The Reconstruction Finance Corporation Rides Again
By now, the deepening economic crisis has become apparent to everyone: production is declining, unemployment is increasing and inflation is surging. Although interest rates have begun to moderate in recent months, they nevertheless remain at relatively high levels in comparison with the last several years. As a consequence of these economic trends, corporate management has encountered considerable difficulty not only in raising the funds necessary to meet their short- and medium-term obligations (thus creating a liquidity crisis) but, perhaps even more importantly, in mobilizing the funds to finance long-term capital investment.
The economic and political elite has responded to this deepening crisis by reversing its earlier policies and adopting expansionary credit policies through the Federal Reserve System in an effort to forestall a full-scale depression. Due to unavoidable time lags, the full impact of this shift in the focus of economic policy will not become apparent for another 6 to 18 months. In the meantime, corporate leaders must struggle with the deepest recession experienced by the American economy since World War II.
Political and academic figures confess their inability to explain the nature of the present crisis, but this has not dampened their enthusiasm for an endless stream of proposals, plans, programs and ideas for the expansion and rationalization of political control over the economic system. Senator Mansfield has renewed his perennial calls for strong price controls. Senator Bentsen has proposed selective credit controls to ensure that "productive enterprises receive the available credit." Milton Friedman, while professing to oppose the current high rate of inflation, has led the campaign for the adoption of a system of universal price indexing to minimize the adverse effects of accelerating inflation. President Ford has responded to the politically sensitive issue of rising unemployment by authorizing acceleration of Federal construction projects, inauguration of a variety of WPA-style Federal employment programs and extension of Federal unemployment insurance. In addition, a concerted effort has been launched to offer the Arabs to the American public as a foreign scapegoat which can be conveniently blamed for the present economic crisis.
From this broad range of responses to the present recession, one in particular deserves to be singled out for special mention since it could portend a fundamental structural transformation of the economic system. This involves several proposals which have been made in recent months for a revival of the Reconstruction Finance Corporation (RFC). Perhaps the most important aspect of these proposals is that they have originated from within a corporate and banking elite which has traditionally influenced government policy in the 20th century. Supporters of the RFC concept include Henry Ford, chairman of the Ford Motor Company; William McChesney Martin, former chairman of the Federal Reserve Board; Alfred Hayes, president of the Federal Reserve Bank of New York; and Gustave Levy, senior partner of Goldman Sachs.
Felix G. Rohatyn, a partner in the investment banking firm of Lazard Freres, has emerged as a leading spokesman on behalf of the growing corporate-liberal consensus regarding the need and desirability for an institution modelled on the pattern of the RFC. In his article published in the New York Times on December 1, 1974, Rohatyn suggests that the new RFC should be vested with an even broader role than the earlier RFC performed. Whereas the earlier RFC had been established to provide emergency loans to financial institutions and corporations threatened with collapse during the Depression, Rohatyn suggests that the new RFC should also be permitted to undertake substantial equity investments in private corporations. Thus, not only will the taxpayers be called upon to rescue faltering firms, but they will also be required to subsidize large-scale purchases of common stock to provide the firms with sufficient equity capital to continue their operations and to prevent further declines in stock market price levels.
Rohatyn notes with approval the growing support for centralized, long-range economic planning by the Federal Government and proposes that a new RFC could serve as a key instrument in the implementation of comprehensive planning. "By injecting equity capital where none is available in quantity, it could facilitate a major restructuring for the public purpose." Rohatyn's article focuses on the role which the RFC would play in advancing liquidity and equity capital to distressed banks and corporations, but there is little indication that he is aware of the exacerbation of inflationary problems which would be caused by such an institution.
To understand the significance of these recent proposals for a revival of the RFC, it is necessary to outline briefly the history of the original RFC. As with many of the measures adopted during the Depression, the RFC's origins can be traced back to wartime intervention. The War Finance Corporation established during World War I provided the inspiration for the RFC and, in fact, the RFC was staffed by much of the same personnel. Eugene Meyer, the chairman of the RFC and former Managing Director of the War Finance Corporation, illustrates the continuity which existed between these two organizations. Historians such as William Leuchtenberg and Murray Rothbard have stressed the importance of wartime institutions in providing training and experience for the personnel which later staffed a broad variety of Hoover-Roosevelt New Deal agencies.
The War Finance Corporation was not terminated until 1929 and, although not occupying a prominent position in economic management during the decade following the end of the war, it did serve as a rallying point for advocates of increased government intervention in the economy. Thus, as the Depression spread in 1931, it was natural that one of Hoover's first responses would be to seek a revival of the War Finance Corporation. Despite the support of Eugene Meyer, then head of the New York Federal Reserve Bank, various financial leaders balked at a proposal by Hoover to cooperate in advancing funds to troubled banks and corporations and Hoover eventually settled for an interim compromise. The National Credit Corporation was established as a stop-gap, "volunteer" credit advancing agency which would operate until legislative support could be mobilized for a formal institution. The RFC replaced the NCC in the following year, beginning operations in October 1932.
The WFC, NCC and RFC along with the Federal Reserve System provided an important element of continuity in the emergence and consolidation of the interventionistic superstructure of "political capitalism" (that is, fusion of the business and government sectors in various degrees) during the period extending from World War I to World War II. Through its control over the monetary supply, the Federal Reserve System pursued expansionary credit policies which caused a systematic distortion in the structure of production (over-expansion in the capital goods sector at the expense of the consumer goods sector). These policies encouraged numerous unsound investments which eventually became recognizably insolvent. Rather than allowing the market process to liquidate these unsound investments, a variety of government agencies such as the RFC were established to advance credit to firms threatened with bankruptcy. Thus, steadily expanding government involvement in the economic system became necessary to sustain the profitability of the over-investment which in turn had resulted from the expansionary credit policies made possible by government collaboration with the banking institutions. The centralization and rationalization of state involvement in the economic system has remained a predominant, if not the central, characteristic of "political capitalism."
Hoover's RFC was established with an initial capital fund of $500 million which was subscribed to by the U.S. Treasury and it was authorized to issue an additional $1.5 billion in government-guaranteed debentures. The scope and powers of the RFC were further expanded by the Emergency Relief and Construction Act of 1932 which nearly doubled total RFC capital. The RFC thus rapidly emerged as a complementary institution to the Federal Reserve System. The "Fed" sought to assure the greater availability of short-term liquidity to corporations through the banking system by lowering the quality and increasing the quantity of assets which member banks could use to borrow from the Fed. Simultaneously, the RFC concentrated on the purchase of long-term obligations and the granting of long-term credit to cover the long-term capital requirements of both financial institutions and corporations.
In performing this function, the RFC advanced approximately $10 billion in credit from 1931-1938—a substantial sum when considered in the context of the Depression-ridden 1930's. The quality of the loans advanced by the RFC is much more significant than the amount. By their very nature, the RFC loans allocated funds to investments which were deemed unsound by private market criteria. Thus over-extended banks were given the highest priority and the railroads which had become heavily indebted to the banks, were leading beneficiaries of RFC credit policies. While the primary function of the RFC was clearly to rescue the strategic, and highly vulnerable, banking system, RFC funds were also allocated for the purpose of reviving the depressed and over-extended agricultural sector and expanding employment through public works projects.
Rohatyn insists that a new RFC would advance credit on a "sound" banking basis but such a claim contradicts the very rationale for an RFC. Firms wishing to undertake truly "sound" investments are always able to raise the necessary financing on the private capital market and, if they are unable to locate the funds for such investment the investments are by definition unsound and should either be abandoned or modified to conform to objective market conditions.
An understanding of the long-term impact of RFC operations on the economic system requires critical examination of the assumptions underlying the proposals for such an institution. Elliot Janeway's prolific writings on contemporary economic trends articulate and popularize many of the fallacious assumptions which have been so important in hiding the underlying nature of the current crisis. First, there is the pervasive belief that the periodic "liquidity crises" experienced by corporations in conjunction with rising interest rates are only "financial problems" which disrupt the operation of an otherwise "healthy" economic system. This gives rise to the further assumption that all that is really necessary to eliminate these problems is to increase liquidity sufficiently to correct the existing disequilibrium. These assumptions are reinforced by the tendency for net earnings ratios to decline in the stock market as interest rates rise at the end of a "boom." As a result, capital flows out of the stock market into short-term money markets, thus generating a growing scarcity of long-term investment funds. As this process intensifies, there is growing pressure to resort to political intervention to resolve the inexplicable, yet somehow temporary, problem of the unavailability of adequate investment capital.
However, is the assumption really correct that the financial problems confronted on an ever-increasing scale by individual corporations are not manifestations of fundamental and pervasive distortions in the capital market? And is it possible that a policy of expanding government involvement in the capital market through such institutions as the RFC will simply aggravate the existing financial problems in the long run rather than resolving them? Satisfactory answers to these questions can only be formulated within the context of a theoretical framework and, while such a framework cannot be developed in detail here, certain broad conclusions can be inferred from the following brief analysis.
Corporate liquidity crises arise when firms discover that their past investment decisions, which were made on the basis of distorted price information (specifically, the market interest rate or cost of money capital), cannot generate the expected returns. The price distortions which influence these investment decisions arise as a consequence of the expansion of the money supply through the Federal Reserve System which artificially lowers the market interest rate. The newly created funds are first channeled into the producer's loan market, lowering the cost of future investment to the producer-entrepreneur. Since the information upon which decisions are made in a market economy is conveyed through the price system, the resulting price distortions create the false impression that there is more real capital available for investment purposes. The entrepreneur is thus led to undertake investment projects which previously had been unprofitable, and there is a general tendency towards over-investment in future consumption goods at the expense of present consumption goods.
However, since there hasn't really been an increase in the availability of factors of production, the new money capital entering the system serves to bid up the prices of the existing factors of production, thereby increasing the costs of the producers. The real situation becomes apparent as unanticipated costs impinge strongly on returns and the increasingly unfavorable cost-yield ratios reveal the unprofitability of much of this new investment.
Moreover, as costs continue to rise to unexpected levels, the entrepreneur is simultaneously confronted with lower revenues than had been anticipated. While the entrepreneur had begun to shift investment to the higher orders of production in response to distorted price information, consumers were in fact demanding more consumer goods than had been expected and the anticipated demand for capital goods from the higher orders of production proved largely illusory.
The situation continues to deteriorate for capital goods producers until their declining revenue proves insufficient to cover even their current costs. In response to growing cash-flow problems, the capital goods producers begin to borrow in ever-increasing numbers on the short-term money markets. Since it is unlikely that real savings will provide sufficient funds to satisfy the growing demand for short-term loans, the capital goods producers (as well as the over-extended financial institutions) confront two possible options: new infusions of credit from government sources or a steadily worsening liquidity crisis.
Assuming that no additional infusions of credit are forthcoming, a period of widespread liquidation will be necessary to permit reorganization of assets to reflect existing market conditions more accurately. This period of liquidation represents a necessary process of price readjustment in which the prices of the factors of production (which had been artificially inflated during the preceding boom) decline to a point where they can once again be profitably employed. This process of price readjustment is a market response to the earlier phase of over-investment and it must be permitted to be carried out to its conclusion if the economy is to regain optimal efficiency in the allocation of resources. Private investment will not be forthcoming until the cost-price relationship is once again equilibrated.
The liquidity crises experienced today by corporations on an increasing scale constitute definitive proof of mistaken entrepreneurial expectations since, if there had been accurate entrepreneurial foresight, management would have ensured the availability of sufficient liquid assets to meet corporate obligations at all times. While it is true that the underlying fault for such mistaken expectations must be attributed to distortions in the price mechanism rather than to the entrepreneurs themselves, it is nevertheless necessary to resist the temptation to "bail out" unsound investments through state subsidies since such an effort will merely aggravate the mistakes already made. Receivership and reorganization of productive assets are not undesirable consequences to be avoided at all costs—on the contrary, they constitute a prerequisite for economic recovery. This recovery will be indefinitely postponed if policies are adopted which seek to preserve the status quo in the organization of production.
This period of price readjustment illustrates the market's role as a learning process in which entrepreneurs learn by their errors and reallocate economic resources to more socially desirable uses (as indicated by consumer preferences). The socialization of private costs undertaken by such state agencies as the RFC distorts, impedes and even halts this learning process by permitting inefficient entrepreneurs to sustain unsound investments. This intervention in the market system imposes a double burden on the public: not only are actual consumer preferences as expressed through the price mechanism not satisfied, but the public is required to finance the inefficient entrepreneurs to protect their unsound investment.
FROM POLITICAL CAPITALISM TO FASCISM
While understandable as a natural response to widespread economic distress, the proposals for the adoption of reflationary policies by the Federal Reserve System and for the creation of institutions such as the RFC to reinforce the Fed's reflationary policies serve merely as futile attempts to salvage a fundamentally distorted system of "political capitalism" and, if implemented, would only prolong the period of readjustment which will eventually prove necessary. A reflationary strategy will internalize the distortions and malinvestments within the economy while generating even further dislocations. Rather than attempting to preserve and maintain the existing system, it is necessary to work for the elimination of the central banking system that serves as the locus of ultimate decision-making within the state "capitalist" system and provides the mechanism necessary for the inflationary expansion of the monetary supply.
Central banking constitutes an inherently inflationary institution and, as long as it continues to operate, it will generate systematic distortions throughout the economy which in turn will require difficult periods of readjustment. The "business cycle" phenomenon is intrinsic to the "political capitalist" system and these periodic crises can only be eliminated by ending state cartellization of the banking sector. The collaboration between the banking institutions and the government in setting the parameters for monetary expansion and banking activity must be perceived as the source of ultimate control over the system of "political capitalism."
Attempts to resolve the growing contradictions within the political "capitalist" system without directly confronting the source of these contradictions will ultimately prove futile. Policies designed to ensure the availability of adequate supplies of liquid capital for troubled corporations may ease their short-term problems but they will provide only a superficial remedy for the steadily worsening financial condition of these corporations. Moreover, such attempts at superficial reforms will inexorably lead to more comprehensive forms of political intervention in the market system. Unwilling to permit the market process to correct the distortions caused in the structure of production, policy-makers will have to steadily expand the scope of state intervention in an effort to insulate corporations from the consequences of their earlier mistakes.
The diversion of credit and resources will internalize the distortions once again within the economic system, thus creating a "need" for further centralization of control and fusing the state and leading corporate and financial interests together into a grand alliance for the preservation of the status quo. Rather than stabilizing the economic system, however, "political capitalism" represents an inherently destabilizing form of social organization since it increasingly impedes the equilibrating function of the market process. Ultimately, this process will result in the emergence of a truly fascistic set of political/economic relationships: the labels and outward appearance of a market system will be preserved while the locus of economic decisionmaking will be firmly imbedded in the state apparatus.
The significance of this shift in the locus of decisionmaking is not that different people would be making the decisions since, in fact, in most cases the same people will be involved, as personnel transfers between corporate offices and government offices become increasingly common. The real importance of this shift involves the abandonment of the market mechanism for the allocation of economic resources and its replacement by a system of arbitrary political decisionmaking operating within a completely different set of parameters and constraints.
One of the defining characteristics of this transition from "political capitalism" to a more "orthodox" fascist economic system involves the expanding role of the state in socializing private costs. Private profits are preserved and protected by an ever-expanding network of state privilege and subsidy designed to shift the cost burden from the individual corporation to the public at large. Thus, corporations benefit from direct subsidies, state contracts, tax privileges, low-cost, guaranteed loans and military and diplomatic protection designed to minimize the uncertainties involved in overseas investment. The RFC represents a key indicator of the progress of the transition from "political capitalism" to a fascist system. On one level, it appears to be simply one more institution for the socialization of private costs by underwriting entrepreneurial error and providing another source of liquid capital to rescue financially troubled corporations.
However, Rohatyn's proposal for a new RFC indicates that it would venture into an area in which the original RFC became only marginally involved: "From its inception, it should be an instrument empowered to make significant equity investments, in the form of either common or preferred stock, for the long-term resolution of financial problems.…The RFC should, thus, become a prominent part of our economic establishment, not just as a last-ditch creditor but as a vibrant instrument of both rescue as well as stimulus." Thus, the new RFC would represent an important instrument for the allocation and coordination of investment directly by the state apparatus.
George F. Will, one of the few conservatives to attack Rohatyn's proposal, perceptively summarized its consequences: "What [Rohatyn] advocates is a decisive step away from private enterprise capitalism.…An economic system in which the government, using instruments vibrant and otherwise, targets major flows of capital is a system properly called state capitalism.…Such an economy is dominated by bureaucrats who direct capital outlays, and hence shape the economy, and hence determine the range of social choices, and hence shape the way people live."
Through an instrument such as the RFC, the fusion between state bureaucrats and "private" economic interests which has already occurred in areas such as banking, the "military-industrial complex" and the atomic energy industry would be gradually extended into other areas of the economic system. Rohatyn suggests in his article that one of the first areas in which the RFC might become "a catalyst of stimulation" would be in a Manhattan-type project for the accelerated development of alternative energy sources.
Robert Caro's important new biography of Robert Moses, The Power Broker, includes an illuminating analysis of "authority capitalism," representing the fusion between the state and corporate interests that Moses actively promoted through a complex network of semi-"independent" authorities and commissions. Caro's analysis of this phenomenon is particularly important because of the growing indications that such forms of political/economic organization may serve as models on the national level. Certainly Rohatyn's RFC would represent an important step in this direction.
THE RFC AND COMPETITION
In addition to the RFC's strategic role as an instrument in the transition from "political capitalism" to fascism, the RFC is also crucially significant on another level. Political intervention in the market has traditionally been employed not only as a device for the centralization and rationalization of control over the economic system; it has also served as a highly useful form of "extra-economic" competition. Thus, both established economic interests and "newcomers" in the market who are unable to achieve their objectives within the framework of market competition have characteristically sought the intervention of the state on their behalf. As Gabriel Kolko and other historians have persuasively demonstrated, the Progressive Era and the emergence of "political capitalism" can only be understood as a systematic and largely successful endeavor by well-established economic interests to protect their position from increasing competitive pressures by relying on state intervention. The highly selective employment of antitrust suits offers another, slightly different example of the role of the state in promoting the interests of one economic interest group at the expense of another group. Thus, depending on their relative degree of access to the state apparatus, economic interest groups may employ the political means as an instrument either to preserve the existing distribution of economic resources, or to redistribute these resources on behalf of emergent interest groups.
Earlier social analysts (most notably Franz Oppenheimer and Albert Jay Nock) have noted the existence of two fundamentally distinct methods for the acquisition of wealth in society: the economic means and the political means. The economic means is limited to the creation of wealth through production and voluntary exchange within a market system while the political means involves the use of coercion to confiscate and expropriate wealth. By its very nature, the political means benefits one group only at the expense of another and its institutionalization within the state sets into motion a process of class conflict which pervades the entire society and profoundly influences the subsequent evolution of both the political and economic system. Meaningful social analysis thus requires the abandonment of the myth of the state's role as a guardian of some vaguely defined "public interest" and its replacement by a detailed analysis of the specific groups in society who benefit by the use of the political means at the expense of other specific groups.
Carl Oglesby and others have sought to elaborate a model of intra-elite conflict which may have considerable relevance both within this general theoretical context and as a key to understanding the precise role which a revived RFC might play as a political/economic instrument of competition. Although Oglesby's model is much too detailed and subtle to summarize adequately here, it essentially interprets the post-Civil War historical development of the U.S.A. in terms of an underlying conflict between a "Yankee" faction and an emergent "Cowboy" faction within the national ruling class. The "Yankee" faction is represented by the established families of the Northeast—the Rockefellers, Morgans, Harrimans, etc.—whose wealth is concentrated in banking and multinational corporations. The "Cowboy" faction, on the other hand, represents a much more heterogeneous grouping which geographically extends along the southern rim of the U.S.A. from Miami to Los Angeles and which has traditionally derived its wealth from domestic oil production, defense contracts and agribusiness.
Although Oglesby himself has not stressed this particular point, the "Cowboy" faction has characteristically been heavily dependent on the political means for the consolidation of its position within the economy. It is no coincidence that the growing challenge by the emergent "Cowboy" interests to the entrenched influence of the "Yankee" faction within the national political elite has closely paralleled the dramatic expansion of the military-industrial complex in the post-World War II period. The "Yankee" faction favored a massive expansion of military expenditures in the 1930's for two reasons: their traditional Anglophile sympathies made them particularly sensitive to the need to render assistance to the British despite the overwhelming isolationist sentiment prevailing among the American public, and they perceived the vital role of military expenditures as a means of reviving the domestic economy. Ironically, however, the massive government contracts subsequently awarded to private firms for military projects played a decisive role in strengthening emergent "Cowboy" interests. World War II agencies such as the War Production Board and the Defense Plant Corporation were very important in the creation and expansion of many individual fortunes in "Cowboy" areas.
Within this context, it should be noted that the original RFC played an early role in strengthening "Cowboy" interests, particularly following the appointment of a Texas Democrat, Jesse Jones, to replace Eugene Meyer as chairman of the RFC. One of the most interesting examples of this involves the RFC's loans to Henry J. Kaiser, a western construction contractor who had relied heavily on government contracts from the Public Works Authority. By 1945, Kaiser had received nearly $200 million in loans from the RFC and these were instrumental in the establishment of both Kaiser Aluminum and Kaiser Steel. Kaiser also coincidentally benefited greatly by antitrust suits which were instituted against ALCOA as "punishment" for its failure to participate sufficiently in the massive war preparation effort which preceded World War II.
Kaiser also profited from liberal financing by A.P. Giannini's Bank of America which in turn had borrowed heavily from the RFC. W.L. Clayton, the Texas cotton king, considerably expanded his holdings with financing from the RFC and later continued his profitable association with the government under such programs as the Export-Import Bank and the Marshall Plan. These brief examples illustrate the importance of the RFC in channelling funds to certain emergent interest groups and suggest the possibility that a new RFC might serve a similar function. For this reason, it will be necessary in the months ahead to analyze in greater detail the sources of support for the establishment of such an institution as well as the personnel which might eventually staff a new RFC in order to understand its impact on regional intra-elite conflict.
As this article suggests, a new RFC would represent a key advance element in the emergence of a distinctly fascist political/economic system and, as such, it raises important issues of strategy. The final and unalterable objective of any opposition strategy to "political capitalism" must be the abolition of the Federal Reserve System as the key instrument in the consolidation of control by the banking institutions over the rest of the economy. Until this core element of the "political capitalist" system is removed, the periodic dislocations of the business cycle and the ever-growing fusion of state and business interests will be unavoidable.
However, this objective will only be attained after a lengthy and difficult educational and political struggle. In the meantime, opposition to proposals for the establishment of a new RFC would serve several important purposes within the context of this longterm objective. Broad opposition to a new RFC would serve notice on the political/economic elite of the country that the transition to more centralized forms of political control will not be an easy one and it may make this elite more reluctant to experiment with other semi-fascist institutions.
Secondly, it would provide a useful issue on which to focus public attention and to begin to raise more fundamental issues regarding the nature of the political and economic system that is emerging in the U.S.A. Presumably relatively few people will be sympathetic to a program which increases the already oppressive tax burden on the public in order to underwrite the mistakes of such corporate giants as Lockheed and Pan American. Successful opposition to the establishment of a new RFC will provide an important first step in raising public consciousness regarding the nature of "political capitalism" and facilitate a direct attack on the very core of that system: the state-enforced cartellization of the banking sector. By focusing on this intermediate objective, the opposition movement will have a valuable opportunity to gain strength and to develop a more consistent and detailed program for the abolition of "political capitalism" itself. The road ahead is a long and difficult one; it is up to us whether we possess the courage and determination to begin the long march.
Walter E. Grinder teaches in the Economic Department of Rutgers University in Newark and is an associate editor of Libertarian Review. Alan Fairgate is currently pursuing a combined MBA-JD program at a leading eastern university.
This article originally appeared in print under the headline "The Reconstruction Finance Corporation Rides Again".