Banking Acts of 1932

Roy Chapin, Henry Robinson, Eugene Meyer, Ogden Mills, George Harrison and Owen Young (Photo: Associated Press)

Some members of the Federal Reserve Board, the leaders of the Federal Reserve Banks of Atlanta and New York, a majority in Congress, and much of the American public wanted the Federal Reserve to respond more vigorously to the deepening downturn. Many wanted the Federal Reserve to extend additional credit to member banks, expand the monetary base, and provide liquidity to all financial markets, acting as a nationwide lender of last resort. Others – including some members of the Federal Reserve Board and leaders of several Federal Reserve banks, prominent business and financial executives, academic economists, and policymakers such as Sen. Carter Glass – resisted these proposals, because they believed these policies would prolong the contraction or generate inflation, leading to even larger future booms and busts (Chandler 1971; Meltzer 2003).

The Reconstruction Finance Corporation Act was one solution to this problem. The act established a new government-sponsored financial institution to lend to member banks on types of collateral not eligible for loans from the Federal Reserve and to lend directly to banks and other financial institutions without access to Federal Reserve credit facilities. “Almost from the time he became Governor of the Federal Reserve Board in September 1930, Eugene Meyer had urged President Hoover to establish” a Reconstruction Finance Corporation (RFC) modeled on the “War Finance Corporation, which Meyer had headed during World War 1” (Chandler 1971, 180). Meyer told the New York Times that the RFC “would be a strong influence in restoring confidence throughout the nation and in helping banks to resume their normal functions by relieving them of frozen assets (New York Times 1932).”

The RFC was a quasi-public corporation, staffed by professionals recruited outside of the civil service system but owned by the federal government, which appointed the corporation’s executive officers and board of directors. The RFC’s initial capital came from $500 million in stock sold to the US Treasury. The RFC raised an additional $1.5 billion by selling bonds to the Treasury, which the Treasury in turn sold to the public. In the years that followed, the RFC borrowed an additional $51.3 billion from the Treasury and $3.1 billion directly from the public. All of these obligations were guaranteed by the federal government.

The RFC was authorized to extend loans to all financial institutions in the United States and to accept as collateral any asset the RFC’s leaders deemed acceptable. The RFC’s mandate emphasized loaning funds to solvent but illiquid institutions whose assets appeared to have sufficient long-term value to pay all creditors but in the short run could not be sold at a price high enough to repay current obligations. The RFC also loaned funds to the receivers of banks in liquidation enabling receivers to repay depositors as soon as possible; Federal Land Banks, which financed farm mortgages; and Federal Intermediate Credit Banks, which financed crops in production; insurance companies; and railroads.

On July 21, 1932, an amendment authorized the RFC to loan funds to state and municipal governments. The loans could finance infrastructure projects, such as the construction of dams and bridges, whose construction costs would be repaid by user fees and tolls. The loans could also fund relief for the unemployed, as long as repayment was guaranteed by tax receipts.

In December 1931, the Hoover administration submitted the Reconstruction Finance Corporation Act to Congress. Congress expedited the legislation. Support for the act was broad and bipartisan. The president and Federal Reserve Board urged approval. So did leaders of the banking and business communities. The bill passed quickly and with few amendments, in part because it was based on the War Finance Corporation of World War 1, which policymakers believed to have been a big success.

During the years 1932 and 1933, the Reconstruction Finance Corporation served, in effect, as the discount lending arm of the Federal Reserve Board. The governor of the Federal Reserve Board, Eugene Meyer, lobbied for the creation of the RFC, helped to recruit its initial staff, contributed to the design of its structure and policies, supervised its operation, and served as the chairman of its board. The RFC occupied office space in the same building as the Federal Reserve Board. In 1933, after Eugene Meyer resigned from both institutions and the Roosevelt administration appointed different men to lead the RFC and the Fed, the organizations diverged, with the RFC remaining within the executive branch and the Federal Reserve gradually regaining its policy independence.

In retrospect, scholars see the Reconstruction Finance Corporation as a limited success. While estimates vary, statistical analysis shows that RFC loans led, on average, to better outcomes for banks and firms (Butkiewicz 1995; Mason 2001; Mason 2003), but not all of the banks and firms that received RFC support survived the Depression.

Like the RFC, the Banking Act of 1932 reformed the Federal Reserve’s role providing credit during economic downturns.²  The act included two principal provisions. One, the Reserve banks received authority to lend to member banks on assets not otherwise eligible for discount, with the approval of five members of the Federal Reserve Board and at an interest rate at least one-half of 1 percent higher than the highest regular discount rate in effect at that Reserve bank. Two, the Reserve banks received authority to use government securities as collateral for Federal Reserve notes in addition to gold and commercial paper, which were the types of collateral authorized by the Federal Reserve Act. Both provisions expired after one year, although subsequent legislation extended these temporary provisions, which eventually became permanent.

The impetus for the act came from the governors of the Federal Reserve Board (Eugene Meyer) and the Federal Reserve Bank of New York (George Harrison).³  In January 1932 the pair became convinced that the Federal Reserve Act should be amended to enable the Federal Reserve to lend to members on a wider range of assets and to increase the supply of money in circulation. The supply of money was limited by laws that required the Federal Reserve to back money in circulation with gold held in its vaults. Gold supplies had fallen since the summer of 1931. Governors and directors of several reserve banks worried about their free-gold positions and stated this concern several times in the latter part of 1931 and early 1932 (Chandler 1971, 186).

Meyer and Harrison met with bankers in New York and Chicago to discuss these issues and gain their support. Then, the pair approached the Hoover administration and Congress. Sen. Carter Glass initially opposed the legislation, because it conflicted with his commercial loan theory of money creation, but after discussions with the president, secretary of treasury, and others, eventually agreed to co-sponsor the act. About these discussions, Herbert Hoover wrote,

A funny thing about this act is that though its purpose was to avoid imminent disaster, the economy being by now in a state of collapse, the objection was raised that it would be inflationary. This was as if a doctor with a dying patient on his hands should refrain from giving him proper treatment for fear if he got well he might do something foolish. Senator Glass had this fear and was zealous to prune back the “inflationary” possibilities of the measure (Hoover 1952, 117).

Within a few days of the passage of the act, the Federal Reserve unleashed an expansionary program that was, at that time, of unprecedented scale and scope. The Federal Reserve System bought nearly $25 million in government securities each week in March and nearly $100 million each week in April. By June, the System had purchased over $1 billion in government securities. These purchases offset huge flows of gold to Europe and hoarding of currency by the public, so that in summer of 1932 deflation ceased. Prices of commodities and securities had begun to return to pre-depression levels. Industrial production had begun to recover. The economy appeared headed in the right direction (Chandler 1971; Friedman and Schwartz 1963; Meltzer 2003).

In the summer of 1932, however, the Federal Reserve discontinued its expansionary policies and ceased purchasing substantial quantities of government securities. “It seems likely that had the purchases continued, the collapse of the monetary system during the winter of 1933 might have been avoided” (Meltzer 2003, 372-3).