WHAT IS AN AGENCY BOND?
You can buy various securities issued by
government-sponsored and government-owned corporations
that—strictly speaking—are not actually a part of the
U.S. Government. These agencies are affiliated with, but separate
from, the U.S. Government.
This tutorial will introduce you to three of these
agencies—the Government National Mortgage Association (GNMA),
the Federal National Mortgage Association (FNMA), and the Federal
Home Loan Mortgage Corporation (FHLMC—although there are
several other, less well-known agencies that also issue bonds.
These include World Bank-related agencies and those that package
student loans. The three agencies' nicknames—Ginnie Mae
(GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC)—refer to
the agencies' bonds as well as to the agencies themselves.
Because of their government affiliation, agency
bonds are very secure, essentially backed by the full faith and
credit of the U.S. Government. Also, thanks to their government
affiliation, agencies receive favorable treatment in several
arenas: They receive low interest rates on money they borrow, have
low capital requirements, and are exempt from state and local
taxes. As a result, government agencies sometimes can offer
investors more favorable bond earnings than would otherwise be
possible.
GNMA, FNMA, and FHLMC all buy mortgages from
financial institutions that make loans, and then they group them
into pools. They then sell unit shares in these pools to investors.
For example, suppose you buy a house or apartment building, taking
out a mortgage loan to complete the deal. The term of the loan may
vary from 15 to 30 years, and the interest rate may be fixed or
adjustable. A government mortgage agency then may buy your mortgage
from your bank and combine it with other mortgages to create a pool
of $1 million or more. The agency then may issue bonds on these
pools through financial institutions, marketing them through
brokers. The bonds thus raise additional capital for the agency to
replenish its resources, as well as to buy and support additional
mortgages.
Agency bonds generally offer a higher return than
Treasury securities, along with higher volatility as the market for
mortgage-backed securities responds to changes in mortgage rates.
If you invest in agency bonds, you receive earnings when the
mortgages in the pool are paid off. The minimum investment
requirement may be $25,000 or more.
Now, let's look at Ginnie Mae, Fannie Mae and
Freddie Mac in more detail.
