Agency Debentures: Definition, Features, Risks, and Examples
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Summary:
An agency debenture refers to debt (bonds) issued by a United States federal agency or government-sponsored enterprise (GSE) to raise funds for financing activities, typically involving mortgage purchases. This article delves into the nature of agency debentures, their features, implications, and their role during the 2008 financial crisis.
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What is an agency debenture?
An agency debenture constitutes debt, usually in the form of bonds, issued by a United States federal agency or a government-sponsored enterprise (GSE). These entities issue debentures to acquire funds necessary for financing their operations, which often include buying mortgages from various lenders.
Key features
Agency debentures:
- Are issued at fixed or variable interest rates.
- Rely on the creditworthiness and integrity of the issuer, rather than collateral.
- Can be fully guaranteed by federal agencies, with tax-exempt interest payments.
- Or, may be implicitly guaranteed by GSEs, with taxable interest payments.
Understanding agency debentures
Agency debentures, unlike traditional bonds, aren’t backed by collateral. Instead, they depend on the issuer’s creditworthiness. Minimum investment levels typically start at $10,000, with increments of $5,000. Federal agency debentures come with full guarantees from the U.S. government, ensuring both interest payments and principal repayment.
On the other hand, GSE-issued debentures carry only implicit guarantees, posing a credit risk to investors. While GSEs can borrow from the U.S. Treasury in dire situations, this isn’t a guaranteed lifeline. Thus, GSE debentures present a degree of uncertainty.
Investment strategy
Investors may opt for agency debentures as part of a low-risk investment strategy. Bonds directly from government agencies offer fixed interest rates and principal repayment guarantees. Common issuers include Fannie Mae, Freddie Mac, Farmer Mac, and Ginnie Mae.
Agency debentures during the 2008 financial crisis
The 2008 financial crisis spotlighted agency debentures, particularly those issued by GSEs like Fannie Mae and Freddie Mac. Operating with implicit government backing, these entities faced near-collapse due to their significant exposure to mortgages. The U.S. Treasury intervened, deeming them “too big to fail,” and bailed them out to prevent a housing market collapse.
Frequently asked questions
What are agency debentures?
Agency debentures are debt instruments issued by federal agencies or government-sponsored enterprises (GSEs) to raise funds for their activities, often involving mortgage-related operations.
Are agency debentures safe investments?
Debentures issued by federal agencies are generally considered safe due to their full guarantees by the U.S. government. However, those issued by GSEs carry some credit risk.
Which entities commonly issue agency debentures?
Fannie Mae, Freddie Mac, Farmer Mac, and Ginnie Mae are among the most common issuers of agency debentures.
What is the difference between federal agency debentures and GSE-issued debentures?
Federal agency debentures are fully guaranteed by the U.S. government, while GSE-issued debentures carry only implicit guarantees, posing some credit risk to investors.
How are agency debentures affected by changes in interest rates?
Agency debentures, especially those with variable interest rates, may see changes in their returns based on fluctuations in interest rates set by the Federal Reserve.
Key takeaways
- Agency debentures are debt instruments issued by federal agencies or GSEs for financing purposes.
- They can offer guaranteed returns but may also involve credit risk, especially with GSE-issued debentures.
- During the 2008 financial crisis, agency debentures issued by GSEs like Fannie Mae and Freddie Mac played a significant role.
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