(Your editor penned this summary version of his writings on the Fed's Great-Depression era attempts at Main Street lending in the hope that a respectable newspaper would publish it. Alas, those newspapers turned it down, as did some more dubious outlets.
As my piece's content seems as pertinent than ever, and it at least has the virtue of being shorter than the others I've written on this topic, rather than consign it to the trash, I offer it here in the hope that some Alt-M readers may see merit in it. My previous posts on the topic are here and here.–Ed.)
The U.S. economy is reeling from what may be its worst crisis ever. Firms are shutting down left and right. To stay open, the survivors—small ones especially—need credit, and plenty of it. Ordinary bankers can't or won't help them, so the Fed is riding to the rescue: for the first time ever, it will lend to all sorts of ordinary businesses.
Today's news? Nope. The date was June, 1934, during the Great Depression. The Fed's current business lending plan, first announced on March 23rd and now poised to start lending very soon, is actually its second try at business lending. Alas, that first attempt went badly, and a look at what went wrong suggests that history may soon be repeating itself.
Unlike the Fed's new effort, which rests on its "Section 13(3)" lending authority, its Great Depression effort rested on a now-defunct Federal Reserve Act provision known as Section 13(b). That New Deal provision was specifically designed to allow the Fed to keep ordinary businesses afloat, and to keep their workers employed, by giving them medium-term loans. FDR, who lobbied for the change, expressed his deep concern "with the situation in our small industries [whose] working capital has been lost or seriously depleted." The Federal Reserve, led by Marriner Eccles, shared that concern.
Like the Fed's current plan, its 13(b) program mainly had it channel credit through commercial banks. And like it, it also involved U.S. Treasury "backstopping" to cover any losses from bad loans. At least one difference seems worth noting, however: while the Fed's new plan allows it to lend many times its Treasury backing, the 1934 plan only allowed it to lend twice its Treasury backstop, and then only because the Fed had another $140 million of its own surplus capital on hand. Even if every dollar of the Fed's 13(b) loans went south, it couldn't possibly go broke.
Still the Fed took few chances with its 13(b) loans. "Advisory Committees" set up in each Federal Reserve District went through applications with a fine-toothed comb before forwarding them and their recommendations to their respective Fed banks. Those banks for their part proved still tougher: by October 23, 1935, they'd granted only one-quarter of 7,140 requests they received. By the end of the depression the Fed's acceptance rate was still just 30 percent. When the program was wrapped-up in 1958, the Fed had used just $27 million of its $140 million Treasury backup.
Despite its cautious approach, the Fed still lost money on many of its depression-era business loans. As of 1940, its business loan portfolio yielded a return of minus 3 percent, much of it due to the Fed's direct business loans: commercial lenders had not, it seems, overlooked many good prospects.
Yet smaller businesses were especially unlikely to benefit from the risks the Fed did take. Instead, when it knowingly took big risks, it did so for larger firms with many employees. Through 1950, the average 13(b) loan was for $175,000, roughly seven times the size of a typical business loan.
By then, however, most businesses had long given up trying to get 13(b) support: in 1939 only 88 firms tried. Many took their requests to the RFC, which offered more generous terms. The rest either managed without government support, or closed.
World War II revived the Fed's 13(b) lending, even putting it modestly in the black. But afterwards applications again fell to a trickle. Then, in 1951, William McChesney Martin, who was as unenthusiastic about the Fed's business lending as Eccles had been in favor of it, was appointed Fed Chair. In 1958, with barely any business loans left on its books, the Fed threw in the towel, allowing its 13(b) authority to be repealed by legislation that simultaneously beefed-up the lending power of the recently-established Small Business Administration.
Posterity has had little good to say about the Fed's first foray into business lending. According to a 1939 study, even during its first and biggest year, it was "of but little assistance to the small industrial concerns for which it had been ostensibly created." Throughout the whole of the Great Depression, it made up only a small share of all government-sponsored business lending, which itself never exceeded 5 percent of commercial banks' unsupported business loans. In short, it was but a drop in a drop in a bucket.
Yet it may prove beneficial, if we allow ourselves to learn from it. One lesson at least seems clear: if the Fed's lending to businesses is to make any difference, it has to be willing to take big risks—and to lose plenty of money.
The challenge is that, so far at least, losing money—even money Congress gives it—hasn't been the Fed's thing. Can that leopard change its spots? Is it now prepared to take big risks and lose big bucks? If it isn't, will its new effort fall as flat as its earlier one did? And if it is, might we come to regret its new spots some day?
Back in 1959, an anonymous St. Louis Fed authority, assessing the Fed's old program, concluded that "Governmental assistance to small business should probably be administered by an agency created solely for that purpose rather than by the central bank whose major duties are credit control and bank supervision." Time will tell whether that verdict still holds.