Chestnut & Cedar Stock Report

Government Agencies and Related Securities

- The Main Issuers

The Main Issuers

Agency	Public / Private	Sector	Explicit U.S. Government Guarantee?
Fannie Mae	Public	Housing	No
Freddie Mac	Public	Housing	No
Federal Home Loan bank	Private	Housing	No
Federal Farm Credit System	Private	Farming	No
Tennessee Valley Authority (TVA)	Private	Utilities	No
Sallie Mae	Public	Education	No
Private Export Funding Corp (PEFCO)	Private	Exports	Yes
U.S. Agency for International Development (AID)	Private	Foreign Housing	Yes
Financial Assistance Corp (FAC)	Private	Farming	Yes
General Services Administration	Private	Housing	Yes
Small Business Administration (SBA)	Private	Small Business	Yes

Are these solid credit quality investments? Yes, without a doubt.

Are these investments guaranteed by the government? Some are; some are not. If the bonds are issued by a Federal Agency, such as Ginnie Mae, then the debt is backed by the full faith and credit of the U.S. Government. If, however, the bonds are issued by a Government Sponsored Enterprise (GSE), such as Fannie Mae or Freddie Mac, then they are not guaranteed by the federal government.

Therein lies the issue: there seems to be a dichotomy between what is written by the GSEs and what is believed (inferred) by investors. Some of these GSEs are clearly telling their bondholders that their debt is not guaranteed by the federal government. Investors, however, are receiving and accepting thin spreads (low rates) on the assumption that there is an implied guarantee that the U.S. Government will make bondholders whole in the unlikely event of a default. It seems that many investors are betting that, because of the affiliation that these agencies have with the federal government, if defaults occur, the federal government will bail them out

When the creditworthiness of the GSE bonds is discussed, you often hear terms like “very secure,” “the government would probably,” “almost risk free,” or “essentially backed.” These are wiggle room terms that should automatically raise red flags to alert investors. Prudence is essential. The author operates under the assumption that unless there is a guarantee in writing, there is none.

Some Food for Thought - Over the years, the issue as to whether or not the debt of these GSEs is guaranteed by the government has been discussed at length. The documentation seems to be clear that the U.S. Treasury will only back Agency debt that it explicitly guarantees. Additionally, the budgeting department of the U.S. government prepares national debt calculations, keeping the debt of some of the Government Sponsored Enterprises out of the calculations. The budget numbers don’t lie.

Let’s be very clear, if a default ever occurs, our government has the money to make everyone whole. We are the richest country in the world. The question is: Should the taxpayers bail out real estate investors or any investors? You just don’t know which way the votes will go.

Don’t misinterpret my point! GSEs provide excellent investment opportunities for income orientated investors. These corporations have major advantages over their competitors. They have a “cheap” cost of funds compared with similar public companies. Some, however, are leveraged, and their operations would be hindered, if they were standalone organizations. Nonetheless, inexpensive borrowing rates and high leverage permit these agencies to maximize their profits and cash flows. They also are exempt from certain state and local taxes.

Life is long, however, and many different situations may present themselves. When lenders tell you that certain debt obligations are not guaranteed, believe them! This way, hopefully, you can plan and implement a proper diversification strategy, so you won’t be overly exposed to any one asset class, in case of an unexpected crisis.