GSE Debt Securities

GSE Debt Securities are actually a type of bond that was created by the United States Congress to provide funding for specific types of borrowers such as students, homeowners and farmers. People within those groups might not qualify for other conventional loans so the government sought to address this very real need. Unfortunately, many people misunderstand the nature of this particular type of bond because of the name GSE which stands for Government Sponsored Enterprises. While they were created to fund loans, thereby enabling consumers within those groups to borrow sufficient money at rates that are affordable, they are not guaranteed loans as many people believe them to be.

Confusion in the Name
Sometimes GSEs are referred to as federally sponsored agencies and even federal agencies. This isn’t exactly true. While the enterprises are sponsored by the federal government they are actually not a part of the government nor are they owned by any government entity. The issuers of GSE securities are generally just companies owned by stockholders with the ability to raise equity capital yet choose to utilize debt financing to support the day to day operations of their respective businesses. Some of the most active companies that issue debt securities are Freddie Mac, the Federal Home Loan Banks, Fannie Mae, Tennessee Valley Authority and the Federal Farm Credit Banks.

Government Sponsored vs. Government Guaranteed Debt Instruments
Although the GSEs were created by the US Congress they purpose is to improve the flow of credit to specific groups within the general population. The main difference between government sponsored and government guaranteed instruments of debt (loans) is obviously in the fact that the government will pay at least a portion of a defaulted loan that has been guaranteed. A government sponsored entity is able to attract lenders that offer lower rates because of the implied guarantee rather than a real guarantee. Not only are lenders willing to lower finance charges and interest rates, but investors are also able to yield higher returns as a result of this implied guarantee. One thing to be aware of is that GSEs are governed by very strict lending procedures. It should be noted that there are also a number of international GSE debt securities issued by such financial institutions as the World Bank.

Auctions and Regular Issuance Programs
GSEs can be issued in a number of ways. They are commonly issued through designated dealers or dealer groups that can either syndicate or utilize auctions to price the securities. Most GSEs today are issued through a variety of issuance programs but with the recent surge of issuance through auctions, experts feel that there is now greater transparency as to pricing structures. Technology has now made it possible to offer greater variety in terms of options, futures and customized rate swaps. In fact, technology now provides for significant flexibility in order to offer totally customized products which can better meet the needs of both investors and issuers.

Even though there is some fair amount of misunderstanding surrounding GSEs in terms of the difference between sponsored and guaranteed, they are still seen as a fairly safe investment product. They are typically bought by both international and domestic banks, hedge funds, insurance companies, mutual funds, corporations, foundations, local and state governments, individual and institutional investors. While the majority of GSEs are issued through the mortgage market, they can be issued to provide affordable student loans as well. While not as secure as Treasury Notes they are able to provide higher yields which make them even more attractive. In the end, you will need to weigh the greater risk of GSEs over Treasury bonds against the ability to realize higher profits.

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