In the 1930s, the United States made a crucial transition in the history of government intervention. Before then, government subsidies were damaging, but infrequent. After the 1930s, government subsidies proliferated and became part of American life. Why did this happen? First, before 1930 subsidies were usually found to be inconsistent with the Constitution. Second, Congress was held accountable for them. When Congress funded Collins’s steamship company, the Union Pacific Railroad, or Samuel Langley’s aerodrome, congressmen—who had to run for reelection—were accountable to voters for the results. In all three of these examples, the failure of the subsidy created a political backlash; Congress, often after much public embarrassment, stopped these subsidies.
Both of those barriers were knocked down in the 1930s. The Great Depression hit the nation, and the presidencies of Herbert Hoover and Franklin Roosevelt changed the way government operated. First, the new appointees to the Supreme Court increasingly viewed the Constitution as a mere guide, not binding law. Second, Congress—with much help from Hoover and FDR—created new government agencies with the power to award many subsidies. Congress funded the agencies through annual appropriations, but the bureaucrats in the agencies, not Congress, doled out the federal cash. In other words, unelected government bureaucrats would be liberally funded by Congress to give away other people’s money on whatever projects they chose.
In many ways, the most dramatic new government agency of the 1930s was the Reconstruction Finance Corporation (RFC). Designed to lend or give cash to industries, the RFC was a new type of government entity, one not even imagined by the Founders. Never in U.S. history (except during World War I) had the United States established an independent agency with power to lend millions, and later billions, to corporations. The board of the RFC, not Congress, gave this money away to the corporations it chose. And the RFC chose many corporations in many different industries.1
President Hoover first promoted the idea for the RFC in 1931, during the Great Depression. When he saw thousands of banks going broke, and Americans losing their savings, he reacted. Also, many key corporations—railroads, for example—were going bankrupt, which disrupted commerce and threw millions of Americans out of work. The RFC, Hoover insisted, should be instituted to make loans (or gifts) to these banks and railroads, which would halt the cycle of bankruptcy and unemployment. Thus, in October 1931, Hoover approached congressional leaders with his idea for a heavily funded RFC. In the meeting, Hoover said he “hoped those present would approve my program in order to restore confidence, which was rapidly degenerating into panic.” Most congressmen, according to Hoover, “seemed shocked at the revelation that our government for the first time in peacetime history might have to intervene to support private enterprise.”2
Hoover’s statement overlooked the government interventions that had already helped to cause the Great Depression and then made it worse. First, in 1928 and 1929, the Federal Reserve raised interest rates four times, which made it harder for businessmen to borrow money to invest, and that hindered economic growth. Second, the Smoot-Hawley Tariff, which Hoover signed in 1930, was the highest tariff in American history. It sharply raised rates on 887 items and virtually stopped foreign trade: Because the United States refused to buy from other countries, other countries would not buy from the United States. Third, Hoover raised tax rates across the board—from 24 to 63 percent on rich people. Wealthy Americans, when faced with such high tax rates, slowed down their investing and often took their capital out of the U.S. economy, making it much more difficult for entrepreneurs to establish new companies.3
Ten years earlier, in the recession of 1921, President Warren G. Harding had done the opposite of Hoover. Harding cut federal spending by more than half, from a $6.4 billion budget in 1920 to $3.1 billion in 1923. Also, he and his successor in the White House, Calvin Coolidge, cut tax rates on all income taxpayers during the 1920s—from 73 to 24 percent on the wealthiest Americans. The results were astonishing: Unemployment plummeted from 11.7 percent to 2.4 percent from 1921 to 1923, and remained low for the rest of the decade. During the 1920s, living standards went up, gross national product increased almost 25 percent, and the federal government recorded budget surpluses every year—until the Federal Reserve raised interest rates and Congress passed the Smoot-Hawley Tariff. Increasing the role of government during the 1930s, then, was not Hoover’s only option, but it was the one he chose.4
Hoover announced the RFC as a minor program in his December 1931 State of the Union message. “It may not be necessary to use such an instrumentality very extensively,” he said, and it would be liquidated “at the end of two years.” Hoover introduced his RFC as an emergency measure, a temporary solution that would be more for show than action. The RFC, Hoover believed, had no place in a normal American economy.5
Some congressmen were instantly skeptical of the RFC idea. John Nance Garner, the Speaker of the House, thought an RFC might help in the emergency, but “when that need is past, it will linger on as a pipe line to the United States Treasury for chiselers and drone businesses.” In January 1932, Congress funded the RFC with $500 million, almost 10 percent of the entire federal budget that year. Congress gave the RFC the right to spend $1.5 billion if necessary, and more was soon added to that. The RFC had the power to bail out banks, railroads, and other corporations of its choosing. The RFC’s directors were supposedly experts who would make sound choices in spending the money. The first president, Eugene Meyer, was also chairman of the Federal Reserve.6
Chester Morrill, the secretary of the Board of Governors of the Federal Reserve, watched the RFC in action and issued this devastating indictment of the negative effects of such an uncontrolled agency:
It became apparent almost immediately, to many Congressmen and Senators, that here was a device which would enable them to provide for activities that they favored for which government funds would be required, but without any apparent increase in appropriations, and without passing any appropriations bill of any kind to accomplish its purposes. After they had done that, there need be no more appropriations and its activities could be enlarged indefinitely, as they were almost to fantastic proportions.7
As Morrill observed, congressmen could promote funding of corporations of their choosing—perhaps key industries in their districts—and bear no real responsibility for spending errors or budget deficits. Unelected RFC officials, who were supposedly experts, would choose who received bailouts and who didn’t. After two years, the RFC spent $2 billion, and the new president, Franklin Roosevelt, gladly persuaded Congress to get its charter extended.
But after two years of RFC’s unprecedented spending, unemployment was still high. That should not be surprising. First, many of the RFC loans were bad investments. Second, the RFC quickly became subject to politics. On the first point, the banks, railroads, and other corporations receiving the RFC money were bad risks, and they could not get conventional loans from banks or other institutions that had to make a profit to survive. Economists Charles Calomiris and Joseph Mason, who studied the RFC loans, estimated that 50 percent of the banks receiving RFC loans were poor risks.8 In other words, these companies resembled the projects of Collins, McKenney, and Langley more than those of Vanderbilt, Astor, and the Wright brothers. When Collins, McKenney, and Langley lost government money, it detracted from U.S. economic development in a small way; when the same result occurred with hundreds of corporations receiving RFC loans, U.S. economic development was hindered in a larger way.
In the case of railroads, RFC loans may have done actual damage to the railroads themselves (as well as to taxpayers). Almost two-thirds of the largest twenty railroads receiving RFC loans from 1932 to 1937 failed anyway. When railroad owners received the government aid, they avoided long-term care and maintenance on their railroads and spent the new cash instead on slashing debt and making interest and dividend payments. Economists Joseph Mason and Daniel Schiffman argue that “RFC loans often merely delayed the inevitable [bankruptcy]; had the government allowed these roads to enter bankruptcy earlier, the economy would have benefitted from bankruptcy-related increases in maintenance.”9
On the second point, the RFC quickly became a political cash cow for the party in power. RFC board members gave taxpayer subsidies to their friends. Eugene Meyer, the first president of the RFC, approved a $5.75 million grant to the Missouri Pacific Railroad to repay its bank loan to J. P. Morgan & Company. Meyer’s brother-in-law, George Blumenthal, just happened to be a member of J. P. Morgan & Company, and the Missouri Pacific went into bankruptcy after repaying its loan to Blumenthal’s bank.10
Such “coincidences” were common. The RFC provided $14 million to the Union Trust Company of Cleveland—and Joseph R. Nutt was chairman of the Union Trust’s board. Nutt was also treasurer of the Republican National Committee. The Baltimore Trust Company received $7.4 million from the RFC, and that bank’s vice chairman was Republican senator Phillips Lee Goldsborough of Maryland. Roy Chapin, Hoover’s secretary of commerce, wangled $13 million from the RFC for his Union Guardian Trust Company, where he served as director.11
One final example is that of Charles Dawes, former U.S. vice president under Calvin Coolidge. Dawes, a loyal Republican, followed Eugene Meyer as president of the RFC, but then Dawes resigned suddenly on June 7, 1932. Within three weeks of Dawes’s resignation, he received an RFC loan of $90 million for the Central Republic Bank and Trust Company, which he also headed. Dawes’s bank went broke even with the RFC loan, although he repaid the loan many years later. The Democrats were frustrated by these loans and passed a bill through Congress requiring all RFC loans to be made public. No longer would Republicans make loans to other Republicans in secret. To protect the RFC, Hoover appointed more Democrats to its board. When the Democrats came to power in 1933, they took over the RFC. What happened? The Democrats often made loans even more unsound than those the Republicans made. President Roosevelt, for example, was able to get RFC loans for his son Elliott and his brother-in-law Hall Roosevelt.12
FDR liked to use the RFC to strengthen the Democratic Party. Jesse H. Jones, Roosevelt’s appointee to head the RFC, was a rich Texas businessman, and he was always on the lookout for ways to use the RFC to help the Democratic Party. For example, Roosevelt wanted to improve coverage of his presidency from reporters. The Chicago Tribune regularly criticized FDR, so Jones tried to help by offering Walter Trohan, a leading reporter on the Tribune, RFC loans to run a variety of small businesses. Trohan, who had an independent streak, turned down Jones’s offer of RFC help. “I didn’t think I would be honest in accepting,” Trohan said.13
Sometimes even Jesse Jones was embarrassed by RFC loans going for such obviously political purposes. Thus Jones sometimes used his position of power not to make direct loans, but to leverage loans through private banks to key Democratic leaders, like J. David Stern, publisher of the Philadelphia Record, a key Democrat paper. Critics would have trouble tracing loans made by private bankers, who, as a favor to Jesse Jones, lent cash to needy Democrats.
Roosevelt repealed the two-year limit set for the RFC and extended the agency through his entire presidency. During World War II, the RFC made many large gifts and loans to industries making weapons for the war effort. The RFC, in effect, became a large bank, and many of its loans helped the United States defeat Germany. Jones wrote a book defending the RFC as needed during the wartime emergency.14
After the war, however, unemployment dropped to 3.9 percent in 1946 and 1947. The Great Depression was clearly over, but the life of the RFC went on as a patronage agency for the party in power. Harry Truman, the new president, controlled the RFC, and his administration used it, as Hoover and FDR had earlier done, to make loans and gifts to corporate friends. Only this time there was no Great Depression as an excuse for the RFC’s existence. Many complaints about corruption and political manipulation within the RFC led Congress to investigate. Senator J. William Fulbright (D-Ark.), chairman of the Senate Banking and Currency Committee, headed the bipartisan inquiry, and during 1950 they steadily interviewed a parade of witnesses about RFC activities.15
After an abundance of testimony, Fulbright released his shocking RFC report in February 1951. It revealed three kinds of ethical problems in the RFC. First, RFC men were taking jobs with the companies they had recommended for loans. Second, Truman protégés at the RFC were taking free services from the companies they helped get RFC loans. Third, wives and children of the president’s (or a U.S. senator’s) staff were helping companies get RFC loans, and then receiving payment from those companies.
One much-discussed example was the Lustron Corporation, a manufacturer of prefabricated houses, which secured a series of RFC loans for $37 million starting in 1946. Lustron won these loans with only $36,000 in assets, and an expensive and untested method of making prefabricated houses with “enameled steel.” The Fulbright committee discovered that E. Merl Young, the RFC official administering the loan, had resigned from the RFC within days after Lustron received a $10 million installment from the RFC. Young then took a new job with Lustron for two-and-one-half times his RFC salary—even though Lustron was losing $1 million each month. The Fulbright committee also discovered that Young gave his wife a $9,450 mink coat and sent the bill to a lawyer in another firm that had just received an RFC loan. Lustron then went into bankruptcy, after spending all of its RFC cash building a mere 2,500 houses. Young, however, didn’t become unemployed; he was discovered to be on the payroll of another company seeking an RFC loan.16
Senator Fulbright found it troubling that RFC officials would recommend loans to shaky corporations, and then, when the loans were granted, take highly paid positions with the shaky corporations. In another example, John J. Hagerty, head of the RFC office in Boston, endorsed a $6 million loan to the Waltham Watch Company. Then Hagerty resigned his RFC position and took a new job with the Waltham Watch Company at triple his RFC salary. When the watch company went broke the next year, Hagerty went back to work for the RFC.17
President Truman didn’t personally manipulate the RFC, but several of his close staff members had done so. Donald Dawson, an old Missouri friend and part of Truman’s White House staff, had helped secure an RFC loan for a Florida hotel, and then he accepted three nights of free lodging from that hotel. “Is there anything wrong with that?” Dawson retorted to the Fulbright Committee. The Los Angeles Times responded, “Men in responsible public office can no more accept favors than grant them. That used to be an elementary point of honor.” The Washington Post concluded: “His [Dawson’s] unfitness for a post in the White House seems abundantly demonstrated.”18
Other examples struck close to Truman. American Lithofold, a St. Louis printing company, tried three times to win an RFC loan, and finally succeeded two weeks after putting William Boyle Jr., a Truman protégé from Missouri, on the company payroll. Shortly thereafter, Boyle, citing health concerns, resigned his position as head of the Democratic National Committee. E. Merl Young, who helped Lustron get its loan, was also a Missouri friend of Truman’s, and Young’s wife, who received the mink coat, was a stenographer in the Truman White House.19
President Truman, although personally not guilty, became defensive and called the Fulbright Report “asinine.” He insisted in a press conference that his administration had a clean house. Under further pressure, he began pointing fingers at Congress and at Republicans. “A great many members of Congress [from both parties],” Truman announced, “had accepted fees for their influence in getting RFC loans for constituents.” Under Truman, the five-member RFC board had both Republicans and Democrats. Thus the political manipulation was bipartisan. Senator Joseph McCarthy, for example, secured a personal loan from the president of Lustron, and then received a $10,000 payment from soon-to-be-bankrupt Lustron to produce a magazine article. Guy Gabrielson, in another example, was chairman of the Republican National Committee, and the Democrats accused him of receiving a fee from the officers of the Carthage Hydrocol company for trying to get them an RFC loan.20
The Fulbright Report ignited a national debate on government subsidies and ethics in government. Many wanted to abolish the RFC. Those who sought RFC loans, the Wall Street Journal pointed out, “turn to the R.F.C. either because the soundness of their project doesn’t impress the money markets or because they are looking for bargain rates.” Jesse Jones, who headed the RFC under FDR, and Herbert Hoover, who founded the RFC, both agreed. “There is no lack of justifiable private credit for either small or large business,” Jones pointed out, “and any business that cannot succeed without government loans in such good times as we have been having the last few years should be liquidated.” Hoover agreed: Small business “can get all the credit it needs from private sources.”21
The corruption within the RFC, however, worried Hoover and others more than the wasted money. “Corruption in government is far wider in effect than corruption in private business,” Hoover noted. And corruption in government “affects the pockets of all taxpayers” and “affects the morals of a people and lowers their respect for government.” According to the Wall Street Journal, “the only way to end political loans is to take the R.F.C. out of politics by abolishing it entirely.” The Los Angeles Times agreed: “It is impossible to drive all the knaves from Washington, but they can be denied access to the taxpayers’ money.” “Today,” the Boston Herald observed, “the RFC is nearer FFA—free for all.”22
Senator Fulbright suggested the nation needed “a restatement of the moral standards of governmental conduct.” He added, “What seems to be new about these scandals is the moral blindness or callousness which allows those in responsible positions to accept the practices which the facts reveal.” Graft had always been present but the growth of government, Fulbright believed, made graft more acceptable. The politicians, RFC bureaucrats, and leaders of the subsidized companies seemed to have less compunction about benefiting from government loans. “It is bad enough,” Fulbright said, “for us to have corruption in our midst, but it is worse if it is to be condoned and accepted as inevitable.”23
The presence of huge amounts of government money and the resulting decline in national ethics alarmed many political observers. President Truman, despite the scandals, wanted to keep the RFC, and so the subsidies kept on coming. “In the realm of morals,” columnist Walter Lippmann noted, “the example set by the prominent is decisive.” He added, “A civilized society must demand of those who have ambition to lead it a higher standard of disinterestedness” than that demanded of others “with no political ambitions.”24
If Lippmann was correct, and many believed he was, then the RFC was a threat to national survival. “Without confidence in their government,” Fulbright said, “the people will not make the sacrifices necessary to oppose Russia successfully.” In the 1952 presidential election, the Republicans, in their party platform, attacked “favoritism and influence in the RFC.” Most Republicans wanted to abolish it. The New York Daily Mirror called the RFC a “corrupting agency” and argued that “lending billions is a peril to national decency. Let’s kill it.” The Philadelphia Inquirer agreed: “Abolish the RFC,” the editor urged. “No other agency . . . has . . . been in the kind of business—making loans to a large variety of enterprises—which laid it open to so many temptations from outside influences.”25
Led by war hero Dwight Eisenhower, the Republicans won big in 1952 and carried both houses of Congress. With some Democratic support, the RFC was officially abolished in 1953. George M. Humphrey, the new Treasury secretary, estimated that liquidating the RFC’s assets would add “[up] to a billion dollars toward balancing the budget.” Thus Congress actually abolished a major government agency, the RFC, after it had made billions of dollars of corporate loans over a twenty-one-year period.26
In politics it’s hard to stop the flow of federal funds, once allocated, because those dollars always spur visions of political gain in elected officials. The Republicans, in a way, were sorry to see the RFC die because its corporate loans always had such potential to gain votes. Secretary Humphrey, therefore, argued that with the RFC gone, it was “politically essential” that Republicans make government loans to smaller businesses—which would cultivate the support of middle-class voters. Even though the RFC was abolished, the Republicans created the Small Business Administration (SBA) to make government loans to “small business.” Robert Taft, the Republican majority leader, agreed that Republicans could gain politically from the SBA because “the Administration has appointed so many big businessmen to important jobs.” Thus, on July 30, 1953, Eisenhower signed the bill creating the SBA with a two-year charter—just like the RFC—to make special government loans to small businessmen and women.27
Wendell B. Barnes, Eisenhower’s appointment to head the RFC, made the SBA as partisan for Republicans as the RFC had been for Democrats. The SBA, Barnes boasted, “employed 197 persons who have been recommended by the Republican National Committee, Republican congressional members, and Republican state organizations.” Barnes concluded, “There is no other Federal agency which can approach this [high] percentage of Republicans employed.” Leonard Hall, chairman of the Republican National Committee, praised the SBA and said, “No federal agency has worked as closely and as cooperatively with the Republican National Committee as has the SBA.” Historian Jonathan Bean, who wrote a book on small business, thus concluded that “the Republicans replaced the scandal-ridden RFC with an agency equally committed to political ends.”28
The SBA, with its $275 million initial funding, was much smaller than the billion-dollar RFC. But with SBA’s value to Republicans, its charter, like that of the RFC earlier, was extended indefinitely. During the 1970s, the SBA was able to expand its loan guarantee commitments almost tenfold, from $450 million to $3.6 billion—which made it larger than the old RFC. According to those who have studied the SBA, much of that money appears to have been used for political ends; small businesses, as a group, were unaffected. Government again was unable to spot market opportunities and pick winners. According to historian Pearl Rushfield Willing, the SBA, in its first twenty-five years of existence, had “a record of scandals, inadequate management assistance and repetitive contract assistance to a limited number of small businesses, many of which did not ‘graduate’ from the nurturing provided by government contracts and did not become self-sustaining firms.”29
The RFC lived on through the SBA, but the long-run impact of the RFC must also be measured by the new organizations created directly with RFC funds. Those organizations include the Commodity Credit Corporation, which tried to raise farm prices, and the Federal National Mortgage Association (Fannie Mae), which lent millions of dollars to homeowners.30 The RFC also supplied funding for the Export-Import Bank (often called Ex-Im), which gave loans to corporations and foreign governments, and for the Emergency Relief and Construction Act of 1932 (ERCA), which gave loans to state governments and was the first direct federal relief program in American history. Because the Export-Import Bank and the ERCA made federal loans to corporations and state governments, those two agencies, as children of the RFC, need special attention.
FEDERAL WELFARE
Before 1932, charities and churches gave relief to individuals on a case-by-case basis. Sometimes the Red Cross or the Salvation Army would organize national relief efforts during major disasters, such as fires in Michigan or an earthquake in San Francisco. People would give to those in trouble in other parts of the country. Usually, however, aid was local—churches or relief boards in Chicago, for example, helped those in need in Chicago.
During the Great Depression, with its high unemployment, the RFC changed the idea that relief raised locally ought to go to local citizens. Instead, relief raised nationally by the federal government through taxes would go to those states with the best political connections. In the tangled web of Washington bureaucracy, the Emergency Relief and Construction Act of 1932 meant that the RFC had a grant of $300 million for well-connected political friends, including mayors and governors. State governors had the chance to argue that more federal dollars should come into their state. Many governors, with the help of big-city mayors, used their political clout to win big chunks of federal relief money. Illinois, for example, was a swing state politically and its officials used their influence to grab $55,443,721, or almost 20 percent of the entire $300 million. Illinois received more than New York, California, and Texas combined.31
Illinois’s leaders were taking a chance because the relief money was technically a loan. That made some states hesitate pushing for federal cash as hard as Illinois did. But many observers believed, as Senator Robert Wagner of New York predicted, “that the repayment would never take place, so that in effect, that $300,000,000, if we look at it realistically, was a gift to the states.” Illinois guessed correctly, and the “loans” became gifts over time. Edward A. Williams, who carefully studied this first money for federal relief, also noted, “The R.F.C. did not make a serious attempt to supervise relief administration in the states.” Williams describes “the looseness of federal control” and notes that states were relatively unsupervised in the way they spent the relief money.32
The next year, President Roosevelt continued federal relief. He signed bills that sharply increased funding available to states. Almost all governors and many mayors again began lobbying to receive large chunks from Roosevelt’s new Federal Emergency Relief Administration (FERA), another layer of bureaucracy on top of ERCA.33
This historic shift to using federal dollars for local relief profoundly changed the American work ethic. Before the RFC and the Hoover-Roosevelt presidencies, state and city leaders had incentives to be frugal in order to aid more of their residents. They took care of their own, and in emergencies they sometimes received assistance from national charities such as the Red Cross or the Salvation Army. During the New Deal years, states had new incentives to look to Washington to solve their relief needs. In fact, they had incentives to do a poor job raising local funds and then exaggerate their needs. That way they could secure more cash for their states, and disperse to other states the costs of raising the taxes to cover these funds.
These new political realities weren’t lost on politicians. For example, Governor Joseph Ely of Massachusetts had asked for no federal funds in 1932 because he believed aid should be raised privately, and his state raised millions to help the residents of Massachusetts. But in 1934, James Michael Curley, who eagerly pleaded tales of woe to Washington to bring federal money to Massachusetts, replaced Ely. By 1935, Massachusetts had solicited and received more than $114 million in federal funds for relief. In retirement, Governor Ely observed, “Whatever the justification for relief, the fact remains that the way in which it has been used makes it the greatest political asset on the practical side of party politics ever held by any administration.”34
THE EXPORT-IMPORT BANK
Created in 1934, the Export-Import Bank was a product of Roosevelt’s New Deal. FDR initially wanted the Ex-Im Bank as a foreign policy tool to make easy credit available to nations he liked. The bank could also give incentives, like low-interest loans, so that other nations would buy American exports.
In traditional finance, large commercial banks often helped Americans trade with other countries by lending money to other countries so they could buy American products. Obviously, the bankers lost money if they made bad loans, so they evaluated the foreign debtors (and sometimes the American exporters) very carefully. If the risk was high, so were the interest rates the banks charged.
The Ex-Im, by contrast, often expected to lose money because it was making risky loans, or giving subsidies, to favored countries or favored American corporations. Unlike large commercial banks, which had to make profits to survive, the Ex-Im could lose money regularly and get replenished in annual appropriations by Uncle Sam. The Ex-Im Bank started with a $10 million grant from the RFC, and, once on its own, it secured millions and even tens of billions of dollars in annual appropriations from Congress. It became both a giver of special loans to favored nations as well as one of the biggest subsidizers of large corporations in America.35
In 1934, the first loan the Ex-Im Bank ever made was to Cuba, again showing the ruinous effects of government-subsidized loans and political interference. Cuba was often in political turmoil, but more so after 1930, when the United States passed the highest tariff in U.S. history, the Smoot-Hawley Tariff. The high duties on imported Cuban sugar were put in place to protect American sugar growers from cheaper imports. Senator Reed Smoot, coauthor of that tariff, was from Utah, and he wanted Americans to buy his state’s expensive beet sugar rather than cheaper Cuban sugar.36
With the United States slashing its use of imported sugar, the total U.S. exports to Cuba shrank from $160 million in 1926 to $27 million in 1932. Two years later, Cuba asked for, and received, an Ex-Im loan to initiate a public works program, similar to what FDR was doing in the United States with the Works Progress Administration. In other words, the Ex-Im Bank gave Cuba special government help perhaps to compensate for earlier government harm from the tariff. By 1938, U.S. trade with Cuba had increased but was barely more than half of what it was before Smoot-Hawley. Much to the distress of Ex-Im officials, Cuba refused to make any payments on its current loan and, in fact, asked for another loan.37
When other Latin American countries saw Cuba tap the United States, they requested Ex-Im loans as well. Many of those loans were never paid back, and some were unsound from the start. Haiti, for example, had already defaulted on earlier U.S. loans, but the Ex-Im Bank made yet another loan to Haiti in 1938 to build public works.38 If we did it for Cuba, why not do the same for Haiti?
W. D. Whittemore, vice president of the Ex-Im Bank, admitted that the loan to Haiti was financially unsound, but he defended the high risks as “dwarfed into insignificance” by the political advantages to the United States. “It has been represented to us,” Whittemore explained, “that if the Good Neighbor [the United States] does not come to her rescue in her hour of need, distress will force Haiti to appeal to Europe (probably Continental).” He argued that U.S. interests would be hurt by having “another European power acquire a political and economic (if not military) base right in our front yard.”39
The implications of Whittemore’s comments are astonishing. First, it shows how far the United States had come in the 1930s in giving federal aid. The United States, Americans were told, should make an economically unsound loan to Haiti, or else some European country might make the money-losing loan and thereby secure a presence in Latin America. But Europeans had always had a strong presence in Latin America. In the early 1800s, when the United States was much weaker, Spain and Portugal owned almost all of Central and South America. Britain in the 1930s still had control over whole countries in Latin America. Even Germany, the probable source of Whittemore’s alarm, already had historic trading relations in Central and South America. Also, if aid to Haiti is important to U.S. foreign policy, shouldn’t that be decided through the State Department, not the Ex-Im Bank?
A second point is that Ex-Im loans were being used to promote public works—roads and infrastructure. These were the very government projects that historically had been so disastrous for the United States. The National Road, America’s first federal road, was a shambles. The canal mania, after two decades of debt, left the states eager to stop building, or turn the projects over to private enterprise. The Union Pacific Railroad was an expensive failure; James J. Hill, with his privately built Great Northern Railway, had finally showed the nation how to build a profitable transcontinental railroad. Why should politicians in Cuba and Haiti be expected to outperform those who had failed in the United States?
One reason President Roosevelt encouraged public works in other countries was that he was financing public works in the United States, through the Works Progress Administration (WPA), which he thought would increase employment and attack the Great Depression. Unemployment, however, can’t be cut in the long run by taxing citizens to pay for it. The money sucked in by higher taxes eliminates investment capital in mainstream America, which means fewer jobs are created.
Henry Morgenthau, FDR’s secretary of the Treasury, confessed that point in May 1939, when unemployment, after massive spending—especially in public works—reached 20.7 percent. “We have tried spending money,” Morgenthau lamented. “We are spending more than we have ever spent before and it does not work.”40 Of course, in Cuba and Haiti, the United States was subsidizing their roads and building, so that might make it profitable to those countries, especially if they could later default on the loans.
Much of public works building, however, is not about economics, but politics. Just as with the National Road, canal building, and the Union Pacific, the construction on these projects in foreign countries was a way for politicians to entrench themselves with voters and hand out jobs as political favors. The leaders in Cuba and Haiti clearly saw that possibility, as did FDR with his WPA. David Lawrence, editor of U.S. News & World Report, has shown that areas receiving large amounts of WPA aid voted heavily Democratic in the 1936 presidential election.41
Many politicians freely admitted this connection. V. G. Coplen, a Democratic county chairman in Indiana, said, “What I think will help is to change the WPA management from top to bottom. Put men in there who are . . . in favor of using these Democratic projects to make votes for the Democratic Party.” James Doherty, a New Hampshire Democrat, agreed. “It is my personal belief that to the victor belongs the spoils and that Democrats who should be holding most of those [WPA] positions so that we might strengthen our fences for the 1940 elections.” One WPA director in New Jersey answered his office phone, “Democratic headquarters.”42 Public works, then, were not an economic solution but a political opportunity.
Another major group that favored the Ex-Im Bank was American exporters. They liked subsidized loans because they increased their trade. Some exporters even wangled Ex-Im loans for their own businesses. An early example was International Telephone and Telegraph (ITT), which owned telegraph service throughout South America. In 1938, ITT considered selling its South American assets to pay off debts that were due. But before doing that, ITT turned to Ex-Im for $10 million cash on the grounds that if ITT sold off its telegraph businesses in South America, Europeans might acquire them and gain a foothold in those countries. The Ex-Im Bank agreed and made the loan. Frederick Adams, the author of a book on Ex-Im, concluded that the “IT&T transaction . . . indicated that the bank would become more aggressive in expanding United States interests in the hemisphere.” The ITT aid marked the beginning of Ex-Im–directed subsidies for large U.S. exporters.43
As the ITT example illustrates, Ex-Im loans amounted to a federal subsidy for exporters. Ex-Im, not the exporter, took the risk on foreign loans. Also, the exporter, because of government help, either received a direct infusion of cash, as ITT did, or could sell his products abroad with the advantage of special low-interest loans to the foreign buyer. Over the decades, exporters began to seek Ex-Im loans instead of commercial loans because Ex-Im’s subsidies gave exporters a special advantage against competitors. In a 1972 audit, the General Accounting Office called Ex-Im a lender of “first resort,” not “last resort.” Commercial banks, the GAO concluded, could have made many of the Ex-Im loans, but large commercial banks couldn’t replenish their funds annually with tax dollars given by Congress. Commercial banks would have made the loans at market rates, and the exporters wouldn’t have had any special advantage.44
Boeing, one of America’s largest exporters, has become the largest receiver of Ex-Im loans over the last forty years. Here, for example, is how the politics of Ex-Im loans often works: In 1977, when Jimmy Carter became president, he appointed fellow Georgian John L. Moore Jr. to be president of the Ex-Im Bank. In February 1980, when Carter was running for reelection, Moore met with Rupert Murdoch, the head of Ansett Airways in Australia, to encourage Murdoch to buy Boeing airplanes. Murdoch was willing to buy Boeing 767s for his fleet, but he wanted a special low-interest loan from Ex-Im. Moore obliged and endorsed the special loan. After the successful meeting with Moore, Murdoch had lunch with President Carter. Three days after Murdoch’s meetings with Moore and Carter, the New York Post, which was owned by Murdoch, publicly endorsed Jimmy Carter for reelection. A week later, Ex-Im officially announced the special deal for Boeing planes for Murdoch. Six months later, in August 1980, Carter signed a bill sharply hiking Ex-Im’s lending limit from $3.75 to $5.1 billion. The winners in this transaction were Boeing, Ansett Airways, and the Ex-Im Bank. President Carter won his endorsement from the New York Post but lost his reelection bid. The American taxpayers were the biggest losers.45
In many of the last twenty years, Boeing has received more financial help from Ex-Im than all other companies combined. In fact, from 1998 to 2005, Boeing received $33 billion in Ex-Im loans or gifts—more than half of Ex-Im’s total funds. Under President Obama, Boeing’s share of the Ex-Im pot has increased even more. In 2012, for example, Boeing grabbed 82.7 percent of all loan guarantees from Ex-Im—$12.2 billion out of Ex-Im’s $14.7 billion total went to subsidize Boeing’s sales.46
Boeing’s political connections to the Obama administration are strong. David Plouffe, Obama’s campaign manager in 2008, was a “management consultant” to Boeing and other companies after Obama became president. Bill Daley went from the Boeing board of directors to White House chief of staff in 2011. And when Gary Locke, Obama’s former secretary of commerce, was governor of Washington, he signed more than $3 billion to Boeing in state subsidies in one legislative session alone. For special help, Boeing hired as lobbyists Linda Daschle, the wife of former Democratic senator Tom Daschle, and the Podesta Group, cofounded by John Podesta, Obama’s transition director.47
Boeing argues that it needs political connections and Ex-Im help to compete with its main competitor, Airbus, a French company. Boeing has a point. Airbus is a virtual government company, heavily subsidized in its operations. Former French prime minister Lionel Jospin said bluntly, “We will give Airbus the means to win the battle against Boeing.”48
Thus we have dueling subsidies. The Ex-Im supports Boeing, and the French prop up Airbus. But dueling subsidies have been a historical disaster. When Britain subsidized Cunard, the United States responded by subsidizing Collins. Then both Cunard and Collins increased their subsidies, but both were inefficient and exposed by Vanderbilt as being so. Why not let the French subsidize Airbus, and the United States would save money and buy whichever plane—Boeing or Airbus—was the cheapest and best built? We do that with products from shirts to shampoo. Why not passenger airplanes?
Boeing argues that unlike shirts and shampoo, airplanes are essential in case of war. Therefore, Boeing must be protected. In our study of federal subsidies, we can see that the argument of emergency, and war in particular, is a strong one often used to justify unwarranted subsidies. The government fur company, through its forts, was supposed to protect us from British encroachment on our Northwest Territory. McKenney failed to do that, but British encroachment didn’t become a military threat (except during the War of 1812). The Collins subsidy was supposed to give us a competitive steamship company, which would have ships usable in case of war. Collins wasn’t competitive and his ships were unusable as war ships. Langley was supposed to give us an airplane useful for military defense, but he also failed.
One might argue that in a nuclear age, any miscalculation is fatal. If we did need Boeing for war, and if Boeing had gone bankrupt, we might not have time to recover. That argument has two problems. First, if true, shouldn’t that decision to protect Boeing be made by the Pentagon, and not by the Ex-Im Bank? Second, the argument probably isn’t true. It assumes Boeing will not be competitive if Airbus is subsidized. Many examples in U.S. history show the subsidized company losing to the privately funded entrepreneur, but examples of subsidized companies defeating entrepreneurs are hard to find. Also, Boeing, even if it lost all European customers, would still be competitive outside of Europe if it produced the better product.49
Throughout the history of Boeing, it has often produced the better product. William Boeing, the company’s founder, was a remarkable entrepreneur along the lines of Vanderbilt and the Wright brothers. Boeing founded the company in 1916 because he had ridden a Curtiss seaplane and thought he could build a better one. He did, and sold several seaplanes to the U.S. Navy during World War I. After the war, with no government contracts, most airplane companies went out of business. Boeing even had his company selling furniture to survive, but he always believed he could build sound planes at competitive prices for customers in peacetime. William Boeing tried to succeed by developing commercial planes to carry passengers and mail.50
Boeing delivered more than 30 percent of the nation’s airmail until February 1934, when FDR decided the mail contracts were too lucrative for Boeing and the other carriers. The president abruptly canceled them, and had the army deliver the mail again. In the first week, five army pilots were killed; by the end of March seven more army pilots died, and FDR decided to give mail delivery back to private carriers.51
William Boeing was so infuriated with FDR that he left the business, but he had established Boeing as a company that succeeded not so much by selling to the military, but by building innovative and safe airplanes for commercial use at competitive prices. After he left the company, his successors were also innovative. They built the B-17 bomber in 1937 largely at their own expense, and during World War II American B-17s accounted for about half of the bombing of Germany. Most of the bombs dropped on Japan came from Boeing’s B-29s, including the atomic bombs.52
After the war, Boeing’s B-47, with its swept-wing design, was a favorite with the U.S. Air Force. On the commercial side, Boeing’s 707 and subsequent models were so successful that most other companies had to merge or shift to other parts of airplane production in order to survive. On the current 787 Dreamliner, according to Boeing president Jim McNerney, “We’re out to about 1,000 in our backlog; you can’t get one until 2019.” With all of those sales and back orders, the Boeing Company obviously is very competitive. The idea that Boeing would need Ex-Im loans to stay in business is refuted by almost one hundred years of company history. Those Ex-Im loans mainly padded Boeing’s profits and gave politicians a way to leverage tax dollars for votes.53
The Ex-Im Bank, the first federal welfare program, and Fannie Mae all began with funds from the RFC. In other words, the RFC launched the D.C. subsidy machine, which still supplies funds to a bevy of political entrepreneurs—with minimal oversight from Congress. No longer must Congress be responsible for misplaced subsidies run amok. When the RFC was finally killed, other government entities, like a hydra-headed monster, were born and matured with power independent of Congress to dole out grants and pry into businesses. The Environmental Protection Agency, for example, has the power to support some businesses, investigate others, and set aside a law of Congress if necessary. After Hoover and FDR, the era of the political entrepreneur was truly at hand.