its “activity in the 1930s had a comparatively modest immediate or direct influence on the housing industry” and that “like so much of the New Deal, its real significance would be experienced after the war”—that is, after the economy had recovered from the Great Depression. According to Grebler, Blank, and Winnock (1956, 148), although it’s likely that FHA insurance “helped to accelerate the expansion of residential building” before the war, it’s also true that much of the construction financed by FHA-insured loans “would probably have occurred without them.”

The post The New Deal and Recovery, Part 28: A New Deal for Housing appeared first on Alt-M.

The New Deal and Recovery, Part 27: Deposit Insurance

Of the many steps taken to combat the depression during the Roosevelt administration’s famous first hundred days, none was more significant than the passage of the June 16, 1933 Banking Act providing for the establishment of the Federal Deposit Insurance Corporation (FDIC).

No step was more significant, and none has been more misunderstood. To delve into that misunderstanding is to realize, among other things, just how hard it can be to answer the question, "how much credit does the New Deal deserve for ending the Great Depression?"

Deposit Insurance Myths

The Banking Act of 1933 was the most sweeping reform of the United States banking system since the passage of the Federal Reserve Act. Also known as the Glass-Steagall Act, after its Democratic co-sponsors Virginia Senator Carter Glass and Alabama Congressman Henry Steagall, it subjected commercial banks to three new sorts of regulation: it prohibited them from underwriting or otherwise dealing in corporate securities; it imposed limits on the interest rates they could pay on deposits; and it established the FDIC, compelling all Federal Reserve member banks to take part in its deposit insurance scheme, and giving non-member state banks the option of doing so, on the condition (which was later modified to apply to large state banks only) that they also become Fed members. While all three reforms had important consequences, either at once or in the long run, deposit insurance had the most obvious bearing on the course of economic recovery, and it’s with that reform alone that this essay is concerned.

Because banks needed time both to qualify for insurance and to contribute to the FDIC’s funding by purchasing shares in it, the FDIC’s opening was scheduled for January 1, 1934, when it would start insuring deposits. Under a temporary plan, all deposits would be insured up to $2500. That plan was supposed to give way to a permanent one, with much higher coverage limits, on July 1, 1934. But in mid-June, Congress decided to put off the permanent plan until July 1, 1935, while raising the temporary plan’s coverage to $5000 for all accounts. The start of the permanent plan was postponed once more, until August 31, 1935, by a Congressional resolution. Finally, just days before that deadline, the 1935 Banking Act put a new permanent plan, preserving the $5000 coverage limit, into effect. In the meantime, the National Housing Act, passed on June 17, 1934, provided for the establishment of a Federal Savings and Loan Insurance Corporation (FSLIC), to guarantee deposits at savings and loans much as the FDIC guaranteed those kept at banks.

So much for the settled facts. The misunderstandings have mainly to do with the novelty of the deposit insurance plan, the purpose it was meant to serve, and the part that the Roosevelt Administration played in its adoption. In 1960, Garter Golembe (1960), a highly regarded bank consultant then working at the FDIC, tried to set the record straight. "Deposit insurance," Golembe wrote, "was not a novel idea; protection of the small depositor, while important, was not its primary purpose; and, finally, it was the only important piece of legislation during the New Deal’s famous ‘one hundred days’ which was neither requested nor supported by the new administration."[1]

Relief or Recovery?

Golembe’s second point justifies treating deposit insurance as having made an important contribution to the process of economic recovery. Instead of merely being aimed at protecting depositors, as many suppose, the more crucial purpose of insurance was, Golembe says, to "restore to the community, as quickly as possible, circulating medium destroyed or made unavailable as a consequence of bank failures" (ibid., 189). Insurance was, in other words, an element of monetary or, if one prefers, macroeconomic, policy, rather than one of mere redistribution, with the correspondingly more ambitious goals of getting people to put their paper money back into the banks, ruling-out further bank runs, and reviving bank lending.

To appreciate the need for some such reform, one need only realize that the banking system that emerged from the national bank holiday was essentially the same one that led to it. Of course many closed banks would never be licensed to reopen; but thousands would be, including many rural banks of the sort that accounted for most of the pre-holiday failures. In the short run,  the Fed’s agreement to cover all cash withdrawals from such banks, together with Reconstruction Finance Corporation (RFC) capital injections, would help bolster confidence in the reopened banks. But those measures were mere stopgaps that could neither rule out future runs nor convince people to redeposit all the paper currency they’d hoarded. If confidence in banks was to be fully restored, and prevented from ever melting away again, something more had to be done.

In defending his insurance plan on May 19th, 1933, Steagall made the macroeconomic case for it clear. The public, he said, was still

afraid to deposit their money in the banks, and the banks are afraid to employ their deposits in the extension of bank credit for the support of trade and commerce. Businessmen and investors are victimized by the same fear. The result is curtailment of business, decline in values, idleness, unemployment, breadlines, national depression, and distress. We must resume the use of bank credit if we are to find our way out of our present difficulties.

In fact, had deposit insurance not served a macroeconomic purpose, Congress would almost certainly have spurned Steagall’s plan, just as it spurned scores of similar plans introduced to it over the course of the previous four decades. And it would have done so for perfectly good reasons.

History Lessons

The FDIC wasn’t the world’s first national-level deposit insurance arrangement—Czechoslovakia beat the United States to that punch by a decade. Nor was it the United States’ first experiment with such insurance. Various state governments tried guaranteeing both banknotes and bank deposits. The first to do so was New York, which established a bank "Safety-Fund" in 1829. The permanent FDIC plan shared many features in common with the Safety Fund, including (ultimately) the latter’s provision exempting the owners of banks that contributed to the fund from double liability—a then-common arrangement that required shareholders of a failed bank to fork up as much as their shares’ par value if that proved necessary to make the bank’s creditors whole.[2]

Begun with high hopes, the Safety Fund ended up a fiasco: by the early 1840s, it was broke, so the government had to lend it the money with which it continued to meet its outstanding commitments. What Howard Bodenhorn  (2002, 157, 182) refers to as a "combustible" mixture of inadequate supervision (including ineffectual or nonexistent portfolio restrictions), "mispriced insurance premia, a limited ability to impose emergency assessments, and fraud" caused the fund to quickly fall victim to "the standard insurance problems of moral hazard and adverse selection."[3]

The Safety Fund’s undoing came too late to stop Vermont and Michigan from setting up similar systems, with similar results. Michigan’s fund, established in 1836, went bust just five years later, having failed to pay a nickel to any of the creditors it was supposed to insure (Golembe 1960, 185). Vermont’s version, set up in 1831, survived longer, but ultimately went awry by letting its members quit whenever they pleased! By 1859, none were left, so it could only cover 72 percent of its obligations, leaving Vermont taxpayers holding the bag for the rest (Golembe and Warburton 1958, 108).

Three other antebellum insurance schemes—in Indiana, Ohio, and Iowa—did much better. But unlike the New York, Vermont, and Michigan arrangements—and also unlike the FDIC’s plan— they depended on the unlimited mutual liability of their members. Mutual liability gave participating banks a powerful incentive to police one another and to close down suspect banks before they became deeply insolvent. All three systems had good records, and all were still solvent when a federal tax on state banknotes, aimed at compelling state banks to join the then-new national banking system, shut them down (Calomiris 1990, 288; Selgin 2000).

Because the tax on state banknotes nearly did away with state banks altogether, for a while it looked as though the United States had seen the last of its experiments with state-sponsored deposit insurance.  But over time, as checks came to be more widely used in payments, non-note-issuing banks became increasingly viable; and it was not long before hundreds were being chartered every year. The outcome of this was the "dual" banking system, consisting of a mix of banks with federal ("national") and state charters, that survives to this day.

Until several decades ago, most United States banks, whether state or national, were "unit" banks, with a single office only, and correspondingly heavy exposure to local shocks. Because state banks tended to be smaller than national banks, they were especially vulnerable. Not surprisingly, such banks failed relatively often, putting pressure on their sponsoring governments to come up with ways to protect their creditors. So it happened that what first looked like state deposit insurance schemes’ last curtain call turned out to be a mere intermission between two acts, with eight new schemes coming on stage between 1917 and 1927.

Alas, these later schemes merely "repeated and compounded the earlier errors of New York, Vermont, and Michigan" (Calomiris 1990, 288), and so ended up faring no better. Thanks mainly to the agricultural bust of the 1920s, by the spring of 1930  every one of them had gone belly-up.

Insurance vs. Branches

Those early twentieth-century deposit insurance schemes were all established in states—Oklahoma, Kansas, Nebraska, Texas, Mississippi, South Dakota, North Dakota, and Washington—where there was strong opposition to branch banking; where laws either prohibited branching altogether or put very strict limits on its growth; and where "business prosperity in general depended on one or two commodities" (White 1983, 191).[4] That was no coincidence. Not letting prospective bank depositors choose between unit and branch banks was one way to keep poorly-diversified unit banks in business. But it still left them exposed to runs once they got into hot water.

That’s where insurance came in. Here again, Carter Golembe (1960, 195) zeros in on the truth. "[I]t is not reading too much into history," Golembe says, to regard deposit insurance  schemes as "attempts to maintain a banking system composed of thousands of independent banks by alleviating one serious shortcoming of such a system: its proneness to bank suspensions, in good times and bad." Henry Steagall, who was second to none in his determination to save the United States’ small unit banks, made no bones about this. "This bill," he said, referring to his May 1933 effort, "will preserve independent dual banking in the United States. … This is what the bill is intended to do" (ibid., 198).

Insurance and branching were, in short, rival reform options; one sought to preserve the unit banking status quo, and particularly state-chartered unit banks, despite their inherent weaknesses; the other would instead have allowed banks to branch statewide, if not nationwide, which would have meant more relatively large and well-diversified banks with branches, and many fewer smaller unit banks. Steagall favored the insurance option, while opposing branch banking tooth-and-nail. Carter Glass, his Senate Banking Committee counterpart, took the opposite position.

Until the Great Depression began, despite scores of attempts on behalf of each, neither federal deposit insurance nor branch banking seemed capable of gaining political traction. But as the Great Depression took its toll, and the number of bank failures mounted, so did the pressure to do something to stop runs, limit bank depositors’ losses, and otherwise overhaul the United States banking system. That pressure, plus some expert logrolling, finally broke the impasse. But it did so only after one of the more determined opponents of deposit insurance blinked.

That determined opponent was none other than Franklin Delano Roosevelt.

Outliving a Cat

"In June 1933," then Council of Economic Advisers chair Christina Romer testified in 2009, "President Roosevelt worked with Congress to establish the Federal Deposit Insurance Corporation." The occasion was a hearing on "Lessons from the Great Depression" being conducted by the Subcommittee on Economic Policy of the Senate Banking Committee.

Of course it’s true that Roosevelt helped establish the FDIC, in so far as it was his signature that turned the Glass-Steagall bill into a law. Yet Romer’s testimony is more than a little misleading: what she doesn’t say is that Roosevelt opposed the Glass-Steagall bill’s deposit insurance provision until the eleventh hour, even threatening to torpedo the whole bill unless it was taken out.

FDRs opposition to deposit insurance was sincere, earnest, and perfectly conventional. In October 1932, while campaigning for the presidency, he responded, privately, to a letter from a supporter urging him to publicly declare his support for federal deposit insurance as doing so would reassure the public while gaining him votes. Roosevelt demurred. Though it might be popular, he said, insurance was also "dangerous," for in time it "would lead to laxity in bank management and carelessness on the part of both banker and depositor," one result of which would be "an impossible drain on the Treasury" (Gates 2017, 310).

Once he was in office, Roosevelt’s opposition to deposit insurance became what one of his biographers calls his "major quarrel" with Congress on banking legislation (Freidel 1973, 441-2). Asked his opinion of deposit insurance during his very first press conference, on March 8th, Roosevelt repeated, off the record, the argument he’d made privately in his letter of the previous October. He added a rather nice numerical example of what he had in mind, and concluded by saying that he opposed "having the United States government liable for the mistakes and errors of individual banks and not [sic] putting a premium on unsound banking." When a reporter pressed further, Roosevelt replied emphatically:

Q: You do have in mind guaranteeing deposits of banks on the new basis?

FDR: No; no government guarantee.

Q: You would have to have that guarantee under the new banking system.

FDR: There would have to be a guarantee? Oh, no. The government isn’t going to guarantee any banks.

In fact, Roosevelt was not being entirely candid, for as we saw in a previous installment, by various provisions of the 1933 Emergency Banking Act the government and the Federal Reserve were in effect planning to guarantee the deposits of reopened banks for a time (Silber 2009). Roosevelt apparently saw no inconsistency between his acceptance of those emergency provisions and his opposition to more explicit and permanent deposit insurance; in any event, the emergency provisions, being stopgaps only, did not end the legislative battle for fundamental reform of the banking system that raged through 99 of the Roosevelt Administrations first 100 days.

By mid-May, however, the tide of that battle was turning decidedly in favor of insurance. A new Steagall bill had made it to the Senate Committee, and Carter Glass, who had already gone so far as to include an optional deposit-insurance plan in his own bill, was persuaded to amend it further, to provide for temporary but mandatory and immediate insurance of all Fed member bank deposits. Arthur Vandenberg, who did that persuading, rose in the Senate to explain why he’d done so. "There is no remote possibility," he said, "of adequate and competent economic recooperation [sic] in the United States in the next twelve months . . . until confidence in normal banking is restored; and in the face of the existing circumstances I am perfectly sure that the insurance of bank deposits immediately is the paramount and fundamental necessity of the moment." Glass accepted Vanderberg’s suggested amendment, on the understanding that Steagall would in turn support his plan for separating investment and commercial banking. The amendment passed handily, allowing Glass’s bill to join Steagall’s in conference.

When Roosevelt learned what had happened, he was anything but pleased. Instead, on June 1st he called both Glass and Steagall to a meeting at the White House, whose other attendees were a motley assortment of Administration critics of deposit insurance (Gates 2017, 316). He also wrote both Glass and Steagall individually, and the conference committee, threatening to veto any compromise that included deposit insurance. But knowing that the whole measure would fail without that provision, they all called the president’s bluff. At last he resigned himself to endorsing the reconciled bill’s insurance provisions, taking comfort in the temporary plan’s limited coverage, and joking with reporters afterwards that the bill had enjoyed "more lives than a cat."

Role Reversal

How is it that Roosevelt so often gets credit for deposit insurance, despite having opposed it so relentlessly? One part of the explanation is that, once he’d signed off on it, Roosevelt himself took credit for it. His doing so merely amused his professional contemporaries; but it has confused later generations who have taken his self-praise at face value. Another is that Roosevelt’s criticisms of deposit insurance were often made either privately or off the record, while his efforts to kill it in Congress all took place behind closed doors. Finally, Roosevelt did sign the Glass-Steagall Act after all, instead of vetoing it as he’d threatened to do, so he at least deserves credit for that. Otherwise—if, say, Congress had instead had to override Roosevelt’s veto—deposit insurance would only qualify as a New Deal measure on strictly chronological grounds.

If the popular view of FDR as a champion of deposit insurance is more fiction than fact, the equally common view that Hoover opposed insurance isn’t much better. It’s true that, for most of his career, Hoover’s views on deposit insurance, and on banking reform more generally, differed little from Roosevelt’s, just as Roosevelt suggested in his March 8th press conference. Instead of favoring insurance, both men preferred Carter Glass’s original reform program. Thus on December 8th, 1931, Hoover (1951, 122) asked Congress to look into "the need for separation between the different kinds of banking; an enlargement of branch banking…; and the methods by which enlarged membership in the Federal Reserve System may be brought on," without mentioning insurance, which he, like Roosevelt and Glass, still considered a bad idea.

But while Roosevelt continued to oppose insurance months after the February-March banking crisis, as that debacle worsened, it caused Hoover to change his mind. On February 28, 1933, he wrote the Federal Reserve Board, asking whether it considered it desirable

1) To establish some form of Federal guarantee of banking deposits; or

2) To establish clearing house systems in the affected areas; or

3) To allow the situation to drift along under the sporadic State and community solutions now in progress (Myers and Newton 1936, 359).

Despite his undeserved reputation as a "do nothing" President, Hoover certainly considered the third option unacceptable, including it only to compel the Board to choose between the others. On March 2nd, with the banking system in free fall, the Board replied that it wasn’t prepared to recommend deposit insurance, given the history of States’ experiments with it, and its "inherent dangers" (ibid., 362). To this Hoover at once replied as follows:

I am familiar with the inherent dangers in any form of federal guarantee of banking deposits, but I am wondering whether or not the situation has reached the time when the Board should give further consideration to this possibility (ibid., 364).

Hoover even included a "rough outline" of an insurance plan, asking the Board for its advice. But the Board replied that it preferred a nationwide bank holiday to any sort of guarantee. Two days later, Hoover handed the reins to FDR; who announced the bank holiday a day later.

FDR’s Last Laugh

If Roosevelt has gotten too much credit for the FDIC’s establishment, he deserves more credit than he’s received for having recognized the dangers it and similar deposit schemes pose, and for having preferred other options for that reason.

That deposit insurance wasn’t the only way to keep a banking system from collapsing was evident enough in 1933 from other countries’ experiences. Hoover (1951, 24), for one, had no trouble recognizing it:

That it was possible, by proper organization and inspection, to have a banking system in which depositors were safe was demonstrated by Britain, Canada, Australia, and South Africa, where no consequential bank failure took place in the depression. Their governments gave no guarantee to depositors. Their economic shocks were as great as ours.

Hoover might also have mentioned Bulgaria, Denmark, Finland, Greece, Lithuania, the Netherlands, Portugal, Spain, and Sweden, none of which had either deposit insurance or a banking crisis during the ’30s. According to Richard Grossman (1994), although the examples of France and Belgium showed that the presence of banks with extensive branch networks was no guarantee against crises, other things equal, banking systems characterized by fewer, larger banks with extensive branch networks tended to be considerably more stable than others.[5]

That uninsured banking systems could be stable explains the fact that, apart from the United States and Czechoslovakia, no other nation chose to guarantee its banks’ deposits until the 1960s; and only a score had done so as late as 1980. Furthermore, those that opted for insurance didn’t necessarily do so because their banking systems had proven unstable without it. Canada, for example, decided to establish its Canadian Deposit Insurance Corporation in 1967 even though no Canadian commercial bank had failed since 1923, and none was then in danger of failing.

Nor does the spread of deposit insurance since the 1960s appear to have occurred in response to policymakers’ perception that their banking systems were at risk of failing without it. Instead,  many nations appear to have jumped on the deposit insurance bandwagon either because (mostly U.S.-trained) economists at the World Bank and the IMF pressured them to do so (Demirgüç-Kunt et al. 2008) or simply because doing so had become fashionable (Demirgüç-Kunt and Detaigiache 2002, 1394).[6]

But what about FDR’s claim that deposit insurance was "dangerous"—that, once insured, "the weak banks would pull down the strong ones" (Freidel 1973, 442), as happened in those states that tried insuring banks before the Great Depression?[7]. It turns out that Roosevelt was wrong—for a while. "Despite initial concerns to the contrary," Eugenie Short and Gerald O’Driscoll (1983, 1) wrote in the early 1980s,

the federal deposit insurance system has worked remarkably well in reducing the number of bank failures and in eliminating depositor loss. The total number of insured bank failures since 1933 has not greatly exceeded the average number of bank failures in any single year during the 1920s… . Moreover, between 1933 and 1982, nearly 99 percent of all deposits in insured banks that failed were recovered by depositors.

But just as Short and O’Driscoll were saying this, serious cracks were forming in the deposit insurance edifice; and soon what once seemed like a banking Arcadia would appear to have been a fool’s paradise. Short and O’Driscoll were themselves well aware of what was happening. The FDIC, they recalled (ibid., 1-2), was part of a package of regulations, the other parts of which—prohibiting banks from underwriting securities and limiting the interest rates they could pay on deposits— served, together with barriers to branching and other constraints on competition, to reduce banks’ incentives and ability to attract insured deposits by taking on greater risks.

However, rising inflation and interest rates, increased international competition, and the rise of money market mutual funds, took an increasing toll on regulated depository institutions during the 1970s, regulators felt compelled to start peeling risk-constraining regulations away while simultaneously boosting insurance coverage. In particular, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 and the Garn-St. Germain Act of 1982 encouraged excessive risk taking by phasing-out deposit rate limits while raising both FDIC and FSLIC insurance coverage from $40,000 per account, where it had been set since 1974, to $100,000 (Keeton 1984; Bundt, Cosimano, Halloran 1992)

This combination of relaxed regulations and increased explicit insurance coverage, coupled with the implicit insurance of banks regarded as "too big to fail," created just the sort of dynamics Roosevelt and other critics of deposit insurance feared, with the sad twist that reforms they had seen as better ways to strengthen the United States banking system, such as allowing banks greater freedom to branch, would now also allow them to compete more aggressively for under-priced, insured funds to invest in risky assets. Soon enough, weak banks, including some very big ones, were toppling, and pulling down, not just stronger ones, but their insurers.

For the FDIC, the reckoning took the form of what one of its publications describes as "an extraordinary upsurge in the number of bank failures" between 1980 and 1994 that put extraordinary strains on its resources, eventually costing it $36.6 billion (FDIC 1997, i, 3). But that was nothing compared to what happened in the $617 billion savings and loan industry. There, after breaking yet another batch of state-run insurance schemes, moral hazard problems put paid to the FSLIC as well, thanks to regulators’ willingness to allow insolvent institutions to keep trying their luck while using accounting gimmicks to boost their reported net worth (Kane 1992). The result was scads of high-risk gambles by S&Ls whose owners had nothing to lose that left the industry even deeper in the red, bankrupting the FSLIC and making it necessary for taxpayers to cover $132.1 billion of failed S&L’s $160.1 billion in insured deposits. Though it wasn’t actually "impossible" for the Treasury to pay that bill, it was certainly proof enough of the danger Roosevelt warned against.

It was, ironically, just as these events were unfolding in the United States that national deposit insurance schemes started to proliferate elsewhere. By the summer of 2018, 107 countries had joined the deposit insurance craze. Most have since struggled with moral hazard problems, with depositors losing their incentive to look out for risky banks, and banks taking greater risks in turn. In dozens of cases, where insurance coverage has been high and supervision lax, instead of enhancing banking-system stability insurance has done just the opposite, "increas[ing] the likelihood of bank crises significantly" (McCoy 2007, 423; see also Demirgüç-Kunt and Detragiache 2000 and Anginer and Demirgüç-Kunt 2018). This, too, must be accounted part of the 1933 Glass-Steagall Act’s legacy.


So, we come back to the question, "How much credit does the New Deal deserve for ending the Great Depression?" and, in particular, "How much credit does FDR deserve for the decision to insure bank deposits?" The answer, I think, is that he deserves much less credit than he’s often given. Much less credit; and absolutely no blame.

Continue Reading The New Deal and Recovery:


[1] To this list we might add a fourth item, noted by Golembe in a subsequent interview, to wit: that the deposit "insurance" provided for by the 1933 Banking Act wasn’t really insurance at all. Unlike genuine insurance policies, it covers depositors for losses regardless of whether the losses were due to recklessness on their or their banks’ part. And unlike genuine insurance funds, the FDIC’s insurance "fund" is an accounting fiction, the truth being that the "premiums" it collects from banks go into the federal government’s general coffers. "The government’s guarantee of deposit," Golembe explains, "was given the name ‘insurance’ because that sounded much less radical than ‘guarantee.’ … [M]any of the bold initiatives of the New Deal were characterized originally as ‘insurance’ in order to make them more acceptable, such as: ‘flood insurance,’ ‘old age insurance’ or ‘crop insurance.’ The problem with calling it ‘deposit insurance’ which it clearly is not, is that some bankers and most academics began to believe it!" For a humorous take on the FDIC’s insurance fund, by one of its former chairs, go here and scroll down a bit.

[2] The 1933 Act did away with double liability for national bank shares issued after its passage, but left it in place for outstanding ones. The 1935 Banking Act allowed any bank to exempt all its shareholders from double liability six months after it publicly announced its intent to do so. Most state bank regulators also did away with double liability during the depression. Jonathan Macey and Geoffrey Miller (1992, 32 and 61) argue, compellingly, that double liability had in fact proven "remarkably effective at protecting bank creditors, including depositors," and "that the nation took a wrong turn" by replacing it with government-administered deposit insurance.

[3] In the deposit insurance context, "moral hazard" refers here to the tendency of depositors to take advantage of having their deposits insured by placing them with relatively risky banks. "Adverse selection" refers to the tendency of riskier banks to be most likely to lobby for, join, and stay enrolled in, deposit insurance schemes.

[4] Although some Mississippi banks had banks head-office city only. Washington provided for branching between 1907 and 1920, when it also prohibited the establishment of further branches.

[5] Significantly, Grossman (1994, 674) also found that "despite anecdotal evidence and the great stress placed on its importance in the literature," the extent of central bank last-resort lending was not an important determinant of banking system stability.

[6] Another contributor to the multiplication of deposit insurance schemes during the 1980s and 1990s was the publication, in June 1983, of Douglas Diamond and Philip Dybvig’s famous article, for which they recently won the Bank of Sweden prize, purporting to offer a rigorous, theoretical case for such insurance. Because it assumes that banks make only safe investments, while depicting bank runs as random events, the Diamond-Dybvig theory implies that any uninsured banking system might fall victim to runs at any time, without allowing for any adverse effects of insurance. It, therefore, makes insurance seem like a no-brainer. Apart from the dubious assumptions that inform it, the Diamond-Dybvig model has many other serious shortcomings, which I review here and here.

[7] Though there’s plenty of anecdotal evidence of moral-hazard problems in all of the state-sponsored insurance arrangements, Kansas’s has been especially well documented for the Kansas case. See Alston, Grove and Wheelock (1994); Wheelock and  Wilson (19942), and Wheelock and  and Wilson (1995).


The post The New Deal and Recovery, Part 27: Deposit Insurance appeared first on Alt-M.

The New Deal and Recovery, Part 26: The RFC, Conclusion

(This is the last installment of a three-part essay. The other parts are here and here.)

A Capital Bank

As its title suggests, the best-known history of the RFC, James Stuart Olson’s (1982) Saving Capitalism: The Reconstruction Finance Corporation and the New Deal, 1933 -1940, is nothing if not a sympathetic review of that agency’s undertakings. Yet according to it, most of those undertakings—or most of them until World War II began—were no more successful than the Reconstruction Finance Committee’s commercial lending venture. The RFC’s support of state relief agencies and public works "did little to stimulate…employment" (ibid., 20); its early agricultural lending projects were failures (ibid., 21; see also 144), as were its efforts to keep the financial system from crashing (ibid., 29) and to raise commodity prices by financing gold purchases (ibid., 110). The Corporation’s loans to railroads "had not improved the railroad bond market" (ibid., 23);  its Mortgage Company, formed in 1935 with $10 billion in capital, was a "cumbersome failure" that "never lived up to its expectations," as were its other attempts to "buttress the real estate mortgage markets" (ibid.; 156; 174; 176). The RFC’s Business Loans Division sputtered out (ibid., 163-4); and the experience of its Export-Import Bank, of which the RFC "was firmly in charge" since 1936, "was no different," its commercial loans having been "hardly enough to affect recovery" (ibid., 153; 164 and 174). The most obvious exception to this otherwise poor record was the corporation’s preferred share purchase program. But as we’ve seen, although that program "set the stage" for recovery by helping to stabilize and repair the nation’s banks and trusts, it was supposed to get banks lending again, and with regard to that objective it, too, was a failure.

Olson recognizes two other success stories among the RFC’s many flops: the Electric Home and Farm Authority (EHFA), which financed consumer appliance purchases, and the Commodity Credit Corporation (CCC), which made no-recourse loans to farmers secured by their crops, which it ended up owning and storing if their value fell below that of the lent sums. But the EHFA, Gregory Field (1990, 55) notes, "was never more than a minor league operation": when Roosevelt shut it down in 1940, it had arranged a grand total of just a quarter of a million sales, worth $36.1 million, or less than 2 percent of all electrical appliance installment sales over the same period (ibid., 57). Olson’s favorable appraisal of it, Field says (ibid., n52), seems to depend in part on his belief that the agency financed 70,000 refrigerator sales in 1934 alone, when the agency’s records actually show that it negotiated only 4,886 refrigerator sale contracts for the entire period from its foundation through June 1935.

As for the CCC, while the $1,885 million in loans it made through the end of June 1941 certainly helped prop up the prices of various farm commodities, they did so only by saddling the CCC with losses equal to almost 10 percent of that sum, and far more crops than it knew what to do with, notwithstanding droughts that spared it a still bigger burden by severely reducing the 1934 and 1936 corn harvests (Shephard 1942, 591-98). Had it not been for WWII, which dramatically increased the demand for all sorts of farm products, the CCC would have ended up costing taxpayers a great deal of money. But even had it suffered no losses at all, the CCC could not be said to have helped end the Great Depression, or even to have helped U.S. farmers taken as a whole (Johnson 1954, 11).[1]

Yet the RFC had one client that benefited immensely from it, and that was glad to take full advantage of its exceptional lending capacity: the federal government itself, and particularly its executive branch. The RFC’s status rendered it "free from the most part from the annual pilgrimages other agencies made to beg for appropriations" (Olson 1982, p. 43). Government officials were quick to recognize the potential advantages of this unusual arrangement, which made it possible for them to secure funding for their various projects without having to pass an appropriations bill. Once they did, appropriations could be dispensed with altogether, for, as a former Federal Reserve official observed some years later, the RFC’s own undertakings "could be enlarged indefinitely, as they were to almost fantastic proportions" (Olson 1982, p. 43).

While the Hoover administration took relatively little advantage of the RFC’s ability to finance "backdoor spending," Roosevelt wasted little time turning the agency into "the capital bank for the New Deal"—a device for financing all sorts of executive undertakings, such as the Treasury’s gold purchases, including the establishment of other alphabet agencies.[2] Under the Leadership of Jesse H. Jones, whom Roosevelt placed in charge of it (and who himself later wrote of Roosevelt’s inclination "to use the RFC as a sort of grab bag or catchall in his spending programs" (Jones 1951, 4), the RFC steered vast amounts of money, directly or indirectly, into every congressional district; and "[o]n any given day there was a line of senators and congressmen waiting outside" Jesse Jones’s office, with the aim of making sure there’s got its share (Olson 1982, p. 49). Little wonder that the Saturday Evening Post described him, on the last day of November 1930, as the second most powerful man in the nation, second only to FDR himself.

And the Post hadn’t seen anything yet.

"Unlimited Power to do Anything"

When, following Germany’s invasion of the Low Countries on May 10th, 1940, Roosevelt responded by promising to equip the nation with "production facilities for everything needed for the Army and Navy for national defense," it was only natural for him to look not just to Congress but to Jesse Jones for some of the billions that effort would ultimately cost. But if the RFC was to contribute any substantial amount toward that effort, its lending capacity would have to be considerably enhanced. Besides having its borrowing capacity greatly increased, it would have to be allowed to take greater risks in extending credit to firms supplying war materiel than it could take otherwise. Despite initial objections by many legislators, including the arch anti-New Dealer (and isolationist) Senator Robert Taft’s (R-OH), to an administration proposal Taft characterized as one that would give the RFC "almost unlimited power to do anything," Congress eventually did just that, allowing the corporation "to take any action deemed necessary" by the President and Federal Loan Administrator "to expedite the defense program" (Cho 1953, 82-87). Asked, at a Senate Banking Committee hearing held toward the end of the war, just what he understood this  language to mean, Jones explained: "We can lend anything that we think we should…any amount, any length of time, any rate of interest, and to any-body."

For the duration of the war, the RFC’s defense-related activities overshadowed all of its other undertakings, to the point, Olson (1982, 217) says, where it  "ceased to be a recovery agency and came to resemble its ancestor, the War Finance Corporation" (ibid., 216). But Olson here understates things considerably, for during WWII the RFC was nothing less than the government’s principal financial agent (Cho 1953, 319). By June 30, 1947, when its authority to do so expired, it had authorized $1.85 billion worth of "national defense" loans to private firms, which was about $300 million more than its ordinary industrial loans. It had lent hundreds of millions to other government agencies for war-related purposes. But its biggest contributions by far consisted of its financing, to the tune of more than $21 billion dollars, eight wartime subsidiaries, including an $8 billion Defense Plant Corporation which, at the war’s end, owned around 11 percent of the United States total industrial capacity (Cho 1953, 109).

All told, the RFC’s defense-related wartime commitments amounted to about $25 billion, with actual disbursements of some $23.5 billion (Cho 1953, 162). During the same period, the RFC handed just $90 million to financial institutions—less than 3 percent of its pre-1935 disbursements to them. In short, if the RFC was promoting recovery during the war, it was doing so fortuitously, as a conduit for military spending.

It’s owing to that RFC role, and in spite of his awareness of the failure of so many of its projects, that James Stuart Olson credits the RFC with "Saving Capitalism." Olson has in mind not the RFC’s activities prior to 1940, when it was ostensibly serving as a New Deal recovery agency, but its contribution to "massive federal spending" afterwards, which he, like most people, credits with ending the depression (Olson 1982, 220). The war thus saw to "the fulfillment of [the RFC’s] 1930’s expectations" (ibid, 224). Perhaps so. But whatever it did for the U.S. economy, the Second World War was not part of the New Deal plan.

A Parade of Scandals

That Congress allowed the RFC to become so powerful was mainly a result of what Hyo Won Cho (1953, 320) calls its "unbounded confidence" in Jesse Jones. But as Cho, a student of the agency’s "evolution," remarks, "a sound government principle cannot be built upon faith in one man, for officials are mortal and fleeting" (Hyo Won Cho, 1953, 320).

After having held the RFC’s purse strings for a dozen years, during the last five of which he served concurrently as Federal Loan Administrator and Secretary of Commerce, Jesse Jones had to let go when Roosevelt offered both of his jobs to Henry Wallace.[3] Although Jones, who detested Wallace, ultimately persuaded Congress to put Wallace in charge of the Commerce Department only, he never worked for the federal government again.

Until Roosevelt’s death, the post of Federal Loan Administrator was filled by Fred Vinson, the future chief justice, after which it went to Jones’s former special assistant, John Snyder. But on June 30th, 1947, Truman signed an amendment that drastically overhauled the RFC. Besides depriving the agency of many of its former powers, now considered redundant, the amendment did away with the position of Federal Loan Administrator, returning control of the RFC to the Board of Directors, which effectively meant allowing it to manage any loan approved by at least any three of its five directors.

The outcome of this lack of overarching supervision was a panoply of postwar RFC loans the sole aim of which seemed to be that of gratifying either its directors’ acquaintances or strangers who bribed their way into their good graces (Cho 1953, 215-69). Although suspicions of RFC favoritism and insider dealing were as old as the agency itself, and those suspicions were far from groundless, its director’s postwar misconduct was far too brazen to stay undercover for long. The big reveal came in the course of hearings held between April 1950 and May 1951 by a special RFC subcommittee of the Senate Banking Committee,  a.k.a. "the Fulbright Committee" after its chair, Arkansas Senator J. William Fulbright.

Those hearings, concerning RFC loans to Texmass Oil, to Lustron Corp. (a manufacturer of prefabricated all-metal homes), to the Kaiser-Frazer automobile company, and to Boston’s Waltham Watch Company, among other doubtful enterprises, make for painful if spellbinding reading. But as this essay is already too long, let’s skip to the committee’s February 5th, 1947 interim report, on "Favoritism and Influence." "[I]n a five-man Board," the report says, "it is possible for the individual members to avoid, obscure, or dilute their responsibilities by passing the buck from one to the other, or to subordinate employees" (United States Congress 1947, 2). And how! The report then proceeds to summarize the frequent, "improper use" of the RFC’s "vast authority" that resulted from outsiders’ influence over its directors, including a

large number of instances in which the Board of Directors has approved the making of loans, over the adverse advice of the Corporation’s most experienced examiners and reviewing officials, notwithstanding the absence of compelling reasons for doing so and the presence of convincing reasons for not doing so (ibid.)

Three months later, Herbert Hoover summed the situation up dryly before the full Senate Banking Committee. "It would appear," he said, "that the test of public interest has been very little applied in recent years" (Cho 1953, 275).

The Fulbright Committee’s revelations only served to turn the volume up on what had already been "a clamor for abolition of the RFC from the Congress as well as from the public" (ibid., 322). The clamorers included none other than Jesse Jones himself, who expressed his opinion to the committee in a letter dated April 10, 1950. "As for the future of the RFC," he wrote, "I think it should be given a decent burial, lock, stock, and barrel." The first, and most compelling, reason Jones offered for taking this position was simply that "none of the conditions which prompted the creation of the RFC exist today" (Cho 1953, 278).

What Jones didn’t say was that most of those conditions had ceased to exist by sometime in mid-1935.

Still, neither the Truman administration nor the Democratically-controlled 82nd Congress chose to bury the RFC, decently or otherwise. On the contrary: they ended up extending its life until 1956. But the grim reaper had other plans: on November 4th, 1952, Eisenhower won by a landslide, and the Democrats lost control of both houses of Congress. The following June, the new government passed the Reconstruction Finance Corporation Liquidation Act, calling for the corporation to be dissolved two years ahead of schedule. Just as it had taken a Republican president to give birth to the RFC, so, too, did it take one to kill it.

Continue Reading The New Deal and Recovery:


[1] That the CCC did not contribute to recovery isn’t very surprising, given that its particular aim, like that of its Hoover-era predecessor, the Federal Farm Board, and of New Deal farm policies generally, was not so much promoting growth in national income as assuring U.S. farmers their "fair share" of it. Hence Henry Wallace’s statement, in his last (1940) annual report as Secretary of the Treasury, that "Even full domestic employment…would not remove the need" for those programs, and the programs’ persistence long after the depression ended. Yet the "fair share" goal itself was rather dubious because the brief pre-WWI period that served as the basis for arriving at it happened to be one during which farmers were more prosperous than ever. On this see Willard D. Arant, Farm Parity Fallacy. New York: National Economy League, 1941.

[2] A story Jones tells in his autobiography (1951, 456-64), illustrates, amusingly, the sort of flexibility of which the RFC was capable, and just how willing FDR was to make use of it. One day in 1942, Roosevelt sent Jones a memo asking him to look into the possibility of having the government buy the Empire State Building, or the "Empty State Building," as it had come to be referred to, since it was mostly unoccupied for most of the 1930s. Those vacancies cost the building’s owner and principal occupant, former New York governor and Democratic presidential candidate, Al Smith, a lot of money. At the price Smith and his associates wanted for it, the skyscraper was no bargain; but Roosevelt wanted to "do something for Al Smith," who helped get Roosevelt’s own brilliant political career started. But why had he approached Jones? "If the President wanted the government to buy the world’s tallest skyscraper for government use," Jones explains, "he should have asked the Public Buildings Administration to buy it; but then he knew that the Congress would not authorize the money, so he turned to me." Jones, being Jones, demurred.

[3] As Cho (1953, 168) explains, although Jones had to resign his position as RFC chairman upon being made Federal Loan Administrator in 1940, because his authority in the new post "transcended that of [the RFC’s] Board of Directors, he continued to dictate the RFC’s policies and supervise its activities.

The post The New Deal and Recovery, Part 26: The RFC, Conclusion appeared first on Alt-M.

The New Deal and Recovery, Part 25: The RFC, Continued

(This is the second installment of a three-part essay. The first part is here.)

Big Engines that Couldn’t

Although Hoover’s Reconstruction Finance Corporation (RFC) was "more largely a banker’s loan bank than anything else" (Ebersole 1933, 477), financial institutions were never the only firms eligible for its support. Railroads were an important exception from the start, though they were so mainly because financial institutions, commercial banks, and insurance companies especially, were railroads’ main investors. Thanks to New York and other state regulatory authorities’ inclusion of many railroad bonds among permissible investments for the banks and insurance companies they regulated, by 1932 those bonds made up 16 and 23 percent, respectively, of bank and insurance company assets (Mason and Schiffman 2002, 3).

Until 1929, railroad bonds had a good reputation: some lines had paid dividends without fail for generations. Hence their bonds’ AAA ratings. But the depression hit railroads hard. Between 1929 and 1933, their operating revenues were cut in half, while their fixed charges, including the interest they owed on their debts, stayed roughly the same. Even railroads that had been paying dividends continuously for generations were forced to stop doing so, causing their bonds to be downgraded. The RFC’s loans to railroads were supposed to help the financial industry by preventing railroads from defaulting on their debts, while sometimes helping the railroads pay for repairs and new constructions and otherwise keep their workers employed.

By the end of 1932, when financial institutions held 45 percent of the RFC’s outstanding loans, railroads were next in line with 21 percent (Ebersole 1933, 477). Unlike the RFC’s loans to banks, its loans to railroads were publicized from the start, because the Interstate Commerce Commission also had to sign off on them, and its policy was to report every loan it approved. Because it was mainly "Class I" railroads, with annual operating revenues of over $1 million, whose securities were on state regulators’ approved lists, most RFC railroad support went to them, with $280 million of a total of $350 million going to just 15 large lines. Over the course of its entire life, the RFC authorized 248 loans, totaling more than $1 billion, to 89 different railroads.

Whether they went to big railroads or smaller ones, the RFC’s railroad loans were generally earmarked for paying those railroads’ other creditors, with just a fifth being designated for upkeep and new construction. The fact that large investment houses were among the railroad creditors whose loans the RFC helped repay gave it still more bad publicity. One of its very first railroad loans, for example, helped the Missouri Pacific to repay a $5.75 million loan to J.P. Morgan and Company. The fact that the Missouri Pacific went bankrupt just over a year later didn’t make the loan it got smell any better.

Yet apart from the Morgan connection, the Missouri Pacific case was to prove typical: during the Hoover years, two-thirds of the fifteen Class 1 railroads that received most of the RFC’s help ended up either going under or surviving only after having the courts intervene to adjust their debts (Olson 1982, 23; 97). Between Hoover’s departure and 1939, when the railroad lending program was wound-up after having lent a grand total of $802 million, twenty-five more Class 1 railroads that it helped suffered the same fate (Schiffman 2003, 806). The table below, reproduced from Mason (2000), shows the fates of a score of the RFC’s major railroad loan recipients. Evidently, however much it may have helped their creditors, the RFC’s largess alone wasn’t generally enough to save the railroads themselves.

The simple truth was that railroads’ woes weren’t just cyclical. Their losses also reflected the growing importance of newer forms of transportation. In October 1932, a group of major universities and insurance companies, all of which were saddled with lots of railroad debt, established a National Transportation Committee, with ex-president Calvin Coolidge as its head, to look into the railroad situation. In its February 1933 report, The American Transportation Problem, the committee concluded that, instead of just being victims of the depression, the railroads were facing "stiff, permanent competition from the [sic] airlines, automobiles, and trucks," from which nothing short of "massive consolidation" could rescue them (Olson 1982, pp. 99-100).

So more credit was no real solution. But that’s not all. A recent, careful study (Daglish and Moore 2018) finds that the first announcement of a railroad’s first RFC loan tended to raise the spread between the yield on its bonds and that of Treasury securities by about 55 basis points, presumably because the loan was regarded by the public as a sign that its recipient was in trouble, and that in the long run, RFC assistance tended to lower railroads’ bond prices even more. So, instead of helping financial institutions with substantial railroad investments stay solvent, RFC support for railroads may have done just the opposite.

Nor does that support appear to have done the railroads themselves much good. On the contrary: most experts believe that RFC loans actually harmed them, by allowing them to delay both their bankruptcy and the reorganization of which many were in desperate need (Olson 98-99; Spero 1939). Because avoiding bankruptcy meant having to continue paying all their creditors, despite fallen revenues, roads that chose that option also tended to skimp on repairs and maintenance (Ebersole 1933, 486-7). For brief downturns, the strategy made sense. During the Great Depression, it became a recipe for railroad suicide. And because RFC loans allowed railroads that got them to stave off bankruptcy longer, they tended to make them that much less viable once they filed for it.

Bankruptcy itself did not, on the other hand, force railroads to shut down: instead of being liquidated, railroads were usually kept running by their receivers while shareholders made plans for their reorganization. Those plans typically emphasized rehabilitating the railroad’s neglected rights of way and equipment (Spero 1939; Mason and Schiffman 2002, 7). Jesse Jones put it pithily: "A bankrupt railroad cannot cut bait," he says (1951, 107); "It has to keep on fishing." And because they’re relieved of the obligation to pay the fixed charges on their securities, bankrupt railroads "are often able to keep their properties in better shape than those which remain out of receivership" (ibid., 108). For this very reason, one ought to take Jones’s claim that RFC railroad loans "created tens of thousands of jobs" (ibid., 106) with a pinch of salt: according to Jones’s own understanding, those loans seem more likely to have reduced overall railroad employment.

And that, according to several relatively recent studies, is just what the loans did. Surveying the whole 1929-1940 period, Daniel Schiffman (2003) finds that, once they went bankrupt, large railroads (which received 96.7 percent of the RFC’s railroad credits) tended to devote considerably more resources to maintaining their equipment and rights of way, and to keeping their workers employed, than they did while avoiding it by taking RFC loans. This was especially so, Schiffman says, during the crucial years 1930 through 1933. "[H]ad all large firms been bankrupt over that period," Schiffman says (ibid., 820), "the additional maintenance spending would have boosted GDP by an average of 0.199 percent a year, and employment would have increased by an average of 0.125 percent per year."  He adds that his findings leave out multiplier effects. The lesson, Schiffman (ibid., 822) concludes, is "that governments should allow distressed firms to go bankrupt, instead of providing bailouts that merely postpone the inevitable.[1]

Minding the Gap

The RFC’s support for railroads was just the first inkling of what was to be a steady expansion of its involvement in lending to non-financial enterprises. During the Hoover administration, the Emergency Relief and Construction Act extended its remit to include lending to state and local governments for relief and public works and to various agricultural credit agencies. But that was nothing compared to the extent of the RFC’s reach under Jesse H. Jones’s leadership during the Roosevelt years. "The ‘new’ RFC," Olson (1982, p. 43) observes, "would provide liquidity and capital to as broad business base as possible… . Slowly, almost imperceptibly as it poured billions of dollars into the economy, the RFC evolved into a major New Deal agency" which "[b]y the mid-1930s…was making loans to banks, savings banks, building and loan associations, credit unions, railroads, industrial banks, farmers, commercial businesses, federal land banks, production credit associations, farm cooperatives, mortgage loan companies, insurance companies, school districts, joint-stock land banks, federal intermediate credit banks, and livestock credit corporations."

In this evolutionary process, no step was more controversial than the RFC’s decision to start lending to all sorts of ordinary businesses. Despite its other efforts, and officials’ attempts to cajole bankers into lending more, by late 1933 the volume of bank lending, and of commercial lending in particular, had hardly budged up from its level when the RFC was established. New Dealers feared that, by denying businesses the working capital they needed, bankers’ excessive caution threatened to undermine the efforts of their flagship recovery agency, the National Recovery Administration (Olson 1982, 137).

In response to such concerns, in September 1933 the RFC first offered to supply short-term funds to banks, mortgage loan companies, and other private lenders for up to six months at just 3 percent interest on the condition that they re-lend them to business firms for 5 percent or less. But the program was practically stillborn (Olson, pp. 139-40): by December the RFC had only lent $2 million under it. The bankers’ explained that, with prevailing money rates generally well below 5 percent—a fact they attributed to the limited demand for credit—the allowed spread just wasn’t big enough to cover their risks and still leave them with a profit. Some months before the RFC’s new initiative began, one of them had tried to warn the Senate Finance Committee that the government was erring by putting the credit-expansion cart before the purchasing power revival horse. "The administration," he said, is "misinterpreting the real problem with the economy. … Banks were accumulating excess reserves…because there was so little consumer purchasing power in the economy. …Even hundreds of millions in RFC and Federal Reserve credit would not address the problem" (Olson p. 159).

But government officials weren’t buying it. Roosevelt even accused bankers of "hoping by remaining sullen to compel foreign exchange stabilization" (Olson, p. 138). Two 1934 studies offered grist for their mill. In the first, a survey of over 6000 firms nationwide conducted that July by the Bureau of the Census, 45 percent reported having trouble getting, with small firms having the most. The second, conducted by economists Charles O. Hardy and Jacob Viner, reviewed 1,788 loan refusals, and concluded that 374 good prospects were among them (Klemme 1939, 368-9). Such studies appeared to reveal a "credit gap," that is, "a genuine unsatisfied demand for credit on the part of solvent borrowers" (ibid., 369). If the bankers wouldn’t fill it, even using cheap RFC credit, why not have the RFC itself do so? So, on June 19th, 1934, Congress gave the RFC permission to go into the commercial lending business.[2]

Alas, the performance of the RFC’s new Business Loan Division mainly served to prove that the bankers had been telling the truth all alone. Because Jessie Jones was determined to keep the RFC from lending to firms bankers themselves had good reasons to avoid, the RFC stuck to its own strict credit standards. Besides having to sport the Blue Eagle, firms to which it lent had to be financially solvent, and had to post adequate security. They were also supposed to show that they’d tried and failed to secure private-sector credit (Olson 1982, 163). Individual RFC loans were also limited to $500,000 and (more importantly) to 5 years maturity. Finally, the loans were made at prevailing market rates. When, some years later, the American Bankers Association sent out a survey asking businessmen whether the RFC’s credit standards were "appreciably less rigid than those of commercial banks," 93 percent of those that responded said that they were either just as rigid, or even more rigid" (Kimmel 1939, 120). In short, whatever their other merits, the RFC’s commercial lending practices seemed tailor-made for testing whether the bankers were telling the truth about not overlooking good borrowers.

And the bankers passed that test with ease.  By September the RFC had received fewer than 1200 business loan applications, and had approved only 100 of them, for a grand total of $8 million in loans. Two months later,  an influential study commissioned by Henry Morgenthau and undertaken by C.O. Hardly and Jacob Viner, concluded—in case it wasn’t already obvious—that because the RFC’s lending policies hardly differed from those of most commercial banks, its business loan program had been "totally ineffective" (ibid., 168).

Not to be daunted, the RFC tried relaxing its lending conditions, particularly by gaining permission, at the end of June 1935, to lend for up to ten years and beyond its original $500,000 limit. But the changes made little difference. After climbing to 412 during the last quarter of 1934, the number of loans authorized by the Business Lending Division fell off rapidly so that, by the end of 1936, it had lent only $80 million to ordinary businesses, compared to $2 billion it lent to banks, and the $600 million it lent to railroads. During the 1938 downturn, it lowered its lending standards still further; yet by the close of that year it had still authorized only $384 million in loans to some 6,000 businesses,  of which it disbursed only $157 million (Klemme, 370). "Even with liberalized regulations and more statutory authority," James Stuart Olson (1982, 172) concludes, "the RFC’s business loan program never got off the ground":

For more than three years [Olson writes], Jesse Jones had criticized and cajoled bankers, telling them to increase the volume of commercial and working capital loans or the country would stay mired in the depression indefinitely. But when the RFC started making those loans, Jones found himself agreeing with them: the number of applications was low and the credit worthiness of prospective borrowers left much to be desired (ibid., 177).

That the RFC’s Business Loan Division succeeded in making many loans at all was due to its eventual willingness to take risks no ordinary bank would have taken: most of its borrowers "were at, or under, the margin of creditworthiness when judged by the ordinary standards of commercial banks" (Saulnier, Halcro, and Jacoby 1958, 253-57). No wonder that, by February 1939, the division had racked up some $28 million in bad loans, meaning loans that had foreclosed, or were in the process of doing so, or ones that were in default (Klemme 1939, 373-74)—a loss rate well beyond what any commercial banker would have considered acceptable. It was, Jones admitted in his Seven Year Report to the President (1939, 10), "a substantially larger percentage of losses" than any of the RFC’s other divisions had incurred. And it was not helping the U.S. economy to recover.

Continue Reading The New Deal and Recovery:


[1] During the Roosevelt administration efforts were made, mostly on the urging of the ICC, to get the RFC to stop lending to doomed railroads. A June 16, 1933 amendment prohibited it from lending to railroads that clearly needed to be reorganized, while another, adopted in 1935, sought to limit its lending to railroads that "could demonstrate…their ability to survive a reasonably prolonged period of depression" (Mason 2000, 15-16). But because the RFC convinced the ICC to make exceptions to these rules, several railroads that received RFC support when they were nominally in effect still went bankrupt (ibid., 17).

[2] The so-called Industrial Advances Act also granted the Federal Reserve banks new powers to make direct loans to businesses by inserting a new section, 13b, into the Federal Reserve Act. These new powers were in addition to the 13(3) lending powers granted to the Fed in 1932, of which it made very little use during the depression. The Fed’s new industrial lending program was, if anything, even less successful than the RFC’s. Assessing it early in 1936, James C. Dolley (1936, 272) concluded that, because "[t]here was no widespread effective demand for industrial working capital credit which was not being accommodated by the commercial banks in 1934, and probably ever since the banking panic in March 1933," it mainly succeeded in saddling the reserve banks with many bad loans. Selgin (2020) compares that failed Federal Reserve effort with the Fed’s attempt to lend directly to ordinary businesses during the COVID-19 crisis.

The post The New Deal and Recovery, Part 25: The RFC, Continued appeared first on Alt-M.

The New Deal and Recovery, Part 24: The RFC

(In writing this series, I allowed myself to skip over some topics. But now that I’m turning the series into a book, to be published by the University of Chicago Press, I have to close those gaps. The most important gap by far concerns the Reconstruction Finance Corporation. Although the RFC was originally established by Herbert Hoover, the Roosevelt administration not only allowed it to survive but turned it into the largest and most powerful of all New Deal agencies. Hence a three-part essay, of which this is the first installment.)

Hoover’s New Deal

There are few more successful examples in history of the propaganda technique known as the "big lie" than the charge that Herbert Hoover was a "do nothing" president. In fact, Hoover was being perfectly truthful when, in the course of the ’32 campaign, he said. "We might have done nothing. … Instead, we met the situation with … the most gigantic programs of economic defense and counterattack ever evolved in the history of the Republic." So, for that matter, was his opponent, who accused the Hoover administration "of being the greatest spending administration in all our history" (Lyons 1948, 287). On public works alone, the Hoover administration spent more than the previous nine administrations combined, notwithstanding that their undertakings included the Panama Canal (ibid., 269). No previous administration, David Kennedy (1999, p. 48) observes, ever "moved so purposefully and so creatively in the face of an economic downturn."

The centerpiece of the "Hoover New Deal"—the Reconstruction Finance Corporation (RFC)—went on to play an even more important role in the Roosevelt version. Under the leadership of Texas entrepreneur Jesse H. Jones, it became nothing less than "America’s largest corporation and the world’s biggest and most varied banking organization" (Jones 1951, 3).[1]

But did it help the U.S. economy recover from the Great Depression?

A Shadow Fed

Although Hoover ultimately supported it, credit for the RFC’s establishment is mostly due to Eugene Meyer, a staunch Republican whom Hoover made governor of the Federal Reserve Board in 1930. Between 1918 and 1925 Meyer served as managing director of the War Finance Corporation  (WFC), the original goals of which were making cheap credit available to firms producing war materials and propping up the price of Liberty Bonds. After the war, Meyer kept the WFC alive by converting it into an agricultural credit agency. But Meyer stepped down in 1925, and the WFC quit extending credit of any sort, though it didn’t officially close until it finished collecting on its debts 14 years later.

As bank failures mounted after 1930, Meyer, in his new post as head of the Federal Reserve Board, pushed hard both for a relaxation of the Fed’s own credit eligibility requirements and for the WFC’s revival. But Hoover favored a private and voluntary alternative, so Meyer instead tried to get bankers to cooperate toward that end. Thanks to Great Britain’s suspension of the gold standard on September 18, 1931, which led to large-scale withdrawals of gold from the United States banking system, and that many more bank failures, he finally succeeded.

The result, announced by Hoover in the wee hours of October 7th, was the National Credit Corporation (NCC), a half-billion-dollar private credit pool to be established and run by bankers and insurance executives. Because the NCC was prepared to rediscount bank assets the Fed wouldn’t accept, and could do so for financial institutions that weren’t Fed members, Hoover and the bankers hoped that the Fed and NCC between them could keep all the nation’s banks liquid enough to avoid suspending en masse. But Meyer himself was far from sanguine; and it was owing to his importuning, rather than to any enthusiasm for the idea on Hoover’s part, that Hoover agreed to declare, in announcing the NCC, that "if necessity requires, I will recommend the creation of a finance corporation similar in character and purpose to the War Finance Corporation, with available funds sufficient for any legitimate call in support of credit.[2]

Nor did it take long for the NCC’s inadequacy to show itself: it took a month just to open for business, and still longer to start making loans. By December it had lent only $10 million.[3] By then Meyer had a bill ready calling for a revived WFC, to be known as the "Reconstruction Finance Corporation." Congress pushed the legislation through as quickly as it could, allowing for the holiday recess; and Hoover made a law of it on January 22, 1933. The new executive agency thus established began with a capital stock of $500 million subscribed by the Treasury, and was authorized to borrow three times that amount. Serving as its head was Chicago banker and former Vice President Charles G. Dawes.

Thrown for a Loop

As long as Dawes was in charge of it, the RFC’s lending was limited to financial institutions and railroads; and its precise remit, according to Hoover’s remarks upon signing it, was narrower still. "It is not created for the aid of big industries and big banks," Hoover said. "Such institutions are amply able to take care of themselves. It is created for the support of smaller banks and financial institutions, through rendering their resources liquid, to give renewed support to business and agriculture."

Yet just which banks the RFC had been helping during its first five months remained shrouded in mystery, for its quarterly reports only revealed the aggregate sums lent to various broad categories of borrowers, with nothing about particular loan recipients. In other words, as journalist John T. Flynn (1933) later complained, "it passed round hundreds of millions of dollars of public money to banks and railroads without affording either to the public, or even to Congress itself, a grain of information about the identity of the objects of its bounty."

A change came following Chicago’s banking crisis. In early June 1932, Dawes abruptly resigned; days later, as he boarded a train to Chicago, he explained that he was heading there to take charge of the Central Republic Bank, of which he was still nominal chairman. Just over a week after he arrived, as the Democratic National Convention was about to convene in the Windy City, Dawes coolly informed a group including Chicago’s leading bankers and RFC board member Jesse Jones, that the Central Republic, which was one of several Loop banks that had been hemorrhaging money for weeks, wouldn’t open the next morning. Fearing a general collapse, Jones quickly arranged, with Hoover’s approval, to have the RFC lend it $90 million—by far its biggest loan yet—to allow it and the other Loop banks to open the next morning.

When word of the so-called "Dawes Loan" got out, accusations of favoritism went flying.[4] Congress’s response became part of the Emergency Relief and Construction act signed by Hoover on July 17th, 1932. On the plus side, this amendment to the RFC Act increased the RFC’s borrowing authority to $3.3 billion dollars, for use in supporting state and local relief agencies,  public works programs, and various agricultural credit agencies, among other things. But the amendment also placed new limits on the RFC’s lending. It forbade loans to financial institutions whose officers or board members included anyone who sat on the RFC’s board, or had done so within a year prior to the date on which a loan was granted; and it called for the corporation to submit monthly reports on its activities, including borrowers’ names, to the Senate and House, or, if Congress wasn’t in session, to the Senate Secretary and House Clerk.

Bigger Isn’t Better

Although the publicity clause wasn’t made retroactive, Congress eventually asked the RFC to supply it with details concerning the loans it had made during its first five months, which it did on January 25th, 1933. It was then possible for Congress and the general public to see just how well the RFC had lived up to President Hoover’s claim that it wasn’t there to help big banks.

What they discovered was that, during the RFC’s first five months, the Central Republic was far from being the only big bank to receive its help. Although the corporation’s officers and champions, including Hoover himself, had technically been telling the truth when they repeatedly pointed out that "most of its loans" went to small banks, the claim obscured the fact that most of the RFC’s money went to relatively large ones. For example, after the corporation had been in business for five weeks, the White House declared that it had lent $61 million, most of which went to 255 "mostly small country banks." What it didn’t say was that more than two-thirds of that amount went to just three banks, all located in fair-sized cities. During the whole of the RFC’s first five months, before its loan recipients’ names were routinely furnished to Congress, more than 40 percent of the $642 million of loans it had authorized went to banks in just seven good-size cities, with banks in Chicago and San Francisco alone receiving $136 million (Flynn 1933). Furthermore, many of the RFC’s loans to smaller banks were aimed at indirectly helping larger ones to which the smaller banks owed money.

Actually, there were good reasons for this record. The pattern of RFC lending to large banks was roughly consistent with the distribution of U.S. banks by size, and with the fact that, other things equal, bigger banks tended to lose more deposits than small ones. And, despite Hoover, some big banks, like Central Republic, were quite unable to "take care of themselves." Finally, the failure of a big bank was more likely to cause other banks to fail. In fact, contemporary complaints notwithstanding, economic historians have not found much evidence that politics shaped the pattern of the RFC’s loans to banks (Mason 2003).

Even so, once it had to submit detailed monthly reports, the RFC quit making very large loans to very big banks. Indeed, it made fewer loans to banks of all sorts. Jesse Jones (1951, 83), who sat on the RFC’s board at this time, and later became its most famous chairman, believed that the publicity "prevented many bankers from applying for help that was sorely needed," owing either to pride or to fear of having their banks stigmatized.  Whatever the reason, it didn’t make the RFC’s job any easier.

Lent to Death

Of course the Hoover RFC didn’t keep the U.S. financial system safe from "unexpected shocks"; neither did it otherwise stop the U.S. economy’s downward spiral. "Perhaps it is too much," Harvard’s Franklin Ebersole (1933, 484) observed, in reviewing its one-year record, "to expect the Corporation should have effected a cure for the crisis and depression. But the label ‘Reconstruction’ offered more than hope and mere salvage." Unfortunately, although Hoover’s RFC authorized $951,000,000 in loans to open banks and trust companies, and another $200,000,000 to closed banks’ receivers, for distribution to their depositors, these amounts simply weren’t enough to either keep open banks liquid or pay off deposits at closed ones in full.

But did they at least help?  "To criticize the Corporation for not keeping banks open or stimulating business recovery," Ebersole (ibid., 486) says, "assumes a large objective—the maximum achievement." But perhaps, he allows, it was only supposed to tide banks, railroads, state relief agencies, and farmers over until other steps could be taken. Alas, he concludes, "even for such a limited objective, it must be said…that [Hoover’s RFC] was a gamble that failed." Charles Calomiris and his coauthors (2013, 528) go still further: they find, not merely the RFC’s loans were generally unhelpful, but that they seem to have made banks that took advantage of them worse off. Besides disqualifying many banks, the RFC’s strict collateral requirements also stripped those that secured loans from it of their best collateral. The fact that the Corporation had priority over banks’ other creditors gave better-informed depositors a reason to steer clear of banks that borrowed from it, and this in turn gave bankers a reason to think twice before asking for the RFC’s help. According to Joseph Mason (2001, 90), this problem was especially important before July 1932, when (owing largely to Eugene Meyer’s influence) the RFC’s collateral requirements were especially strict.

The verdicts of some other economists aren’t quite so severe. Ernest Klemme (1939, 366) and Berylt Sprinkel (1952, 218) maintain that the RFC’s loans reduced bank suspensions and bolstered depositor confidence until the Michigan banking crisis proved the last straw. James Butkiewicz (1995) finds that the RFC’s loans helped before it was compelled to publicize them, cutting bank suspensions "almost in half," but that they made little difference afterward. Joseph Mason (2001, 89), on the other hand, finds "a positive significant relation  between loan publicity and bank survival." One explanation for such apparently contradictory findings is that the most vulnerable banks were also the ones that chose not to seek the RFC’s help once they could no longer have it confidentially.

Standing back from all of this research, the picture one takes in shows an RFC hampered in its efforts to keep the banking system liquid, but not always for the same reason. The corporation’s strict collateral requirements limited its success through July 1932, while banks’ fear of adverse publicity did so afterward. The result, either way, was that the RFC’s bank lending program failed to deliver the goods.

6000 Bailouts

Five days after FDR took office, with all of the nation’s banks closed and economic activity practically at a standstill, no one doubted that, considered as a recovery device, the RFC had been a flop. "Despite unprecedented efforts on behalf of the private economy," James Stuart Olson (1982, p. 17) writes, "the RFC had not revived commercial credit, business investment, production, or employment." The Roosevelt administration "was not even sure the RFC was really strengthening the banking system."

So far as the nation’s banks were concerned, the fundamental problem, which became all too evident in the course of the national bank holiday, was no longer a lack of liquidity. They needed capital, and plenty of it: on mark-to-market terms, the U.S. banking system as a whole was broke (Kimmel 1939, 9).  And the RFC was about to start giving it to them, by not just lending to them but buying their preferred stock shares, notes, and debentures. Although the RFC would still lend to banks after its share purchase program began, its loans would no longer have to keep struggling banks alive as their primary aim. Instead, they would mostly be used to assist in the liquidation of banks that died.[5]

Although the share purchase program was the first major New Deal addition to the RFC’s powers, several Fed officials had first proposed it in the wake of the Chicago banking crisis. Although Hoover resisted the idea at first, in late January 1933, having at last been won over, he asked for legislation to be drawn up. But like most Hoover administration ideas for dealing with the then unfolding banking crisis, this one could get nowhere without Democratic support, which Hoover couldn’t secure. So a modified version of the plan ended up becoming the Title II Emergency Banking Act (Olson, 38-39).

Two sorts of banks and trusts benefited from the RFC’s "capital correction plan." First, of the 4215 banks that couldn’t be licensed to reopen immediately after the holiday, 3100 were considered salvageable with the help of RFC-supplied capital. The RFC would also inject capital into several thousand others which, though they’d been licensed to reopen, lacked enough capital to qualify for FDIC insurance when that became available. Regulators were determined to see most if not all banks enrolled in the new insurance scheme once it was running, whether they were legally required to or not, and the FDIC helped them accomplish that goal by agreeing to insure still under-capitalized banks provided the RFC promised to recapitalize them within six months of its doing so.

Despite these ultimately impressive numbers, as the figure below (reproduced from Mason 2000) shows, the RFC’s share purchase program got off to a slow start. The same stigma problem that had limited bank’s willingness to borrow from the RFC once its loans were routinely publicized now made them hesitate to sell their shares to it. So, for that matter, did their fear that the RFC would end up interfering with their management—as it eventually did, in some instances. During its first months, the RFC only received offers from a few dozen banks and trusts. But as 1934, and banks’ need to qualify for insurance, approached, the trickle became a torrent. When the government’s temporary deposit insurance program went into effect on January 1, 1934, 90 percent of the nation’s commercial banks and 36 percent of its savings banks were able to take part in it; by March the RFC had purchased stock from more than half of the nation’s banks (ibid., 23). But it still had to inject more capital into many to help them meet the FDIC’s stricter capital requirements when those kicked in the following July.

Not surprisingly, the RFC’s share purchase program proved more capable of keeping banks alive than its bank lending program had been (Calomiris et al., 543); and the program deserves to be considered a crucial part of the government’s solution to the banking crisis. It also rescued untold numbers of bank depositors who might otherwise have lost their savings, or endured long delays in recovering them.

But important as the RFC’s contributions to financial stability and relief were, they fell short of achieving its ultimate objective, which was the revival of bank lending (Olson 1982, 128; Mason 2000, 24). Disappointed, and observing how bankers were sitting on substantial excess reserves, RFC officials and others blamed them for not living up to their end of the bargain, and determined that, if they wouldn’t do their part, the government would do it for them.

(To be continued.)

Continue Reading The New Deal and Recovery:


[1] Attempts to correct the record regarding Hoover’s willingness to resort to government intervention in response to the depression have been made by both his champions and his critics.  See Patrick O’Brien and Philip Rosen (1966, in two parts) for an excellent survey. Although, in one of his own otherwise excellent contributions to that literature, Steven Horwitz (2011) attributes the phrase "Hoover New Deal" to Murray Rothbard, Rothbard himself (1972, 128n21) points out how Chase National Bank economist Benjamin Anderson first used it back in the day.

[2] The fons et origo of the myth that the RFC was Hoover’s idea appears to be Jesse Jones’s 1951 memoir (1951, 14). Despite their opposite party affiliations, Meyer and Jones were friends until 1942, when The Washington Post, which Meyer had owned since 1933, published an editorial harshly critical of Jones’s handling of the RFC’s synthetic rubber program. When the two men ran into each other that evening at the entrance to the Willard Hotel ballroom, where the Alfalfa Club was holding its annual dinner, the confrontation ended in fisticuffs. Meyer, the younger of the two,  was 66. Asked about the fight the next day, Roosevelt remarked, off the record, that he hoped "there wouldn’t be a second round" (Tuttle 1981, 35-6).

[3] In fairness to Hoover, and to the bankers behind it, the NCC’s failure was not solely its own fault. Instead, its efforts were frustrated by the Federal Reserve’s refusal to loosen its own credit eligibility requirements, as the NCC’s organizers had hoped it would do so in its dealings with it.

[4] Other large RFC loans also raised eyebrows because prominent Republicans were among their recipients’ directors. They included loans for more than $26 million that the RFC made to two Cleveland banks whose directors happened to include Charles Dawes’s successor, Atlee Pomerene, and Joseph Nutt, the treasurer of the Republican National Committee. Although it may have been a coincidence, the fact is that Republicans commanded the boards of almost every big bank that the RFC helped during the Hoover years. (Flynn 1933).

[5] The importance of the RFC’s loans to defunct banks shouldn’t be underestimated. These may, indeed, ultimately have accomplished more than its loans to open banks. As Lester Chandler (1970, 149) explains, besides allowing depositors at failed banks to be paid relatively quickly, they allowed those banks’ liquidators to avoid having to sell their assets in a hurry, which would have meant realizing less on them as well as harming other institutions holding the same assets by depressing their prices. Between March 1933 and October 1937, the RFC authorized more than $875 of such loans. The Fed’s 13b lending program was, if anything, even less successful than the RFC’s version.

The post The New Deal and Recovery, Part 24: The RFC appeared first on Alt-M.