On 20 January 1926 it replaced the first Luther cabinet, which had resigned on 5 December 1925 following the withdrawal of the German National People's Party (DNVP) from the coalition in protest against the government's support of the Locarno Treaties.

The short-lived cabinet attempted to deal with a growing economic crisis and rapidly rising unemployment by implementing measures to stimulate the economy.

It faced strongly conflicting viewpoints when a referendum to expropriate the dynastic properties of the former German Empire's ruling houses was initiated.

On 7 December, two days after Luther resigned as chancellor, President Paul von Hindenburg intervened, calling on the parties to speedily agree on a new government and hinting that, given the economic difficulties of the winter, he would welcome a grand coalition.

After it was discussed by the President with the other parties, Erich Koch-Weser (DDP) was asked on 14 December to form a cabinet based on a grand coalition.

[1] Hindenburg then asked acting Chancellor Hans Luther, an independent, to try to form a new cabinet based on the parties of the political centre.

Luther was able to do so after the DDP agreed to Koch-Weser remaining out of the cabinet and to being represented instead by Wilhelm Külz (Interior) and Peter Reinhold (Finance).

[3] Luther and Finance Minister Peter Reinhold agreed that tax cuts and other measures to stimulate the economy, such as allowing money from the unemployment fund to be used, were urgently needed.

Both the SPD and the nationalist German National People's Party (DNVP) were unwilling to accept the compromise, and talks on the issue ceased on 28 April.

Massive protests by the parliamentary groups of the Centre Party, SPD and DDP forced him to change the decree so that it would apply only at consular institutions in European ports and in non-European locations.

Although the cabinet and the parliamentary groups of the other parties warned against pursuing this issue too far, which could easily lead to the dissolution of the Reichstag or to a presidential crisis, the DDP demanded "personnel change" (i.e. a voluntary resignation by Luther) and a suspension of the flag decree.

[3] Luther had announced in the Reichstag that the decree would be implemented at the latest by the end of July 1926 but that the cabinet would be ready to revoke it if the Parliament and President had found another compromise solution by then.

To ensure continuity of government, Hindenburg appointed Reichswehr Minister Otto Gessler of the DDP as caretaker chancellor until a new cabinet could be formed.