US Reconstruction Finance Corporation: Preferred Stock Purchase Program

The RFC’s size and scope grew as the Depression went on. Initially it was primarily used as a collateralized lending vehicle to provide liquidity to national and state banks, trusts, and insurance companies in the early months of the Depression, in effect acting as a lender of last resort (Final Report of the RFC 1959). However, these loans were generally very short term, strictly collateralized, and given at penalty rates. In particular, encumbering their higher quality assets as collateral for borrowings may have impaired the banks’ ability to access other sources of funding.  For these reasons, these loans could not address the growing insolvency of the nation’s banks. Banks that received such assistance often became more indebted and in effect subordinated their depositors, resulting in an even greater risk of a run (Calomiris et al. 2013).

As a result, Title III of the Emergency Banking Act (EBA), which was passed on March 9, 1933, enabled the RFC to directly invest in, or subscribe to, the preferred equity of state and national financial institutions (P.L. 73-1).

Title II of the EBA, also called the Bank Conservation Act, authorized the Comptroller of the Currency to appoint a conservator if a bank was struggling. The conservator essentially had the same powers that a receiver of an insolvent bank would have, including liquidation authority (P.L. 73-1).

Title IV of the EBA amended Section 10(b) of the Federal Reserve Act to allow the Fed, under “exceptional and exigent circumstances,” to lend at a penalty rate of at least 1 percent above the “established rate” to member banks that were unable to find credit elsewhere (P.L. 73-1). It also significantly broadened the Reserve Banks’ lending authority, allowing them to lend to any “individual, partnership or corporation” if “secured by direct obligations of the United States.” This language remains in Section 13(13) of the Federal Reserve Act.

Section 304 of the Emergency Banking Act, passed on March 9, 1933, stated that any national bank, state bank, or trust company could “request the Reconstruction Finance Corporation to subscribe for preferred stock in such association, state bank, or trust company, or to make loans secured by such stock as collateral”. Section 304 also permitted the RFC to sell any or all of the preferred stock obtained via these methods in the open market (P.L. 73-1).

On March 24, 1933, an amendment to Section 304 was passed, allowing the RFC to directly purchase capital notes and debentures of state banks that could not issue preferred stock that was exempt from double liability (P.L. 73-4). In June 1933 and January 1935, the RFC’s authority to purchase preferred stock was extended to both insurance companies and national mortgage associations (P.L. 73-35; P.L. 74-2).

Sections 14 and 15 of the Reconstruction Finance Corporation Act laid out the reporting obligations for the RFC. Section 14, which set a 10-year sunset date for the Corporation, also mandated that a final report be submitted to Congress before the dissolution of the Corporation. Section 15 required the Corporation to make mandatory quarterly reports to Congress that contained: 1) the aggregate loans made to each class of borrower, 2) the balance sheet of the corporation, and 3)  the names and exact compensation of any employees of the RFC making more than $400 a month (P.L. 72-2). 

On March 6, President Roosevelt issued Proclamation 2039, which declared a four-day bank holiday so that the US government could better address the collapsing financial system (Proclamation 2039). While several states had already declared their own bank holidays, Proclamation 2039 “turned a maze of state restrictions into a uniform national policy” (Silber 2009). The American people largely seemed to respond to the closings “with good nature,” and “many thought it a great joke that they were unable to get into the banks for the purpose of making deposits” (FRB Boston 1996).

On March 9, a special session of Congress convened to draft emergency legislation in the wake of the crisis (Jabaily 2013). What emerged was the Emergency Banking Act, and with it, the RFC’s preferred stock purchase program. Roosevelt did not immediately reopen the banks following the Emergency Banking Act and instead extended the holiday for three additional days until March 13 (Silber 2009). President Roosevelt and Chairman Jesse Jones were also active in emphasizing the importance of rescuing “sound” banks while still soliciting as many applicants for the RFC as possible.

In his inaugural address on March 4, 1933, FDR expressed the need for “a strict supervision of all banking and credits and investments; there must be an end to speculation with other people’s money, and there must be provision for an adequate but sound currency” (Roosevelt 1933b).

Additionally, FDR asked Congress for, if circumstances demanded it, “the one remaining instrument to meet the crisis—broad executive power to wage a war against the emergency, as great as the power that would be given to me if we were in fact invaded by a foreign foe” (Roosevelt 1933b). This was a broad, immediate declaration that the government would do whatever it took to resolve the banking crisis.

On Sunday, March 12, Roosevelt delivered the first of many “Fireside Chats,” in which he addressed the American people directly about the bank runs that had been plaguing the country. Roosevelt explained that only sound banks would be allowed to re-open, and that a bank’s location, as well as its status as a member (or non-member) of the Federal Reserve System, would determine when it would open. Banks that were in the 12 cities where there were Federal Reserve Banks would open that Monday, followed by banks that were located in cities that had recognized clearinghouses on Tuesday, and all other banks on Wednesday and succeeding days. President Roosevelt reiterated the point, however, that “a bank that opens on one of the subsequent days is in exactly the same status as the bank that opens [Monday]”. To stoke confidence, Roosevelt said, “I can assure you that it is safer to keep your money in a reopened bank than under the mattress” (Roosevelt 1933a).

Title IV of the EBA, which broadened the lending authority of Federal Reserve Banks and allowed them to issue emergency currency not backed by gold, was another important component to the government’s response. At the time, some bankers interpreted the Emergency Banking Act as a moral guarantee by the government on the deposits in the banks that it permitted to reopen after deciding them to be sound. Bankers believed that, since Roosevelt communicated that re-opened banks would be “100 percent sound and assured of sufficient currency to meet all obligations,” they would be safe (Silber 2009). As such, Title IV, in conjunction with the Fireside Chat and banking holiday, was seen as an implicit deposit guarantee for banks that would re-open (P.L. 73-1; Silber 2009).

When much of the banking system re-opened on March 13, depositors all across the country waited outside of banks to return their money. More than half of the deposits taken out in the bank run had been redeposited within two weeks of the end of the bank holiday. Stock exchanges, which had been voluntarily closed along with the banks, re-opened to the “largest one-day percentage increase ever,” with the Dow Jones Industrial Average rising by 15.34 percent. These efforts by the new president illustrated the importance of concise communication in a crisis and helped end the bank runs that marked the early part of the Depression (Silber 2009).

Even after the Emergency Banking Act, the banking holiday, and the reassurance of FDR’s Fireside Chat in March 1933, the RFC was still having trouble soliciting applicants for its capital assistance programs (Jones 1951). Jones made two nationwide radio addresses on August 1 and November 1, 1933 (Jones 1933). In the first, he was stern with bankers, telling them to quit stockpiling excess reserves and reverse the outflow of credit that was occurring at this time (Olson 1988).

After the first radio address, Jones gave a speech at the American Bankers Association convention on September 5 where he “advised the bankers to ‘be smart, for once’,” which did not play well among the members. Jones spoke again that night, addressing the negative reception his first speech garnered and saying that, “more than half the banks represented at the gathering in front of me were insolvent, and no one knew it as well as the men in our banqueting room. I then sat down” (Jones 1951). FDR briefly discussed eligibility for deposit insurance, which was scheduled to go into effect at the beginning of 1934, in a national radio address in October 1933, stating that “…on or before [January 1, 1934] the banking capital structure will be built up by the government to the point that the banks will be in sound condition when the insurance goes into effect” (Roosevelt 1933c). This, in conjunction with Section 12B(i) of the Glass-Steagall Act, which specified that insolvent institutions would not be eligible for deposit insurance, illustrated the importance of receiving RFC aid sooner rather than later (P.L. 73-66).

With the establishment of Glass-Steagall, contentious speeches by Jones, FDR’s radio address, as well as Jones’ successful push to involve the larger banks in New York and Wall Street (see Key Design Decision No. 9 for more details), the RFC saw a dramatic increase in applications for its preferred stock program. The organization processed as many as 100 applications a day until the end of 1933 (Final Report of the RFC 1959). By the end of 1933, the RFC had disbursed about $264 million in preferred stock aid, compared to $63 million at the end of the third quarter.

Originally, a governor of the Federal Reserve Board and the Farm Loan Commissioner were also members of the RFC’s board of directors (P.L. 72-2); Federal Reserve Board Chair Eugene Meyer was the first chairman. This was done in part because of the “urgent requirements of the moment,” and because the RFC would need “great help from the Federal Reserve System,” according to Meyer. After six months, Meyer felt that the RFC had developed enough for him to request to be removed (Meyer 1954). This was done via the Emergency Relief and Construction Act on July 21, 1932, which replaced Meyer and the Farm Loan Commissioner with two more political appointees (P.L. 72-302). Of the six other members of the RFC’s board, no more than four could be of the same political party, and only one member per Federal Reserve district was permitted. Each board member had a two-year term and earned $10,000 a year for their service (P.L. 72-2).

Both the Federal Reserve and Treasury played significant roles in the operation of the RFC. The Reserve Banks were “authorized to act as depositories, custodians, and fiscal agents for the Corporation”. Proceeds from loans were generally disbursed through the Reserve Banks and their branches. Additionally, these banks held the primary obligations of borrowers, and any collateral pledged to the RFC for loans (Circular No. 4).

The RFC kept all of its funds on deposit at Treasury, and the Secretary of the Treasury had to request any subscriptions to, loans secured by, or outright purchases of preferred stock issued by banks, trust companies, or insurance companies. After the request was made, the president could approve or disapprove the aid (Circular No. 4).

Early on, the RFC approved two separate loans totaling about $90 million for the Central Republic Bank of Chicago, headed by former U.S. Vice President Charles Dawes, who had briefly served as RFC Chairman. This rescue was quite controversial, as many believed that Dawes used his political clout to get the assistance. This rescue led Congress to pass the Emergency Relief and Construction Act of 1932, which required the RFC to publish the name of any RFC beneficiaries in its monthly reports to Congress (Mason 2003; P.L. 72-302).

The decision to publicize the names of borrowers generated considerable controversy both in Congress and in “almost every community where there was a bank”. Senator Henry Steagall and Speaker of the House John Garner, specifically, were consistent proponents of publicizing the names of applicants even retroactively, while critics voiced that publication had, and would continue to, “[crush] the life out of numerous institutions”. A bill was passed that retroactively published the names of borrowers despite Congressional opposition (Jones 1951).  

However, the RFC was set up in such a way that made it more insulated from political probing and manipulation. First, any loans (and other investments) had to be “fully and adequately secured” (P.L. 72-2). However, the collateral requirements were not specified, and only RFC staff were allowed to evaluate institutions. Last, while the RFC was initially funded by a $500 million dollar appropriation, any additional funding came by way of issuing government-guaranteed bonds, which would usually be sold to Treasury (Mason 2001b). This design allowed the RFC to exercise more flexibility and independence without fear of having to return to Congress for additional funds.

The RFC had around 30 field offices across the US and one in Puerto Rico that were given a large amount of autonomy over which institutions would receive aid (Circular No. 4; Mason 2001b). Similar to the private sector, the RFC would “…pick a man to be completely responsible for the operations of an office and let him succeed or fail on the basis of whether or not his office showed a profit” (Mason 2003). These loan managers could approve direct business loans of up to $100,000. Anything greater than this amount, required the manager to defer to the central office in Washington to make the decision. By decentralizing control and profit-constraining its local offices, the RFC largely prevented “inefficient credit or capital allocation that may have arisen from ineptitude or local political influence (Mason 2001b).”

At a minimum, there would be at least one RFC office in every Federal Reserve district. If aid decisions made by the more local offices had an adverse effect on overall RFC earnings, however, they were held accountable to the central office (Mason 2003).

The RFC was allowed to subscribe to preferred stock, make loans secured by preferred stock, and directly purchase capital notes and debts. Although there was an overall cap on how much the RFC could borrow to finance its operations, this did not affect how much it could borrow to finance its preferred stock assistance (Circular  No. 4). (See Key Design Decision No. 9 for more details.)

While the Corporation had no direct limit on how large its bank assistance programs could be, the RFC originally could not have more than three times its capital stock outstanding in any obligations, including notes, bonds, debentures, or any other obligation (P.L. 72-2). However, this amount would be increased to 6.6 times its capital stock after the Emergency Relief and Construction Act was passed (P.L. 72-302). With a capital stock of $500 million subscribed to from the Treasury, this meant that the maximum amount the RFC could lever itself started at $1.5 billion and ended at $3.3 billion (P.L. 72-2).

While the $500 million was a sizable amount for the time, most of the RFC’s operations were financed through borrowings (Final Report of the RFC 1959). Initially, the RFC was “authorized and empowered, with the approval of the Secretary of the Treasury, to have outstanding at any one time in an amount aggregating not more than three times its subscribed capital, its notes, debentures, bonds, or other such obligations” (P.L. 72-2). This amount would later be increased with the passing of the Emergency Relief and Construction Act of 1932 to 6.6 times its subscribed capital, representing an increase from $1.5 billion outstanding to $3.3 billion outstanding in borrowing authority (P.L. 72-302).

Throughout its lifespan, the RFC borrowed a total of approximately $54.4 billion, with about $51.3 billion and $3.1 billion of these issued to the Treasury and the public, respectively. Banks and other institutions that the RFC had invested in bought the public securities. These were typically for terms of one to three years and carried interest rates that ranged from 0.875 to 3 percent (Final Report of the RFC 1959). Borrowings from Treasury were a bit more varied. The maturities ranged from demand (overnight) to three and a half years, with interest rates fluctuating from 0.125 to 3.5 percent.

Much of the work done to determine which institutions were likely to receive RFC assistance came over the bank holiday that FDR announced on March 4, 1933. During the initial evaluation of the banking system, all national banks were classified as Class A, B, or C banks. Class A banks were considered sound and were reopened immediately after the bank holiday ended. Class B banks were undercapitalized but still had enough franchise value and were reopened “as quickly as they could be got into shape”. Class C banks were insolvent, and there was already a clear loss to depositors. These banks were placed into conservatorship so that they could be either rehabilitated or liquidated, depending on the severity of their impairment (Jones 1951).

Subsequent to the EBA, the RFC sent teams of examiners to determine if applicants were sound enough to lend to (Olson 1988). Despite FDR’s assertion in his first Fireside Chat that only sound banks would reopen, “it developed that probably no fewer than 5,000 of these banks [required] considerable added capital to make them sound” (Jones 1951) This caused the RFC to establish a standard in which they would provide assistance to an institution only if the “sound value” of its assets was greater than or equal to its liabilities (Circular No. 6).  In Jesse Jones’ recounting of the program, he specified that these banks required only a 90 percent ratio of sound asset value to liabilities (Jones 1951). In other words, corporations whose assets equaled 90 percent of their liabilities, according to Jones, were eligible for RFC assistance. While it could be argued that these valuations, in many cases, were quite generous, Jones stated that, “I told [President Roosevelt] we should try to interest people in the various communities in reestablishing the banks by putting some of their own money in the stock” (Jones 1951).

Banks that did not measure up to these requirements were placed in conservatorship, which Jones called the “hospital,” and by mid-December of 1933, there were more than 2,000 banks in this condition. In an attempt to reduce this number, Jones went to the Senate Banking and Currency Committee to ask them if they could help him in reducing the threshold of assets to liabilities to 75 percent. However, Jones’ efforts were unsuccessful (Jones 1951).

Though application was voluntary, the RFC heavily encouraged some of the largest banks to get involved, even if they only took modest amounts of capital. Jones encouraged these larger banks to take capital “to take the curse off the many weaker banks which did need new capital” (Jones 1951).

Ultimately, two-thirds of the banks that applied and received RFC assistance were state banks, while the rest were national banks (Jones 1951).

Institutions in New York and on Wall Street were also reluctant to join the program. Jones believed that, “if the big banks of New York would cooperate with our program by selling us preferred stock or capital notes, the banks in the country would follow”. Later in 1933, after a $25 million capital injection to the Manufacturer’s Trust Company on October 28, as well as candid meetings with Jones and Roosevelt, both New York State and Wall Street banks began to apply in droves. National City Bank and Chase National each obtained $50 million in preferred stock and reduced the amount of common equity in their capital structures (Jones 1951).^FNNational City Bank reduced the total value of its shares of common stock from $124 million to $77.5 million while issuing $50 million in new preferred equity to the RFC. Chase National similarly reduced its common stock value from $148 million to $100 million. 

An Act passed on June 10, 1933 allowed insurance companies to request that the RFC subscribe to or make a loan secured by preferred stock that was exempt from double liability to shareholders. Just as in the case with financial institutions, insurance companies that couldn’t issue preferred stock could issue capital notes to the RFC for purchase for the same effect. This authority had a limit of $50 million outstanding (P.L. 73-35).

Similarly to banks and trusts, insurance companies would receive aid “on the basis of the sound net worth of the company,” which was calculated by obtaining the market value for all assets, which were usually mortgages and securities, that had a market value. Where market value couldn’t be obtained, the sound value of the assets would be used (Circular No. 8).

According to page 3 of the Circular No. 8, when applying for aid, insurance companies had to submit:

1. A copy of the charter under which the preferred stock subscription was to be issued.
2. A copy of the statutes that gives the applicant the authority to issue preferred stock or capital notes if they were not able to issue preferred stock.
3. A copy of resolutions adopted, or proposed to be adopted, by the board of the insurance company that authorized the sale of preferred stock or capital notes.
4.  A copy of the applicant’s latest examination report.
5. Copies of the applicant’s convention reports as filed with the superintendents of insurance of the various States for the last preceding five full years, and a complete copy of the annual financial statement on the regulation convention forms as of the most recent date available, but in no event more than four months prior to the date of application.^FNApplicants were required to use market values of securities in these convention reports, although the supporting documents that applicants were to submit (such as balance sheets and annual financial statements) would not use these.
6. Statements of the applicant’s cash receipts and disbursements for the last five full years, as well as the period of time between the application date and the date that the company filed the above mentioned convention reports.
7. If not fully reflected in the convention reports, supporting schedules [showing] in detail all assets pledged to secure borrowed money, together with schedules of assets deposited with the various state departments of insurance.
8. A complete statement of any reorganization plan that the applicant plans on putting into operation. The applicant was also required to provide a statement of approval of the plan by their respective state insurance supervisory authority, as well as any additional conditions that said authority attached to the plan, and,
9. A complete statement of the sources where other funds are planning to be raised. This includes the names of the subscribers to any class of capital stock or purchasers of capital notes, as well as those offering preferred stock as collateral for RFC loans.

Insurance companies were subject to even more stringent requirements than banks and trusts. The RFC would not purchase, subscribe to, or issue a loan secured by preferred stock, if either any “officer, director, or employee” of the insurance company made $17,500 or more a year. Additionally, the applicant had to pledge not to increase compensation for any employee nor retire any stock, notes, or obligations while the RFC had capital in it. Insurance companies also had to submit a list consisting of the names and amount of equity held by any shareholders who owned 10 percent or more of their capital stock to the RFC.  Unlike banks and trusts, who had to show that their earning capacity was sufficient enough to support annual dividend payments of up to 6 percent, insurers were required to demonstrate only ability to pay up to 5 percent dividends for the first five years (Circular No. 6; Circular No. 8). However, after this point, this threshold was bumped up to 6 percent (Circular No. 8).

The Reconstruction Finance Act was amended on January 31, 1935, “to assist in the reestablishment of a normal mortgage market”. This amendment added Section 5c to the RFC Act, which authorized the RFC to subscribe to or make loans upon non-assessable stock of any class of any mortgage loan company or national mortgage association, or other real-estate lender, up to a maximum amount of $100 million outstanding at any one time (P.L. 74-2). The RFC’s original enabling Act in 1932 authorized the RFC to make loans to these organizations, but not to inject capital (P.L. 72-2).

The RFC used this authority to create two subsidiaries that dealt in real estate mortgages. They were the RFC Mortgage Company and the Federal National Mortgage Association, later known as Fannie Mae. The capital stock of each company was subscribed to by the RFC. The former was eventually re-integrated back into the RFC, while Fannie Mae is still around to this day. The RFC ultimately subscribed about $46 million in the capital stock of the two mortgage lenders and disbursed more than $1.7 billion in loans. This funding was used to purchase hundreds of thousands of mortgages, including those insured by the Veterans Administration and the Federal Housing Authority (Final Report of the RFC 1959).

Applicants could be banks that were either currently operating or closed but contemplating reorganization. Even newer banks and thrifts were allowed to apply (Circular No. 6). The process required institutions to submit the following:

1. A copy of the charter under which the preferred stock subscription was to be issued
2. If the applicant is not a national bank, copies of the statutes that allow the applicant to issue preferred stock
3. A copy of a resolution adopted or proposed to be adopted by the board of directors of the applicant authorizing the sale of such stock
4. A copy of the latest report of examination of the applicant
5. A statement by the applicant on their condition at the close of business on the day the application was forwarded
6. Schedules in adequate detail showing assets pledged to secure borrowed money, public funds, or other liabilities (Circular No. 6).

If the applicant was requesting a loan secured by preferred stock, there were additional requirements. Applicants had to include statements of:

1. The proposed terms of the loan
2. The applicant’s financial condition
3. Any additional collateral offered for the loan in addition to the preferred stock (Circular No. 6).

Even though there was a clear application process and obvious need for assistance across the financial sector, many banks did not immediately apply to the RFC. In fact, prior to the advent of the FDIC at the beginning of 1934, many banks conserved their liquidity in case a run occurred. “A few [banks] even solicited deposits with the boast that they were 75 percent liquid. One bank, which had amassed an uncommonly large surplus, bragged of being 110 percent liquid”. Many of these banks, despite already having excessive amounts of liquidity, continued to hoard more by calling in loans and thus forcing liquidation from their borrowers, often destroying their net worth (Jones 1951).

No further detail has been found for limits on individual participation amounts.

The initial Emergency Banking Act allowed national banks to issue cumulative, non-assessable preferred stock, as well as allowing such stock to secure loans made by the RFC (P.L. 73-1). On March 24, 1933, an amendment to the EBA was passed, clarifying that, for state banks and trust companies, the RFC could subscribe only to preferred stock that was non-assessable (P.L. 73-4).^FNAssessable stock was a type of equity whereupon a company would sell stock at a discount to investors with a guarantee that these investors would later participate in a secondary offering. The amount that the company could ask of these shareholders was generally equal to the difference between the face value and the original (discounted) purchase price. However, the RFC could still make loans secured by assessable preferred stock (Circular No. 6). Unlike the federal regulations that governed national banks, some state regulations prevented state banks and trust companies from issuing non-assessable preferred stock (Kroszner 1994). For these banks and trusts, the amendment also authorized the RFC to purchase capital notes of debentures in place of preferred stock to give them relief (P.L. 73-4).

RFC preferred stock was also senior to other types of equity, with dividends being paid out annually and usually at less than 1 percent below market rates, but greater than those on short-term business loans (Mason 2001b; Calomiris et al. 2005). While the original Emergency Banking Act stipulated that applicants needed to be able to pay out dividends of up to 6 percent, dividends were quickly started at 5 percent and were subsequently reduced to 4 and then 3.5 percent (Mason 2001b). Banks wanted the RFC to lower them to 3 percent, but the Corporation was having difficulty getting banks to pay them on time and had to more firmly demand prompt repayment from applicants, who were often delaying repayment anywhere from 10 to 60 days. Only institutions that repaid on time were given the lower rate (Jones 1951).

Interest rates on loans secured by preferred stock of trust companies, which were heavily involved in the mortgage market, were set at 4 percent until March 31, 1939, at which point they would increase to 5 percent. In the case of preferred stock subscriptions or direct purchases of capital notes and debentures, the dividends (or interest rates) would be set at 4 percent through January 31, 1935, before falling to 3.5 percent through January 31, 1940, and subsequently returning to 4 percent after that date (Circular No. 18).

Despite a massive infusion of RFC capital, bank lending was still lacking by 1936 (Circular No. 18). Banks often retired RFC capital without replacing it with private capital. As a result, a bank’s overall capital would fall when it retired its RFC capital. To counter this trend, the RFC decided to “accept interest-bearing US government bonds at par and [accrue] interest from banks in retirement of their RFC capital whenever the retirement would take place.” This would allow banks to earmark liquid Treasuries against RFC capital and thus obtain even cheaper funding. Essentially, this arrangement worked similarly to a modern-day repurchase agreement. Using the cash received by the RFC from its preferred stock investment, the bank would buy Treasuries and sell them to the RFC – effectively extending a secured loan to the bank. The rate on this “repo” loan would be set at the Treasury rate, and the bank would repay the loan when it retired the RFC capital, thereby decreasing its overall funding costs.

The RFC required there to be “a reasonable margin of protection for the preferred stock to be taken by the Corporation, represented by common stock, or by a class of preferred stock subordinated to that to be taken over by the Corporation, or otherwise” (Circular No. 6).

The RFC anticipated involvement in cases where capital was:

1.  Partially impaired.
2.  Entirely eliminated by losses.
3.  Entirely eliminated and have caused deposits to become impaired (Circular No. 6).

For the first case, the RFC analyzed the remaining capital structure to see if its investment would be sufficiently protected. For the second, protection for the RFC investment was to be provided by either: (1) the purchase by stockholders, depositors, or others of additional common or subordinated preferred stock, or (2) voluntary subordination or reduction by creditors or depositors of their claims against the applicant. For banks that had impaired deposits and no capital, claims against the bank would be reduced on a pro rata basis until the total of deposits and other liabilities equaled the value of the assets. These banks would then solicit additional common and/or subordinated preferred stock in the same way that institutions did in the second category (Circular No. 6).

There were further stipulations that applicants had to meet to receive RFC aid. As stated in Circular No. 6, the Corporation specified that preferred stock issued to it was to be protected by:

1. Substantial voting rights in all matters concerning the issuing institutions.
2.  Limitations on common stock dividends.^FNFor trust companies, there was no maximum on common stock dividends set (Circular No. 18).
3. Compulsory regular application of a substantial part of net profits of the issuing institution to the retirement of preferred stock.
4. Understandings from time to time between the bank and this Corporation with respect to general policies.
5.  An agreement to furnish the Corporation from time to time such reports of the bank’s operations and policies as the Corporation may require.

In addition to the above requirements, any institution requesting aid had to show that “its earning capacity [would] be sufficient at least to enable it to pay dividends on the preferred stock at the rate of [6 percent] per annum” (Circular No. 6). 

For the preferred stock program specifically, the RFC never defined an exit strategy, though many institutions repaid the government investment rapidly. In particular, most of the institutions in New York, where the most powerful banks were located, repaid their preferred stock by July 1934, less than a year after they had received it. However, Jesse Jones did specify that “we [at the RFC] held to the conviction that, given a stable banking system in which public confidence had been restored, the banks would earn the money to pay for and retire their preferred stock within 20 years without, meantime, depriving their common stockholders of dividends”. Participating banks ultimately repaid their preferred stock issued to RFC at a much faster rate. All but 392 of the more than 6,000 participating banks retired their RFC capital by 1951 (Jones 1951).

The authority from Section 304 of the Emergency Banking Act that allowed the RFC to directly invest in financial institutions was repealed through an act passed on June 30, 1947. However, the previous authorities that allowed the RFC to make loans to financial institutions were extended on that same date (P.L. 80-132). Despite this continued ability, the RFC did not issue any new loans to any banks or trusts because the power was seen as an emergency one only (Final Report of the RFC 1959).

As for the RFC itself, Section 4 of the Reconstruction Finance Corporation Act specified that “the corporation shall have a succession period of 10 years from the date of the enactment hereof, unless it is sooner dissolved by an Act of Congress” (P.L. 72-2). The initial 10-year horizon would be revised and extended as the RFC’s powers grew with new developments in the Depression and the advent of World War II.^FNSection 6 of an Act passed on June 25, 1940, extended the succession date to January 22, 1947. An Act passed on August 7, 1946, further extended this to June 30, 1947 (P.L. 79–656). This was extended another year by an Act passed on June 30, 1947 (P.L. 80-132). Last, an Act passed on May 25, 1948, further extended the Corporation’s lifespan through June 30, 1956 (P.L. 80-548).

After a series of legislations that further extended its succession date, the Reconstruction Finance Corporation Liquidation Act was passed on July 30, 1953, giving it a final sunset date of June 30, 1954 (P.L. 83-163). Any further liquidation was done by the Secretary of the Treasury, who continued liquidation of the RFC until it was abolished on June 30, 1957 (Reorganization Plan No. 1 of 1957).  

Prior to the Depression, most of the US banking system operated under a standard of double liability, which meant that in the event of insolvency, a bank’s shareholders could be responsible for some of the debts of the bank in addition to their own investments. A large number of people had bought bank stock in the boom prior to the Depression and, when those investors became seriously financially impaired, the system of double liability served to only further strain them. This problem, coupled with the advent of deposit insurance and the fact that the volume of failed banks enforced widespread belief that double liability was not an effective mechanism of preventing bank failures, forced governmental action (Miller and Macey 1992).

Section 22 of the Glass-Steagall Act of 1933 repealed double liability for any newly issued national bank shares following the passing of the law (P.L. 73-66). The Banking Act of 1935 amended Glass-Steagall by giving national banks the option to remove double liability from their stock so long as they gave a public, six-month notice (Miller and Macey 1992).

The creation of the FDIC via Section 12(b) of Glass-Steagall was another pivotal moment in the government’s efforts to fight the Depression (P.L. 73-66). Deposit insurance was scheduled to go into effect on January 1, 1934 and was seen as “a necessary prelude to a full restoration of public confidence in the banks” (Jones 1951; P.L. 73-66). However, there were still thousands of banks in December 1933 that were still in the “hospital” and would not qualify for deposit insurance. President Roosevelt, by stating that any banks that were given deposit insurance must be sound, had emphasized the need for all banks to be insured by the start of 1934. There was fear among some administration officials that “another bank debacle would occur if, suddenly, it had to be made known to the public that some 2,000 banks could not qualify for deposit insurance”. In late December, Jesse Jones and Treasury Secretary Henry Morgenthau quickly hammered out an agreement for these hospital banks. Treasury certified them as solvent and the RFC pledged to make them so within six months, which the Corporation did by broad solicitation of subordinated private capital and injecting some of its own (Jones 1951).