317 December 21, 1983 THE RECONSTRUCTION FINANCE CORPORATION'S MURK Y HISTORY INTRODUCTION A modern version of the Depression-era Reconstruction Finance Corporation (RFC) is a favorite proposal of national industrial policy advocates industries and regions for more than two decades. It was an earlier age's attempt by gove rnment to allocate credit and pick winners.

Five bills (S.265, H.R. 134 H.R. 1480, H.R. 1827, H.R. 2612 designed to revive the RFC already have been introduced in the 98th Congress As Richard McKenzie notes in Part I of this study the RFC concept has many inherent flaws original corporation indicates strongly that it would be a serious mistake for Congress to consider reestablishing the RFC. The history and economic consequences of the RFC imply that, even under the most favorable circumstances for its suc c ess, a new RFC would not enhance the productivity or efficiency of the American economy The RFC channelled federal. money into selected The history of the A BRIEF LOOK ,AT Tm RFC I President Herbert Hoover first proposed the establishment of the Reconstru ction Finance Corporation in December, 1931.l The RFC Act was approved on January 22, 1932, and the corporation began operations almost immediately.

The RFC was based on and descended from the War Finance Corporation (WFC of 1918-1929.2 And just as the WFC had been The establishment of the RFC is discussed in Herbert C. Hoover, Memoirs Vol. 3 (New York: MacMillan, 1952 pp. 107-111 See Gerald D. Nash, "Herbert Hoover and the Origins of the Reconstruction Finance Corporation," The Mississippi Valley Historic a l Review, December 1959, pp. 455-468 2 created to deal with the emergencies caused by World War I, the RFC was created to deal with the emergencies caused by the Great Depression. Hoover regarded the corporation as a temporary organization; yet it survive d until 1953 Although Franklin D. Roosevelt had considered doing away with the RFC during his campaign, after his election he moved to strengthen the corporation as part of his New Deala3 significant action with res ect to the RFC was his appointment of Je s se H. Jones as chairman3 A conservative Houston businessman, Jones had been one of the original Democratic members of the board of directors. Although he nominally ceased to be chairman when he became Federal Loan Administrator in 1939, Jones effectively c ontrolled the RFC from 1933 to January 1945, when he left govern- ment service His most When Jones became Secretary of Commerce in 1940, the RFC became part of the Commerce Department. by Jones in an authoritarian, paternalistic manner, and his wishes wer e always acceded to by the other directors variety of enterprise credit Corporation, for instance, and used its loans to help raise the prices of numerous agricultural products. Mortgage Association, the Electric Home and Farm Authority, the Export-Import B ank, and the Disaster Loan Corporation were all at one time among the subsidiaries of the RFC.6 purchased gold when the Roosevelt Administration attempted to drive up the price of that metala7 in war production,and the purchase and stockpiling of strategi c materials.8 Its main subsidiaries for these purposes were the Defense Plant Corporation, the Defense Supplies Corporation, the United States Commercial Company, the Rubber Reserve Company, and The corporation was run Under Jones, the RFC became involved i n an extraordinary The corporation organized the Commodity The Federal National The corporation even During World War 11, the corporation became involved heavily The role of the RFC in the New Deal is described in Arthur M. Schlesinger Jr., The Age of Roo sevelt, Vol. 2 (Boston: 425-4

33. Also, see Franklin D. Roosevelt, The Public Papers and Addresses of Franklin D. Roosevelt, Vol. 2 (New York: 398-403.

For a highly favorable biography of Jones, see Bascom N. Timons, Jesse H. Jones (New York: Holt, 1956 See Jesse II. Jones and Edward Angley, Fifty Billion Dollars (New York MacMillan, 1951), and Timons, Jesse H. Jones, especially pp. 222-233.

Many of these subsidiaries were later transferred to other departments or made independent Houghton Mifflin, 1958), pp.

Random House, 1938), pp.

See Jones- and Angley, Fifty Billion Dollars, pp. 245-2

54. The activities of the Defense Plant Corporation, the most important war time RFC subsidiary, are described in Gerald T. White, Billions for Defense: World War I1 (University, Alabama: University of Alabama Press, 1980).

Government Financing by the Defense Plant Corporation durinq 3 the Metals Reserve Company. Wherever possible, the RFC lent funds to private industry to carry, on war production and purchases.

But when private action was not feasible, the RFC built.plants and purchased materials itself I In addition to its war-related activities, the corporation continued its operations in the civilian economy most imDortant of these activities was its intervention to help One of the the Offke of Price Administration's OPA) attempt to keep con sumer prices from rising. The RFC subsidized the production of meat, bread, and other commodities whose costs o f production ex ceeded the price ceilings set by OPA pendence and a fair degree of bipartisanship. Jones even managed to maintain the independence of the corporation after he had become a member.of Roosevelt's cabinet, though this may have been due to his dislike of many, perhaps most, of the policies of the New Deal.g According to Arthur M. Schlesinger, Jr Under the direction of Jones, the RFC maintained its inde the] RFC in short, took on the character not of the First New Deal but of Jesse Jones a basis for economic planning it became an enormously astute and versatile financial exercise conducted on private princi les if under public auspices and with Instead of providing public money.1 E By January 1945, Roosevelt had had enough of Jones's'inde pendenc e and nominated Henry Wallace, then Secretary of Commerce as his replacement. 'Congress, however, refused to approve Wallace as a Federal Loan Administrator and de facto head of the The RFC was removed from the ConunercrDepartment and became an independent agency.

Despite its. nominal independence, the RFC lost its bipartisan nature after the war and became embroiled in a series of bribery and corruption scandals. According to a Senate investigation of 1951, securing an RFC loan through the Democratic Natio nal Com mittee had become a common practice The Democrat-controlled Senate of 1951 recommended reform and when the Republicans came to power in 1953, they moved quickly Jones entitled a section of his autobiography 1 Was Not a New Dealer."

The book contains many passages critical of Roosevelt and the New Deal.

See Jones and Anglep, Fifty Billion Dollars, pp. 255-311.

Schlesinger, The Age of Roosevelt, Vol. 2, p. 433.

Jones contributed to the rejection of Wallace by testifying against his confirmation. S ee Edward L. Schapsmeier and Frederick I. Schapsmeier Prophet in Politics: Henry A. Wallace and the War Years, 1940-1945 (Ames Iowa: Iowa State University Press, 1970), pp. 120-124, and Norman D.

Markowitz, The Rise and Fall of the People's Century (New York Press, 19731, pp. 130-135 lo l1 The Free 4 to abolish the FWC. The RFC Liquidation Act of 1953*terminated its lending authority and abolished the corporation, effective June 30, 19

57. The rem aining functions and outstanding loans of the RFC were transferred to the Housing and Home Finance Agency, General Services Administration,'Small Business Administration and Treasury Department. Over the course of its existence, the RFC had lent approxima t ely 13 billion and spent many billions more on a wide variety of programs THE RE'C AS AN EMERGENCY FINANCIAL INSTITUTION The four most important peacetime activities of the RFC were loans and investments in financial institutions, direct business loans an d investments loans on agricultural commodities, and loans to aid in financing self-liquidating public works projects.

Table 1 provides a summary of RFC activities from from February 2 1932, to January 19, 1941.

The agricultural and public works expenditures were actually part of larger New Deal programs in those areas and so should not be assessed apart from the programs as a whole.

RFC, therefore, should focus on the economic effects of the finan cial and direct business expenditures of the RFC Analysis of the The RFC and the Banking Crisis The RFC initially attempted to encourage recovery by making low interest loans to private financial institutions hoped that these private institutions would then re-lend.the funds.

In 1932, the RFC lent close to $1 billion to commercial banks.

Although the rate of bank .failures temporarily slowed down after the corporation began lending, this was probably a coincidence.12 By early 1933 banks again began failing at an alarming rate, and RFC loans failed to avert the banking crisis.13 The ineffective ness of the RFC was most apparent in February 1933, when the banks in Michigan collapsed despite the efforts of the RFC directors to save the leading banks of Detroit.14 around the country until RoosevelQ, on March 6, dec l ared a bank holiday reasons. First, and probably most important, the forces leading to collapse may have been too great to be counteracted by the funds made available by the RFC. Between October 1929 and March 1933 the nation's basic money supply fell fro m $28 billion to $19 It was The situation deteridrated The RFC failed to halt the banking crisis for three principal l2 See Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States 1867-196i BIB, 19631, pp. 320-321 1 Princeton: P rinceton*University Press for the l3 See Lester V.-Chandler, America's Greatest Depression: 1929-1941 (New York: Harper Row, 1970 pp. 66-90.

See Jones and Angley, Fifty Billion Dollars, pp. 54-71. 5 TABLE' 1 Loans and Investments of the RFC from February 2 , 1932, to January 19, 1941 Amount millions of $1 I Loans on cotton, corn, tobacco, and other commodities 830.0 Loans for distribution to depositors in closed banks 1,030.8 Loans to railroads 795.7 Loans to drainage districts 91.1 Loans to public school a u thorities 22.9 Loans to business 241.1 Loans to banks and trust companies 1,138.4 Loans to Federal Land Banks 387.2 Loans to mortgage loan companies 519.0 Loans to agricultural and livestock credit corporations 191.6 Disaster loans '12.0 Loans for self-li q uidating construction projects 463. i Loans to insurance companies 90.7 Loans to joint stock land banks 24.7 Loans to Rural Electrification Administration 150.5 Loans on p.referred stock in banks and insurance companies 79.8 Loans to Secretary of Agricult u re 37 .O Loans to Export-Import Bank 25.0 Other 1 o ans 25.8 Purchases of preferred stock, capital notes, and debentures of commercial banks 1,197.8 Pe 1: cent of total 10.2 12.5 9.7 1.1 0.3 2.9 13.8 4.7 6.3 2.3 0.1 5.6 1.1 0.3 1.8 1.0 0.5 0.3 0.3 14.6 Pu r chases of securities from Public Works Administration 640.6 7.8 Other purchases 11.1 0.1 Total 8,220.5 100.0 Loans and purchases in aid of national defense 62.1 0.8 I Source: The Public Papers and Addresses of Frank1in.D. Roosevelt, Vol. 2 New York: Rando m House, 1938 pp. 403-40.4;'Vol. 7 (New York: Random House 1941 pp. 99-100 6 billion massive collapse, the billion dollars lent by the RFC may simply and between 1929 and 1933, fross national product fell from $103.1 billion to $55.6 bi1lion.l In the face o f such a have been too little The second reason for the ineffectiveness of the RFC was that it usually took the strongest assets of a troubled bank as security for the 10an.l~ This adherence to sound banking practice deprived banks of assets needed to mee t further demands for cash. The banks needed capital, but the RFC did not provide it A third reason that RFC loans were ineffective was that they were publicized loan was correctly regarded by depositors as a sign tha-t the bank was financially weak. The e nsuing panic often put the bank in worse condition than before the loan was made refused to apply for loans, believing that the damage from publi city would outweigh the direct financial benefits of the loan.

The banking system's need for capital was final ly met by the Emergency Banking Act of March 9, 1933, which authorized the RFC to invest in the preferred stock capital notes and debentures of commercial: banks. Subsequently the RFC invested over $1 billion in such instruments--equal to about one-third of total bank capital in 19

33. The RFC eventually invested in over 6,000 banks the Banking Act of 1933, which established federal deposit in surance. All banks that were members of the Federal Reserve System were required to have their deposits insured by the Federal Deposit Insurance Company (FDIC mitted upon the approval of the FDIC, but many of the 9,000 non member banks that applied for membership were not financially sound enough to qualify. The RFC invested in those banks and thus played an importan t role in launching the FDIC Information that a bank had received an RFC Indeed, many banks The biggest surge in RFC investment came with the passing of Nonmember banks could be ad The various banking reforms, and the FDIC in particular, are generally cred i ted with establishing a sound national banki'ng system by the mid-1930s. The RFC played an important role in this restoration of the banking system inferred from the fact that its loans and investments in finan cial institutions had virtually ceased by 19 3 9 11 percent) of the $1.2 billion the RFC spent purchasing bank capital was spent.after October 23, 1937 made after that date. By the beginning of World War I1 the greater part of the corporation's banking investments had been retired and as Jesse Jones p r oudly pointed out, the interest and dividends I 1 Its success can be Only $133 million No loans to banks were l5 l6 Friedman and Schwartz, A Monetary History of the United States, pp. 712-713 U.S. Department of Commerce, Historical Statistics of the Unite d States Office 19761, p. 224 Washington, D.C Government Printing Colonial Times to 19

70. Part I l7 Friedman and Schwartz, A Monetary History of the United States, pp 330-331n. on the loans and urchases eventually yielded a substantial ac counting profit.18 success of the RFC as an emergency financial institution.

Its own obsolescence, then, demonstrated the TE RFC AS A NATIONAL INVESTMENT BANK The only direct business loans the original Act 'empowered the RFC to make were railroad loans.. The inclusion o f such loans was primarily for financial reasons; insurance companies, savings banks, and other institutions held several billion dollars in railroad bonds road loans and imposed his own conditions on the railroads conditions often included reorganization and new management.lg The railroads were to remain the largest industrial borrowers from the RFC Jesse Jones took particular interest in the rail These Despite the end of bank failures'and panics after 1933, com mercial banks were slow to increase their b u siness and industrial loans. Fearing another banking crisis, banks steadily increased and decreased me percentage of assets in loans the percentage of total assets held in the form of cash assets Jones was not prepared to wait for bankers to adjust to FDI C.

He believed that "there was no longer any valid excuse for a bank to cram its vault with idle cash which borrowers could be using with profit all and industrial loans, then the RPC would. In June 1934, Congress authorized the RFC to make loans to busine ss and industry With its expanded lending powers, the RFC became, in 'effect a national investment bank. Jones favored making industrial and business loans that would be profitable. The purpose of many of the business loans, he.said, was to keep people at work in a period of massive unemployment. At times, this goal was in con flict with the principle of profitability. The result was that the RFC avoided risky, potentially profi.table investments but also avoided what Jones called the "Santa Claus giveawqy s ll 'favored by some members of the Roosevelt Administration If the banks would not make business The balance sheet on business loans, then, is not as impres sive as that on banks. Jones's highly sympathetic biographer admitted that the RFC's small busines s loans showed a rate of loss of lo'percent, the greatest of any peacetime RFC endeavors.21 Repayments of RFC business loans always lagged behind those of other loans. l8 The "profits" resulted from the fact that the RFC acquired interest-free funds from t h e Treasury and then lent 'the funds at close to market rates of interest (usually 4 percent l9 2o m p. 52 21 See Jones and Angley, Fifty Billion Dollars, pp. 105-145 See Timons, Jesse H. Jones, pp. 229-231.a J Scale of RFC Lending to Business As Table 1 s h ows, the total amount lent to business by the prewar RFC was comparatively small and had at most a trivial ef- fect on economic recovery. This may have been due to the ina- bility or unwillingness of Jones to find suitable investments. Although a more vig o rous loan program might have done more to fight the Depression, it might have simply led to greater losses.22 After World War I1 and the departure of Jesse Jones, the RFC greatly increased its loans to business and industry. postwar years, over half of th e RFC's funds were channelled into such loans. The postwar era also was marked by greatly increased private lending to business and industry, so although the absolute amount of RFC loans increased, their relative importance decreased. Beryl Sprinkel has es t imated that the share of loans from govern- ment agencies (mainly the RFC) in all business credit fell from 3 to 4 percent in 1940 to less than 2 percent in'1950.23 The end of high unemployment and declining fears of further financial panics caused banks t o lose their fear of making loans. The RFC adjusted to this improving situation by no longer making busi- ness and industrial loans ip the absence of private credit. policy was for the RFC to make loans that private financial insti- tutions might have mad e at higher rates of interest In the The The Distribution of RFC Lendinq to Business The justification for this type of RFC lending during the postwar era was that it was necessary in order to help small busi- ness. Small businesses paid higher market inte r est rates than 1 The RFC should not be singled out for the inadequacy of its efforts to counter the Depression torians is that New Deal spending was not particularly expansionary classic paper on the subject is E. Cary Brown, "Fiscal Policy in the Thirtie s: A Reappraisal," American Economic Review, December 1956 pp. 857-8

79. See, also, Larry C.-Peppers, "Full Employment Surplus Analysis and Structural Change History, Winter 1973, pp. 197-2

10. On the countercyclical role of tions of the Reconstruction Finance Corporation," The Journal of Business,.

October 1952, pp. 211-224 main economic effects of the New Deal occurred in the long run rather than the short run See, for example, Gary H. Wal ton, ed., Regulatory Change in an Atmosphere of Crisis: Current Implications of the Roosevelt Years New York: Academic Press, 1979).

Sprinkel, "Economic Consequences of the Operations of the Reconstruction Finance Corporation pp. 220-221 The consensus amo ng economists and economic his The The 1930's," Explorations in Economic the RFC, see Beryl Wayne Sprinkel, "Economic Consequences of the Opera The view of many economists today is that the 2s 9 large businesses; the RFC closed the "credit gapt1 by making loans to small businesses at below market rates.24 The alleged purpose of RFC loans was in sharp contrast to the reality. In fact, most of the funds of the RFC were lent to large businesses. For example, of the $349 million lent in 1949 the largest 93 loa n s accounted for $200 million, or 57 percent of the total.25 In'Table 2, RFC loan authorizations by size of loan are given for the years 1948 and 1949 category 25,000 or less) accounted for 53 percent of total loans but only 5.3 percent of total funds. Mor e than three quarters of RFC funds were distributed in the form of large business loans 100,000 or more Indeed, in 1949 the RFC lent more money 44 million) to one company (Kaiser-Frazer automobiles) than it lent to small businesses in 1948 and 1949 combine d Loans in the small business The RFC was mainly making business and industrial loans to firms that could acquire funds nowhere else-at least at the same highly favorable terms. The loans were usually made at 4 percent interest, a rate at which these firms could not have acquired private funds. The RFC, in other words, was making highly risky loans without charging a risk premium. Since the interest rate was not being,used to allocate RFC funds, the quantity of loans demanded exceeded the quantity supplied, and some nonmarket method of allocation had to be adopted to handle the excess demand for loans. Although its directors claimed that it was the Ilpublic interesttt that dictated what loans were made another form of credit rationing was actually used. Acco r ding to a Senate report of 1951 many RFC loan applications in the past 2 years have been approved by the Board of Directors without any apparent affirmative reason. I'n fact, many applications have been approved by the board notwithstanding the existence. o f persuasive reasons why loans should not be made The Senate report found that certain Washington attorneys and certain other people were unduly influential with officials of the RFC. In some instances the reports have been received in sworn 24 The existe nce of the credit gap was discussed at great length before the Senate Committee on Banking and Currency in 1951.

Act Amendments of 1951: Hearings Before the Committee on Banking and.

Currency, United States Senate, 82nd Congress, 1st Session (Washington D .C See U.S. Congress, RFC Government Printing Off ice, 1951 pp. 43-88 25 Ibid D. 199 26 Congress, Favoritism and Influence: Interim Report of the Committee on Banking and Currency Pursuant to Senate Resolution 219, 82nd Congress 1st Session (Washington, D .C Government Printing Office, 1951), p. 5. 10 TABLE 2 RFC business loanlauthorizations 1948 and 1949, by size Size of loan I I I Per- I Gross I Per I RFC I Per- I I Number I cent I Amount I cent I Share I cent I I I I 1 I. I I I I 5,000 and under I 1,309 I 16.2 I $3,827,439 I 0.4 I $5,001 to $10,000 I 1,090 I 13.5 I 8,488,939 I 1.0 I $10,001 to $25,000 I 1,894 I 23.3 I 33,847,186 I 3.9 I I *I I I I Total 25,000 and under I 4,293 I 53.0 I 46,163,564 i 5.3 I I I I I I $25,001 to $50,000 I 1,597 I 19.7 I 62, 010,992 I 7.2 I $50,001 to $100,000 I 1,303 I 16.1 I 102,304,275 I 11.

9. I I I I I I Total 100,000 and under I 7,193 I 88.8 I 210,478,831 I 24.4 I I I I I I $100,00l'to $200,000 I 381 I 4.7 I 58,512,468 I 6.8 1 $200,001 to $500,000 I 326 I 4.0 I 102,742,7 39 I 11.9 I I I I I I Total, $500,000 and under I 7,900 I 97.5 1 371,734,038 I 43.1 I I I I I I $500,001 to $1,000,000 I 98 I 1.2 I 71,184,016 I 8.3 I Over $1,000,000 I 102 I 1.3 I 418,453,702 I 48.6 I I I I I 100.0 I I 8,100 I 100.0 I 861,371,756 I Grand Total a Source: U.S. Congress, RFC Act Ameqdments of 1951: Hearings before th I ing and Currency, United States Senate, 82nd Congress, 1st Sea D.C Government Printing office, 1951 p. 340 3,687,271 I 0.5 7,592,435 I 1.0 29,032,663 I 3.8 I 40,312,369 I 5.3 I 52,635,996 I 6.9 86,843,373 I 11.5 I 179,791,738 I 23.7 I 51,058,428 I 6.8 89,456,978 I 11.8 -I 320,307,144 I 42.3 .I 63,752,124 I 8.4 372,980,638 I 49.3 I I 757,039,906 ,100.0 I I I I Committee on Bank lion (Washington I 11 5 testimony which asserts tha t for a sufficient fee these people would give assurance, where no one else could, that matters pending before the RFC would have a SUC- cessful outcome.27 The funds of the RFC, then, were allocated by bribery.

The Corruption'of the RFC The principle figur es in the scandals that surrounded the postwar RFC included Donald Dawson, Walter Dunham, William Willett, E. Merle Young, and Joseph Rosenbaum.28 Dawson was President Harry S. Truman's assistant in charge of personnel and was closely associated with the D emocratic National Committee. Dunham and Willett were directors of the RFC who owed their jobs to Dawson. Young was an RFC examiner until 1948, when he resigned to become an employee of the Lustron Corporation on the day that the loan he had arranged'for them was approved. Youngts main duty for Lustron was apparently to work for the Democratic National Com- mittee during the election of 19

48. After the election, Young served as an informal broker between the RFC, the Democratic National Committee, and Ros enbaum, a Washington lawyer who fre- quently represented loan applicants.29 the handling of its loan to Central Iron and Steel Company.3o Because of the questionable financial practices of its parent company (Barium Steel Corporation the initial applicati o n was scheduled for rejection by the examiners. Willett, however, appointed a substitute examiner and the loan was granted. The RFC lent a total of $6.3 million to Central Iron and Steel over the objections of all examiners and reviewers-?with the excepti o n of Hubert B. Steele, the substitute appointed by Willett! One month after the loan was authorized, Steele resigned from the RFC to take a job with Rosenbahn, who had represented Central Iron The method of operation of the postwar RFC can be seen in 27 I bid 28 Ibid p. 5-84 For a' good short summary of the RFC scandals, see Bert Cochran, Harry Truman and the Crisis Presidency (New-York Wagnalls 19731, pp. 246-2

48. For a'detailed and critical study of the.

Funk and scandals see Jules Abels, The Truman Sca ndals (Chicago 1956), pp. 70-122 This brief sketch cannot do full justice to the relationships among the Henry-Regnery 2s principals in the scandals surrouading the RFC wife of Donald Dawson, was an employee of the.RFC wife of E. Merle Young, was a secret ary on the White House staff interrelationships among those connected with the RFC were so complex that the Senate Subconanittee attached a chart illustrating them to its report For example, Alva-Dawson Loretta Young, the The Favoritism and Influence.

See U.S. Congress, Favoritism and Influence pp. 9-10, 30 I 12 and Steel in the negotiations. He received $5,000 from Rosenbaum on his.first day on the job.31 The corruption and bribery attending the Central Iron and All of the questionable loans together may w ell have Steel loan was not an isolated instance tionable loans investigated by the Senate accounted for $123 million accounted for a majority of RFC loan commitments uncovered by the Senate wgs by no means just a small blemish on an otherwise respectable corporation Just four of the ques The corruption Economic Consequences In Contrast to its lending policies, the economic effects of the postwar RFC are fairly easy to determine. The RFC caused capital, raw materials, and land to be allocated to enterprise s that could not have obtained those resources in the market. The market (correctly) believed that enterprises such as Kaiser-Frazer automobiles would probably Given the high employment that marked the postwar years, the resources used by the firms support e d by the RFC would evidently have been used for other, more produc tive activities criteria, the RFC thus served to reduce the productivity of the economy and reduce the pace of job creation. The amo-unts involved however, were small relative to the total financial capital market.

So the reduction in productivity effected by the RFC must.there fore have been correspondingly small By allocating resources according to nonmarket CONCLUSION The activities of the Reconstruction Finance Corporation were camnlex and coincided with mainr ecnnnrnic and nnlikical upheavals in the U.S. An overall assessment, therefore, is dif ficult. As an emergency financial institution, the RFC was suc cessful, especially after March 19

33. As a national investment bank, however, the RFC was a sordid failure. It is surprising then, that most of the recent proposals to revive the RFC do not envision it as an emergency financial institution, but as a na tional investment bank.q3 These prop o sals can only be based on what the RFC might have been-=not what.it was r I The practice of RFC employees leaving to go to work for former'clients or their law firms had become so common that laws prohibiting the practice had been proposed. See U.S. Congr ess, RFC Act -hendments-of 1951, p. 35.

The relations between Kaiser-Frazer and the RFC are summarized in U.S.

Congress, RFC Act Amendments of 1951, pp. 173-176.

For example, see Robert Reich, _The Next American Frontier (New York Times Books, 1983).

McKenzie, "National Industrial Policy: An Overview of the Debate,"

Eeritage Foundation Backgrounder No. 275, July 12, 1983 32 33 For a summary of the major proposals, see Richard B 13 Economic historians, especially ''new economic historians, I frequently u se counterfactual propositions in their attempts to explain and interpret the past contrary to fact, though perhaps possible. The counterfactual is an explicit way of looking at what might have been or at what might be was not corrupt or directors were so lely concerned with the public interest and that the RFC enjoyed the confidence of'Congress-one that held true for the Jones era.

RFC make a positive contribution to the productivity of the Ameri can economy however, that even an RFC meeting'all the assump tions of the counterfactual would face three difficult problems A counterfactual is an event The appropriate counterfactual in this case is that the RFC Further ass~imptions would be that its director Under these assumptions, could a revived There is no s i mple akwer to this question. It is probable a) Political Pressure Even an uncorrupt RFC would be subject to pressure to make or not make) certain.loans. With the growth and increasing sophistication of special interest groups, this problem would be even.g r eater for a present-day RFC than it was for the original corporation scale, it is quite possible that firms would be founded for the express purpose of influencing government loan policy Indeed, if the RFC were to be revived on a large Definition of Ifpub lic Interest In designing loan policies, the Ifpublic interest" can mean different things to different people. For example, it might mean encouraging industry in New England or supporting small business.

The original RFC interpreted public interest broadly enough to justify loans to pool halls, breweries, professional baseball teams, and rattlesnake farms.34 Even the corporation's staunchest supporters during the 1951 Senate hearings seemed confused about what RFC investment policy was supposed to acc~mpli s h c) Hiqh Risk Loans A third problem for an RFC would be its fauiction of making lbans to firms that could not find financing elsewhere there are thousands of financial institutions in the economy, by the time a firm applied for an RFC loan, a wide consen s us would probably exist that the loan was not a good one. In making the loan, the RFC would in a sense overrule the market. Now it is certainly'possible that in some instances the RFC would be right and the market wrong. It is difficult, however, to accep t the proposition that such instances would be frequent Since 34 3s U.S. Congress,'RFC Act Amendments of 1951, pp. 91-94.

See w pp. 22-34, for an example of this confusion. I 14 In sum, the question of whether an RFC would be good for the economy depends f or an answer upon whether it is preferable for the market to allocate resources or for the director (or directors of a government agency to allocate resources according to some nonmarket criterion. The problems associated with nonmarket allo cation would lead most economists to prefer the market.

Prepared for The Heritage Foundation by Clark Nardinelli Department of Economics Clemson University