Read Larry Swedroe on Mortgage Backed Securities (Annette Thau is another book recommended here).I learned the mechanics of Agency Bonds and basically they work like Treasuries with some caveats:
1) The government agency backing them can close them at various specified call dates. For the long bonds I’ve seen there are many call dates in the future.
2) Essentially backed by the full faith and credit of the US Govt.
3) They pay higher interest, especially at longer durations of 10 years and more. These days 6% interest is not uncommon.
My questions about them are:
1) If they are closed, does the govt pay them at par value or market value (current bid price on open market if there is one)?
2) If par value, does that mean if you buy them at below par you stand to make some profit?
3) Do they pay accrued interest?
4) How easy is it to sell them on the open market for a fair price?
5) What role do they play in a portfolio?
Bottom line:
- most US Agency bonds have prepayment risk
- if you buy one, you price it on Yield to Worst or Yield to Call (usually the same) *not* on Yield to Maturity
If interest rates go up, you won't get called as you might have hoped. The underlying mortgageholders extend, and so you might wind up holding the bond to maturity.
Conversely if interest rates fall, you are quite likely to get called.
In other words, you bought a short term security when you wanted a long term one, and a longer term security when you thought you were buying a shorter term. Now you do get a higher yield for that trouble, but it does rather blow the rationale for holding bonds.
GNMA bonds, and some other government agencies (like FBH, I believe) are indeed, legally, "full faith and credit".2) Essentially backed by the full faith and credit of the US Govt.
FNMA and FMAC bonds are not. As these institutions were taken into "conservatorship" in summer 2008, essentially they are US Federal government owned, and we'd have to assume the US government is on the hook-- but I don't think there's any law that says that?
"Assume" is a big word. Although these institutions are critical to the functioning of the US mortgage market, the Obama Administration and the Congress could not agree a way forward. I don't think either of the 2 subsequent administrations did anything, either. So basically these things stagger on, paying a nice dividend to the US Treasury (which needs it) but with no recapitalisation. The possibility of ending the 30 year fixed term mortgage, which is the logical consequence of not doing something about this, is too horrible to contemplate (for many stakeholders: home building industry, borrowers, political system). So I imagine that a fudge will continue.
You have to take your own view about whether things which are too horrible to imagine, in terms of their systemic (system-wide) consequences, have 0% chance of happening.
Statistics: Posted by Valuethinker — Sat Jan 04, 2025 4:07 pm — Replies 6 — Views 307