Implied Government Backing & Treasury Bonds
Original post by Jonathan Langsdorf of Demand Media
The investment category of government bonds includes several types of bonds, such as Treasury bonds. Other government bond subcategories include agency bonds and government sponsored entity bonds. The financial security backing the different types of bonds varies, as will the yield investors expect to receive from the bonds.
The U.S. Treasury issues several types of debt securities including Treasury bills, notes, bonds and Treasury inflation protected notes -- TIPS. The securities issued by the Treasury are backed by the "full faith and credit" of the federal government. There is not an implied government backing of Treasury bonds, the bonds have a direct U.S. government guarantee. Interest and principal payments on Treasury bonds are paid out of taxes collected by the government.
Several federal government agencies issue or guarantee investment bonds. These agencies include the Government National Mortgage Association -- Ginnie Mae -- and the Small Business Administration -- SBA. Bonds from these agencies also have a full federal government guarantee. Agency bonds typically make payments from a pool of assets such as government guaranteed home mortgages or small business loans. If the assets backing the agency bonds do not generate sufficient cash flow to service agency bonds, the government agency will provide money to make bond holders whole.
Government Sponsored Entities
Government Sponsored Entities -- GSEs -- are corporations established by by law, but function independently of the federal government. The major GSEs are Fannie Mae, Freddie Mac, Federal Farm Credit Banks, Federal Home Loan Banks and the Tennessee Valley Authority. These entities were created to provide loans or funding to specific groups or projects. The bonds issued by a GSE are not backed by the federal government. Due to the close ties with the government, GSE bonds have been considered to have an implied government backing and the rating agencies have given the GSE credits ratings at the same level as the federal government.
Government Bond Considerations
Since GSE bonds are not direct obligations of the federal government, historically, they paid a higher rate of interest than comparable Treasury bonds. The federal government take over of Fannie and Freddie in 2008 gave an indication the lengths the government would go to to support these GSEs. For the highest level of safety, investors should stick with Treasury bonds.
- Investing in Bonds: The GSE Debt Market: An Overivew
- Fidelity: Agency/Government Sponsored Enterprises (GSEs) Product Overview
- "New York Times"; In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans; Stephen Labaton; Edmund L. Andrews; Sep. 7, 2008
About the Author
Jonathan Langsdorf has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Langsdorf has a bachelor's degree in mathematics from the U.S. Air Force Academy.