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How the Fed Made Section 13(b) Loans

December 1, 2002


How the Fed Made Section 13(b) Loans

The time is ripe for an alliance of all forces intent upon the business of recovery. In such an alliance will be found business and banking, agriculture and industry, and labor and capital. What an all-American team that is!

Franklin D. Roosevelt, Oct. 24, 1934
Address before the American Bankers Association

President Roosevelt's team included the hard-working members of the Federal Reserve banks' newly created Industrial Loan divisions, which were units of the banks' Discount Departments, and the citizen members of the Reserve banks' Industrial Advisory Committees. Their job? To implement Section 13(b) of the Federal Reserve Act and get the Reserve banks into the business of making working capital loans to industrial and commercial enterprises.

But how was such a task accomplished? It was true, as the accompanying article shows, that the Federal Reserve was already given some lending powers through its discount window in 1932 and 1933, so the banks had some practice in this matter; but those were restrictive programs and little used. The 1934 legislation added a whole new layer of business to the banks. What follows is a brief description of how such loans were handled at the Federal Reserve Bank of Minneapolis. Other than offering perfunctory explanations, no record in "official" histories—Fed publications or other published historical works—was found on this subject, so the following is based on a review of the Minneapolis Fed's archives. It's not clear from those archives that every Reserve bank managed this business in the same way, but it may be safe to assume that there were similarities.

"Men of practical affairs"

First, the Industrial Advisory Committee: Subject to the approval of the Federal Reserve Board, each bank appointed this group, which consisted of not less than three or no more than five individuals "actively engaged in some industrial pursuit." One Minneapolis Fed document called them "men of practical affairs and sound business judgment" who "insist that an enterprise must be fundamentally sound to qualify." These practical men received no remuneration for their work, but were reimbursed for expenses relating to their service, and were apparently appointed for indefinite terms. The job of this committee was to review loan applications and make recommendations to the Reserve bank.

At the Minneapolis Fed, records suggest that this group first met on July 30, 1934, about six weeks after the legislation was signed into law. Prior to the meeting, a member of the Federal Reserve Board, Eugene R. Black, made a "brief statement regarding the new functions of the Federal Reserve Banks." Unfortunately, that statement or any discussion that may have ensued, are not recorded in the meeting's minutes. Three members of the bank's Committee were present at this inaugural event, with an additional two joining the group at the subsequent meeting. Also, three members of the bank's Executive Committee—including President J.N. Peyton—were also present at the meeting and "participated in the discussion relative to a number of applications." Again, that discussion is not recorded.

Minutes of these meetings largely consist of lists of loan requests and the Committee's action, whether it was a "request for final application and further investigation" or a denial.

Minneapolis Fed records indicate that these meetings were held through 1955 (Section 13(b) was repealed in 1958), but with increasingly less frequency and with very little business. Although they began as twice-monthly meetings in 1934 with numerous applicants, they sometimes occurred just once a year in the early 1950s with as few as two items on the agenda. Also, two original members of the group—Chairman Sheldon Wood and John Bush—remained on the Committee throughout its tenure (although the chairman was absent from the final two gatherings). Putting on the commercial banker hat

When an applicant submitted a request for a Minneapolis Fed working capital loan, the Reserve Bank would record the receipt of the application, acknowledge receipt to the applicant and then turn over the application to Dun & Bradstreet for a credit report. After the credit report was received, the bank would then assign an "investigator" to the "case," who—after making a determination that the application met with the requirements of the law—would make a field investigation.

This field investigation included a verification of financial statements and an examination of the applicant's books and records "to assure that applicant has not failed to disclose any of his liabilities." Assets were also appraised to determine liquidation value.

During the examination the investigator studied "the applicant himself" to determine management skill and efficiency and would interview local bankers, if any, and others familiar with the business. "When all possible information" was assembled, the investigator would prepare a report for the Industrial Advisory Committee, a copy of which was mailed to each member in advance of a meeting.

Following the Advisory Committee meeting, the Minneapolis Fed's Discount Committee would further review the Advisory Committee's recommendation; this Discount Committee was the final arbiter on whether credit would be extended to an applicant. If approved, the applicant would then receive a letter stating terms and conditions of the loan. Security on such loans included stocks and bonds, town real estate, farm real estate, chattel mortgages on furniture and fixtures, logging equipment and "various other types of security."

The above quote, along with other quotations in this section, are taken from a staff presentation given at the Minneapolis Fed in December 1936 by E.F. Klein, head of the Discount Department. We conclude with an extended passage from Klein's lecture (collected in an internal publication called "Staff Lectures on Federal Reserve Operations"), which gives a sense for the way in which central bankers in the 1930s—just 20 years from the Federal Reserve's creation—were beginning to act a lot like commercial bankers.

In conjunction with our duties as investigators we service all loans. Borrowers are required to furnish periodical financial statements. Their statements are analyzed by our department. We visit all borrowers, usually once a year, at which time we re-examine the books and records, re-appraise the collateral and re-investigate the character and ability of the management in an endeavor to determine the progress of the business.

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