Government Agency Securities: A Comprehensive Overview

August 25, 2024 3 min read Finance Investments Government Securities Investment Vehicles Financial Markets Credit Ratings U.S. Government Agencies

Government Agency Securities are securities issued by U.S. government agencies like the Federal Home Loan Bank, the Federal Farm Credit Bank, or the Federal National Mortgage Association. These securities, while highly rated, are not backed by the full faith and credit of the U.S. government.

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Government Agency Securities are financial instruments issued by various agencies of the U.S. government. These agencies include the former Federal Home Loan Bank (FHLB), the Federal Farm Credit Bank (FFCB), and the Federal National Mortgage Association (FNMA), among others. While these securities usually carry high credit ratings due to their government affiliation, they lack the full faith and credit guarantee of the U.S. government.

Types of Government Agency Securities

There are several types of government agency securities:

Federal Home Loan Bank (FHLB) Securities: Issued by the Federal Home Loan Banks to support mortgage lending and related community investment.
Federal Farm Credit Bank (FFCB) Securities: Issued by the Federal Farm Credit Banks to provide credit to agricultural and rural communities.
Federal National Mortgage Association (FNMA) Securities: Commonly known as Fannie Mae, these are issued to support mortgage market liquidity.

Credit Ratings and Perceived Security

While these securities have high credit ratings due to their stable and reputable issuers, it’s important to note that they do not benefit from the full faith and credit of the U.S. government. This means that in case of a default, the U.S. government is not legally obligated to cover the debt. However, the implied backing often provides a level of investor confidence.

Investment Considerations

Risk: Generally considered low-risk due to the backing by quasi-governmental institutions.
Return: Typically offer a higher yield compared to Treasury securities, compensating for the slightly higher risk.
Liquidity: Good liquidity in secondary markets, although not as high as Treasury securities.

Examples of Government Agency Securities

FHLB Bonds: Used by the FHLBs to raise funds to support mortgage lending.
FFCB Bonds: Issued by the FFCBs to provide financing to the agriculture sector.
FNMA MBS: Mortgage-backed securities issued by Fannie Mae to enhance secondary mortgage market liquidity.

Historical Context

These securities have evolved over time, with agencies being established primarily during the Great Depression (e.g., Federal Home Loan Bank in 1932) to support various economic sectors. Over the years, these institutions have become integral to the U.S. financial system.

Applicability and Relevance

Investors, both individuals, and institutions frequently buy these securities as part of a diversified portfolio. They are also relevant for financial institutions that require highly-rated fixed-income assets.

Comparison with Treasury Securities

Credit Guarantee: Treasury securities are backed by the full faith and credit of the U.S. government; government agency securities are not.
Yield: Government agency securities generally offer higher yields.
Risk: Treasury securities are considered virtually risk-free, while agency securities carry slightly higher risk.

Treasury Securities: Debt instruments directly issued by the U.S. Department of the Treasury.
Mortgage-Backed Securities (MBS): Securities backed by a pool of mortgage loans.
Credit Risk: The risk of default on a debt.

FAQs

Are Government Agency Securities risk-free?

No, they are not considered risk-free, although they carry high credit ratings and low risk.

Can individuals invest in Government Agency Securities?

Yes, individual investors can purchase these securities, often through brokers or financial institutions.

How are the returns on Government Agency Securities taxed?

Interest on these securities is typically subject to federal income tax but may be exempt from state and local taxes.

References

“Government Agency Securities,” Investopedia.
“Federal Home Loan Banks: History and Functions,” U.S. Government Publication.
“The Federal Farm Credit System,” National Agricultural Library.

Summary

Government Agency Securities play a crucial role in the U.S. financial system, offering a reliable investment option with high credit ratings. Though not backed by the full faith and credit of the U.S. government, they provide competitive returns with relatively low risk. Understanding these securities’ characteristics, historical context, and investment considerations can help investors make informed decisions.