Full text of Economic Brief : Fed Credit Policy During the Great Depression, No. 13-03

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Economic Brief

March 2013, EB13-03

Fed Credit Policy during the Great Depression
By Tim Sablik

Responding to the financial crisis of 2007–09, the Federal Reserve made
loans to nonbank firms and purchased (and continues to purchase) mortgage-backed securities. These actions are examples of credit policy, which
is distinct from monetary policy. But this is not the first time the central
bank has engaged in credit policy. During the Great Depression, Reserve
Banks exercised broad authority to lend to nonbank businesses.
For much of its history, the Federal Reserve has
conducted monetary policy through the discount window—initially by rediscounting shortterm commercial paper and later by purchasing
Treasury securities on the open market. This
policy of holding only high-quality, liquid assets
protected the Fed’s balance sheet from risk and
avoided allocating credit to any particular sector
of the economy. During the 2007–09 financial
crisis, however, the Fed departed from this practice by purchasing mortgage-backed securities
(MBS) and accepting MBS as collateral on loans
to non-depository financial institutions.
Although definitions for credit policy vary, economist Marvin Goodfriend, a former director of
research at the Richmond Fed who has written
extensively on the subject, defines credit policy
as “lending to particular borrowers or acquiring
non-Treasury securities with proceeds from the
sale of Treasuries.” This Economic Brief employs
Goodfriend’s definition.
By allocating credit to specific firms or sectors,
Goodfriend argues, the Federal Reserve distributes public funds (seigniorage reserves) to specific entities without the democratic review process
that accompanies congressional appropriations.
Additionally, when the Fed accepts non-Treasury
EB13-03 - Federal Reserve Bank of Richmond

assets onto its balance sheet, it exposes the public to the risk of securities not backed by the full
faith and credit of the United States government.
For these reasons and others, some economists
and policymakers have contended that the Fed
should not engage in credit policy.1
The Fed’s proper role in providing liquidity has
been debated many times during its history.2 In
fact, as early as the congressional debates over
the Federal Reserve Act of 1913, some members
of Congress argued that the Federal Reserve
should have the authority to extend credit to
individuals, as well as member banks, to allow
the central bank to expand liquidity more effectively during financial crises. Ultimately, Congress
decided that the Fed should not compete with
commercial banks to make loans to the general
public and should act as a lender of last resort
for banks only.
The Fed’s First Crisis
The United States was in the grips of the Great
Depression in January 1932, when President
Herbert Hoover signed legislation creating the
Reconstruction Finance Corporation (RFC). This
government entity was charged with making
loans primarily to banks, credit unions, and
other financial institutions. At the time, Reserve
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Banks were only allowed to make very short-term
loans to member banks and accept only real bills
(short-term debt from businesses) as collateral. The
Hoover administration felt that immediate action
was needed to inject capital into banks. The RFC represented the largest U.S. government intervention
in private markets during peacetime to date.3 Nevertheless, Hoover balked at granting the RFC authority
to lend to individuals, vetoing a bill in July 1932 that
would have given the RFC such power. Congress
promptly passed a new bill that amended the Federal Reserve Act by adding section 13, paragraph 3,
which read in part:
“In unusual and exigent circumstances, the
Board of Governors of the Federal Reserve
System, by the affirmative vote of not less
than five members, may authorize any Federal
reserve bank … to discount for any individual,
partnership, or corporation, notes, drafts, and
bills of exchange of the kinds and maturities made eligible for discount for member
banks under other provisions of this Act when
such notes, drafts, and bills of exchange are
indorsed and otherwise secured to the satisfaction of the Federal Reserve bank.”
Although section 13(3) seemed to signal a major
expansion of the Federal Reserve’s ability to allocate
credit to individuals and businesses, a number of
limitations kept it from having much of an immediate
impact. The act stipulated that Reserve Banks could
lend to individuals through the discount window
only in exchange for commercial paper eligible for
discount to member banks, which was not typically
held by nonbank entities. Additionally, the Federal
Reserve Board of Governors issued guidance stating
that section 13(3) loans should not be made to banks,
preventing nonmember banks, which would have
been most likely to hold the appropriate commercial paper, from accessing the discount window. For
these reasons and others, section 13(3) had minimal
impact—the Reserve Banks loaned a total of about
$1.5 million to 123 businesses over four years starting
in 1932, according to Howard Hackley, who wrote a
history of the Fed’s lending practices while serving as
the Board’s general counsel from 1957–71.4 Another

reason for the minimal impact of section 13(3) was
that it soon would be superseded by even broader
authority to conduct credit policy.
Lending to Industry
On March 9, 1933, in the wake of a resurgent banking crisis, President Franklin D. Roosevelt signed the
Emergency Banking Act. Although the legislation
further amended section 13 of the Federal Reserve
Act, Roosevelt and Congress decided that these
changes were not enough. The banking crisis of
1933 had left banks reluctant to make long-term
loans, and regulators required them to maintain
certain liquidity levels. By early 1934, Roosevelt was
concerned that banks were not extending the longterm credit small businesses needed to maintain
their working capital.
At the time, the Federal Reserve was limited to making loans with maturities of no greater than 90 days,
and the RFC could only lend to financial institutions.
The Board of Governors agreed that something had
to be done to meet the need for long-term loans to
small businesses. According to a letter to the Senate Banking and Currency Committee in April 1934,
quoted by Hackley, the Board said that “there exists
an undoubted need for credit facilities for industry
and commerce beyond those that are now being
supplied through the commercial banks or that can
be supplied through the ordinary operations of the
Federal Reserve System.”5
Congress began debating two proposals to remedy
the perceived lack of credit for working capital. The
first bill would have created a system of 12 federal
credit banks modeled after and overseen by the 12
Reserve Banks. But Congress ultimately decided that
the Reserve Banks should handle the loans directly.
The second proposal was to expand the authority of the RFC to make loans to businesses. Though
both plans seemed to address the same perceived
problem, the RFC was envisioned as a temporary
organization to serve as a backup to the Fed during
the crisis.6
Congress passed both laws in the summer of 1934,
adding section 13(b) to the Federal Reserve Act,

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granting Reserve Banks the authority, under exceptional circumstances, to directly extend loans with
durations of up to five years to established businesses
within their districts. Additionally, section 13(b) gave
nonmember banks and other financing institutions
access to the discount window. They also could
purchase loan commitments from their respective
Reserve Banks. The commitments gave the private
lenders the option of transferring covered loans to
the Reserve Banks (retaining only 20 percent of the
risk) if the lenders faced sudden needs for liquidity.
These loans and commitments were subject to the
approval of the Board of Governors, but soon after
the law’s passage, the Board granted authority to
each Reserve Bank to review and approve their own
loans and commitments. The Board also expressed
its support for the goals of the Fed’s new authority
in a press statement issued on June 28, 1934:7
“Recognizing the need of these industrial and
commercial businesses for additional working
capital to enable them to continue or resume
normal operations and to maintain employment or provide additional employment,
Congress has granted the Federal Reserve
banks broad powers to enable them to provide such working capital, either through the
medium of other banks, trust companies, and
other financing institutions or, in exceptional
circumstances, directly to such commercial and
industrial businesses. It is believed that the facilities thus afforded will aid in the recovery of
business, the increase of employment, and the
general betterment of conditions throughout
the country.”
The Board noted that the Federal Reserve’s intent
was not to “compete with local banks, but rather
assist and cooperate with them in meeting local
requirements for working capital.” There was some
concern in Congress and the Roosevelt administration that the Federal Reserve would be too reluctant
to engage in direct lending, so the law established an
Industrial Advisory Committee (IAC) at each Reserve
Bank to oversee loan requests. Each Reserve Bank appointed five IAC members to one-year terms subject
to approval by the Board of Governors.

The total amount in the Federal Reserve System
available for lending was not to exceed the combined surplus of the Reserve Banks as of June 1,
1934, which was $138.4 million. Additionally, the
secretary of the Treasury was authorized to pay
$139.3 million to the Reserve Banks for lending
purposes, bringing the limit on outstanding credit
to $277.7 million, which was to be divided proportionally among the 12 Reserve Banks. The Fed quickly
began to advertise its new authority, as described
by Board member M.S. Szymczak in a speech to the
Illinois Bankers Association: “Every effort has been
made through pamphlets, letters, addresses, personal calls and even by radio to make the new functions of the Federal Reserve Banks widely known.”8
By the end of 1934, the Federal Reserve System had
approved 1,020 of 5,108 applications for commitments and direct loans. From the law’s passage on
June 19, 1934, to May 1, 1935, systemwide direct
loans included $32.6 million to manufacturers, $5.8
million to wholesalers and retailers, and $5.5 million
to miscellaneous industries such as construction,
mining, lodging, and transportation. The grand total
for approved direct loan applications was $43.9 million, or $738.4 million in 2013 dollars. (See Table 1
on the following page for a breakdown of loans and
commitments by business category.)
The amount of loans and commitments outstanding
would peak by the end of 1935 at about $60 million. (The Richmond Fed had about $2.9 million in
loans and $2.3 million in commitments.) In 1935, and
again in 1938, the lending authority of the RFC was
expanded, and it took the lead in making government loans to industry. By 1937, the Federal Reserve
System approved just 126 new loan and commitment requests, and the Richmond Fed approved just
$220,000 in new loans.
Exiting Direct Lending
The RFC’s broader authority to make industrial loans
made Federal Reserve credit through section 13(b)
less attractive to businesses. As the Great Depression
persisted, some members of the Board of Governors
argued that restrictions on the Fed’s lending authority
should be removed or additional authority should be

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Table 1: Loans and Commitments Approved by Reserve Banks from June 19, 1934, to May 1, 1935
Commitments

Direct Loans

Business Categories
Manufacturers:
Aircraft
Autos, trucks, and accessories
Chemicals and allied products
Electrical goods
Food products
Furniture, office and household equipment
Hides and leather
Jewelry and silverware
Liquors, wines, and beer
Lumber and builders’ supplies
Machinery and machine tools
Metals
Paper products
Railway equipment
Rubber goods
Stone, clay, and glass products
Textiles
Wearing apparel, shoes, etc.
Wood products
Other
Total

No.

Amount

No.

Amount

0
17
15
9
27
31
4
2
21
31
33
27
10
1
1
6
19
34
6
20
314

$0
7,732,500
363,500
1,027,000
1,029,300
1,964,500
111,400
27,300
2,455,500
2,286,600
3,285,000
2,798,000
398,700
250,000
200,000
1,265,000
2,493,500
1,256,500
451,000
460,640
$29,855,940

2
16
28
4
68
46
6
6
15
46
51
49
14
0
1
13
35
48
13
50
511

$1,150,000
4,072,000
882,517
32,000
1,959,000
2,448,000
352,600
67,500
987,000
3,332,000
3,924,400
4,112,500
1,636,400
0
30,000
235,250
3,735,750
1,466,450
474,000
1,728,500
$32,625,867

Wholesale and retail trades:
Autos and accessories
Chain and department stores
Clothing, dry goods, jewelry
Drugs, tobacco, and liquor
Florists, nurseries, etc.
Food products
Furniture
Grain, feed, seeds, etc.
Hardware and machinery
Lumber and builders’ supplies
Oil
Other
Total

11
15
16
6
4
30
5
12
0
42
4
10
155

$116,200
689,000
435,500
126,000
49,000
1,985,900
53,000
753,000
0
1,630,700
360,000
235,500
$6,433,800

22
48
25
13
5
50
13
28
4
40
18
26
292

$224,150
650,800
230,850
96,000
97,000
1,359,450
180,500
799,000
78,000
927,550
814,000
355,000
$5,812,300

19
8
1
1
0
22
0
6
5
62

$1,572,000
188,500
6,000
60,000
0
953,000
0
120,000
227,500
$3,127,000

37
4
13
15
3
51
1
4
30
158

$1,553,500
334,500
277,200
966,500
210,000
811,600
75,000
515,000
750,900
$5,494,200

531

$39,416,740
$662,546,488

961

$43,932,367
$738,448,575

Miscellaneous:
Contractors and construction
Hotels, apartments, restaurants, etc.
Laundries, cleaners, and dyers
Mines and quarries
Oil and gas production
Printing, publishing, and allied trades
Shipbuilding and repairing
Transportation
Other
Total
Grand Totals
Grand Totals in 2013 Dollars

Source: Federal Reserve Bulletin, June 1935, p. 340
Note: Direct loans were called “advances” in 1935. “Commitments” were essentially loan guarantees extended to lenders
by Reserve Banks covering up to 80 percent of each loan’s risk.

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vested in a new entity to continue to provide credit
to the struggling economy. In a statement to the
Senate Committee on Banking and Currency in 1939,
during hearings on a bill to modify section 13(b),
Fed Chairman Marriner Eccles said, “I believe that the
authority which has been given to the Federal Reserve banks in this respect has not been sufficiently
comprehensive. Many loans which might otherwise
have been made have had to be declined because
of restrictions in the law.”9
Eccles outlined a plan to create an Industrial Loan
Corporation as part of the Federal Reserve System
to oversee greater industrial loans and the purchase
of companies’ preferred stock. Such a plan would
have repealed section 13(b), separating the lending
function from the Federal Reserve’s monetary policy
role, similar to Roosevelt’s original proposal. This
bill did not pass, but as the United States geared up
for war in the 1940s, the Federal Reserve would be
called upon to assist in making industrial loans for
militarization due to its experience lending under
section 13(b).10
In 1947, Chairman Eccles again appeared before
Congress during a hearing on a bill to repeal section
13(b) and grant broader, more permanent lending
authority to the Federal Reserve. Eccles still perceived
a need for the Federal Reserve to play some role in
credit policy, but by then he viewed it largely as a
supporting role:
“The history of the Federal Reserve Act and its
sole purpose was not to help banks as such
but its purpose was to help commerce, agriculture, and industry, that was its basic purpose.
The purpose was to see that the credit was
provided. What this [bill] is undertaking to
do is intended to help the banks to provide
that credit.”11
By the 1950s, sentiment at the Board had shifted
against Federal Reserve lending to nonbank businesses.12 In 1957, Fed Chairman William McChesney
Martin testified before the Senate Banking and Currency Committee during consideration of a new bill

to address small business credit concerns. Although
Martin expressed support for government institutions to address gaps in private sector lending, he
said that “it is undesirable for the Federal Reserve to
provide the capital and participate in management
functions in the proposed institutions.”
On Aug. 21, 1958, the Small Business Investment
Company Act repealed section 13(b) of the Federal
Reserve Act, officially putting the Federal Reserve out
of the commercial lending business. However, the
emergency lending powers granted under section
13(3) remain part of the Federal Reserve Act and were
employed during the most recent crisis to extend aid
to financial institutions. Following the financial crisis,
there has been some movement toward limiting the
Fed’s involvement in credit policy. In March 2009, the
Federal Reserve and the Treasury Department released a joint statement noting that “actions taken by
the Federal Reserve should … aim to improve financial or credit conditions broadly, not to allocate credit
to narrowly-defined sectors or classes of borrowers.”13
More recently, the Dodd-Frank Act modified section
13(3) by striking the language allowing Reserve Banks
to discount to “any individual, partnership, or corporation” and replacing those words with “participant
in any program or facility with broad-based eligibility.” Additionally, the Board of Governors now must
obtain approval from the secretary of the Treasury
before allocating credit under section 13(3).
Tim Sablik is an economics writer in the Research
Department of the Federal Reserve Bank of
Richmond. He expresses appreciation to Robert
L. Hetzel, a senior economist and research advisor
at the Bank, for contributing information, insight,
and guidance for this article.
Endnotes
1

Richmond Fed researchers have written extensively on the
topic of Federal Reserve credit policy. See, for example,
Federal Reserve Bank of Richmond Economic Quarterly,
Winter 2001, vol. 87, no. 1, special issue commemorating the
Treasury-Federal Reserve Accord; and Hetzel, Robert L., “The
Case for a Monetary Rule in a Constitutional Democracy,”
Federal Reserve Bank of Richmond Economic Quarterly,
Spring 1997, vol. 83, no. 2, pp. 45–65. Additionally, Richmond
Fed President Jeffrey Lacker has supported the idea of a

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“credit accord,” whereby the Fed would make an agreement
with fiscal authorities not to engage in credit policy. See,
for example, “Perspectives on Monetary and Credit Policy,”
Speech at the Shadow Open Market Committee Symposium,
New York, Nov. 20, 2012, and “The Dangers of the Fed Conducting Credit Policy,” Federal Reserve Bank of Richmond
Region Focus, Fourth Quarter 2012, vol. 16, no. 4, p. 1.
2

This Economic Brief looks at the early history of the Federal
Reserve’s involvement in credit policy. For a broader overview
of the Fed’s historical involvement in credit policy, see Price,
David A., “When the Fed Conducts Credit Policy,” Federal
Reserve Bank of Richmond Region Focus, First Quarter 2012,
vol. 16, no. 1, pp. 6–8.

3

For more information on the RFC, see Todd, Walker F.,
“History of and Rationales for the Reconstruction Finance
Corporation,” Federal Reserve Bank of Cleveland Economic
Review, Fourth Quarter 1992, vol. 28, no. 4, pp. 22–35.

4

Hackley, Howard H., Lending Functions of the Federal Reserve
Banks: A History, Board of Governors of the Federal Reserve
System, May 1973.

5

Hackley, p. 134.

6

According to Hackley, the RFC was viewed at the time as a
temporary emergency agency. This was reflected in the bill
to expand its lending authority, which was set to expire on
Jan. 31, 1935. Additionally, the original language of the RFC
bill stipulated that the RFC would only make loans when
credit “is not otherwise available at banks or at the Federal
Reserve bank of the district in which the applicant is located”
(emphasis added). The italicized words were removed from
the final bill, making it less clear that the RFC should be
secondary to Reserve Banks in making industrial loans.

7

Reprinted in the Federal Reserve Bulletin, July 1934,
vol. 20, no. 7, p. 429.

8

Szymczak, M.S., “Recent Relations of the Federal Reserve
System with Business and Industry,” Speech before the Illinois
Bankers Association, Decatur, Ill., May 20, 1935.

9

Board of Governors of the Federal Reserve System, “Statement of Chairman Eccles before the Senate Committee
on Banking and Currency with Reference to S. 2343,”
June 5, 1939.

10

The Federal Reserve System would play a major role in
guaranteeing government loans to the defense industry
made under the V-loan program during World War II.
According to Hackley, the Fed would approve $128 million
in loans in 1942, “the peak volume for any year in the
history of their industrial loan operations.”

11

“Federal Reserve Assistance in Financing Small Business,”
Hearing before the Senate Committee on Banking and
Currency on S. 408, April 17, 1947.

12

Congress also had begun to question the wisdom of the
government being involved in credit allocation during this
time. The RFC ceased operations in 1953 amid allegations
of political corruption and patronage.

13

Board of Governors of the Federal Reserve System and the
Department of the Treasury, “The Role of the Federal Reserve
in Preserving Financial and Monetary Stability,”
March 23, 2009.

This article may be photocopied or reprinted in its
entirety. Please credit the author, source, and the
Federal Reserve Bank of Richmond and include the
italicized statement below.
Views expressed in this article are those of the author
and not necessarily those of the Federal Reserve Bank
of Richmond or the Federal Reserve System.

FEDERAL RESERVE BANK
OF RICHMOND
Richmond Baltimore Charlotte

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