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RECONSTRUCTION FINANCE CORPORATION
WASHINGTON
HENRY T. BODMAN
MEMBER OF THE BOARD
May H , 1947
Dear Marriner:
In accordance with our conversation of last evening, I am enclosing additional
copy of the talk I made before The Economic Club
of Detroit.
Yours very truly,
The Honorable Marriner S. Eccles
Chairman, Board of Governors of the
Federal Reserve System
Washington 25, D. C.
Enclosure
May 16,
Dear Harrys
Thank you for sending me the copy of the talk
you made before The Economic Club of Detroit. I was
very Mich interested in seeing it and in noting particularly the conclusions you have drawn, and with which incidentally I would agree, as to ihe role of Government
lending.
I am in accord also with your view that in
periods of generally good business conditions Government
policies should call for liquidation of loans. Likewise,
I think you are right in saying that it was not intended
that loans be made for the purpose of protecting private
capital investments against the normal competitive risks
of business. It seems to me that you correctly look
through these operations to their broader underlying
purpose, which basically is to help maintain and stabilize
production and employment. On that basis, I should not
expect you individually to see any objection to the Reserve System's having in place of its direct lending
powers, the repeal of which we have recommended, a substitute stand-by authority to guarantee in part loans
that would tend to accomplish this broad basic purpose
and not merely protect capital against competitive risks.
It has been a long time since you came over to
luncheon and I hope that remission may shortly be repai red.
With kindest personal regards.
Sincerely yours,
The Honorable Henry T. Bodman,
Reconstruction Finance Corporation,
Washington 25, D. C.
N FINANCE CORPORATION
WASHINGTON
HENRY T. BODMAN
MEMBER OF THE BOARD
April 21,
Dear Mr. Eccles:
Mr. Bodman suggested I send you the
enclosed copy of an address -which he made before
The Economic Club of Detroit on April H t h .
Very truly yours,
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Florence M. Smoot
Secretary to Mr. Bodman
Honorable Marriner S. Eccles
Chairman, Board of Governors of the
Federal Reserve System
Washington 25, D. C.
Enclosure
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FOR RELEASE NOON
APRIL 14, 1947
THE RELATIONSHIP UF GOVlLRiIMEWT LENDING
TO
THE FREE ENTERPRISE SYSTEM
An Address
HEIIRY T. BODMAN
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Member, Board of Directors
Reconstruction Finance Corporation
Before
THE ECONOMIC CLUB OF DETROIT
April 14, 1947
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THE BELAIIONSHIP OP GOVERNMENT LENDING
TO
THE YKSSE ENTERPRISE SYSTEM
After an absence of several years, it is a privilege to attend
this meeting of the Economic Club which plays such an important part in
the life of Detroit.
At a time when the free enterprise system is being weighed in the
balance of world opinion, it may be appropriate to consider some of the
questions which arise in the operation of that system.
Detroit, which has
contributed so much to our economic progress and to the American standard
of living, and which in a sense so exemplifies the free enterprise system,
is particularly concerned with the manner in which these questions are going
to be resolved.
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What I want to talk about is one of the fundamental questions
which arises in the relationship of Government to the enterprise system.
It is the question of lending Government money to private business. In
order to illustrate some of the problems involved in this question, I intend
to draw upon my experience with the RFC.
We all know that the driving force in our enterprise system is the
incentive for profit. Through this incentive we develop competition.
It is
competition among buyers that tends to guarantee the seller that he is
getting the best price for his goods or services.
It is competition among
sellers which protects buyers and consumers and tends to insure that they
receive the most for their money.
The result of this competition is to reward
him the most who consistently offers the greatest value of goods or services
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at the lowest price.
In this way the incentive for profit makes it everyone*s
business to improve the general standard of living.
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It is the essence of this system that there should be no
artificial aide or restraints, and that temporary surpluses or temporary
scarcities should be recognized as conditions which will be corrected by
the system itself.
This means that, for our system to work efficiently, we want
as little Government as possible*
Under such a system the Government'8
primary responsibility should be to act as an inspire to insure that unfair
advantage is not taken of one group by another, and to insure that fraud
and other evils which crop up are eliminated.
The business system and the natural laws of economics work with
maximum efficiency when they are free from outside artificial intervention
and control. To the extent that monopoly, or Government restraints or activities, are injected into the picture, the system takes on elements of
rigidity which tend to prevent the free operation of those natural economic
laws which are the basis of the system.
In the same way, if the Government fails as umpire to discharge
its responsibility for detecting and penalizing unfair practices, the
operation of the system becomes similarly impaired.
These considerations, I think, are fundamental in the concept
of the enterprise system as we allvant it to be. However, we started a
long time ago to permit and, in some cases, to request the Government to
extend its activities beyond what one would expect of an umpire. As a
result of this our system has not, for a good many years, been entirely
free from Government intervention in some form. For example, some of the
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states went into the canal business 100 years ago; the Federal Government
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made land grants to the railroads to get them started; we have had special
treatment for silver for at least 50 years, and the Government has been
aiding agriculture for quite a while.
In recent years the Government has
gone into the housing "business in a substantial way.
If our objective for the enterprise system is the minimum of
Government intervention, assistance and activity, many of these things tend
to operate against it, no matter how well justified they may be from other
standpoints.
Unfortunately for all of us, the enterprise system has not always
worked as smoothly as might be hoped for.
of gear.
It occasionally gets badly out
If we think back a few years we recall that for some reason, or
perhaps a variety of reasons, our economic system bogged down in the early
1930s.
Whatever the causes of the last great depression were, by 1930 or
1931, the condition of our economic system had become a matter of grave
national concern.
In view of the critical nature of this situation, President Hoover
decided that the existence of a strong Federal lending agency would provide
a bulwark against further deterioration of the economy.
To this end in
December 1931, he asked for, and Congress granted, authority to organize the
RFC with broad powers to make loans to banks and other financial institutions
for the purpose of aiding agriculture, commerce and industry.
This was a bold step.
It meant that, in spite of possible long-
term complications, the Government would engage in the field of private
financial transactions.
to private institut ions*
It would enter the lending business and make loans
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It is essential to recognize, however, that the loans were not
made for the purpose of saving the banks for their stockholders. The true
basis was the public interest involved in preventing economic collapse bycoming to the rescue of the large number of individuals and business concerns who were the depositors of the banks. To save the economic system of
the country it was necessary to save the depositors; to save the depositors
it was necessary to save the banks.
In considering the consequences of the decision to put the
Government into the lending business, it may be interesting to have a look
at the results of the operation of the RFC as a lending institution since
its inception in 1932.
The chart before you shows the amount of loans and investments
which RFC has held at various times from 1932 to date.
It shows, as of each
calendar quarter, the major types of loans and investments in RFC!s port-*
folio (excluding loans to the United States and foreign governments). By
the end of 1934 the total RFC credit outstanding amounted to almost $3 billion,
Of this amount, $1.7 billion represented loans to or investments in banks
and other financial institutions. These were equivalent to 77$ of the total
loans and investments held on that date, excluding loan commitmente.
It will be observed that in the years beginning in 1935, the
banks which had obtained RFC assistance began to repay their loans and to
retire the preferred stock which RFC had bought. These repayments have
continued at a fairly rapid rate with the result that, in comparison with
the maximum investment of $1.7 billion in 1934, the total amount owing RFC
on these loans and investments in banks is today only about $200 million.
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The segment on the chart marked "Public Purpose Loans1* consists
of investments made in such projects as drainage districts, irrigation
districts, special municipal authorities and the like.
In this category
are included two projects that were very large and which may be worthy of
special mention. The first of these was a $179 million loan made in the
early 1930s to the Metropolitan Water District of Southern California to
finance the construction of an aqueduct from the Colorado River to Los Angeles.
This loan was later sold by the RFC to private investors at a profit. A
second large loan included in this group was one for about $70 million for
the construction of the San Francisco Oakland Bay Bridge, This loan likewise
was sold to private investors at a profit in 1939, Such "Public Purpose
Loans", which reached a peak of $417 million in 1938, have since been
liquidated to the present balance of $114 million.
The next type of RFC asset shown consists of loans to railroads.
In comparison with a figure of $494 million of such loans held in 1936,
total loans and investments in railroads now amount to only $153 million.
Under the caption "Mortgage Loans11 are included loans, made or
purchased, on real estate properties by RFC and its subsidiary companies.
These include loans on both residential and business properties. Loans of
this type reached a peak of $309 million and have been sold or liquidated
almost completely, the total of such assets now held amounting to only
^19 million.
At the bottom of the chart is a segment marked "Business Loans"
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which represents loans made to ordinary business concerns such as those
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engaged in manufacturing, trade and other industries. Loans of this type
were first authorized "by an amendment to the RFC Act passed in 1934 as the
result of a "belief that many worthy industrial borrowers were unable to
get necessary bank credit due to the condition of the banking system
immediately following the 1933 crisis. This situation, it was believed,
was retarding the improvement in business and employment conditions which
was the Nation's number one problem.
In an effort to solve this problem,
Congress, in 1934, authorized the BFC to make loans to any business enterprise for the purpose of stimulating business and promoting employment.
The law provides that such loans can be made if they are so secured
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as reasonably to assure repayment, but only if credit cannot be obtained
from private sources on reasonable terms, RFC is not authorized to compete
with private lending institutions.
The purpose of authorizing the RFC to make loans to ordinary
business concerns was to alleviate the general unemployment situation of
the '308, This very broad authority, which is still in effect, is, I think,
too general under present economic conditions.
It was not intended that
loans be made for the purpose of protecting private capital investments
against the normal competitive risks of business.
At the beginning of the war emergency, RFC was given very broad
authority to make loans for national defense purposes. These are also
included as "Business Loans" on the chart, in the upper part of that
portion of the bar.
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You will note that the peak of "Business LoansM outstanding was
reached in the latter part of 1944 at just over $500 million and that since
the war there has been a marked liquidation to the present figure of
$267 million.
Of this latter amount, only about 20$, or $54 million,
represents loans of the non—war type.
Taking an over-all view of the chart, it can be seen that a peak
in total loans and investments was reached in 1935 at about $2,3 billion,
and that a later peak of $1.9 billion came during the war period.
Since
then these loans and investments have been reduced to three quarters of a
billion dollars
a reduction of nearly 60$. The volume of loans now held
is at the lowest point since the RFC first got under way in 1932*
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This
liquidation in loans since the war period is consistent with my thoughts
on what the RPC's policy should be during periods of good general business
conditions.
There is one portion of these bars which we have not talked about.
That is the segment marked "Automatic Participations with Banks11. This was
an arrangement inaugurated just before V-S Day to assist in the financing
of small business concerns during the reconversion period. Under it the
RFC, in effect, automatically guaranteed up to 75c/o of certain small loans
made by approved banks. The chart shows that as of December 31, 1946, BPC
was, in effect, guaranteeing over $250 million of such loans.
It will be
noted that this is the only lending activity which expanded in 1946. The
RPC discontinued the practice of automatically guaranteeing loans last
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January.
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In the aggregate, RFC has loaned about $8.3 billion, of which
$7.5 billion, or about 90$, has been repaid.
It has taken losses of
about $22 million on these loans and has set up reserves out of earnings
of over $100 million to cover losses which may be realized on the
$750 million of loans still held. After deducting these losses and reserves
and the expense of handling the loans, including interest on money borrowed,
the earnings made to date by HFC on its lending activities are in excess of
$500 million.
In its war activities, the Corporation was assigned many responsibilities totally unrelated to the purpose for which it was originally
organized.
It handled for the Government the construction of over $8 billion
of plants and facilities for the manufacture of war products; it arranged
for and supervised the construction and operation of some 50 plants for
the manufacture of synthetic rubber; it purchased $12 billion of war material
covering every conceivable item from 13 billion gallons of aviation gasoline
to metals and minerals bought in 51 foreign countries; it trained pilots
for South American airlines and borrowed $370 million worth of silver from
the U. S. Treasury for use in war plants in place of copper.
In all, a total of $23 billion was spent or invested for these
and other war purposes by RFC.
Its war activities were staggering in scope
and size and completely overshadow the Corporation's normal peacetime
operations.
The net unrecoverable cost to the Corporation of these war
operations to June 30th last is estimated at $5.5 billion* All of these
war activities are being wound up as rapidly as possible.
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Returning now to the non-war phases of RFC, it may be interesting
to inquire what we can learn from our experience with the Government as
a lender of money. One thing is that it got into the lending business in
the first place as the result of a widespread public demand for the Government to intervene because of the economic consequences which were contemplated
in the event of its failure to do so.
But we can also learn that if the Government is not to intervene,
or take an active part in business affairs (which it will do if sufficient
pressure is brought to bear upon it), we must all exercise a greater degree
of patience in adversity and the greatest degree of restraint at all times
in asking the Government for help*
I strongly believe that all elements of the enterprise system
must practice a high degree of restraint as a matter of principle if our
system is to remain free from Government intervention and controls. We
must resolve to deny ourselves the apparent short-term benefits of Government
assistance if we are to preserve and maintain the long-term advantages of
the enterprise system.
It is, therefore, disturbing to me to note that in the past year
there have been numerous instances of particular industries which have
requested the Government to interfere with the laws of supply and demand for
their special benefit. While various groups, besides industry groups,
including labor, have been guilty of special pleading, it is my opinion that
if the enterprise system is to survive, business must set the example by
not asking for help, even when the going gets rough.
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I say this particularly "because in recent months certain members
of the banking profession, and other fields of endeavor, have yielded to
the temptation to lean on the Government.
At a time when the banking system
should be able to look after itself, there have been too many instances in
which banks, opposed in principle to Government lending, have asked the EJC
to go into partnership with them by sharing the risk on loans they would
not otherwise make.
Continued requests for Government help will surely
lead to further Government intervention.
Nevertheless, no matter how good a job we may do of resisting
the temptation to lean on the Government, experience has shown that from
time to time we get into periods of economic crisis, such as 1932, when
the Government will be called upon to step into the picture. One of the
things it is certain to be called upon to do is to make loans.
If that
is the case, and I am afraid that it is, it appears to me that this would
be the proper time to adopt some principles pertaining to Government loans.
It would seem safer to formulate these principles at a time like the present
when there is no economic crisis, than to take a chance on making a good
last-minute decision when we are up against the gun.
To this end, and because I suppose it is my business to do so,
I would like to try to answer what I think is the $64 question about the
Government being in the lending business.
I have given that question a lot
of thought in the past year that I have been with the ETC and will venture
the following conclusions.
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First:
I believe that, with proper safeguards, the Government
would be justified in lending its credit to stimulate economic recovery in
a period of financial crisis such as we had in 1932 and 1933, Although
such lending constitutes "Government-in-business11, it is the kind of action
which may become necessary in the* national interest and was regarded as
such when the HFC was conceived in 1931.
Second:
Even in prosperous times, there may be certain projects
which, from a national defense standpoint, need to be undertaken but which
private capital may be unwilling to undertake.
Some projects are too large.
Some are not attractive from a profit standpoint. There is rarely much of
a profit incentive in peacetime in the enterprise system to undertake projects
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which are beneficial from the standpoint of national defense. Often there
is no financial incentive to develop or preserve natural resources unless a
special inducement is provided by the Government.
Sometimes this inducement
may best be provided by loans from the Government which cannot be obtained
from private sources. This may become necessary in view of the importance
of natural resources to our national defense position*
Third:
Occasionally, there may be loans which, in the public
interest, should be made, in good times or bad, to protect our domestic or
foreign position. This category of loans is difficult to define, and I have
been unable to write a general formula describing it. But there are a few
specific examples. One is our air transport system which may need financial
assistance in the next few years. There may be certain railroad situations
in need of temporary financial assistance to preserve vital transportation
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in the years to come.
I think there is a "basis on which such help may
properly be provided "by the Government in the absence of private capital.
In a world which is moving as rapidly as ours, there will undoubtedly be
other purposes of the same general character and importance for which
Government credit may have to be extended.
Beyond these three types of loans,- those to overcome a national
financial crisis; those in the interest of national defense or for which
resources must be preserved or developed; and those of a special nature which
I have yet successfully to define (except by analogy and example), I feel
that loans for other purposes, if justified at all, must be regarded in the
nature of social objectives.
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If v/e attempt to achieve too many objectives
by means of Government lending, we may find that the long-term disadvantages
of such programs will more than offset the immediate gains in other directions.
Having ventured to draw these conclusions, I feel that I should
add a word of caution. Although I believe that the Government may be justified
in lending its credit to stimulate economic recovery in a period of severe
financial crisis, I also believe that no bureau should be put in the position
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of having to decide whether, at any particular time, the financial crisis
is severe enough to warrant such action.
The decision to use the taxpayers1
money for this purpose is of such tremendous social, economic and political
significance that it should not be left to any one bureau of the Government.
My experience also convinces me that, except in times of crisis,
a broad authorization to a bureau to make loans for general purposes is
extremely dangerous. The bureau, or the responsible individuals in any bureau
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which is so empowered, will be subject to tremendous pressure from those
who believe that Government intervention and activity are desirable or
essential as a general proposition.
We must remember that Congress has the responsibility for the
basic decisions regarding the extent to which the Government is to be in
business.
If Congress is going to adopt a policy of Government lending,
it must be specific, so as to relieve the bureau from responsibility for
policy decisions which are the province of Congress itself, and from
pressures which mere administrative officials may find it impossible to
ignore.
We have all noted with dissatisfaction, and even with alarm, the
recent tendency of Congress to announce a broad general principle, and to
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leave it to an administrative body to work out nearly all the important
pelley determinations.
In many cases Congress ha6 gone too far in sub-
contracting the job of writing the rules.
I fully recognize the magnitude of the job which Congress has,
and the limitations which sometimes prevent the careful investigation and
analysis of all the questions which come before it. A certain degree of
delegation will, of course, be necessary. However, I am hopeful that the
extent of it can be curtailed.
It will be interesting to observe whether
the Congressional Reorganization Act will permit of more time and study
of such problems and a better appreciation of just what is involved in some
of the policy decisions which heretofore have been left to the administrative
agencies.
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If our system of free enterprise is not to "be hampered by an
increasing degree of Government control and intervention, we must practice
the self-restraint I have advocated.
We cannot expect to have a free
enterprise system if, irdividually, we are to turn to the Government for
help whenever it is convenient to do so. Neither can the Government
underwrite the normal business losses which are an essential part of the
profit system.
When all the world is looking to us as the last bulwark of freedom
and opportunity, we must demonstrate that the enterprise system, based on
free competition and the incentive for profit, will continue to afford the
highest standard of living the world has ever known.
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R.FC. LENDING ACTIVITIES*
TREND OF LOANS AND INVESTMENTS
MILLIONS
OF DOLLARS
1932-
OUTSTANDING
MILLIONS
OF DOLLARS
1946
— 3000
3000 —
nnlln
LOAN COMMITMENTS
2500
2500
MISC
2000
2000
1500
1500
•::BANKS1 AND' OTHERFINANCIAL INSTITUTIONS
1000
w
RAILROADS
1
1000
AUTOMATIC
-PARTICIPATIONS
WITH BANKS
>PUBLIC PURPOSE LOANS
500
500
m
•MORTGAGE XOANSl
BUSINESS LOANS
torn
M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947
1932
1933
1934
1935
http://fraser.stlouisfed.org/
'Excludes
loans
t
o
,
and
Investments
in,
U.
S.
and
Foreign
Governments.
Federal Reserve Bank of St. Louis
^ _ _ _ _
@FedFRASER