Do bank bailouts work? The effect of Reconstruction Finance Corporation aid during the Crisis of 1933

Do bank bailouts work? Government aid initiatives implemented to stem the current crisis raise important questions about the role of monetary policy in preventing bank failures. The scale of this bailout program defies comparison with any other aid package implemented in the post-World War II period. Fortunately, the operations of the Reconstruction Finance Corporation (RFC) during the Great Depression provide a historical experiment to examine the effects of government rescue programs on financial institutions.This paper examines the effects of the RFC's loan and preferred stock programs on bank failure rates during the crisis of 1933. Using a new database on Michigan banks, I employ survival analysis to examine the effectiveness of the RFC's loan program and preferred stock purchases on bank failure rates. My analysis suggests that the loan program increased the failure rates of banks during the crisis by increasing the indebtedness of financial institutions. Conversely, I find that the RFC's purchases of preferred stock increased the chances that a bank survived the financial crisis. Injections of capital helped repair the balance sheets of banks and restored confidence in the financial system. Ultimately, this historical experiment provides some insight into how government aid programs might curtail banking crises.