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US Reconstruction Finance Corporation: Preferred Stock Purchase Program

By March 1933, the Reconstruction Finance Corporation’s (RFC)’s early collateralized lending programs had failed to prevent the recurrence of bank runs and panic in financial markets. These conditions forced newly elected President Franklin Delano Roosevelt to call for a nationwide bank holiday from March 6 to March 9. On the final day of the holiday came the Emergency Banking Act (EBA), which gave the RFC the power to make investments via preferred equity of distressed institutions. Under the EBA, the RFC could subscribe to and make loans on cumulative non-assessable preferred stock issued by state and national banks and trust companies. Unlike most bank and trust company equity at the time, the shares were preferred (senior to common shares), which protected the government’s investment, and non-assessable, meaning the RFC would have no further liability if the companies experienced losses. Subsequent amendments and additions in March and June would expand this authority to insurance companies, and to more than preferred stock for previously ineligible state banks. Any institution could file an application to one of the RFC’s 31 field offices. The RFC required more impaired institutions to raise additional capital or impose haircuts on existing creditors. Aid offices sought to maximize profits and had a fair bit of autonomy. Larger requests had to be approved by the main office in Washington D.C. and by the Secretary of the Treasury. Dividends were normally just below market rates and were lowered throughout the life of the program. Widespread participation in the program did not occur until Chairman Jesse Jones aggressively communicated the necessity of the program to bankers in September 1933 and Roosevelt explained in October that federal deposit insurance would only be eligible to solvent institutions when it began on January 1, 1934. The RFC ultimately injected about $1.17 billion of capital into nearly 7,400 institutions, representing nearly one-third of total bank capital in the system at its peak. Unlike the earlier loan assistance, it was seen as a resounding success and was widely credited with stabilizing the financial system.