Why We Need a New Reconstruction Finance Corporation

May 8, 2020

Among the more novel ideas for responding to the COVID-19 crisis is the reboot of a long-forgotten New Deal-era institution: the Reconstruction Finance Corporation (RFC). Operating from 1932 to 1957, the agency lent and invested tens of billions of dollars to banks, manufacturers, state and local governments, federal agencies, and more—even creating whole industries from scratch when World War II shut off US industry and military from needed overseas supplies. At the time, it became the world’s biggest investor.

Does it make sense to reboot the RFC today? As scholars have highlighted, such a model could power ideas like a National Pandemic Production and Financing Board or Health Finance Corporation, which would take equity stakes in health supply companies to help ramp up and produce medical equipment. Versions of these ideas have been championed on the left and the right, and by politicians from Sen. Bernie Sanders (I-VT) to Sen. Marco Rubio (R-FL).

Indeed, the needs are great: Amid an uncoordinated global bidding war that’s driving PPE prices up by as much as 1,064 percent, the World Health Organization estimates that PPE manufacturing must increase by 40 percent. These market failures fall within the standard economic justifications for the creation of public funding bodies, which could also offer other benefits, such as greater democratic control over the relief effort.

While some of these proposals envision a temporary reboot to address discrete industrial conversion and coordination problems in the medical supplies industry, a growing chorus of scholars and advocates is pushing for a more permanent agency that could address another existential structural challenge facing the planet: a just decarbonization of the global economy. And as the virus mutates into broader disruptions of markets from oil to airlines to toilets, the line between the health response and the economic response will tend to blur. All are big problems that markets and firms can’t solve on their own, and all will require speedy and robust government intervention.

In this post, I lay out five reasons why a renewed RFC might be an answer.

Reason 1: It would improve the US’s haphazard use of the Defense Production Act.

One of the main tools the Trump administration has been using to respond to the COVID-19 health and economic crises is the Defense Production Act of 1950 (DPA), a law initially passed by Congress to facilitate the Truman administration’s mobilization for the Korean War, but reauthorized dozens of times since. It copied many elements of the Roosevelt-era First and Second War Powers Acts, which enabled the wholesale conversion of domestic supply chains to fight World War II while keeping the civilian economy adequately stocked with the things people need to survive.

As I explained in The Nation, the DPA remains a powerful tool that the government could use in its pandemic response, from reallocating private-sector health care capacity to public use, to investing in domestic vaccine production, to getting Silicon Valley coders to help fix the government’s outdated online benefits portals. And, as the president showed with his invocation of the DPA to maintain meatpacking operations, the law has wide reach. Used properly, it could address disruptions in many markets beyond health care.

To date, however, the administration’s use of the DPA has lurched haphazardly from one emergency to the next. During World War II, the RFC provided the funding and coordination that organized the use of emergency powers by the disparate agencies. A rebooted RFC could make today’s use of the DPA more rational. While creating a whole new agency would be daunting, the reality is that the federal agencies tasked with using the DPA have seen withered planning capacity for decades. So the transaction costs are already with us.

Reason 2: It would fund the emergency response even if Congress won’t.

Today, a gridlocked and austerity-minded Congress balks at appropriating sufficient money to ensure emergency readiness. While some legislators called for $3 billion to be appropriated for DPA spending, the CARES Act included only a third of that amount. Some news reports indicate that further spending measures may be difficult to get through the Senate.

Then and now, the US system of government’s numerous veto points make emergency response harder than under parliamentary or authoritarian systems. A work-around, as social scientists Sarah Quinn and Suzanne Mettler have argued, is so-called off-balance sheet money creation.[1] The RFC, for example, was allowed to borrow money from the Treasury and the capital markets, and then invest in relief and mobilization efforts that would eventually generate a return for taxpayers, all while skating past austerity hawks determined to cut or freeze government spending. While the agency didn’t rely extensively on the option of issuing its own bonds to be traded in private capital markets, most contemporary development banks, such as the World Bank, are more apt to do so. Though this allows even more financial firepower to be brought to bear, it comes with its own costs . . .

Reason 3: A new RFC could allow us to finance relief with accountability.

As social scientists Chris HumphreyEugénia C. Heldt, and Henning Schmidtke have found, modern development banks have to pay close attention to the whims of Wall Street and the credit rating agencies that rate their bonds—skewing their priorities toward the preferences of private finance. In some ways, the US is there already, as much of the emergency response is run by the Federal Reserve, an autonomous agency that is partly governed by private banks and lacks the democratic accountability of other executive branch agencies. Currently, the Fed is putting fewer restrictions on its lending than even the administration’s lending facilities, which ban stock buybacks, among other requirements.

A rebooted RFC could solve that problem. During the New Deal and World War II, it brought democratic accountability to a process that otherwise would have shifted major powers to finance. Initially, when the RFC was established under Hoover, the Fed was on its board. But, in the first few months of operation, the Fed’s preference for austerity and hands-off interference with private management hindered its effective operation. By the summer, the more competent and relief-friendly members of the board were able to get the Fed off, gaining the majority and holding it thereafter. Unlike the Fed, the RFC can and did force out bad managers and require strong labor standards in private companies benefiting from loans—all things the bloated financial sector could benefit from today. Also unlike the Fed, the body was accountable to the president and to Congress.

Reason 4: A new RFC would be a way to check Trumpian cronyism.

Finally, as I’ve argued in Politico, the RFC’s initial year of operation (in an election year!) offers lessons for how Congress can check Trump’s incompetence and venality. The most consequential aspects of the RFC—the types of projects it chose to fund, the way its board was structured to achieve bipartisan balance, avoid cronyism, and overcome the timidity of a Republican president—were pushed by Democrats in the House majority and Senate minority, whose votes were needed to authorize creation of the corporation. This specific constellation of power is identical to the one today, and shows how bipartisan power-sharing on a new RFC board could allow more oversight.

Reason 5: A health-specific RFC could pave the way for a more permanent funding body to promote structural change.

While legislators have sought to renew general-purpose RFCs dozens of times over the years (a Republican Congress voted it closed in 1953), there’s also a history of more temporary and subject-specific RFC proposals that think seriously about accountability. In 1975, over concerns that smaller universities and colleges were suffering from low enrollment due to the fallout from the oil shocks and economic crisis, Rep. Peter Peyser (R-NY) introduced a bill to create a Higher Education Reconstruction Finance Corporation. More recently, after the devastation of Hurricane Irma in 2016, Sen. Bernie Sanders proposed a Puerto Rico Reconstruction Finance Corporation that would buy up bonds from the island’s struggling municipal governments and corporations. And, in March 2020, Rep. Danny Davis (D-IL) outlined a plan for an RFC-style National Infrastructure Bank that would address the country’s $4.6 trillion deficit in public works.[2] Crucially, all three of these proposals have board structures that assure partisan balance, as well as representation by educators, labor, and/or affected citizens.

Here, history is also a guide. When initiated, the RFC was slated to operate for only a year, with a focus primarily on banks. But nothing succeeds like success, and that first year illustrated how effective government could be: The RFC and its subsidiaries would eventually have a hand in almost every aspect of industry.

A Health or Food Supply Reconstruction Corporation in 2020 could again demonstrate the idea’s value, paving the way for a broader Green Reconstruction Corporation in 2021.

[1] There are also downsides, as their books explore.
[2] His bank would be authorized to lend about that amount, relying on $100 billion in callable capital from the Treasury—and the difference made up by selling securities on private financial markets. (Additionally, the Davis bill authorizes $50 billion in annual appropriations to start up the bank.)