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Vol. 28, No. 4

ECONOMIC REVIEW
1992 Quarter 4

White- and Blue-Collar Jobs
in the Recent Recession
and Recovery: Who’s Singing
the Blues?

by Erica L. Groshen and Donald R. Williams

Assessing the Impact of
Income Tax, Social Security
Tax, and Health Care Spending
Cuts on U.S. Saving Rates

by Alan J. Auerbach, Jagadeesh Gokhale, and Laurence J. Kotlikoff

History of and Rationales for
the Reconstruction Finance
Corporation
by Walker F Todd

FEDERAL RESERVE BANK
OF CLEVELAND

1992 Quarter 4
Vol. 28, No. 4
White- and Blue-Collar
Jobs in the Recent
Recession and Recovery:
Who’s Singing the Blues?

by Erica L. Groshen and Donald R. Williams
Throughout the 1990-91 recession, media reports, unaided by rigor
ous substantiation, asserted that white-collar workers were being hit
disproportionately hard. This paper investigates the veracity of that
claim by using aggregate data from the Bureau of Labor Statistics for
the six downturns and recoveries since 1960. The authors find that, as
usual, the latest episode exacted a greater toll on blue-collar workers.
However, the extremely slow growth in white-collar employment was
unusual by historical standards. Furthermore, the recent recession was
generally harsher than the previous downturns for white-collar workers,
but milder than the historical median for their blue-collar counterparts.

Assessing the Impact of
Income Tax, Social Security
Tax, and Health Care Spending
Cuts on U.S. Saving Rates

by Alan J. Auerbach, Jagadeesh Gokhale,
and Laurence J. Kotlikoff
Today’s policy reform proposals seem to be motivated not by concerns
about the dramatic decline in U.S. saving rates during the past decade,
but instead by the recent sluggishness in economic growth, perceived
unfairness in the tax system, and runaway health care expenditures.
These concerns have given impetus to proposals for reductions in in
come and Social Security taxes on middle-income households and for
health care spending cuts. The impact of such plans on national saving
will obviously depend on the financing method adopted. This paper,
through the use of generational accounting, assesses their likely effect
on both current and future national saving.

Economic Review is published
quarterly by the Research Depart
ment of the Federal Reserve Bank
of Cleveland. Copies of the Review
are available through our Public
Affairs and Bank Relations Depart
ment, 1-800-543-3489.

Coordinating Economist:
James B. Thomson
Advisory Board:
David Altig
Erica L. Groshen
William P. Osterberg

Editors: Tess Ferg
Robin Ratliff
Design: Michael Galka
Typography: Liz Hanna

Opinions stated in Economic
Review are those of the authors
and not necessarily those of the
Federal Reserve Bank of Cleveland
or of the Board of Governors of the
Federal Reserve System.

Material may be reprinted
provided that the source is
credited. Please send copies of
reprinted material to the editors.

ISSN 0013-0281

History of and Rationales
for the Reconstruction
Finance Corporation

by Walker F. Todd
Proposals for government intervention to support the capital positions
of financial institutions tied to regional or national interests usually
build upon a memory, increasingly hazy with the passage of time, of
the original governmental rescue program of the 1930s, the Recon
struction Finance Corporation (RFC). This paper analyzes the history
of and theoretical rationales for the RFC. Particular attention is paid to
the necessity of separating the traditional fiscal policy operations of a
government-funded rescue mechanism from the traditional monetary
policy operations of a central bank. The author also draws compari
sons between the RFC of the 1930s and today’s Resolution Trust Cor
poration, created by Congress to manage the thrift industry crisis of
the late 1980s.

White- and Blue-Collar Jobs in the
Recent Recession and Recovery:
Who’s Singing the Blues?
by Erica L. Groshen arid Donald R. Williams

Introduction
Was the 1990-91 recession predominantly
“white collar,” as many analysts and media
reports have claimed? And if so, did this public
focus on the layoffs of managers, professionals,
and scientists arise because the downturn hurt
white-collar workers more than their blue-collar
counterparts, or because their plight was some
how worse than in previous recessions? This
paper examines these questions by analyzing
the absolute and relative severity of the recent
recession for both occupational groups, using
aggregate data from the Bureau of Labor Statis
tics (BLS) for the six downturns since I960.1
Our results show that during the 1990-91
slump, the labor market faced by blue-collar
workers was worse and deteriorated more than
the white-collar job market. However, the lack
of white-collar employment growth was un
usual by historical standards. Furthermore, the
latest recession was harsher than most previous

Erica L. Groshen is an economic
advisor at the Federal Reserve Bank
of Cleveland, and Donald R. W il
liams is an associate professor of
economics at Kent State University.
The authors are grateful to John
Stinson and Thomas Nardone of
the Bureau of Labor Statistics for
providing unpublished data, to
Mark Sniderman and Patricia
Beeson for helpful discussions,
and to Colin Drozdowski for re
search assistance.

ones for white-collar workers, but milder than
the historical median for blue-collar workers.
The 15 months of recovery beginning in May
1991 also sent contradictory signals, but clearly
stacked up as the weakest rebound ever for
both occupational groups.
One difficulty in answering the questions
posed here is pinpointing the trough of the
1990—91 recession. For previous downturns, we
use the peak and trough months designated by
the National Bureau of Economic Research
(NBER). Because the trough of the recent reces
sion has not yet been named, we follow the
lead of many analysts who, using the same gen
eral criteria as the NBER, conclude that April
1991 will eventually be chosen.2 In section V,
we compare the pace of the current recovery for
white- and blue-collar workers and consider how
our qualitative conclusions might change if May

■

1 For further comparisons between the 1990-91 recession and pre
vious ones, we refer readers to McNees (1992). For a description of other
labor market conditions during the recent recession, see Meisenheimer,

Mellor, and Rydzewski (1992).

2 The day before this article went to press, the NBER’s Business
Cycle Dating Committee, which is the official arbiter of the economy’s
peaks and troughs, designated March 1991 as the trough of the 1990-91
recession. Fortunately, our assumed trough is only one month later, and
experiments conducted with several alternative dates do not affect our
qualitative results. A set of slightly revised tables using March 1991 as
the trough is available from the authors upon request.

1991 through July 1992 were included in the re
cession. In general, experiments with alternative
troughs and with monthly measures do not affect
our results.3

I. Why Occupations
Are Affected
Differently by
Recessions
Conceptually, white-collar workers hold salaried
or professional jobs and usually do not perform
manual labor. In contrast, blue-collar workers
hold hourly jobs that generally involve some
physical tasks. O n average, white-collar posi
tions require more formal education and train
ing, while most blue-collar skills are acquired
relatively quickly, often on the job.
The reasons why economic downturns have
different impacts on these two groups hinge on
the various roles in the production process that
employees play. Historically, contractions have
had a muted effect on white-collar workers be
cause their employment is less closely tied to
production levels. Typically, when a U.S. com
pany faces falling demand, it cuts output and
lays off production (blue-collar) workers. By
contrast, white-collar workers are likely to be
retained in the short run. Their salaries are
generally considered part of the fixed costs of
operation, since their replacement costs (hiring,
training, and so on) are higher and their services
are not easily divisible. The employment of ac
countants and engineers by the auto industry,
for example, is not as cyclically sensitive as that
of assembly-line workers.
Second, the compensation plans of whitecollar workers are often more flexible than those
of their blue-collar counterparts. Thus, the ad
justment to an economic downturn may take
the form of lower profit shares or bonuses for a
firm’s white-collar staff, while blue-collar work
ers are more likely to lose their jobs.
Finally, the last 30 years have witnessed a
strong secular decline in the blue-collar share of
U.S. employment. Explanations for this phenom
enon include technological changes that con
serve on low-skill labor (such as automation)
and increased competition from less-developed
■ 3 Throughout this paper, recession-linked changes in employ
ment/unemployment are measured from the month of the previous peak
to the month of the trough. We do not investigate the possibility that
white- and blue-collar labor markets experienced different business cycle
lags. We also conducted analyses using three-month moving averages
(recommended by the BLS because of monthly variations in occupational
classifications) and found that our qualitative results were unaffected. For
ease of exposition, we present only the basic analysis here.
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Federal Reserve Bank of St. Louis

countries. Employment losses arising from such
structural shifts are most intense during a reces
sion, either because they actually induce the
slowdown or because cyclical drops in demand
force marginally productive employers to m od
ernize or to cease operations more quickly than
they would during an expansion. Thus, the over
all trend away from blue-collar employment also
tends to deepen recessions for these workers.
On the other hand, three factors peculiar to the
1990-91 recession suggest an enhanced impact
on white-collar workers this time around, and per
haps in future downturns. First, recessions do not
affect all industries equally. A slowdown will
exact a greater toll on white-collar workers if it is
centered in industries that employ a high percent
age of these employees. Downturns in the bank
ing, finance, or computer industries (all of which
led the way into the latest recession), for example,
will hit white-collar workers harder than dow n
turns in the auto industry. Second, the recent
growth in contracting out for traditional whitecollar functions (such as accounting, advertis
ing, and secretarial and design services) may
provide employers with a route for minimizing
the indivisibility of their white-collar staff. Con
sequently, as their customers cut back, service
providers will lay off the white-collar workers
whose services they used to farm out.
Finally, the absolute impact of a recession on
any group of workers will rise with that group’s
share of total employment and total labor costs.
The shift toward white-collar employment over
the past 30 years, when coupled with the rising
pay differential between white- and blue-collar
workers, suggests that employers may increas
ingly resort to white-collar layoffs when they need
to cut costs. Conversely, during a recovery, we
would expect labor market conditions to improve
more rapidly for those groups that suffered high
rates of temporary layoffs during the recession, as
well as for those with a strong secular growth
trend. For white-collar workers, these two influ
ences tend to work at cross-purposes.

II. Defining Collar
Color: The Data
The most comprehensive U.S. employment Figures
are gathered in the BLS’s monthly, householdbased Current Population Survey (CPS). At pres
ent, the BLS organizes occupational statistics in
to six broad categories: 1) managerial and pro
fessional specialties, 2) technical, sales, and
administrative occupations, 3) service occupa
tions, 4) precision production, craft, and repair

F I G U R E

U.S. Labor Market Indicators
by Major Occupational Group
Millions
80

1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991

Millions
7

6
5
4
3

2
1
0

1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991

Percent of labor force
18
C. Unemployment Rate

16
14

workers, 5) operators, fabricators, and laborers,
and 6) farming, forestry, and fishing occupa
tions. The first two categories are clearly whitecollar jobs, while the last three are distinctly
blue collar. Service occupations, on the other
hand, do not fit easily into either broad group.4
Since the BLS does not provide seasonally ad
justed data for services, we exclude this cate
gory from our analysis.5
These six occupational categories have been in
place only since the BLS changed its classification
system in January 1983. Fortunately, although the
change affected all levels of classifications, the
effect on the white-collar/blue-collar distinction is
minimal.6 The pre-1983 category “white-collar
occupations,” now officially dropped, contains
(with few exceptions) the same detailed occupa
tions now grouped into the first two categories
listed above.7 The occupations in the pre-1983
“blue-collar” classification plus the “farm worker”
category correspond roughly to the last three post1983 categories.8 The “service occupations” cate
gory has remained essentially the same.
Further assurance that the occupational group
ings are reasonably comparable over time can be
found by examining a time series of labor market
statistics. On the basis of answers recorded in the
CPS, the BLS divides the U.S. population into
three categories: the employed, the unemployed,
and persons out of the labor force. Those in the
latter category are not actively seeking employ
ment, usually because they work without pay in
the home or are retired, disabled, in school, or
too young. Seasonally adjusted employment
and unemployment totals and employment
rates over the January 1958 to July 1992 period are
presented in figure 1 for these three broad occupa
tional categories. No obvious discontinuities show
up in any of the series in January 1983.

'«Blue collar

■

4 Service occupations include workers in private households and in
the protective, health, food, and personal service industries. Like blue-collar
jobs, service jobs are usually paid hourly, may be somewhat physical in na
ture, and require only moderate to low levels of general education. But like
white-collar personnel, service workers generally produce intangible, nonstorable products.

6
4

2
0

4 - -

■ J___ L

W hite collar

J___ L

1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991

NOTE: All data are seasonally adjusted. Shaded areas indicate recessions. Ser
vice occupation data are estimated from totals and subtotals provided by the
BLS and thus should be interpreted with caution.
SOURCES: Data for 1958-77 and 1983-87 are from the U.S. Department of
Labor (1983, 1988). Data for 1978-82 were obtained directly from the BLS.
Data for 1988-91 are from the U.S. Department of Labor, Employment and
Earnings, various issues.

■

5 Seasonally adjusted data are not provided because the series is
too volatile.

■

6 For further discussion of the BLS changes, see the appendix.

■

7 The pre-1983 white-collar category includes professional and
technical workers, managers and administrators, sales workers, and cleri
cal workers.

■

8 The pre-1983 blue-collar category includes craft and kindred work
ers, operatives (except transport), transport operatives, and nonfarm laborers.
Our analysis adds farm workers to the pre-1983 data and includes farming,
fishing, and forestry workers in the post-1983 data to improve comparability
over time.

What is clear from the figure is that whitecollar and, to a lesser degree, service employ
ment grew dramatically over this period, while
blue-collar employment remained essentially
flat. Furthermore, the cyclical sensitivities of all
three series differ by occupational groupings. In
particular, panel C suggests that white-collar un
employment rates are both lower and less cycli
cal than blue-collar rates. Because the 1990-91
recession saw a dramatic increase in the number
of unemployed for both groups, these charts
alone cannot reveal whether the downturn can
accurately be termed white collar.
There are no definitive criteria for judging a
recession’s severity. Thus, we focus on a wide
range of employment and unemployment meas
ures, comparing particular points in time (how
bad things are at the trough) as well as changes
over the cycle (how much they deteriorated
from the peak).9 We examine both unemploy
ment and employment, each of which can be
charted by the number of workers so classified
or be combined into the unemployment rate.
Focusing on the unemployment rate helps to
mitigate problems of interpretation posed by
offsetting movements in the individual series.
The appropriateness of any particular meas
ure depends on the reason one is interested in
the white-collar/blue-collar distinction. For ex
ample, in order to target job services appropri
ately, the differential impact of the recession on
the pool of unemployed persons would be the
measure of choice. For those making or advising
others on career decisions, a measure of risk or
increase in risk of joblessness, such as the unem
ployment rate and its change, would be more
useful. And for those interested in placements
or office space needs, the employment-related
indicators would be of greatest relevance. Al
though we try to summarize across all measures
whenever possible, it is clear that sometimes
our answers are not entirely uniform.

III. Absolute
Measures

that blue-collar, not white-collar, workers bore
the brunt of the downturn.10
Beginning with unemployment measures
(rows 1 to 6 of table 1), we note that in April 1991,
even though white-collar workers accounted for
over half of total employment, they constituted
less than two-fifths of the unemployed, below the
blue-collar share (row 1).11 Less than half the in
crease in joblessness over the course of the reces
sion came from the white-collar ranks (row 2).
Furthermore, the white-collar unemployment rate
was less than half the blue-collar rate, with the latter
rising about twice as much from peak to trough
(row 5).
Only when we examine changes relative to the
base of unemployment at the beginning of the re
cession (rows 3 and 6) does the increase in whitecollar unemployment appear comparable to, or
slightly worse than, that for blue-collar workers.
That is, these measures tell us that the pool of un
employed became slightly more white collar over
the course of the downturn, although it was still
dominated by other occupations.
The employment measures presented in rows
7 through 9 of table 1 also offer little evidence
of a w^hite-collar recession. Blue-collar employ
ment shrank about 3 percent, while the number
of white-collar positions actually expanded, al
beit slowly. In fact, since the white-collar and
service occupations added jobs, the decline in
blue-collar slots actually accounted for more
than the total number of jobs lost.
To evaluate the recession and its aftermath as
a whole, we repeated the analysis assuming a
trough of July 1992. The results are reported in
the last three columns of table 1. Although this
change does not alter the qualitative conclusions
discussed above, it does make the recession
appear somewhat worse for white-collar work
ers when judged by unemployment measures.
For every unemployment labor market indicator,
extending the period of analysis raises the value
of the white-to-blue-collar ratio. For employ
ment measures, on the other hand, considering
the whole period improves the picture for
white-collar personnel.

To determine whether white-collar workers suf
fered disproportionately during the 1990-91
recession, we examine a variety of labor market
indicators for the period. These figures reveal

■

10 These results are qualitatively similar to those obtained using
preliminary data for February 1990 through February 1991, reported in
Eberts and Groshen (1991).

■

9 Other nonemployment indicators that would be interesting to in
vestigate are income, wealth, bankruptcy rates, or unemployment in
surance changes over the course of the recession. Unfortunately, data for
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many years are not available.

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■

11 The blue-and white-collar shares of employment and un
employment do not sum to 100 percent because service occupations are
excluded.

TAB L E

Impact of the 1990-91 Recession on
White- versus Blue-Collar Workers
July 1990-April 1991
w ca
(percent)

Labor Market Indicator
Unemployment measures
Share of employment at end of period
Share of increase in unemployment
Percent increase in unemployment
Unemployment rate at end of period
Change in unemployment rate
Percent increase in unemployment rate
Employment measures
Share of employment at end of period
Share of employment change
Percent change in employment

BCb
(percent)

July 1990-July 1992

WC/BC
(ratio)

WC
(percent)

BC
(percent)

WC/BC
(ratio)

39.2
46.6
26.9
4.2
0.9
25.4

44.5
46.1
22.7
9.0
1.7
23.9

0.88
1.01
1.19
0.47
0.53
1.07

39.8
45.6
47.1
4.8
1.4
42.4

42.5
38.3
33.7
9.8
2.5
34.5

0.94
1.19
1.40
0.49
0.57
1.23

57.5
-20.6
0.3

28.8
121.5
-2.8

2.00
-0.17
-0.10

57.8
-953.2
1.8

28.6
935.5
-3.3

2.02
-1.02
-0.55

a. White collar.
b. Blue collar.
NOTE: All data are seasonally adjusted. Because seasonally adjusted data are not available for service occupations, they are omitted from the
table. In April 1991, total unem ploym ent was 7,568,000 and total employment wai? 116,844,000. In July 1992, total unem ploym ent was
8,843,000 and total em ployment was 117,759,000. Blue- and white-collar shares of unemployment and employment do not sum to 100 percent
because service occupations are omitted.
SOURCE: U.S. Department o f Labor (1983,1988, Employment and Earnings, various issues).

iB S fg fffS P

TABLE

White- and Blue-Collar
Unemployment during Recessions
Peak to Trough Increase
in Unemployment
(thousands of workers)

Peak to Trough
Percent Increase in
Unemployment

Unemployment Rate
at Trough
(percent)

Recession

W Ca

BCb

1960-61

244

722

36.2

1969-70

557

984

32.5
64.6

68.6

3.3
3.6

Peak to Trough
Percent Increase in
Unemployment Rate
WC

8.8

28.1

7.4

61.0

37.9
68.1

1973-75

935

2,330

77.2

125.7

4.8

11.9

69-6

126.1

1980

244

1,122

13.2

38.2

3.8

10.9

11.2

41.0

1981-82

978

2,284

44.2

64.8

5.6

15.6

39.6

67.5

1990-91

628

622

26.9

22.7

4.2

9.0

25.4

23.9

a. W hite collar.
b. Blue collar.
NOTE: All data are seasonally adjusted. April 1991 is estimated trough o f 1990-91 recession.
SOURCE: U.S. Department o f Labor (1983, 1988, Employment and Earnings, various issues).

D
TABLE

White- and Blue-Collar
Employment during Recessions
Peak to Trough Change
in Employment
Peak to Trough Percent
(thousands of workers) Change in Employment
Recession

W Ca

BCb

1960-61

760

-1,110

2.7

-3.8

1969-70

308

-894

0.8

-2.9

1973-75

989

-2,395

2.4

-7.2

1980

736

-1,888

1.4

-5.4

1981-82

844

-2,903

1.6

1990-91

167

-985

0.3

-8.5
-2.8

a. W hite collar.
b. Blue collar.
NOTE: All data are seasonally adjusted. April 1991 is estimated trough of
1990-91 recession.
SOURCE: U.S. Department of Labor (1983, 1988, Employment an d Earnings,
various issues).

IV. A Historical
Perspective
Since the 1990-91 recession was clearly not a
white-collar one judged by the absolute criteria ex
amined above, we now refocus on whether whitecollar workers were hit harder than in the past.
First, we compare their unemployment experience
during the latest recession to recent patterns. Next,
we compare their employment experience during
past recessions to the latest pattern. Finally, we
compare the relative historical severity of the re
cent recession for white-collar workers (using both
employment and unemployment measures) to
that for blue-collar workers.
Was white-collar unemployment higher or
did it increase more during the latest recession
than in the earlier downturns? The answer is no.
Table 2 presents separate white- and blue-collar
unemployment-based measures of severity for
the six most recent recessions. Column 1 shows
that the number of jobless white-collar workers
rose by greater absolute amounts in both the
1973-75 and 1981-82 downturns. In percentage
terms (column 3), which control for burgeoning
white-collar employment, the current whitecollar increase in joblessness is the second low
est. Turning to unemployment rates, columns 5
and 7 show that the white-collar rate at the
1990-91 trough was lower than in two previous
recessions and that it increased less than in four

previous recessions. Thus, using the yardstick
of their own unemployment in previous slow
downs, white-collar workers did not appear to
fare worse this time.
Was job creation particularly slow for whitecollar workers? Most definitely. Table 3 reports
changes in employment during the six most re
cent recessions. Columns 1 and 3 reveal a strik
ing difference between the 1990-91 episode
and the previous five. White-collar employment
growth during the latest downturn was by far
the slowest observed. And although the meager
addition of 167,000 white-collar jobs is still bet
ter than the drop in blue-collar employment dur
ing the mildest recession examined, in light of
the previously unabated growth of white-collar
jobs, this stall clearly sets the 1990-91 recession
apart. The disparity between the unemployment
and employment results must stem either from
a drop in white-collar labor force participation
or from a switch to blue-collar or service jobs.
In a historical sense, was the latest recession
relatively more severe for white-collar than for
blue-collar workers? Unlike the previous two
questions, this one requires looking at a wide
variety of indicators. Table 4 presents five pos
sible ways of approaching the issue. The first
column, provided for comparison purposes,
shows the growth in white-collar workers’ share
of total employment over the past 30 years. If
white-collar jobs were as cyclically sensitive as
blue-collar and service jobs, then column 2,
which reports the white-collar share of employ
ment change, would be identical to column 1.
Instead, these numbers are uniformly negative,
indicating that white-collar employment con
tinued to expand while total employment fell.
Column 3 of table 4 shows that although
white-collar workers remained a minority of the
unemployed in April 1991, they still constituted
a greater percentage than during all five pre
vious recessions. What’s more, column 4 indi
cates that the current white-collar share of
additions to the unemployment line is also at a
record high. These numbers, while lower than
the white-collar share of jobs, represent substan
tial and historically high percentages.
We saw in figure 1 that the highest jobless
rate reached by white-collar workers (more than
5 percent in 1982) barely approaches the lowest
rates experienced by blue-collar workers over
the last decade. Hence, column 5 of table 4
focuses on the gap between the two rates. The
white-collar unemployment rate for April 1991 is
almost half that of blue-collar workers. Historically,
it is the second highest white-to-blue-collar ratio,
just barely superseded by the 1969-70 downturn.

T A B L E

Relative Employment and
Unemployment Measures
during Recessions
White-Collar Percent of:

White-Collar/Blue-Collar Ratio of:

Employment_______________Unemployment
Recession
1960-61

Level at
Trough

Unemployment

Increase in

Change, Peak
to Trough

Rate at
Trough*

Unemployment Rate,
Peak to Troughb

Level at
Trough

Change, Peak
to Trough

44.4

3,304.4

22.9

21.5

0.38

0.74

32.1

1969-70

48.7

-68.9

31.6

0.49

0.90

1973-75

50.1

-92.9

29.0

25.8

0.40

0.55

1980

-58.7

26.2

0.35
0.36

0.27

-54.5

28.3
29.7

15.6

1981-82

52.9
54.4

1990-91

57.4

-20.6

39.2

43.6

0.47

1.07

0.59

a. Ratio o f colum n five to colum n 6 in table 2.
b. Ratio of colum n 7 to colum n 8 in table 2.
NOTE: All data are seasonally adjusted. April 1991 is estimated trough of 1990-91 recession.
SOURCE: U.S. Department of Labor (1983, 1988, Employment and Earnings, various issues).

TAB L E

■

Relative Rankings of
Severity of Recessions
Criterion

Recession

(IV)
Percent
Unemployment
Change in
Rate at
Unemployment
Trough
Rate

(I)

(ID

Absolute
Increase in
Number
Unemployed

Percent
Increase in
Number
Unemployed

(III)

W Ca

BCb

(V)
Absolute
Change in
Number
Employed

(VI)
Percent
Change in
Number
Employed

1960-61

5
2

1969-70

1973-75

1980

1981-82

1990-91

3
6

a. W hite collar.
b. Blue collar.
NOTE: 1 = most severe, 6 = least severe.
SOURCE: Derived from tables 2 and 3.

T A B L E

White- and Blue-Collar Employment
and Unemployment during the First
15 Months of Recovery

Percent Change
in Employment
Recession
1960-61

Percent Change
in Unemployment

Unemployment
Rate

Change in
Unemployment
Rate

Percent of Increase
in Unemployment
Rate Recovered3

w cb

BCc

1.4

1.0

-21.7

2.6

6.5

-0.7

101.2

95.5

1969-70

1.8

6.6

-1.2

-17.3
-10.8

3.5

6.2

-0.1

-2.3
-1.1

7.4

37.8

1973-75
1980d

3.5
1.6

5.1

3.0

-22.2

4.8

9.1

0.0

-2.8

1.2

2.9

6.1

-13.2

4.0

9.3

0.2

-1.5

-43.0

42.3
48.7

1981-82

5.2

5.9

-25.1

-37.2

4.1

-5.7

97.4

90.0

1.5

-0.5

15.9

9.0

4.8

9.9
9.8

-1.5

1990-91

0.6

0.8

-66.6

-44.7

a. Defined as the change in the unem ploym ent rate over the 15 months following the trough, divided by the rise in the unem ploym ent rate
from the previous peak to the trough.
b. W hite collar.
c. Blue collar.
d. Because the recovery following the 1980 recession lasted only seven months, we present statistics for July 1980, the next peak.
NOTE: April 1991 is estimated trough o f 1990-91 recession.
SOURCE: U.S. Department of Labor (1983, 1988, Employment an d Earnings, various issues).

What about relative increases in the propor
tion of unemployed? Column 6 of table 4
reports the ratio of the percentage increase in
the white-collar unemployment rate to that for
blue-collar employees. In all five previous reces
sions, white-collar jobless rates increased
proportionally less than blue-collar rates (that is,
the ratio was less than one). Only in the recent
downturn was the opposite true.
By the five measures considered in table 4, the
1990-91 recession appears to have been deeper,
in a historical sense, for white-collar than for bluecollar workers. To reinforce this point, table 5
presents the results discussed earlier in a different
form. We rank each recession according to the
various criteria considered above, side by side for
both groups of workers. Among white-collar
employees, the harshest downturns occurred in
1973-75 and 1981-82, using the unemployment
criteria (I-IV). Using those (within-white-collar)
criteria, the 1990-91 recession ranks either third or
fifth in terms of severity. However, when changes
in employment (criteria V and VI) are considered,
the latest downturn was the deepest for white-collar
workers. For blue-collar workers, it does not rank
above fourth for any of the measures listed above.
For a relative perspective, we next compare
the rankings of white- and blue-collar workers
for each recession. For example, by criterion I,

the 1990-91 recession was relatively deeper for
white-collar workers (third compared to sixth in
severity). Using this approach and considering
all six criteria (particularly the employmentbased gauges), the latest downturn ranks consis
tently more severe for white-collar workers. This,
then, is one sense in which the recent recession
is more white collar than earlier downturns.

V. How Have
White-Collar
Workers Fared
since April 1991?
Table 6 compares various measures of whiteand blue-collar workers’ relative performance
between April 1991 and July 1992 with the first
15 months of recovery after the earlier reces
sions. In the past, the lower cyclical sensitivity
of white-collar jobs has meant that recoveries
were felt most strongly in the blue-collar job
market. Historically, during the first 15 months
after a trough, both blue- and white-collar employ
ment has risen, but blue-collar employment has
usually picked up at least as fast, and often much
faster, than the white-collar numbers, presumably
reflecting workers recalled from temporary layoffs.
Similarly, the ranks of the blue-collar unemployed

KQ
have shrunk faster than those of jobless whitecollar workers, which have sometimes con
tinued to rise after the trough.
If we use the unemployment rate at the pre
vious trough as a benchmark, we can measure the
extent to which labor markets recover in the first
15 months after a recession. Column 9 presents
such estimates for each of the earlier recessions.
For instance, by May 1962, 15 months after the
February 1961 trough, the white-collar unemploy
ment rate had already subsided to slightly below
its level at the previous peak. In contrast, 15
months after the next trough, it had fallen by only
7.4 percent of the amount it had climbed between
December 1969 and November 1970. Comparing
the white-collar and blue-collar extents of recov
ery in columns 9 and 10, respectively, reinforces
the notion that the pace of recovery tends to be
faster in the blue-collar job market.
The bottom row lists figures for the current
recovery. Columns 1 and 2 show that employ
ment of white-collar workers has increased,
while blue-collar jobs have continued to con
tract. Nevertheless, column 3 indicates that
white-collar unemployment has risen rather than
fallen — which also happened after two earlier
downturns, though not nearly as dramatically.
This suggests that entrants into the white-collar
labor market are far outstripping increases in
available positions, raising joblessness much
more rapidly in the white-collar ranks. The 9.0
percent uptick in blue-collar unemployment
since April 1991 is uncharacteristic of recent re
coveries. Unemployment rates have risen for
both white- and blue-collar occupations, with
the white-collar rate adding another two-thirds
of what it gained before April 1991, and the
blue-collar rate adding almost half again what it
had gained before.
Although this analysis of recoveries suggests
that the current one is particularly weak, it does
not contradict our previous conclusions. Labor
market conditions for blue-collar workers con
tinue to be worse than for their white-collar
counterparts. Judged by employment measures,
this recovery is slow for white-collar workers,
but not unusually so, while blue-collar workers’
losses are unprecedented. Furthermore, unem
ployment indicators for May 1991 through July
1992 hardly point to a recovery for either type
of worker. Although it is not unusual for whitecollar joblessness to pick up during recoveries,
the current rise is uncharacteristically large. And
since I960, no other recovery has seen a net
increase in blue-collar unemployment over the
15 months following the trough.

VI. Conclusion
This paper investigates whether the recession that
began in July 1990 can accurately be characterized
as white collar. We examine the employment/
unemployment status of white- and blue-collar
workers during the latest downturn and in the five
post-1960 recessions in order to address the ques
tion from various angles. The answer we offer
depends crucially on how the question is posed.
The absolute, narrowly focused question of
whether white-collar workers bore the brunt of
the recent recession yields a strong no: Blue-collar
workers suffered larger unemployment increases
and job losses and experienced higher unemploy
ment rates. And when we ask whether the level
of, or the increase in, white-collar unemployment
reached a historical high, the answer is also an un
equivocal no. By every measure considered here,
the 1990-91 recession was less severe in this
respect than at least two previous downturns.
But when we ask whether the growth of
white-collar employment fell to a record low for
a recession, the answer is a definite yes. Whitecollar job growth essentially stopped during the
latest downturn, as opposed to just slowing, as
it did in the previous five episodes.
Furthermore, when we ask whether, com
pared to their own experience in the earlier reces
sions, this one had a more severe impact on whitecollar workers than on their blue-collar counter
parts, the answer is also yes. In particular, when
measured relative to their own history of employ
ment changes during recessions, white-collar
workers were clearly hit disproportionately hard.
By all employment/unemployment criteria exam
ined here, the latest downturn for white-collar
workers ranks worse, in a historical sense, than
the downturn for blue-collar workers.
Last, when we ask whether white-collar work
ers are lagging their blue-collar counterparts dur
ing the current recovery, the answer is less clear.
The 15 months beginning in May 1991 rank as the
weakest historically for both occupational groups,
particularly for blue-collar workers.
Any explanation for the pattern of occupa
tional impact seen in the 1990-91 downturn
will ultimately require further analysis of secular
changes in the structure of employment. Per
haps the changes in the white-collar labor mar
ket that we attribute to the recession in fact
reflect a long-run shift in the previously uninter
rupted growth of white-collar jobs, as suggested

ID
in Cappelli (1992).12 If so, the 1990-91 employ
ment decline and tepid recovery may actually
be the result of increased permanent, rather
than cyclical, trimming of the corporate whitecollar work force.13
Also of interest is why the recent recession
slowed white-collar employment relatively more
than it raised unemployment. Since losing one’s
job is usually a ticket to the unemployment line,
the dissimilar results for these two measures
present a puzzle. What did the displaced whitecollar workers do during the recession instead
of joining the ranks of the unem ployed?14 And
do their activities explain the sharp rise in whitecollar unemployment during the recovery?
Until CPS data files with individual responses
are released for analysis, we cannot answer
these questions, but we can list some intriguing
possibilities. White-collar workers may have
delayed or avoided entry (or reentry) into the
labor market by pursuing more education or
training, by accepting early retirement offers, or
by performing nonmarket activities in the
home. Alternatively, they may have worked,
perhaps temporarily, at blue-collar or service
jobs. The answer should provide insights into
the labor market of the 1990s, since these pos
sibilities have different implications for both the
composition and quality of the work force.
Finally, our conclusion that the 1990-91 down
turn was more white collar than usual should not
obscure the overriding fact that, judged by
employment/unemployment criteria, recessions
still exact a greater toll on blue-collar workers. By
all measures examined here, the harshest reces
sions experienced by white-collar workers barely
measure up to the mildest suffered by their bluecollar counterparts. In any absolute sense, the
1990-91 slump was clearly a blue-collar recession,
like all those at least as far back as I960.
■

12 Also consistent with this hypothesis is evidence of a shift in the
industrial distribution of displaced workers during the 1980s away from
manufacturing and toward the service and retail trade industries (see
Podgursky [1992]).

■

13 In fact, this recovery has been characterized by a dramatic in
crease in the percentage of job losers across all industries who expect
their layoffs to be permanent (see Altig and Bryan [1992] and U.S. Depart
ment of Labor [1992]). In general, layoffs from nonmanufacturing jobs
are much more likely to be permanent.

■

14 Of course, these numbers are not strictly contradictory. The
number of unemployed white-collar workers has increased by 628,000,
while white-collar jobs have grown little. However, as our analysis indi
cates, it is this recession’s employment growth that was particularly slow.
Thus, it may be more appropriate to think of the total number of white-collar
jobs lost as the number that would have been created had the secular trend
toward increased white-collar employment continued unabated. The unusual
spurt in white-collar unemployment during the early months of the recovery
http://fraser.stlouisfed.org/
may also be part of the story.

Federal Reserve Bank of St. Louis

Appendix
In January 1983, the BLS changed its occupation
classification system from the Dictionary of Oc
cupational Titles to the Standard Occupational
Classifications (see Green et al. [19831). Fortu
nately, although the shift affected all levels of
classifications, we believe that the effect on the
white-collar/blue-collar distinction is minimal.
The few instances in which the reclassifica
tion moved workers across broad occupational
categories are listed in table A-l. Were such
movements substantial, they could compromise
the comparability of the data over time. Using
1982 employment figures, about 200,000
workers were moved from white collar to blue
collar, 123,000 from blue collar to white collar,
409,000 from services to white collar, 7,000
from white collar to services, and 8,000 from
blue collar to services.
The total number of individuals reclassified
constitutes less than 1 percent of U.S. employ
ment, and the largest individual change,
moving practical nurses from services to white
collar, affects less than half of 1 percent of total
employment in 1982. Thus, we feel reasonably
confident that the reclassification is unlikely to
have affected our qualitative results.

D
T A B L E

A- 1

Effect of 1983 Change in the BLS
Occupational Classification System
Moved
---------------------------From
To

Occupation

1982
Employment

Percent of
Total 1982
Employment2

Ship officers, pilots, and pursers

WCb

BCC

41,000

0.04

Inspectors (not elsewhere classified)

136,000

Railroad conductors

23,000

0.13
0.02

Decorators and window dressers

123,000

0.12

Health trainees

Services

9,000

0.01

Practical nurses

Services

400,000

0.40

Therapy assistants

Services

7,000

0.01

Urban rail conductors

Services

8,000

0.01

a. Total employment in 1982: 101,206,000.
b. W hite collar.
c. Blue collar.
SOURCE: Unpublished data from the U.S. Department o f Labor, Bureau o f Labor Statistics.

References
Altig, David, and Michael F. Bryan. “Can Con
ventional Theory Explain the Unconvention
al Recovery?” Federal Reserve Bank of
Cleveland, Econom ic Commentary’, April 15,
1992.
Cappelli, Peter. “Examining Managerial Displace
ment,” Academ y o f M anagem entJou rn al,
vol. 35, no. 1 (March 1992), pp. 203-17.
Eberts, Randall W., and Erica L. Groshen. “Is
This Really a ‘White-Collar Recession?” Fed
eral Reserve Bank of Cleveland, Econom ic
Commentary, March 15, 1991.
Green, Gloria P., Khoan tan Dinh, John A.
Priebe, and Ronald R. Tucker. “Revisions in
the Current Population Survey Beginning in
January 1983,” Em ploym ent a n d Earnings,
February 1983, pp. 7-17.
McNees, Steven K. “The 1990-91 Recession in
Historical Perspective,” Federal Reserve Bank
of Boston, New E ngland Econom ic Review,
January/February 1992, pp. 3-22.

Meisenheimer, J.R., Earl F. Mellor, and L.G. Rydzewski. “The Job Market Slid in Early 1991,
Then Struggled to Find Footing,” M onthly
Labor Review, vol. 115, no. 2 (February
1992), pp. 3-17.
Podgursky, Michael. “The Industrial Structure of
Job Displacement, 1979-89,” M onthly Labor
Review, vol. 115, no. 9 (September 1992),
pp. 17-25.
U.S. Department of Labor, Bureau of Labor Sta
tistics. Labor Force Statistics Derived from
the Current P opulation Survey, 1948-1981.
Washington, D.C.: U.S. Government Printing
Office, 1983.
______ . Labor Force Statistics Derived from the
Current P opulation Survey, 1948-1987.
Washington, D.C.: U.S. Government Printing
Office, 1988.
______ . Issues in Labor Statistics, Sum m ary
92-8. Washington, D.C.: U.S. Government
Printing Office, July 1992.
______ . Em ploym ent a n d Earnings, various
issues (monthly).

Assessing the Impact of Income
Tax, Social Security Tax, and
Health Care Spending Cuts
on U.S. Saving Rates
by Alan J. Auerbach,
Jagadeesh Gokhale,
and Laurence J. Kotlikoff

Introduction
Economists and policymakers have been ex
pressing concern of late about the prospects for
U.S. economic growth. Foremost among their
concerns is the recent decline in U.S. saving.
The net national saving rate, which averaged
8.5 and 4.7 percent in the 1970s and 1980s, re
spectively, registered an abysmal 1.7 percent in
1991 (see table 1). Many fear that continued low
saving will constrain investment and cause
productivity to stall in the future.
The total amount of saving is determined by
several factors. Among them are the degree of
uncertainty about future economic outcomes,
the extent of foresight exercised by households
in anticipating future needs, the demographic
composition of the population, the complete
ness of financial and insurance markets, and the
thrust of government economic policies. Current
projections suggest that two particular factors
will play an important role in determining the
future course of U.S. saving: the demographic
transition currently under way and the chroni
cally increasing costs of health care. Both may
pose serious obstacles to achieving greater
saving in the future.

Alan J. Auerbach is a professor of
economics at the University of
Pennsylvania and an associate of
the National Bureau of Economic
Research, Jagadeesh Gokhale is an
economist at the Federal Reserve
Bank of Cleveland, and Laurence
J. Kotlikoff is a professor of eco
nomics at Boston University and
an associate of the National Bu
reau of Economic Research. The
authors thank Charles T. Carlstrom,
Erica L. Groshen, and Alan Viard for
helpful comments, Edward Bryden
and Susan Byrne for research assis
tance, and John Sabelhaus for criti
cal data on consumption.

Debate continues on how best to reform Social
Security and Medicare to meet these challenges.
Further, many economists recommend greater fis
cal stimulus by way of income-tax cuts for achiev
ing faster rates of economic growth. Although the
likely impact of these policies on national saving
is obviously important, little direct attention has
been paid to it, probably because these policies
are not motivated primarily by a desire to influ
ence saving.
Economic theory suggests that individuals’ con
sumption and saving decisions are intimately re
lated to the amount of their available resources —
their net worth and expected future income. For
an individual, the net availability of resources de
pends, in part, on the size of the fiscal burden im
posed by government tax and transfer policies.
Thus, measuring the impact on saving of a given
policy change requires prior estimation of the
policy-induced changes in the fiscal burdens fac
ing members of different generations. This can be
done by using generational accounting. Else
where, we have used this method to explore the
impact of alternative fiscal policies on U.S. saving
rates.1 This Economic Review applies the same
■

1 See Auerbach, Gokhale, and Kotlikoff (1992a,b) and Kotlikoff (1992).
In addition, see Office of Management and Budget (1992), chapter 26.

TABLE

Saving Rates in the United States
(percent of net national product)
Personal

Private

National

1960-1969
1970-1979
1980-1984

7.2
8.6
8.7

11.8
11.9
10.4

9.1
8.5
5.8

1985
1986
1987
1988
1989
1990
1991

6.7
6.6
4.0
4.1
5.0
6.0
6.4

9.6
8.3
6.5
7.2
7.1
7.2
—

4.4
3.0
2.7
3.6
4.0
2.9
1.7

Years

NOTE: Personal saving is defined as saving by households. Private saving is
defined as personal saving plus saving by businesses. National saving is
defined as private saving plus saving by the U.S. government.
SOURCE: Authors’ calculations based o n the Economic Report o f the Presi
dent, February 1992, various tables.

for the maximum age of life; R = 1/(1+ r), with
r being an exogenously given rate of return on
capital; Ct stands for consumption, Wt for wages,
and 7] for net payments — taxes net of transfer
receipts — made to the government during
period t. The right side of equation (2) equals the
present value of resources, PVR0, where the first
term, A 0, is current nonhuman wealth, the second
temi is human wealth, and the third term is the
present value of net payments made to the gov
ernment over the remaining lifetime — the indi
vidual’s generational account.
Consider the special case where u (C t) equals
log (C t), where there are only two periods in a
lifetime (youth and old age), and where individ
uals possess no assets when young and work
only during the first period. In this case, it is easy
to verify that optimum consumptions when
young and old are
PVR.,
= ---- —

(3)
v

(1 + P)

and
method to examine the likely impact of alterna
tive Social Security and Medicare policies on
U.S. saving rates.

I. The Analytical
Framework2
As mentioned earlier, policy-induced changes
in the fiscal burdens facing different generations
affect their net resource availabilities and, hence,
their consumption. As a simple illustration, con
sider an economy in which individuals choose
consumption profiles to maximize remaining
lifetime utility denoted by

T—a
(1)

^ = I P

‘ u(Ct),

t= 0

subject to the budget constraint

T- a

t —0

t= 0

(2) £ «'c,=^0+x r' w.-'L

r' t,.

Here, u(.) denotes a single-period utility func
tion and (3 a time preference factor. The individ
ual’s current age is denoted by a, and T stands

■ 2 The appendix contains a more detailed account of the method
http://fraser.stlouisfed.org/
and data used.
Federal Reserve Bank of St. Louis

t p vs,

c- = (PVR ,, - c ; ) / R = (1 + p ) - = PVR „,

where subscripts y and o designate values
when young and old, respectively, and super
script * denotes optimum value. Reasonable
values of P , ((3 < 1 ), yield propensities to con
sume out of PVR that rise with age. Such pro
pensities are qualitatively consistent with the
empirical evidence. In the two-period example,
letting Wy = 90, W0 = 0, Tv= To = 20, R = 0.5,
and P = 1 produces PVR y = PVR 0 = 60. The
capital stock is 40 and total income per period is
130. O f the total (170) disposable resources
each period, the government consumes 40, C
= 30, C’/ = 60, and saving by the young is 40.
Now consider a tax-cut policy: The govern
ment continues to consume 40, but reduces T0
by 5 for just one period. The debt so generated
is serviced by increasing Ta to 25 in every sub
sequent period, the additional tax being used to
pay interest on the initial borrowing of 5. The
generation that is old when the policy change
occurs enjoys a reduced tax liability and, follow
ing the consumption rule, increases its con
sumption by 5, to 65. Saving in this period is
thus depressed to 35. Clearly, if T , rather than
T0, had been reduced by 5, saving would have
fallen to 37.5 in the first period. Further, if govern
ment spending had declined simultaneously with
the decrease in T0, saving would have remained

TABLE

Current and Projected Population
Proportions for Selected Age Groups
(percent)

Year

1990
2000
2010
2020
2030
2040
2050

Share of Persons
Not in the Labor
Force to Those
in the Labor Force:
(P-LF )/ LF *

Age Group
0-16

17-64

65 +

24.54
24.23
22.09
21.01
20.38
19.78
19.64

63.18
63.16
64.67
62.52
59.35
59.21
59.26

12.28
12.62
13.24
16.47
20.27
21.01
21.10

1.12
1.10
1.09
1.15
1.23
1.25
1.26

a . P = total population, LF = labor force.
SOURCE: Authors’ calculations based on the Social Security Administration’s
Alternative II Population Projections. Data on the labor force were obtained
from the U.S. Department o f Labor, Bureau of Labor Statistics.

unchanged; it would have increased if the tax
cut had instead been bestowed on the young.
The impact on saving thus depends not only
on the amount of the tax cut, but also on who re
ceives it. In addition, it hinges on whether and by
how much government consumption spending is
altered. Estimates of policy-induced changes in
the net tax liabilities for each generation provided
by generational accounting can, therefore, be
combined with estimates of propensities to con
sume out of resources to assess the resulting
change in aggregate saving. The saving estimates
reported in this paper are based on a model in
which individuals’ economic life spans extend
from age 18 through 90. Age-specific consump
tion propensities estimated from the Bureau of
Labor Statistics’ Consumer Expenditure Survey are
used in the calculations.
Three caveats must be considered when eval
uating the results from experiments based on such
a procedure. First, this procedure ignores incentive
and price effects of policy changes. For example,
policies that alter marginal tax rates may introduce
a further indirect effect on saving by causing some
individuals to revise their labor supply decisions.
The model also ignores effects arising from
changes in factor prices, which may be large espe
cially if policy shifts are expected to be temporary.
In general, however, these effects will reinforce
the direction of change in saving rates induced by

the income effects described above. For exam
ple, policies that boost saving rates by redistrib
uting resources away from older generations
will tend to increase the capital stock and,
hence, to reduce interest rates and raise wage
rates. These factor price changes will reinforce
the redistribution of resources away from older
generations and further augment saving rates.
Estimates from policy simulations in Auerbach
and Kotlikoff (1987) suggest that such wage and
interest-rate changes occur only slowly. Because
of discounting, the long-run impact of factor
price changes on the present value of resources,
and thus on saving, is likely to be small.
Second, if the change in policy is partially
anticipated, experiments that assume the change
to be unanticipated will overstate the saving im
pact. Third, some policy changes affect the de
gree of uncertainty about future economic
events, especially regarding income and govern
ment transfer receipts, and thus may influence
households’ propensities to consume out of
resources. In general, consumption propensities
will be lower if policy changes increase the de
gree of uncertainty regarding future economic
outcomes.3 As yet, however, there exist no reli
able estimates of how changes in uncertainty
regarding future income affect average and mar
ginal propensities to consume out of resources.

II. The Policy
Experiments
Social Security and
Income Tax Policies
In the United States, the baby boom generations
will begin to retire in about 20 years. According
to table 2, individuals above age 65 currently
make up about 12 percent of the population. By
2030, however, their proportion will grow to
about 20 percent. Table 2 also shows that the
proportion of young individuals in the popula
tion is projected to decline over the same
period. The last column of the table reveals that
as the baby boomers begin to retire, the ratio of
individuals not in the labor force to those who
are in it may be expected to increase from its
current level of 1.12 to 1.15 by 2020, and to at
tain levels greater than 1.20 in the following dec
ades. The need to support a growing number of
dependents will undoubtedly reduce the ability
of future working generations to save.

■ 3

See Carroll (1992).

TABLE

Changes in the Net National Saving
Rate Due to Alternative Social
Security and Income-Tax-Cut
Policies (percentage-point change)
Reduce Social Security Taxes

Year

1990
1995
2000
2005

Dissipate the Social
Security Surplus

Reduce Income Tax

Increase SS
taxes after
2020

Reduce SS
benefits after
2020

Increase
income tax
after 2020

Increase SS
taxes after
2020

Reduce SS
benefits after
2020

Increase
income tax
after 2020

Lower
government
consumption

(la )

(lb )

(lc)

(2a)

(2b)

(3a)

(3b)

-0.40
-0.51
-0.60
-0.67

-0.08
-0.11
-0.14
-0.17

-0.34
-0.43
-0.51
-0.56

-0.89
-0.68
-0.72
-0.67

-0.72
-0.47
-0.48
-0.40

-0.41
-0.51
-0.59
-0.66

0.58
0.58
0.47
0.32

SOURCE: Authors’ calculations.

Anticipating these demographic trends, the
1983 amendments to the Social Security law
sought to switch from a pay-as-you-go system to
one funded by 1) raising current Social Security
taxes, 2) gradually increasing retirement ages in
future years, and 3) subjecting future Social Secur
ity benefits to income taxation.4 As a result, the
Social Security Trust Fund has recently begun
accumulating annual surpluses. Although these
surpluses are earmarked for financing increased
benefit payouts as the baby boomers begin retiring
early in the next century, they may also be induc
ing larger deficits on the rest of the government’s
budget. Recently, proposals have been made for
reducing Social Security and income taxes to pro
vide a tax break for the middle class and to spur
consumption demand to lift the economy out of
its sluggish pace.5
The proposals for Social Security and incometax cuts point to the possibility that fiscal policies
negating the purpose of the Social Security sur
plus may be adopted. Since the government’s
finances must obey an intertemporal budget
constraint, a tax cut today will compel a com
pensating change in revenues or outlays, either
now or in future years. We therefore investigate
the savings impact of the following hypothetical
policies: 1) A 20 percent cut in Social Security
taxes through 2020 coupled with either a) higher

■

4 See U.S. Congress (1983).

■

5 At this writing, the Clinton Administration is considering income-

tax cuts for middle-income Americans, although combined with increases
http://fraser.stlouisfed.org/
rich.
Federal Reserve Bank offor
St.theLouis

Social Security taxes thereafter, or b) reduced
Social Security benefit payments thereafter, or
c) higher income taxation thereafter; 2) a dis
sipation of Social Security surpluses through
higher government consumption to be replaced
with either a) higher Social Security taxes after
year 2020, or b) reduced Social Security benefits
after year 2020; and 3) an 8 percent cut in in
come taxes until 2020 coupled with a) higher in
come taxes thereafter, or b) contemporaneous
reductions in government consumption spend
ing equaling the reduction in revenue.6
Each of these policies maintains intertemporal
balance in the federal government’s budget. That
is, the loss in revenue from the initial tax cuts or
spending increases is made up, in present value,
by larger revenue from future tax hikes or future
benefit cuts. Each of these policies imposes a
unique set of gains and losses on different genera
tions. As a result, each policy may be expected to
have a distinct impact on current and future
saving rates.
Columns 1 through 3 in table 3 show the im
pact on saving rates of Social Security tax-cut
policies.7 To understand the implications of
policy (la), which reduces Social Security taxes
until the year 2020 and increases them there
after, consider the case of the relatively older
generations, those aged 35 and older in 1990.

■

6 An 8 percent cut in income taxes results in the same amount of
revenue loss as a 20 percent cut in Social Security taxes.

■

7 All numbers in tables 3 and 4 indicate percentage-point changes.

D
These generations’ present value of resources
(PVRs) are larger because they benefit from the
immediate Social Security tax cuts, but are not
much exposed to the higher Social Security taxes
upon retirement after 2020. The net positive effect
on their resources of the reduced Social Security
taxes will increase their consumption. For some of
the slightly younger generations, too, the presentvalue gain from the immediate tax cuts will be
greater than the present-value loss from the higher
taxes 30 years later. Their resources, and hence
their consumption, will also be larger.
Those younger generations w ho will not be
in the work force for most of the years before
2020, but will face the higher future taxation,
will suffer a net loss in their resources. Most of
these individuals, however, were not in the
work force in 1990 and will not engage in con
sumption for a number of years thereafter.
Thus, older generations will experience a gain,
and younger generations a loss, in their PVRs.
Given that the old have larger propensities to
consume, this pattern of changes in the PVRs
will induce larger aggregate consumption.
Hence, saving rates will be lower. Table 3
shows that policy (la) reduces current and fu
ture saving rates by between 0.40 and 0.67 per
centage point. In contrast, policy (lb ) exposes
the older generations to reduced Social Security
benefits upon retirement. Thus, the increase in
their PVRs and, therefore, in their consumption
will not be as large as under policy (la). This ex
plains why the reduction in saving rates under
this policy is not as large as that under policy
(la). The saving-rate reductions for policy (lb )
range between 0.08 and 0.17 percentage point.
Policy (lc) involves an income-tax hike after
the year 2020. Unlike Social Security taxes,
which fall exclusively on wage and salary in
comes, part of the revenue from income taxa
tion comes from taxation of capital income,
which accrues mainly to older and retired gen
erations. As a result, the increase in the PVRs of
generations that are of working age in 1990 will
not be as large as with higher future Social Se
curity taxation. This induces a comparatively
smaller increase in these generations’ consump
tion and, hence, a smaller decline in saving
rates. Saving-rate reductions due to this policy
range between 0.34 and 0.56 percentage point.
Columns 4 and 5 in table 3 show the impact
of policies (2a) and (2b), respectively. Here, the
annual Social Security Trust Fund surpluses are
dissipated through higher government spend
ing. To compensate, policy (2a) raises Social
Security taxes, while policy (2b) reduces Social
Security benefits after the year 2020. Both

policies lower current and future saving rates
because the direct negative effect due to higher
government consumption expenditure is not
fully offset by the lower consumption expenditure
of generations whose PVRs are reduced as a result
of higher future taxes (policy [2a]) or lower future
Social Security benefits (policy [2b]). Policy (2a)
lowers saving rates by about 0.9 percentage point
in 1990. Future saving-rate reductions are lower
because Social Security surpluses that are available
for dissipation decline gradually as the baby boom
generations approach retirement age. Again, be
cause older generations escape higher future taxa
tion under policy (2a) but receive lower benefits
under policy (2b), the decline in saving rates is
greater for policy (2a).
The last two columns of table 3 show the
effects on saving rates from income-tax-cut pol
icies. Under policy (3a), income taxes are in
creased after the year 2020. This policy is similar
to the Social Security tax-cut policy (la). Saving
is reduced because older generations benefit
from the immediate cut in income taxes, but are
not alive when income taxes are increased in the
future. Saving-rate reductions under this policy
range between 0.41 and 0.66 percentage point.
Under policy (3b), government spending is re
duced in each year by the amount of revenue lost
from the income-tax cut. The direct effect of the
expenditure reduction in increasing the national
saving rate is partially offset by greater consump
tion induced by lower taxes. This policy neverthe
less boosts saving rates by about 0.6 percentage
point in the years immediately after 1990. The in
creases in saving rates are lower for years further
in the future because generations that gain the
most from current tax-rate reductions then enter
age groups with high consumption propensities.
Thus, the direct gain in saving due to government
spending reductions is increasingly offset by
higher private consumption in later years.
The impact on saving rates of the policies
considered here is relatively small. The results
show that policies involving current tax cuts or
current spending increases that are paid for by
future tax hikes will affect saving rates adversely.
Tax-cut policies that involve contemporaneous
reductions in government spending will in
crease saving rates, however.

Medicare Policies
The high and rising cost of health care provision
provides a second cause for concern about future
saving. The fraction of GDP accounted for by
health care expenditures grew from about 6.0

T A B L E

Changes in the Net N ational
S avin g Rate Due to Reduced
G row th of M edicare and
M edicaid Expend itu res
(percentage-point change)

Medicare and Medicaid Growth Rate Reduced after:
1995
1990
1995
2000
2005

1.23
1.61
2.11
2.69

2000

2005

0.68
0.89
1.19
1.54

0.41
0.54
0.73
0.94

SOURCE: Authors’ calculations.

percent in 1965 to 13.9 percent in 1992. Older
individuals spend more on health care than do
younger persons.8 An increasing share of older
people in the population will be a major demandside factor causing future increases in the price of
medical services. Supply-side factors such as faster
wage gains relative to other sectors, technological
advances that are skill and labor intensive and
therefore costlier, and shortages of skilled person
nel are also likely to contribute to higher health
care costs in the future. If current laws and prac
tices continue, health care expenditure as a per
centage of GDP is projected to climb to 32.0
percent by 2030.9 Policy measures aimed at curb
ing these escalations will surely be adopted in the
future, but the alacrity with which they are
adopted and prove successful may be crucial in
determining the outcome for saving rates.
Several proposals for health care reform and,
in particular, for curbing future increases in
Medicare and Medicaid spending are currently
being debated. We do not explore the impact of
alternative ways to reform the health care sys
tem, but rather examine the effects on saving of
reducing the growth rate of Medicare and Medi
caid spending to equal that of the overall econo
my by a target year in the future. Under the
framework adopted here, the current saving rate
(in 1990) is assumed to incorporate individuals’
expectations regarding the path of Medicaid and
Medicare expenditures over the coming decade.

■

8 See U.S. General Accounting Office (1991).

■

9 These projections were obtained from the Health Care Financing

Administration. See Burner, McKusick, and Waldo (1992).

The policy experiment thus refers to the
effect on the saving rate of an announcement
by the government of a credible plan for reduc
ing the growth rate of these expenditures by a
specified year. In this experiment, the compen
sating change is a reduction in fiscal burdens for
all future generations. We consider the impact
on saving rates of three alternative dates by
which the growth of Medicare and Medicaid
spending would be reduced to equal the overall
economic growth rate.
Table 4 shows that credible plans to reduce
the growth rates of Medicare and Medicaid ex
penditures soon would have a substantial posi
tive impact on saving rates. A plan for reducing
their growth by 1995, for example, provides a
relatively large and positive impulse to current
and future national saving. In this case, national
saving rates increase by more than 1.2 percent
immediately, and by even larger amounts in the
early years of the next century. The impact on
saving rates is greater, the earlier the target year
for bringing these expenditures under control.
Reducing the growth rate of Medicare and Medi
caid spending may be expected to produce by
far the largest positive impacts on saving rates.

III. C o n c lu s io n

This paper uses the method of generational ac
counting to investigate the impact on saving
rates of Social Security and income-tax-cut poli
cies. In exploring the saving-rate changes under
alternative financing arrangements for these tax
cuts, we estimate that the effects are not very
large. Saving rates are affected adversely under
all alternatives that do not involve simultaneous
reductions in government consumption. In addi
tion, we find that a decrease in the rate of
growth of Medicare and Medicaid expenditures,
coupled with a reduction in payment burdens
on future generations, is likely to have relatively
large positive effects on current and future sav
ing rates in the United States. The increases in
saving rates from such a policy will be larger,
the earlier it is implemented.

make over their remaining lifetime. Tx
s . k is
projected according to

Appendix —
Generational
Accounting
Methodology

(A2)

Estimating
Policy-Induced
Changes in the
Present Value
of Resources

px
A ^

'T X

1__ I
S= t

1 s , i, k r

s, k

1 = 1

n o + r /)
j= t+1

Calculations are as of year t, and D is the
maximum possible age, which is assumed to be
90 years. GA (k ) ~J k stands for the generational
account under the set of policies, n, for the gen
eration born in year k, where t- D < k < t . The
superscript x stands for the generation’s sex;
a: = male or female. P s
x k represents the popula
tion in year 5 of the generation of sex x that was
bom in year k. Intermediate population projec
tions constructed by the Social Security Admin
istration are used in the computations. Tx
s .k
stands for that generation’s average per capita
tax payment/transfer receipt of the /th type in
year s. Transfer receipts enter into the computa
tions with a negative sign. Equation (A l) thus
represents the actuarially discounted sum of
average tax payments minus transfer receipts
that all surviving members of a generation will

G A *k(71) =
k + D

_ R u s - k A u O + g ,y - ‘
k

* ? , p ?k + K , p {

j —o

The methodology of generational accounting
was developed for comparing the fiscal burdens
on current and future generations, where each
generation includes individuals of a particular
age and sex. Each generation’s generational ac
count, GA (n ), represents the average per capita
lifetime net-payments burden on members of
that generation under the prevailing set of fiscal
policies denoted by 7t. The methodology en
ables a computation of the GAs that would exist
both before and after any contemplated policy
change. The difference in these GAs represents
the change in the present value of resources,
A PVR = GA (n 1) — GA (n 2) , accruing to that
generation as a result of the policy change.
The GA (n ) for a generation currently living
is computed according to the formula
(A l)

Tx
s, i,

Here, At , stands for the aggregate tax pay
ments or transfer receipts of the /dl type made
by all individuals alive in year t. These aggre
gates for the various tax/transfer types are com
puted from the National Income and Product
Accounts. Taxes include labor and capital in
come taxes, Social Security taxes, indirect taxes,
property taxes, and seigniorage. Transfers cover
Social Security, Medicare and Medicaid benefits,
and welfare benefits such as food stamps, un
employment insurance, Aid to Families with
Dependent Children, and general welfare pay
ments. The tax and transfer categories are com
prehensive, including all revenues and transfer
payments undertaken by federal, state, and
local governments.
R* ■stands for the share of taxes/transfers of
type i made by the generation of sex x and age
j in year t relative to the share for a 40-year-old
male in year t. These relative-share profiles by
age and sex for various tax/transfer types are
obtained from the Census Bureau’s Survey of In
come and Program Participation (SIPP) and from
the Bureau of Labor Statistics’ Consumer Expen
diture Survey (CES). Projections of future taxes/
transfers assume that the relative-share profiles
will remain unchanged through time.
Future aggregate taxes and transfers will be
larger as the economy grows. Hence, the aggre
gates for future years are obtained by multiply
ing the year t aggregates by a growth factor.
The growth rate, g(, chosen for most tax and
transfer categories is 0.75 percent, since this
value is consistent with the average annual rate
of U.S. productivity growth in recent years. The
exceptions are the growth rates selected for
Medicare and Medicaid expenditures. Projected
annual aggregates obtained from the Health
Care Financing Administration are used for
these two categories. Equation (A2) thus com
putes the aggregate taxes/transfers of type i
that individuals of sex x born in year k expect
to pay/receive in year s.

FI GURE

Average Propensities to
Consume by Age and Sex
Percent of PVR

Age
SOURCE: Authors’ calculations.

Constructing the
Average
Propensities to
Consume (APCs)
Equations (A l) and (A2) constitute a procedure
for distributing any given national tax or transfer
aggregate among currently living generations ac
cording to the per capita relative-share profiles
corresponding to that aggregate. We use the
same procedure to construct APCs for different
generations. For this, we require generationspecific estimates of total annual consumption,
C x k's, and of the present values of resources,

P V R f k’
sThe C x
t k's are obtained by distributing total
personal consumption expenditures in 1990 ac
cording to a relative-share profile for total con
sumption estimated using CES data. The PVRX k ’s
are estimated as the sum of human and nonhu
man wealth minus the per capita generational
account for this generation.10 We estimate the
average per capita human wealth level for each
generation as the present discounted value of
that generation’s projected per capita labor in
come. Current per capita labor income is esti-

■ 10 The computation and results from the generational accounting
exercise used here are discussed in Budgetofthe U.S. Government, Fis

cal Year 1993.
■

mated by distributing total labor income in 1990
according to its relative-share profile obtained
from SIPP data.11 Future labor incomes are ob
tained by annually compounding the 1990 labor
incomes at the rate of productivity growth of
0.75 percent. We estimate generation-specific
nonhuman wealth by distributing aggregate
private net worth by age and sex according to a
profile for asset holdings obtained from SIPP
data.12 The age-specific average propensities to
consume are A PCXa = C x k/P V R Xk, where the
subscript a stands for the generation’s age and
equals t- k . The estimated age-specific APCs
depicted in figure 1 are assumed to remain con
stant over time.

Estimating
Changes in
Saving Rates
Estimating the consumption change arising from
a shift in policy requires computing the product
of the policy-induced change in resources and
the m arginal propensity to consume resources
for members of each generation. However, no
reliable empirical estimates of age-specific mar
ginal propensities to consume exist. Here, all
individuals are assumed to maximize a homothetic utility function. Homotheticity of the util
ity function implies equal average and marginal
propensities to consume resources. This allows
a substitution of average instead of marginal
propensities to consume resources in the com
putations. The change in aggregate saving fol
lowing a policy change is derived as
I-

(A3)

AS, = - X
xe( m. f)

A C ?*.

k = t - 90

where A Cx k is computed as APCXa x A PVRXk.
As formula (A3) shows, only individuals 18
and older are assumed to engage in consump
tion spending. A change in policy will, of
course, affect the PVR s of individuals who are
less than age 18 in the beginning year, year t.
The changes in the PVR s of generations less
than 18 years of age will, under this assump
tion, affect aggregate consumption only in years
when these generations are 18 or older. To com
pute consumption changes for future years,
equation (A3) is applied to cohorts aged 18
through 90 in those years. For each cohort, the
A PVRs applicable in these years are computed as

11 The share of labor is computed according to the formula sL =

Cl (NNP-IT-P), where CL is compensation to employees, NNP is the net
http://fraser.stlouisfed.org/
national product, IT is indirect taxes, and P is proprietors’ income.
Federal Reserve Bank of St. Louis

■ 12 Total private net worth in 1990 was $18,573 trillion, according
to the Board of Governors of the Federal Reserve System (1991).

(A4)

A PVR?+Sk =
(A P V R f+s_ 1 k- A C ?+S_ 1 k) (1 + r ) ,

where r is the rate of interest.13 A C * k= 0 if the
cohort born in year k is less than 18 years of age
in year 5. To calculate the change in the national
saving rate resulting from a change in policy,
we project future net national product using a
0.75 percent rate of productivity growth. The
annual changes in saving rates are estimated as
A s t = A S t/N N Pt . Policy changes are assumed
to be initiated in 1990. For each of the policies
considered, we estimate A s t for t = 1990
through 2005 and report these for selected years.

References
Auerbach, Alan J., Jagadeesh Gokhale, and
Laurence J. Kotlikoff. “Generational Account
ing: A New Approach to Understanding the
Effects of Fiscal Policy on Saving,” Scandina
vian Jo u rn a l o f Economics, vol. 94, no. 2
(1992a), pp. 303-18.
______ , ______ , an d ______ . “Social Security
and Medicare Policy from the Perspective of
Generational Accounting,” in James M. Poterba, ed., Tax Policy a n d the Economy, vol. 6.
Cambridge, Mass.: National Bureau of Eco
nomic Research and MIT Press, 1992b.
Auerbach, Alan J., and Laurence J. Kotlikoff.
D ynam ic Fiscal Policy. Cambridge: Cam
bridge University Press, 1987.
Board of Governors of the Federal Reserve Sys
tem. “Balance Sheets for the U.S. Economy,
1960-91.” Washington, D.C.: Board of Gover
nors of the Federal Reserve System, March
1991.
Burner, Sally, David R. McKusick, and Daniel R.
Waldo. “Projections of National Health Ex
penditures through the Year 2030,” Health
Care F inancing Review, 1992 (forthcoming).

http://fraser.stlouisfed.org/ 13 A 6 percent rate of interest is used in all present-value
calculations.
Federal Reserve Bank of
St. Louis

■

Carroll, Christopher D. “How Does Future In
come Affect Current Consumption?” Board of
Governors of the Federal Reserve System,
Economic Activity Section, Working Paper
No. 126, May 1992.
Kotlikoff, Laurence J. G enerational A ccounting:
K now ing Who Pays, a n d When, fo r W hat
We Spend. New York: The Free Press, 1992.
Office of Management and Budget. Budget o f
the U.S. Government, Fiscal Year 1993Washington, D.C.: U.S. Government Printing
Office, 1992.
U.S. Congress. United States Code Congressional
and Administrative News: Ninety-eighth Con
gress, First Session, 1983, vol. 2. St. Paul, Minn.:
West Publishing Co., 1983.
U.S. General Accounting Office. “U.S. Health
Care Spending, Trends, Contributing Factors,
and Proposals for Reform,” Washington, D.C.:
U.S. Government Printing Office, June 1991.
U.S. President. Econom ic Report o f the Presi
dent. Washington, D.C.: U.S. Government
Printing Office, February 1992.

History of and Rationales
for the Reconstruction
Finance Corporation
by Walker F. Todd

Walker F. Todd is an assistant
general counsel and research of
ficer at the Federal Reserve Bank of
Cleveland. An earlier version of this
paper was presented to a con
ference on financial crises spon
sored by the Jerome Levy
Economics Institute at Bard Col
lege, Annandale-on-Hudson,
New York, on November 22,1991.

[I]t became apparent alm ost immediately, to
m any Congressmen an d Senators, that here was
a device [RFC] which would enable them to pro
videfo r activities that theyfavoredfor which
governm entfunds would be required, but unthout
any apparent increase in appropriations, an d
unthout passing an appropriations b ill o f any kind
to accomplish its purposes. After they had done
that, there need be no more appropriations an d
its activities could be enlarged indefinitely, as they
u>ere alm ost tofantastic proportions.
Chester Morrill, former Secretary,
Board of Governors, on the RFC
(cited in Olson [1988], p. 43)

Introduction
The creation of the Resolution Trust Corporation
(RTC) in 1989, the evolution of a “too-big-tofail” doctrine within the bank regulatory com
munity in the 1980s, and more recent recom
mendations that means of regular government
intervention be created to support some finan
cial institutions all recall the history of the Re
construction Finance Corporation (RFC) during
http://fraser.stlouisfed.org/
the Great Depression. This paper explores the
Federal Reserve Bank of St. Louis

Helpful comments, suggestions,
and encouragement were provided
by Ned Eichler, William Greider,
Erica L. Groshen, Joseph G.
Haubrich, George Kaufman, Martin
Mayer, Hyman P. Minsky, Richard
Nelson, Robin Ratliff, Joseph C.
Reid, Richard C. Schiming, Anna J.
Schwartz, James B. Thomson, and
Jack Willoughby.

lessons learned from our nation’s previous largescale effort to rescue financial institutions and
discusses their current relevance.1
Then faced with the worst financial crisis in a
century, U.S. policymakers of the 1930s deliber
ately enacted a set of reforms that included central
bank restructuring, bank regulatory reforms, fed
eral deposit insurance, and a separate, politically
accountable, publicly funded rescue mechanism,
the RFC. Those policymakers paid careful attention
to statutory and institutional structures that separated
the fiscal policy operations of the debt rescue mech
anism, the RFC, from the monetary policy operations
of the central bank, which then were dominated by
the Federal Reserve’s discount window.
In contrast to most recent proposals for in
creased levels of government intervention to
fund the capital structures of financial institu
tions directly, the RFC had a clearly defined net
work of checks and balances with respect to both
the activities in which it was authorized to engage

■

1 As used in this paper, “debt rescue,” “rescue,” and “bailout” are
used interchangeably and might properly be defined as the government's
payment or assumption of a person’s debts owed to third parties, without
adequate security for that payment or assumption to ensure that the
government w ill recover its outlays in full in the near term (currently,
under two years).

and the sources of its funding. Yet, despite these
checks and balances, and despite the compara
tively competent management of the agency for
13 years, the RFC’s lending and capital support
operations still became politicized over time.
After the 1946 elections, congressional Republicans
made it one of their first orders of business to begin
the dismantling of the RFC. It would be difficult to
argue that they were wrong to do so (Sprinkel
[1952]). Recent commenters on the RFC have
focused primarily on the desirability and efficiency
of government intervention in financial markets
(Keeton [1992]), rather than on the merits or de
merits of particular institutional structures for such
intervention, the historic causes of intervention, or
the monetary policy aspects of the 1930s reforms.2
Today, in the search for a governmentally
sponsored financial rescue mechanism, it
would be helpful to review the lessons of his
tory that bear upon the legal, economic, and
political factors that contributed to the creation
and ultimate demise of the RFC. Particular con
sideration should be given to the rationale for
the institutional barriers of the 1930s that
separated the RFC’s solvency support or capital
replacement mechanisms from both the central
banking functions (the Reserve Banks) and
federal deposit insurance (the Federal Deposit
Insurance Corporation [FDIC] and, later, the
Federal Savings and Loan Insurance Corpora
tion [FSLICD.
Modem advocates of RFC-like schemes either
have ignored or have passed lightly over the rhe
torical inconsistency between advocacy of free
markets on the one hand, and publicly funded
bailouts of large financial firms on the other. One
specific plan reminiscent of the RFC, prepared by
a group of advisors to New York Governor Mario
Cuomo, was presented to President-elect Clinton
in November 1992 and was described as follows:
[T]he report urged the Federal Reserve to play a
far more aggressive role in spurring the economy,
saying it should pump $20 billion in capital into
the nation’s banks to make it easier for them to
lend money. But Mr. [Robert] Rubin [Chairman of
Goldman Sachs and a member of the Cuomo
Commission] dissented from that proposal, saying
it would be undue Government interference in
business. (Greenhouse [1992])

Such a proposal would be tantamount to re
quiring the Federal Reserve today to play the

■ 2 See, for example, Phillips (1992), Calomiris (1992), and Buthttp://fraser.stlouisfed.org/
kiewicz (1992).
Federal Reserve Bank of
St. Louis

role of the RFC during the Great Depression in
supporting the solvency or capital structure of
financial institutions. It would also extend the
Federal Reserve’s monetary policy function well
beyond its normal roles of ensuring a steady
supply of liquidity to the aggregate economy
and stabilizing the domestic price level.
Even if it were decided to have the federal
government intervene to such an extent in the
private economy, the institutional structure and
legal form of the intervention still would matter
a great deal (see, for example, Sprinkel [1952],
Todd [1988], and Schwartz [1992]). Perhaps the
best argument in favor of a revived RFC is that
keeping the bailout lending device (the RFC)
separate from the monetary policy device (the
Fed and, to a lesser extent, the FDIC) would
both enable monetary policy to be conducted
independent of the bailout function and in
crease the political accountability to taxpayers
for any publicly funded debt rescue.
An understanding of the RFC’s history and in
stitutional structure should assist policymakers
in decisions regarding the desirability and effi
ciency of rescuing segments of the financial
services industry. Also, knowledge of the his
tory of the RFC should predispose policymakers
toward keeping government-funded debt res
cue operations separate from the Federal
Reserve’s monetary policy operations.

I. History of the RFC
Although government intervention in business
operations has a long and involved history, the
classically liberal political philosophy of most
U.S. administrations prior to Herbert Hoover
limited their market interference to relatively few
peacetime interventions until the RFC. The ac
tual prototype of the RFC was the War Finance
Corporation (WFC), chartered in 1918 to enable
the federal government to centralize, coordinate,
and fund the procurement and supply opera
tions that accompanied formal U.S. entry into
World War I in April 1917.3
The WFC was loosely modeled on methods
used by J.P. Morgan & Company to coordinate
and fund the British Treasury’s purchases of
U.S. war supplies between January 1915 and
April 1917. The WFC’s operations, in turn, were
guided by an Advisory Commission and were

■ 3 See text of War Fi nance Corporation Act at Federal Reserve Bulle
tin, vol. 4 (February 1918), pp. 9 5 -98 (proposed bill), and ibid. (April
1918), pp. 300-06 (bill as enacted). See also Olson (1988), pp. 10-14,
Dos Passos (1962), pp. 219-27, and Clarkson (1924).

B O X I

Herbert Hoover’s Intentions
for the RFC
Hoover’s message to Congress (January 1932) proposed that
RFC funds be used for the following purposes:
(a) to establish and finance a system of agricultural credit
banks ... [ancestors of the Farmers Home Administration!;
(b) to make loans to the existing [Federal] Intermediate
Credit Banks ... [part of the Farm Credit Administration];
(c) to make loans to building and loan associations, savings
banks, insurance companies, and other real estate mortgage
agencies so as to enable them to postpone foreclosures [an
cestor of the Federal National Mortgage Association];
(d) to make loans to banks and financial institutions “which
cannot otherwise secure credit where such advances
will protect the credit structure and stimulate employ
ment” [emphasis added];

banks. Prior to 1932, the Federal Reserve Banks
were not authorized to make advances against
assets other than “real bills” or government se
curities, and they could not lend for longer than
15 days on the government securities owned by
member banks. The proposed credit pool,
called the National Credit Corporation (NCC),
was to make extraordinary advances until the
December 1931-March 1932 session of Congress
could act upon Hoover’s recommendation to
authorize Reserve Banks’ emergency advances
for up to 120 days collateralized by government
securities or any other satisfactory assets.
Hoover also proposed to the FAC “... [i]f neces
sity requires, to recreate the [WFC]... with avail
able funds sufficient for any emergency in our
credit system.”5 The NCC was organized in Oc
tober 1931, but was superseded when the RFC
Act was signed into law on January 22, 1932.6
Describing his abandonment of free-market
principles to bail out the commercial banking
system, Hoover wrote:

(e) to make loans to the railways to prevent receiverships
[this was in fact the most significant use of the RFC dur
ing its first year of existence and relieved some of the
biggest banks of some of their most problematic assets—
railroad bonds];
(0

[When I met with a group of Congressional leaders
on October 6, 1931,11presented a program for
Congressional action if the bankers’ movement
[NCC] did not suffice. I hoped those present
would approve my program in order to restore
confidence which was rapidly degenerating into
panic. The group seemed stunned. Only [Speaker

to finance exports that would aid the farmers and the un
employed [ancestor of the Export-Import Bank];

of the House John Nance] Gamer and [Senate
Majority (Republican) Leader William] Borah

(g) to finance modernization and construction of industrial
plants and utilities so as to increase employment and
plant efficiency [ancestor of the Defense Plant Corpora
tion of World War II and of the Defense Production Act
of 1950]; [and]
(h) to make loans to closed banks upon their sound assets
so as to enable them at least partially to pay out deposits
to a multitude of families and small businesses w ho were
in distress because their deposits were tied up pending
liquidation or reorganization of these banks [emphasis
added] [ancestor of the FDIC’s powers under the original
FDIC Act (1933) to speed up payment of liquidation
proceeds to holders of “frozen” bank deposits]. (Hoover
[1952], p. 98)

subject to “preference lists” issued by the War
Industries Board.4
In fall 1931, the onset of the worst part of the
Great Depression, President Hoover proposed
to the Federal Reserve System’s Federal Advisory
Council (FAC) the formation of a $500 million
credit pool, to be funded entirely by commer
cial banks and to have the authority to borrow
another $1 billion, if necessary, for the purpose
http://fraser.stlouisfed.org/
of refinancing assets on the books of distressed
Federal Reserve Bank of St. Louis

reserved approval. The others seemed shocked at
the revelation that our government for the first
time in peacetime history might have to intervene
to support private enterprise [in this case, by creat
ing the RFC]. (Hoover [1952], p. 98)

Although this was hardly the first time that the
U.S. government had supported private enter
prise through protection, subsidies, or bailouts,
it certainly was the first time that it had done so
on a grand scale in peacetime.
■

4 The WFC was easily the largest-scale effort at central planning in
U.S. history before 1932. See Tansill (1938), pp. 7 9 -8 1 ,9 0 -1 1 3 , Chernow(1990), pp. 186-91, Dos Passos (1962), pp. 219-27, Pusey (1974),
p. 216, Clarkson (1924), and Federal Reserve Bulletin, vol. 4 (1918), pp.
931-34.
■ 5 Hoover (1952), pp. 84-98, quotation at p. 98. See also Pusey
(1974), pp. 216-17, and Friedman and Schwartz (1971), p. 320.

■

6 Hoover (1952), pp. 84—98, Friedman and Schwartz (1971), p. 320,
Pusey (1974), pp. 217-19, and Butkiewicz (1992). The official text of
Hoover’s statement on the creation of the NCC, together with Federal Reserve
Bank of New York Governor (President) George Harrison’s reply, is at Fed
eral Reserve Bulletin, vol. 17 (October 1931), pp. 551-53. A statement by
the organizers of the NCC is at ibid., pp. 555-57. President Hoover’s state
ment on the RFC and the text of the RFC Act are at Federal Reserve Bulletin,
vol. 18 (February 1932), pp. 89-9 0 ,94 -9 9 .

The original RFC was given a Treasury capital
contribution of $500 million, with initial author
ity to borrow up to $1.5 billion more “from
either the Treasury or private sources.”7 Hoover
initially asked for $3 billion of RFC borrowing
authority, but that increased amount was not
granted until July 21, 1932, when the Emergency
Relief and Constmction Act raised the ceiling to
$3-3 billion, of which $300 million was set aside
for unemployment relief (Friedman and Schwartz
[1971], p. 320; Federal Reserve Bulletin, vol. 18
[1931], pp. 473-74).
Although the original RFC Act was altered
substantially in subsequent years, its main ele
ments were in place from the beginning, either
in Hoover’s original plan or in the modifications
made during the next year. Bailout loans were to
be made not by the central bank (Federal Re
serve), but instead by this new, separately char
tered, government-sponsored enterprise, the RFC.
To ensure further structural separation between
the governmental bailout (fiscal) and central bank
ing (monetary) functions, Section 9 of the RFC Act
provided explicitly that obligations of the RFC
“shall not be eligible for discount or purchase by
any Federal Reserve Bank” (Federal Reserve B ul
letin, vol. 18 [1932], p. 97). RFC obligations were
issued in the public debt market and counted
both in federal budget receipts and expenditures
and in limitations on federal debt outstanding.
The inauguration of the Roosevelt Adminis
tration on March 4, 1933, finally enabled a major
change in the RFC’s formal powers to occur: The
preferred stock purchasing power was added.
The vehicle for that change was the Emergency
Banking Act, enacted March 9, 1933- The proce
dures for passage of that bill were extraordinary;
among other things, the House of Representa
tives had no copy of it.
The Speaker recited the text from the one avail
able draft, which bore last-minute corrections
scribbled in pencil.... With a unanimous shout,
the House passed the bill, sight unseen, after only
thirty-eight minutes of debate.... The Senate, over
the objections of a small band of progressives
[Senators Lafollette, Borah, Case, Dale, Nye, and
Shipstead, together with Senator Costigan, the
lone Democrat voting no], approved the bill un
amended 73-7 at 7:30 that evening and at 8:36
that same night it received the President's [Roose
velt’s] signature. (Leuchtenberg [1963], pp. 43-44;
Federal Reserve B ulletin, vol. 19 [1933], p. 115-18

[text of Act])

http://fraser.stlouisfed.org/
■ 7 Olson (1988), pp. 37-40.
Federal Reserve Bank of St. Louis

President Hoover’s advisors played a princi
pal role in preparing the legislation, but the pri
mary draftsman of the final version was Walter
Wyatt, then general counsel of the Federal Re
serve Board Qones [1951], pp. 21-22; Olson
[1988], pp. 37-40). Eugene Meyer, still Governor
of the Federal Reserve Board but no longer Chair
man of the RFC at the time, and Treasury Secretary
Ogden Mills were the principal Hoover advisors
in this effort (Pusey [1974], pp. 232-38).
Under Section 304 of the Emergency Banking
Act, the RFC was authorized to purchase preferred
stock of banks “in need of funds for capital pur
poses either in connection with the organization
or reorganization of such [banks]” (Federal Re
serve Bulletin, vol. 19 [1933], p. 117). Wyatt was
familiar with the issue and could have given the
Reserve Banks a capital replacement or solvency
support role in the draft statute if he had chosen
to do so. But in fact, he gave that role to the RFC,
not to the Reserve Banks.8
W hen the Roosevelt Administration took over
in March 1933, the leadership and scope of the
RFC also changed. Jesse Jones, a prominent
Houston businessman, was appointed chairman
(Federal Loan Administrator). He already had
served one year as a member of the RFC’s board
of directors, participated in the first big bank res
cue operation of the Depression (the Central
Republic Bank of Chicago bonow ed $90 million
from the RFC in June 1932), and managed to
weather the political storm that erupted when
the list of the RFC’s borrowers was made public
in August 1932. Jones remained as chairman of
the RFC until January 1945 9
Under Jones, the RFC spent about $50 billion
of the public’s money, of which more than $22

■

8 Olson (1988), pp. 38-39, notes that the idea of RFC investment
in the preferred stock of troubled banks was promoted during the spring
and summer of 1932 by, among others, Federal Reserve Bank of New
York Governor (President) George Harrison and director Owen D. Young
“because so many banks had capital as well as liquidity problems.” By
December 1932, Governor (Chairman) Eugene Meyer of the Federal
Reserve Board, who understood the fiscal/monetary policy distinction
less well than the New York Reserve Bank officials, “began arguing that
either the RFC or Federal Reserve Banks [should] invest in [banks’]
preferred stock.”
■

9 Jones (1951), pp. 72—83. See generally Olson (1988), Pusey
(1974), pp. 216-26, and Butkiewicz (1992). Morgan (1985), p. 743,
describes the reasons for Jones's termination as follows:
By the end [of 1944], President Roosevelt decided to fir e ... [Jones]
largely because Jones had opposed the third term (1940) and fairly
openly supported Dewey (1944). As a consolation prize, FDR offered
to fire Marriner Eccles and to let Jones have the chairmanship of the
Federal Reserve.
See also Jones (1951), pp. 255-311.

billion fueled World War II procurement and
production. About $10.5 billion went for the
fight against the Great Depression “without loss
to the taxpayers,” if the time value of money
were ignored. The rest of the RFC’s funds were
channeled to foreign aid, domestic relief, and post
war reconstmction and conversion loans to indus
try. These were significant amounts at the time
because, in 1933, gross national product was only
about $56 billion (the initial appropriation for the
RFC was about 1 percent of GNP, equivalent to
$65 billion today) (Jones [1951], p. 4).10
Jones was both a populistic and a parsimoni
ous man. In the words of Hyman Minsky, “He
spent the public’s money as though it were his
own.” 11 His overall aim for RFC interventions
in the economy was not to increase central plan
ning or corporatist control, as some New Deal
ers understood and intended to practice those
concepts, but rather to exercise his own judg
ment in producing outcomes roughly analogous
to those that would have been expected had the
markets been left alone. Thus, bankers were re
quired to reduce their salaries and sometimes to
change managements in exchange for RFC capi
tal assistance; dividends on common shares
could not be paid until preferred shareholders’
dividends (including those of the RFC) were

■

10 Schiming (1992) notes that, for perspective, the Mercury and
Apollo space program outlays of the 1960s should be compared with RFC
outlays. In the period 1961-1969, total “space research” program outlays in
the federal budget summaries appearing in Federal Reserve Bulletins m e
$34.1 billion, about 3 percent of the final year (1969) GNP. Peak-year outlays
were $5.93 billion in 1966, about 4.5 percent of federal budget outlays, but
still slightly less than 1.0 percent of nominal GNP. Thus, proportionately,
initial-year outlays for the RFC (about 1.0 percent of GNP) exceeded even
peak-year outlays for the Mercury—Apollo space programs.
■

11 Author’s conversation with Hyman Minsky, November 22,1991.
See Buchanan and Tullock (1965), Buchanan (1968), Buchanan and
Wagner (1977), Kane (1989), pp. 95-114, Kane (1990), pp. 760-61, and
Greider (1992b) for varying explanations of the rarity of efficient manage
ment of public funds.

■

12 See Olson (1988), pp. 111-114,173, Greider (1992a), Rohatyn
and Cutler (1991), Willoughby (1992), and Cummins (1992). In contrast
to the kinds of measures that Jones required of bankers receiving RFC
assistance, the Treasury Department during 1992 requested repeal of
analogous provisions regarding salaries and management changes
enacted as part of recent banking legislation (see Rehm [1992], Greider
[1992b], and Willoughby [1992]). A 1992 federal housing assistance bill
passed by Congress and expected to be signed by President Bush “toned
down a provision [of the FDIC Improvement Act of 1991] requiring regu
lators to issue guidelines for executive compensation. Now guidelines
need be issued only to cover unsound institutions.” (Garsson [1992b]).

■ 13 See Penning (1968), Upham and Lamke (1934), Jones (1951),
http://fraser.stlouisfed.org/
(1952), Olson (1988), and Keeton (1992).
Federal Reserve Bank ofSprinkel
St. Louis

paid; and bankers were required to post reason
ably good collateral and eventually to repay bor
rowings, typically over 10 years. There was no
hint that the government was making a perma
nent capital injection into the banks or was mak
ing a market in their common shares (Jones
[1951], pp. 25-37; Olson [1988], pp. 47-62, 7883, 124-127), as some of Jones’s New Deal
contemporaries and some current theorists and
politicians have advocated.12
The high points of RFC operations affecting
the banking industry occurred during 1932 and
just after the bank holiday of March 1933- O f the
17.000 commercial banks in existence going into
the holiday, only 12,000 survived, and half of
those were borrowing some or as much as all of
their capital from the RFC under the preferred
stock provisions of the Emergency Banking Act.
Federal deposit insurance (added in June 1933
as part of the Glass-Steagall Act) did not yet
exist. Almost all large banks, in addition to the
5.000 conservatorships, receiverships, and as
sisted mergers, funded themselves through the
RFC. With bailout loans to other industries in
cluded, ranging from insurance companies and
savings and loans to real estate and steel mills,
the RFC became a principal influence on credit
availability in the U.S. economy.13
Over time, the RFC became corrupted by poli
tics, as Jones came to control enormous patronage.
Between 1947 and 1953, the prevailing opinion in
Washington, particularly among congressional
Republicans, was that central-planning-style in
terventions in the economy were inefficient
and harmful, and the RFC was phased out. Its
formal operations ceased in 1953, with the final
accounts settled in 1957 (U.S. Treasury [1959],
Sprinkel [1952]). Some of its operations sur
vived as independent new agencies, like the
Export-Import Bank and the Federal National
Mortgage Association, or as part of ongoing
Cabinet-level departments.
The bailout lending, preferred stock purchas
ing, and direct or industrial lending powers of
the RFC were not transferred anywhere else—
certainly not to the Federal Reserve, or to the
FDIC prior to 1982— and should be presumed
to have died with the RFC in 1957. No serious
effort was made to revive those powers in Con
gress until the borrower-specific federal loan
guarantee programs were enacted for Lockheed,
New York City, and Chrysler Corporation during
the 1970s. In those cases, the only role played
by any federal department or agency other than
the Treasury Department, which provided the
guarantees, was the role of fiscal agent explicitly

assigned to the Federal Reserve Banks for the
Lockheed loan guarantee in 1971.14

II. Six Lessons
Learned from
the RFC
The RFC embodied six key features that are
relevant to how one might use such an agency
today and, by inference, how one should not
use a central bank.
First, the RFC was explicitly prohibited by
law from funding itself via the Reserve Banks,
either directly or indirectly. This prohibition was
intended to avoid potential conflicts between
the Reserve Banks’ central banking (monetary
policy) operations and politically driven bailout
loan requests, which are fiscal policy operations
in the classic models of political economy.15
Second, the RFC also was prohibited from ex
tending credit to new enterprises trying to enter a
market. Typically, the RFC made loans only to es
tablished enterprises initiated, set on foot, or un
dertaken “prior to the adoption of th[e RFC] act.”
(RFC Act, section 5, in Federal Reserve Bulletin,
■

14 See Todd (1988) and Schwartz (1992) regarding the evolution
of RFC-like intervention schemes into federal loan guarantees, particular
ly after 1942. See also Hackley (1973), pp. 133-61. The 1970s’ federal
emergency loan guarantee statutory references are Lockheed Corpora
tion, Public Law No. 92-70 (1971); New York City (first rescue), Public
Law No. 94-143 (1975); New York City (second rescue), Public Law No.
95-339 (1978); and Chrysler Corporation, Public Law No. 96-185
(1979). In addition, the Defense Production Act of 1950,50 U.S.C. Ap
pendix Sections 2061 et seq., reenacted in 1992, continues authorization
for V-loans, a form of reimbursable loan guarantee program administered
by the Reserve Banks for the Treasury since 1942.
■

15 See Greenspan (1991), pp. 435-36; but see, against his views,
Greenhouse (1992). Chairman Greenspan's views on Federal Reserve
funding of the Treasury’s or a deposit insurance fund’s obligations are
particularly instructive. Addressing the Bush Administration’s early 1991
proposal, with which some members of Congress seemed sympathetic,
to have the Reserve Banks lend up to $25 billion directly to the FDIC’s
Bank Insurance Fund (BIF), Chairman Greenspan’s remarks were as fol
lows (source cited):
[A]n element of the Treasury’s proposal that has troubled the Board is the use
of the Federal Reserve Banks as the source of these loans. To prevent such
loans from affecting monetary policy, the loans would need to be matched by
sales from the Federal Reserve's portfolio of Treasury securities.... Not only
would use of the Reserve Banks for funding the BIF serve no apparent economic
purpose, it could create potential problems of precedent and perception for the
Federal Reserve. In particular, the proposal involves the Federal Reserve directly
funding the government. The Congress has always severely limited and, more
recently, has forbidden the direct placement of Treasury debt with the Federal
Reserve, apparently out of concern that such a practice could compromise the
independent conduct of monetary policy and would allow the Treasury to escape
the discipline of selling its debt directly to the market. Implementation of the
proposal could create perceptions, both in the United States and abroad, that
the nature or function of our central bank had been altered. In addition, if im
plementation of the proposal created a precedent for further loans to the BIF or
to other entities, the liquidity of the Federal Reserve’s portfolio could be reduced

sufficiently to create concerns about the ability of the Federal Reserve to control
http://fraser.stlouisfed.org/
the supply of reserves and, thereby, to achieve its monetary policy objectives.

Federal Reserve Bank of St. Louis

vol. 17 [1932], p. 96.) Thus, from a normal, freemarket, procompetitive perspective, the RFC was
interventionist and anticompetitive, providing sub
sidized credit to existing businesses that was un
available to new entrants into those lines of
business.
Third, through direct purchases of preferred
stock after March 1933 (Emergency Banking Act,
section 304, in Federal Reserve Bulletin, vol. 18
[19331, p. 117), the RFC could provide govern
mental recapitalization of the banking industry in
a way that would be undesirable if undertaken by
a central bank.16 The RFC’s preferred stock pur
chases were one step short of nationalizing the
banking system (see, for example, Phillips [1992]
and Wyatt [1933]). Governmental recapitalization
of the banking industry would amount to de facto
nationalization if there were insufficient collateral
for the government’s loans or if there were no
credible schedule for repayment in full of the
government’s assistance within a reasonable time,
such as five years (the longest term of Federal
Reserve advances ever explicitly authorized by
statute) or 10 years (the longest statutory term of
RFC assistance).
Fourth, no small part of the success of the
RFC may be due to its leader, Jesse Jones.
Changed times and changed personalities might
make it difficult to appoint anyone comparable
to him today. A czar of banking recapitalization
today would face conflicting choices between
fiscal prudence (reducing spending on the debt
rescue) and fiscal imprudence (increasing
spending on the debt rescue). Either choice
would alienate one set of political constituencies
while pleasing the other set. If enough constit
uents were alienated by such choices, and if
reappointment accordingly began to appear
politically impossible, then one would have to
view even the initial appointment of another
Jones as highly improbable.17
■ 16 The point that it is theoretical ly improper for a central bank to pro
vide capital replacement or solvency support for the banking industry is
made explicitly in the report of a conference of South American central bank
ers that appears in Federal Reserve Bulletin, vol. 17 (January 1932), p. 45.
The conference report, prepared largely by and under the influence of Federal
Reserve Bank of New York officials, including future president Allan Sproul,
stated that central banks must not in any way supply capital on a permanent
basis either to member banks or to the public, which may lack it for the con
duct of their business.

■

17 See, for example, Buchanan and Tullock (1965), Buchanan (1968),
and Buchanan and Wagner (1977)— all on “public choice" analysis as it
might apply to this issue— and Greider (1992a, b), Kane (1989), pp. 9 5 114, and Kane (1990), pp. 760-61, on the “principal—agent” conflict as
applied specifically to the bank supervision/bank recapitalization problem in
the thrift industry. See also a reference to what now would be called the
“principal-agent" conflict, applied to the RFC, in Olson (1988), p. 43 (quot
ing Chester Morrill, former secretary of the Board) [prefatory quotation for
this paper].

Fifth, for more than one year (January 1932March 1933), the RFC operated in an environment
in which there was no deposit insurance and Fed
eral Reserve notes were convertible into gold. The
FDIC, authorized in June 1933, did not begin oper
ations until January 1934. Neither of these condi
tions— an externally constrained central bank and
no deposit insurance— prevails today. The simple
vision of federal deposit insurance in the early and
mid-1930s was the role of a liquidator primed with
cash, not the more extensive role of bank super
visor and engineer of reorganizations of open
banks that the FDIC plays today (see Penning
[1968] and Todd [1991], pp. 85-90). The actual
experience of the 1930s suggests that the optimal
use of an RFC would be to compensate for the
deficiencies of deposit insurance, where it was
deemed desirable to do so, and to lend in cases
(such as to insolvent banks) that would be danger
ous for lending by an externally constrained Re
serve Bank (for example, under a gold standard)
(see Todd [1988,1991]; compare with Epstein and
Ferguson [1984]).
Sixth, because the RFC’s finances were exter
nally constrained, its operations were directly
and politically accountable (initially, through
the office of the Federal Loan Administrator;
later, through the Department of Commerce,
whose chief officer, the Secretary of Commerce,
is a full member of the President’s Cabinet).
The external constraint arose from the RFC’s in
capacity to fund itself off-budget or for a very
long time.18
In summary, the principal danger posed by
governmental bailout mechanisms, or by a Fed
eral Reserve that undertakes RFC-like operations,
is that, from public choice theory, we know that
it is difficult for the government to extend credit
directly to selected businesses (already established
ones, at that) and simultaneously to avoid political
pressures to distribute the loans or investments in
a partisan manner or to selectively favored constit
uencies (see Olson [1988], p. 67, and Buchanan and
Tullock [1965], especially pp. 265-95). In current

■ 18 The RFC initially was authorized to issue obligations not in excess
of three times its subscribed capital (originally $500 million) and to borrow
for not in excess of five years. Its obligations were explicitly guaranteed by
the full faith and credit of the United States (RFC Act, sections 2 and 9, in
Federal Reserve Bulletin, vol. 18 [February 1932], pp. 94,97). Similarly,
obligations of the modern Resolution Trust Corporation (RTC) explicitly
carry the full faith and credit of the United States when the principal amount
and maturity date are stated. 12 U.S.C. Section 1441a (j)(3) (1992).

■

19 See, for example, Eichler (1989), Kane (1989), Mayer (1992),
pp. 57-89, and Woodward (1992). Woodward provides a good working
definition of “forbearance” : the policy of permitting capital-deficient in
stitutions to operate under the protection of federal deposit insurance.
http://fraser.stlouisfed.org/

Federal Reserve Bank of St. Louis

discussions, a useful distinction could be made
between an RFC that primarily protected exist
ing firms (an RFC with a notably corporatist
tinge) and an RFC implementing an industrial
policy that attempted to identify, protect, and
subsidize emerging industries (Schiming [1992]).
It would be better to do neither and to let mar
ket forces select winners and losers and encour
age promising new industries.

III. Forbearance,
the Too-Big-to-Fail
Doctrine, and the
RTC: Comparisons
between the Rescue
Structures of the
1930s and Those
of the 1980s
The crises that emerged in the thrift and banking
industries in the 1980s prompted a variety of
governmental attempts to either buy time to
allow market-driven corrective forces to work
out a positive solution or prevent further loss of
depositors’ confidence that their deposits would
be repaid at par value. Initially, forbearance
seemed to be the mechanism of choice, with the
former FSLIC and the FDIC being authorized in
1982 to issue income maintenance certificates
and net worth certificates to keep insured in
stitutions open, even if technically insolvent.19
The too-big-to-fail doctrine had precursors in
regulatory discussions of the 1970s, but gradually
became fully articulated in the early 1980s. The
doctrine was brought into public debate with the
1984 decisions by both insurance funds to treat
their largest insured institutions as “too big to fail”
because of the generalized loss of depositors’ con
fidence that might be engendered by a closing
without repayment of deposits at par: The FSLIC
preserved American Savings Bank of Stockton,
California ($34 billion total assets), its largest insured
thrift. The FDIC, with funding provided temporarily
by the Federal Reserve, preserved Continental Illi
nois of Chicago ($41 billion total assets), the tenthlargest FDIC-insured institution. Both were rescued
even though only small shares of their funding were
provided by their own, retail, insured deposits
(Mayer [1992], pp. 108-15, 254-56; Todd and
Thomson [1990]).
In the case of Continental, the shareholders
of the parent holding company were offered a
settlement initially valued at 20 percent of the
shareholders’ equity in the remaining bank,
plus stock options and a contingent claim on
recoveries from liquidations of presumptively

bad assets (Sprague [1986], pp. 186-88, 209-10).
These rescues, which preserved large, insolvent
institutions, were analogous to the role of the
RFC in the 1930s, but they were not done as effi
ciently or as cheaply as the RFC could have
done them after March 1933, when the preferred
stock purchase plan began. In any case, al
though there was limited statutory authority for
the FDIC to provide open-bank assistance to
prevent immediate loss to the fund after 1982,
there was no comparable, explicit statutory
authority for other too-big-to-fail actions under
taken by the commercial banking regulators in
the 1980s. In contrast, the Emergency Banking Act
of 1933 explicitly authorized the RFC to recapitalize
insolvent or marginally solvent banks. The RFC’s
power to fund receiverships existed since 1932, and
the comparable power to fund conservatorships
was added by the Emergency Banking Act.
Eventually, in 1989, the thrift crisis of the 1980s
led to the creation of the Resolution Trust Corpora
tion (RTC) as a passive liquidator of insolvent in
stitutions formerly insured by the FSLIC. Although
it appears that the sponsors of the RTC had a
rough model of the RFC in mind, especially its
operations in 1932, the RTC proved to be quite dif
ferent from the RFC of 1933 and after.
Also, the federal bank regulators’ concepts of
too big to fail and systemic risk have continued
to evolve since the RTC was created in 1989. In
this context, “systemic risk” has the meaning
attributed to it in the FDIC Improvement Act of
1991 (FDICIA) [Section 141 (a)(1)(G)]: a regula
tory determination that failure to repay uninsured
claims on insured institutions at par “would have
serious adverse effects on economic conditions or
financial stability.” The following section evaluates
the effectiveness of the RTC and the continued
evolution of the too-big-to-fail/systemic risk doc
trines in light of the lessons learned from the
experiences of the RFC in the 1930s.

Forbearance and
the Too-Big-to-Fail
Doctrine
During the 1980s, and particularly after 1982, thrift
industry regulators found themselves in a situation
in which they required a large amount of new
funds to deal with weak institutions in the tradi
tional manner (closing and liquidating or assisting
with the required mergers of such institutions).
However, neither Congress nor the Executive
Branch was willing to provide the necessary
funds to the FSLIC before 1986, and the amount
finally provided in 1987 ($10.8 billion) proved

inadequate (Mayer [1992], pp. 230-42). Thus,
the thrift regulators were forced to forbear, that
is, to defer events that would force the account
ing recognition of the economic losses already
accrued to the FSLIC (Kane [1989], pp. 70-114).
The forbearance devices actually used took sev
eral forms, ranging from decreased frequency
and intensity of examinations to lower capital
requirements and approval of accounting
regimes designed to make embedded losses in
asset portfolios appear to be increases in regu
latory capital instead (Mayer [1992], pp. 57-115).
Writing on the importance of supervisory for
bearance as a cause of the thrift industry’s col
lapse in the 1980s, Kane (1989), p. 78, notes:
[Oapital forbearance — which has to an important
extent been forced on FSLIC by Congress, both in
its unwillingness to increase FSLIC’s human or
capital resources to handle the surge in client [S&L]
economic insolvencies and in formal limitations
on closure powers enacted in the Competitive
Equality Banking Act of 1987 — served to bifur
cate the industry into the living and the living
dead. While many of the living have been able to
strengthen their capital position, the zombies
have been getting worse.

Kane also notes the cumulative impact of the
FSLIC’s forbearance policies: Between 1982 and
1987, the number of insolvent open institutions
rose from 237 to 515, and the number of insol
vencies resolved by the FSLIC fell from 247 in
1982 to only 36 in 1984 (Kane [1989], p. 26).
The FDIC and other federal regulators were
simultaneously developing and expanding the
concept of banks “too big to fail,” with Conti
nental Illinois serving as the principal catalyst in
1984. The collapse of nearly all large bank hold
ing companies in Texas from 1986 until 1989 and
of a few large ones in the Middle Atlantic region
and New England after 1989 gave rise to further
refinements of large-bank failure resolution proce
dures under the systemic risk doctrine (Todd and
Thomson [1990] and Kaufman [1992]).
The relevance of these developments to
analysis of the RTC depends on the assumptions
that one is prepared to make about the efficacy
of and motives for supervisory behavior during
the 1980s. If, as the authorities cited argue, the
regulatory process had lost its way prior to the
enactment of FDICIA, then too many weak or
failing thrifts and banks were being kept open in
stead of being closed down and liquidated. The
decisive factor in the political process was that it
was apparently cheaper in the short term to ig
nore failing bank cases in a fiscal environment

that simply would not have provided sufficient,
on-budget funding to close weak institutions di
rectly (see, for example, Kane [19891, pp. 18-22,
and Mayer [19921, pp. 90-115). In hindsight, it
appears that a full-fledged RFC with the capacity
to either recapitalize weak and marginally insol
vent banks or provide the funding to pay off de
positors and general creditors would have proved
quite helpful (see Keeton [1992]). But instead, the
eventual government-funded liquidator, the RTC,
was created in 1989 with all of the liabilities but
comparatively few of the asset and funding
powers of the old RFC.

The RTC and the RFC
In August 1989, the RTC was chartered for
seven years to deal with the wave of thrift in
stitution failures in the late 1980s.20 Like the
RFC, the RTC was intended as a temporary ex
pedient only, with its authority to administer
new cases to expire in September 1993 and its
charter to expire in 1996. But although the RFC
became an active solvency-support provider
after March 1933, the RTC’s role has been
restricted to passive liquidation only— an impor
tant distinction between the roles of these two
rescue agencies.
Funding the RTC has been problematic. The
initial vehicle was the Resolution Funding Cor
poration, an entity whose acronym (RFC)
evokes memories of the original rescue agency
of the 1930s. Like the original RFC, the modern
RTC has borrowed funds to enable it to repay
depositors of failed thrifts initially and then has
had to administer assets until resale. The RTC
also has obtained funds through additional,
direct appropriations and through borrowings
for liquidity purposes through the Federal
Financing Bank. The ultimate cost to taxpayers
backing RTC obligations is the difference be
tween the amounts initially disbursed to repay
depositors and the amounts realized upon even
tual resale of seized assets, adjusted for ongoing
costs of administration of those assets.
The funding sources of the modern RTC are
more varied, but its cash flow is more con
strained than that of the old RFC. Both entities
share a common funding restraint: Neither
could borrow at the Federal Reserve Banks.
The 1930s’ RFC was authorized to issue its own
debt instruments into the public debt market
(the Federal Financing Bank did not exist until
■

20 Financial Institutions Reform, Recovery, and Enforcement Act of

August 9,1989, Section 501; 12 U.S.C. Section 1441a (1992), as
http://fraser.stlouisfed.org/
amended (FIRREA).
Federal Reserve Bank of St. Louis

1973) and had a substantial amount of positive
cash flow. After all, the RFC did not lend to sig
nificantly insolvent firms, most of its loans were
short term, and loan repayments and scheduled
preferred stock redemptions provided the cash
flow. The RTC, on the other hand, is required to
fund depositor payoffs for even grossly insol
vent thrifts and has, by definition, a large portfo
lio of nonperforming, difficult-to-sell assets. The
RTC’s cash flow, other than from asset sales, has
been minimal for several months at this writing.
In fact, it is because of these funding constraints
that some proponents have advocated a role for
the Federal Reserve in any new or expanded
bank or thrift rescue operations (see Green
house [1992] and Rohatyn and Cutler [1991]).
Although most of the RTC’s funding is onbudget, and although its funding corporation
has issued off-budget bonds (which still count
as part of gross public debt) with maturities as
long as 40 years, the RTC exhausted its avail
able cash for thrift failure resolutions in March
1992, and Congress still has not appropriated
new funds. Worse yet, as Kane (1990), p. 756,
has noted, there are political and bureaucratic
pressures at work that tend to increase the even
tual, final, taxpayers’ cost of the RTC’s opera
tions, such as the “counterproductive layers of
go-slow administrative restraints [at the RTC].”
(See also Pike and Thomson [1991] )
Two principal lines of argument have emerged
regarding the disposition of RTC assets. One line
argues that the RTC should liquidate its entire port
folio as quickly as possible, even if that means ini
tially absorbing large losses from the face value of
its assets, because the losses embedded in the
RTC’s portfolio generally will not improve under
government management (Eichler [1989], Kane
[1990], and Pike and Thomson [1991D. Also, the
carrying costs (the accrual of interest on borrowed
funds, maintenance costs regarding real property,
and administrative expenses for a large bureauc
racy) are sufficiently large that the total cost of the
RTC after five or seven years probably would be
less than if the alternate path were followed.
The second line of argument is that the RTC’s
affairs should be managed so as to minimize
nominal losses from face value upon resale of the
properties. This would entail a readiness to ex
pend necessary sums for maintenance and im
provements, because borrowing costs currently
are low and because bureaucratic and adminis
trative expenses should not prove significantly
greater in the near term than those required for a
sales force to liquidate all the properties. Initially,
proponents of this second view argued that the
RTC could become the government’s general

manager for all rescue operations, including res
cues of nonbank, nonfinancial firms, thereby
more fully mimicking the original RFC (see Mayer
[1992], pp. 260-325, especially pp. 315-18).
In general, this second view, omitting the
proposed role of the RTC as general manager of
all governmental rescues, has dominated RTC
operations thus far, largely because of fears in
regions like Texas and New England that mas
sive sales of foreclosed real property would fur
ther depress an already depressed real estate
market. Proponents of the first view argue that
liquidation sales would clear the market and es
tablish a bottom value for real estate upon
which a sustainable recovery of prices could be
founded— something that cannot occur as long
as there is a substantial amount of real estate in
government hands that overhangs the market
and eventually has to be sold anyway (Mayer
[1992], pp. 260-86, 308-10; compare with
Eichler [19891, pp. 143-46).
Similar matters were argued at great length
during the RFC’s operations in the 1930s, with
the central planning/corporate state factions of
the New Deal (such as Rexford G. Tugwell and
Adolf A. Berle) arguing for permanent manage
ment of assets in the RFC’s hands (Schlesinger
[19591, pp. 432-33, and Olson [1988], pp. 11114, 173). Jones eventually aligned himself with
the fiscal conservatives (including Senator Carter
Glass, Budget Director Lewis Douglas, and Post
master General James Farley), who wanted to
return RFC assets to private hands as soon as
possible and eventually to dismantle the RFC.21
Cost estimates regarding the modern RTC’s
operations vary. The original RFC broke even,
ignoring the time value of money (Jones [1951],
p. 4). But the combined cost of the RTC and
FSLIC resolutions (deadweight loss) is expected
to be about $200 billion at present value, largely
reflecting the difference between failed thrifts’
liabilities paid off at par today and the RTC’s re
coveries on assets sold in the future.22 This loss
represents nearly $2,000 for every individual
income tax return.
It still is generally expected that nearly 900
thrifts (almost one-third of the industry in 1987)
holding more than $400 billion in assets will fail
and be managed by the RTC before its interven
tion authority expires in September 1993- At the
end of March 1992, when the RTC’s available cash
was exhausted, it had disposed of 640 closed insti
tutions holding $311 billion of total assets, for
which it obtained $202 billion at book value
(Resolution Trust Corporation [1992]).23 The Bush
Administration estimates that an additional $42 bil

lion of funding, beyond the $80 billion already

appropriated in 1989 and 1991, would be neces
sary to complete the RTC’s operations, in addi
tion to funding the Southwest Plan deals (see
note 22), with a further $8 billion funding re
quest for initial capitalization of the Savings As
sociation Insurance Fund, the successor of the
FSLIC, after 1992.

The Central
Bank’s Role
A tendency to use central bank resources to
fund a bailout increasingly politicizes the bank’s
monetary policy functions, which risks causing
it to resemble the way in which national devel
opment agencies are used and often abused in
developing countries (providing assistance from
public funds to the most powerful and politically
well-connected entities in the state).24 Gener
ally, industrial-economy central banks are some
what insulated from political requests to fund
specific rescue operations. For example, during
1992, Sweden, Norway, and Finland, all industrial
economies, decided to bail out their banking sys
tems, but they established new governmental
agencies outside their central banks (RFC
analogues) to do so.25
Some industrial-economy nations, however,
do use their central banks to fund rescue oper
ations. The French bankers’ association has
■

21 See Olson (1988), pp. 36-37, 84-1 0 3,1 7 3 ,1 9 3; Browder and
Smith (1986), pp. 110-16; and Schlesinger (1960), pp. 515-23.
■ 22 This $200 billion estimate of loss is divided between $135 billion
for RTC resolutions and $65 billion for so-called “Southwest Plan” resolu
tions committed by FSLIC before FIRREA was enacted in 1989. See Mayer
(1992), pp. 249-59, on the Southwest Plan. The $135 billion portion of the
$200 billion estimate is likely to rise again (and the $65 billion portion to fall
somewhat) if short-term interest rates increase. The Congressional Budget
Office also currently estimates the RTC’s portion of this cost at $135 billion,
reduced from its $155 billion estimate in late 1991, attributing the reduction
primarily to lower-than-expected interest rates during the past year. See
Garsson (1992a). At this writing, in early December 1992, the Federal
Reserve discount rate is 3.0 percent, as is the federal funds target rate that
the market perceives.
■ 23 Using June 30,1992 data provided by RTC regional sales of
fices, the Southern Finance Project calculated that the RTC was recover
ing about 55 percent of the book value of commercial real estate assets
sold (Schmidt [1992], Thomas [1992], and Southern Finance Project
[1992]).
■

24 See, for example, the case of the Central Bank of the Philippines,
which assumed the foreign debt of its government’s state-sponsored
enterprises in the early 1980s and consequently lost $13 billion on its in
come statement during 1991, with even greater losses expected during
1992 ( LDC Debt Report [1992]). See also Schwartz (1992), Todd (1988,
1991), and Epstein and Ferguson (1984).
■ 25 See Brown-Flumes (1992), Corrigan (1992), Fossli (1992),
and Taylor (1992).

officially asked the French government for assis
tance with about $15 billion of nonperforming
property loans on the books of the nation’s
banks, including “one option proposed ... for
cheap refinancing of troubled loans through the
Bank of France” (Dawkins [1992a, bl). Japan
also has been studying methods for relieving its
banking system of nonperforming real estate
loans without using taxpayers’ funds but has not
yet settled upon a final plan (Chandler [1992]).
Some Japanese bankers have requested central
bank assistance in this plan, but the government
has not yet committed such resources to the effort.
In the case of the Federal Reserve Banks, it is
official Federal Reserve policy that Reserve
Banks’ advances should not be used to sub
stitute for the capital of depository institutions
and that Federal Reserve resources should not
be used so as to enable the Treasury to avoid
the discipline of selling its debt instruments into
the open market.26

IV. Conclusions
This paper reviews some of the important lessons
to be learned from the experience of the original
RFC, which was the principal government-funded
bailout agency for both banks and nonbanks from
1932 to 1947. Having tried forbearance and seen it
fail to deal adequately with the thrift industry’s
problems after 1982, Congress created the RTC,
which it apparently hoped would resolve those
problems much as the RFC had done in the
1930s. Unfortunately, the RTC has proved to be
a much weaker entity, and it has had no new
appropriations for failure resolutions since
March 1992, with its mandate to deal with new
cases set to expire in September 1993When capital replacement problems analogous
to those of the thrift industry began to emerge
in the banking industry in the mid-1980s, regu
lators initially responded by adopting forbear
ance policies regarding certain classes of loans
(developing-country debt, agricultural loans,
and commercial real estate) and by articulating
and elaborating on the too-big-to-fail doctrine,
which also produced an offshoot called the sys
temic risk doctrine. Since the debate began on
FDICIA in 1991, increased attention has been

■

26 Federal Reserve Regulation A, governing use of the Reserve
Banks’ discount windows, has provided for nearly 20 years that “Federal
Reserve credit is not a substitute for capital and ordinarily is not available for
extended periods.” 12 C.F.R. Section 201.5 (aX1992). All words in this para
graph of the regulation following “capital” have been omitted since 1980.
http://fraser.stlouisfed.org/
See Greenspan (1991), pp. 434-36, partially quoted in note 15.

Federal Reserve Bank of St. Louis

paid to RFC-like solutions for the banking indus
try’s problems as well.
Although some authorities still advocate crea
tion of a new RFC, or the conferral of RFC-like
powers on the Federal Reserve, others oppose
such a measure and express doubt that it would,
in fact, be needed. In retrospect, recreating the
RFC probably would have been a better solution
to both thrift and banking industry problems in
the mid-1980s than what actually was done in
1989 and afterward. However, even the original
RFC with a second Jesse Jones in charge would
have been hard-pressed to function effectively
in the 1980s, when a large number of the institu
tions to be rescued were grossly insolvent, not
just marginally insolvent or undercapitalized,
and when Congress refused for long periods to
appropriate necessary operating funds for the
eventual rescues.
Remembering the RFC and Jesse Jones fondly
in hindsight tends to cloud the issues that need to
be resolved in any debate about creating a new
RFC or assigning its functions to the Federal
Reserve. Even with a comparably capable man
like Jones running it, the original RFC was not im
mune from well-founded charges of political
favoritism, corruption, and abuse.
An RFC certainly might prove useful today.
As Keeton (1992) has shown, an RFC can be an
effective way for the government to preserve
financial institutions that otherwise would fail,
but it is doubtful in the present environment that
the government could undertake such rescues
in a way that would maximize long-term effi
ciency and minimize short-term political con
siderations. Having the Federal Reserve Banks
provide the funds for such a rescue operation
would only muddy the waters further by reduc
ing the customary measure of direct political
accountability for such rescue decisions that cur
rently is obtained through forcing periodic con
gressional appropriations of new operating funds.
The ultimate objection to RFC-like rescue oper
ations, and even more to having Reserve Banks
(repositories of the society’s common fund of
monetary reserves) fund such rescues, arises from
the incidence of the costs to society from such
operations. Bailouts entail social costs because
they misallocate scarce resources in the direction
of activities that the market, by refusing to fund at
previous levels, already has rejected, regardless of
whether the Fed or a new RFC steps in.
Any revived RFC should be established only
as a temporary rescue device. If it lingers indefi
nitely, it risks becoming a tool for corporatist
management of the industrial and financial
economies. Jones, for example, saw the RFC as

a temporary rescue device to save capitalism.
Still, a new RFC is an idea (albeit an inherently
bad one) worth discussing if the only alternative
permitted by the political process is central-bankfunded rescues of politically designated target
firms. Any new RFC should be separately char
tered with a fixed expiration date for its activities
and a comparable deadline for the maturity of
its funding instalments. The RFC should be
funded on-budget and through regular appro
priations. The Federal Reserve should be pre
cluded explicitly from funding the RFC, directly
or indirectly, to ensure that institutional checks
and balances remain in place.
Overall, in thinking about ideas for particular
bailouts and bailout devices like the RFC, it is
useful to recall the following wisdom extracted
from 19th-century experiences with the problem
of social cost:
[Policymakers came to understand that] efficiency
and equity required that public subsidies to pri
vate persons be openly assessed, and not accom
plished by inattention or concealment.... [W]e had
to leam that the incidence of cost was socially as

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■ 9211
Dynamics of the Trade
Balance and the Terms
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■ 9213
Relative Price
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■ 9215
Do Hostile Takeovers
Reduce Extramarginal
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by David K. Backus,
Patrick J. Kehoe, and
Finn E. Kydland

■ 9212
The Efficiency and
Welfare Effects of Tax
Reform: Are Fewer
Tax Brackets Better
Than More?

■ 9214
On Markovian
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by David Altig and
Charles T. Carlstrom

by Peter Ritchken and
L. Sankarasubramanian

by Jagadeesh Gokhale,
Erica L. Groshen, and
David Neumark

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U.S. Air Passenger
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Hub Locations,
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by Neil Bania,
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Thomas J. Zlatoper

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