US Reconstruction Finance Corporation: Preferred Stock Purchase Program

Abstract

By March 1933, the early collateralized lending programs of the Reconstruction Finance Corporation (RFC) had failed to prevent the recurrence of bank runs and panic in US financial markets. These conditions forced newly elected President Franklin Delano Roosevelt to call for a nationwide bank holiday from March 6 to March 9. On the final day of the holiday, a special session of Congress passed the Emergency Banking Act (EBA), which gave the RFC the power to make investments via preferred equity of distressed institutions. Under the EBA, the RFC could subscribe to and make loans on cumulative non-assessable preferred stock issued by state and national banks and trust companies. Preferred shares (senior to common shares) protected the government’s investment and were non-assessable, meaning the RFC would have no further liability if the companies experienced losses. Subsequent amendments and additions to the EBA in March and June expanded this authority to insurance companies and to other types of securities to enable state banks and trusts to participate. Any institution could file an application to one of the RFC’s field offices. The RFC required relatively impaired institutions to raise additional capital or impose haircuts on existing creditors. Aid offices sought to maximize profits and had a fair bit of autonomy. Larger requests had to be approved by the main office in Washington, DC, and by the Secretary of the Treasury. Dividends were normally just below market rates and were lowered throughout the life of the program. Widespread participation in the program did not occur until Chairman Jesse Jones aggressively communicated the necessity of the program to bankers in September 1933 and Roosevelt explained in October that federal deposit insurance would be eligible only to solvent institutions when it began on January 1, 1934. The RFC ultimately injected about $1.17 billion of capital into nearly 7,400 institutions, representing nearly one-third of total bank capital in the system at its peak. Unlike the earlier loan assistance, the program was seen as a resounding success and was widely credited with stabilizing the financial system.

Keywords: Capital injections, collateralized loans, Great Depression, Jesse Jones, preferred stock, Reconstruction Finance Corporation, RFC, United States

JEL Classification: G01, G28