The Federal Reserve's expanded lending, a salve for the financial markets' current crisis, was meant to aid the 'forgotten man.'
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By Maura Reynolds
WASHINGTON -- — It was July 1932 when Speaker John Nance Garner rose to address the U.S. House of Representatives, complaining that the government was helping big business but not the little man.
In an emergency, the Texas Democrat declared, even ordinary citizens should be eligible for help.
"I plead with you to let all the people have some drippings," said Garner, recently chosen to be Franklin D. Roosevelt's running mate. "Do not keep it just for a few."
The Great Depression had gripped the country, and under Garner's prodding, the Federal Reserve Act was amended to permit a wide expansion of federal lending under "unusual and exigent circumstances." Last week, after more than 70 years of gathering dust, the measure was pulled out like a rabbit from a hat to rescue one of the biggest financial institutions in the country.
Garner may have rolled in his grave at what the Fed did with his largely forgotten bit of populist lawmaking, but most economists applauded.
"It was almost a miracle that it was there, and it was a miracle that someone in the Fed figured out how to use it," said David M. Jones, a former Fed official who is now chief economist at Investors Security Trust in Fort Myers, Fla.
The credit system may face more rough weather in the months ahead, and the key question seems to be how bad a recession the United States is in for, not whether it faces one at all. Fed Chairman Ben S. Bernanke's decision to rescue investment house Bear Stearns Cos. by extending central bank lending to major financial institutions other than traditional banks is widely credited with giving anxious markets a breather and possibly averting a 1930s-style crisis.
Normally, the Fed makes direct loans only to depository institutions. March 16, after hasty meetings and a vote by its senior decision-makers, the central bank announced that it would loan $30 billion to JPMorgan Chase & Co., effectively underwriting its fire-sale purchase of Bear Stearns.
Moreover, the Fed promised that for at least the next six months, it would permit about 20 other "primary lenders" to take out direct loans as well, using whatever collateral the central bank decided was appropriate, including troubled mortgage-backed bonds.
Bear Stearns, caught in the sub-prime mortgage debacle and the resulting credit freeze-up, had been thrust suddenly to the brink of collapse. The financial community was rife with rumors that other major firms might go under too.
Wall Street faced the prospect of a 21st century version of an old-fashioned run on the banks as investors lost confidence in the huge companies that had grown up outside traditional banking.
For months, Bernanke had been searching for new tools. The Fed's traditional crank for boosting the economy -- lowering bank interest rates -- was less effective than in the past.
The bold expansion of Fed lending appeared to provide an answer, at least temporarily. The stock market steadied and even gained ground last week, aided also by an aggressive Fed rate cut Tuesday. Commodity prices plunged, a sign of renewed confidence in the financial system. And Wall Street's other major investment houses held on.
As the drama unfolded, economists and other analysts repeatedly compared and contrasted the current crisis with the Depression.
David Moss, an economic historian at Harvard Business School, said a major difference was that during the Depression, the Fed was part of the problem.
It was largely in denial in the early years, stingy about lending to distressed banks and a virtual slave to the gold standard, which led it to raise interest rates right when they should have been lowered.
This time, the gold standard is long gone and the Fed is alert to the risks and moving aggressively to try to address them.
"As an academic, Ben Bernanke studied the Depression," Moss said. "Now, as Fed chairman, it's clear he's learned from the mistakes of the 1930s and is using those lessons on a daily basis."
Alice M. Rivlin, a former vice chairwoman of the Fed and Clinton administration budget director, praised Bernanke for using all the powers at his disposal.
She called it "very interesting but totally irrelevant" that the statute Bernanke used to authorize his rescue of Bear Stearns was intended for the opposite purpose.
"I think the Federal Reserve needs maximum flexibility at the moment to deal with the situation," she said. "If [the statute] weren't there, we would have to put it there. Luckily, it was there."
As it happens, Garner -- now best remembered for his assertion, in bowdlerized form, that the vice presidency wasn't "worth a bucket of warm spit" -- hadn't been thinking about the Federal Reserve at all. The target of his wrath was the Reconstruction Finance Corp., which then-President Herbert Hoover had set up to rescue big businesses such as banks, insurance companies and railways.
In particular, Garner pointed out that the Reconstruction Finance Corp. spent $90 million to bail out a big Chicago bank with strong ties to the GOP, while refusing the city money to pay its workers, including teachers and firefighters.
There were good economic reasons to save the Chicago bank. Its failure would probably have triggered the collapse of dozens of smaller banks. Because federal deposit insurance did not yet exist, that would probably have wiped out the savings of thousands of ordinary Americans.
Besides, the Reconstruction Finance Corp. was not allowed to lend to local governments, much less individuals.
That, Garner said, was exactly the problem. "How can you say that it is more important in this nation that the New York Central Railroad should meet the interest on its bonds . . . than it is to prevent the forced sale of 500,000 farms and homes?"
His motivations may not have been entirely altruistic. The presidential campaign was heating up as Hoover, seeking reelection, battled challenger Roosevelt. Garner saw a chance to burnish his populist credentials.
"Politically, the loan looked like cronyism of the worst order," said George Nash, the author of a three-volume biography of Hoover.
Garner decided to use a big Depression-relief bill then nearing completion to champion the cause of the "forgotten man."
In early July, Congress sent the bill to Hoover's desk, including the Garner-backed provision to let the Reconstruction Finance Corp. loan federal money to individuals, cities and smaller businesses.
Hoover complained that Garner's language would turn the Reconstruction Finance Corp. into the "most gigantic banking and pawn-broking business in all history."
Eventually, a behind-the-scenes compromise was negotiated, and Garner's idea became law as an amendment to the Federal Reserve Act.
The provision was invoked during the Depression, but sparingly. All together, just $1.5 million in loans were approved, the last one in 1936.
Now, it has found an entirely new purpose in an entirely new era.
"We were on the brink of a total financial collapse," said Fed watcher Jones. "This saved us."
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