“If the Federal Reserve could bail out Wall Street, it can help the 3.5 million American citizens in Puerto Rico improve its economy and lift its children out of poverty. Today, I am calling on the Fed to use its emergency authority under Section 13(3) of the Federal Reserve Act to pave the way for an orderly restructuring of Puerto Rico’s public debt.”

— Bernie Sanders, speech in Puerto Rico, May 16, 2016

Ahead of the June 5 primary in Puerto Rico, Sanders is pushing his plan to relieve the island territory of its crippling debt. With House legislation in limbo, Sanders is calling on the Federal Reserve to take action — similar to what it did for the big banks during the 2008 financial crisis. Sanders says he plans to propose legislation in the Senate after the election, to help Puerto Rico.

During his speech, Sanders pointed to the section of the Federal Reserve Act that allows the Fed to extend credit to entities other than banks, to support his argument. Is that really feasible?

The Facts

Puerto Rico owes more than $70 billion, due to a decade-long economic recession caused by several factors. The government owes so much that it can’t repay its debt by raising taxes or cutting spending. Residents are leaving in droves, as the island is running out of cash to fund core public services.

As a U.S. territory, Puerto Rico can’t declare bankruptcy or restructure its own debt like states can under U.S. bankruptcy laws. So Sanders’s proposal is to get the Fed to help Puerto Rico — after all, it did so for the big banks.

Sanders cited Section 13(3) of the Federal Reserve Act, which says that in “unusual and exigent circumstances,” the Fed can lend to “individuals, partnerships and corporations” that are “unable to secure adequate credit accommodations from other banking institutions.” Sanders wants the Fed to use this authority to lend to Puerto Rican public corporations and restructure the debt through a “reverse Dutch auction.” Through this process, Puerto Rico’s public corporations would buy back the debt they owe and force creditors to compete against each other to sell back the debt, according to Sanders’s proposal.

The Fed invoked this authority to provide a loan to Bear Stearns on March 14, 2008, as it teetered on the edge of collapse. It was considered an unusual loan, as Bear Stearns was not a commercial bank at the time.

The Sanders campaign pointed to an October 2014 report on potential policy options for Puerto Rico, written by Arturo Estrella, economics professor at Rensselaer Polytechnic Institute who worked for the New York Fed for two decades. “In certain episodes of acute perceived risk, the Federal Reserve has shown an inclination to interpret its powers fairly broadly,” Estrella wrote, and the Fed broadened its interpretation of Section 13(3) throughout the financial crisis.

But developments since the October 2014 have made it much less likely, or even possible, for the Fed to take such a drastic step for Puerto Rico.

Loans under Section 13(3) were intended to go to solvent entities, and made with the expectation of a full repayment. But in June 2015, Puerto Rico declared it could not repay its debt and likely would default on its payments. Since then, it has missed hundreds of millions of dollars in payments — and the island would now be considered insolvent and ineligible for the loan.

“If you look at my study, it is very hopeful because it was written in October 2014. With the governor’s announcement in June of the following year [about the government’s inability to repay the debt] — I was there in Puerto Rico — and I thought, well, this changes everything,” Estrella told The Fact Checker.

Moreover, in November 2015, the Fed adopted new regulations downsizing its emergency lending powers — a requirement under the 2010 Dodd-Frank financial overhaul law, which Sanders voted for. This took effect January 2016. (Fed Chair Janet Yellen has said since June 2015 that Puerto Rico debt “isn’t a matter in which I have an opinion. It’s something the Federal Reserve can’t and shouldn’t be involved in. I think it’s appropriate for Congress to consider what’s best to do in this case.”)

Estrella said 13(3) is now probably the least likely regulation to be used for Puerto Rico: “I agree with what he’s [Sanders] saying, I think the Fed should and could do more. The question is, now with the perception of insolvency, is 13(3) applicable? If I were at the Fed, I would be hesitant to use 13(3) at this point.”

In his policy memo, Sanders offers another section in the Federal Reserve Act as an alternative. That section allows the Fed to purchase “bonds and notes of the United States” with a maturity date of six months for states, or with no limitation for maturity for foreign countries. But since Puerto Rico is neither a state nor a foreign country, it’s not clear whether this regulation would apply.

Campaign spokesman Warren Gunnels pointed to this as a more promising option, pivoting from the authority that Sanders cited in the speech. “Senator Sanders has been calling on the Fed to use its authority right now to facilitate an orderly debt restructuring in a way that is fair and just,” Gunnels said.

“In 2008, the Fed moved heaven and earth to provide trillions in low-interest loans to big banks and corporations when they were hurting. …  We believe the Fed needs to be just as creative in helping to alleviate the humanitarian crisis in Puerto Rico as it was when it rescued Wall Street financial institutions,” Gunnels said.

The Pinocchio Test

Sanders calls on the Fed to use its emergency lending authority to help Puerto Rico, just as it had used the same authority to rescue failing firms during the financial crisis. But this is quite misleading. The Fed has now adopted limits to its lending authority after the financial crisis, consistent with requirements under Dodd-Frank. Interestingly, Sanders — who supported such restrictions under Dodd-Frank — now wants the Fed to get creative in interpreting its authority to help Puerto Rico.

In his speeches, proposal and his pending legislation, Sanders creates a misleading impression that the Fed has the same authority it had back then, and therefore can rescue Puerto Rico. That’s not the case.

Three Pinocchios

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