SUNNY SIDE OF THE STREET: ANALYSIS OF THE FINANCIAL SYSTEM & THE ECONOMY (part 27)

Government-Sponsored Enterprises

by

Charles Lamson

Government-sponsored enterprises (GSEs), as the name suggests, are corporations that are sponsored or chartered by Congress. Despite the federal charter, most GSEs are privately owned and privately managed. Some GSEs have issued shares of stock that are publicly held like shares in other corporations, and the stocks of these GSEs are traded on organized exchanges.

GSEs issue short-term securities that sell at a discount and long-term bonds that pay semiannual coupon payments. The majority of the issuances are long term. The proceeds are used to assist in some aspect of lending that the federal government has deemed desirable. GSEs operate mainly in the areas of housing, farm credit, and student loans. The securities that GSEs issue, called government agency securities, are considered government securities for SEC purposes.

In most instances, the federal government has no legal obligation to guarantee the timely payment of interest and principal of GSE securities. However, many market participants assume that the government does de facto guarantee the payments. The yield spread between government agency securities and U.S. government securities is due to difference in liquidity and risk. The yield spread between government agency securities and U.S. government securities is due to differences in liquidity and risk. The yield spread can be significant because secondary markets do not have the breadth and depth of Treasuries. If market participants question the de facto government guarantee, the spread can also widen.

The GSE Housing Market

The GSEs that pertain to the housing market are the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Association (Ginnie Mae). Fannie Mae and Freddie Mac provide loanable funds to the housing sector by selling their own securities and using the proceeds to purchase mortgages or mortgage-backed securities in the secondary mortgage market. The securities that Fannie Mae and Freddie Mac issue are backed by the principal and interest payments on the mortgages or mortgage-backed securities that Fannie Mae and Freddy Mac have purchased. However, there is no explicit government guarantee---Fannie Mae and Freddie Mac are privately owned and their stocks trade on the New York Stock Exchange. The difference between Fannie Mae and Freddie Mac is that Fannie Mae primarily buys the mortgages of banks while Freddie Mac primarily buys the mortgages of thrifts.

Congress created these GSEs in order to make housing more available by increasing the funds flowing into mortgages. The goal is to expand the opportunities for low - and moderate - income families to purchase houses. HUD regulates these GSEs with regard to meeting this goal and ensuring the financial safety and soundness of the corporations.

Ginnie Mae is part of the Housing and Urban Development (HUD) Department of the U.S. government. As such, it is more accurately characterized as a government-owned enterprise. For a fee, Ginnie Mae guarantees that the mortgages purchased with bond proceeds will be repaid and, hence, the bonds will be repaid. Unlike Fannie Mae and Freddie Mac, Ginnie Mae does not issue bonds. Other financial institutions such as banks, savings associations, or mortgage brokers issue the bonds that are guaranteed by Ginnie Mae, referred to as Ginnie Mae bonds. The minimum denomination for Ginnie Mae bonds is $25,000. Unlike Fannie Mae and Freddie Mac, Ginnie Mae securities are fully backed by the U.S. government and, thus, have no default risk.

The GSE Farm Loan Market

The Federal Farm Credit Banks Funding Corporation (FFCBFC) issues bonds and discount notes and uses the proceeds to make loans to farmers in order to facilitate the funds flowing into agriculture. The bonds carry no explicit government guarantee that the principal and interest will be repaid. The FFCBFC ran into financial problems in the late 1980s because many farmers defaulted on high interest loans made in the late 1970s and early 1980s. Congress created the Farm Credit Financial Assistance Corporation (FACO) in 1987. FACO issues bonds and uses the bonds to assist the FFCBFC. Unlike the bonds of the FFCBFC, FACO bonds do have an explicit government guarantee.

The GSE Student Loan Market

The Student Loan Marketing Association (Sallie Mae), a publicly traded company, issues securities and uses the proceeds to purchase student loans. The securities are not backed by an explicit federal government guarantee. However, the federal government guarantees repayment of many of the student loans. The purpose of Sallie Mae is to increase the funds flowing into student loans and to make student loans more liquid. The company is the nation's largest supplier of student loans.

Other GSEs

In 1987, Congress created a new GSE, the Financing Corporation (FICO) in response to the savings and loan crisis. FICO was to issue up to $10.825 billion in 30-year bonds to help shore up the insurance company (the FSLIC) that at the time insured deposits in the failed thrifts. FICO was capitalized by nonvoting stock purchased by the 12 regional Federal Home Loan banks. It is to be dissolved by 2026 or earlier.

In 1989, Congress created another GSE, the Resolution Trust Corporation (RTC), in response to the savings and loan crisis. The RTC was to dissolve or find buyers for the failed thrifts and liquidate the $450 billion of real estate properties owned by the thrifts being dissolved. Thirty-year bonds were issued to help finance the RTC, but the federal government did not explicitly guarantee the bonds. The RTC went out of business on December 31, 1995, after it had completed its work. By that time it had resolved the insolvencies or closed over 750 savings associations.

Recap

GSEs are privately owned government-sponsored enterprises that issue financial securities. The funds that are raised are used to provide funds to areas that the government deems desirable, including housing, farm credit, and student loans. The major GSEs that pertain to the housing market are Fannie Mae and Freddie Mac. The FFCBFC issues securities and uses the proceeds to make loans to farmers. Congress created FACO in 1987 because of financial troubles of the FFCBFC. Sallie Mae is a publicly traded company that issues securities and uses the proceeds to purchase student loans.

*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED., 2003, mAUREEN BURTON & RAY LOMBRA, PGS.  363-366*

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