Agency Security

A conservative client wants exposure to United States agency debt but insists on securities that carry the direct backing of the federal government itself. Which of the following carries the full faith and credit of the United States government?

1. A.Federal Home Loan Bank consolidated bonds.The Federal Home Loan Banks are a government-sponsored enterprise; their debt is not federally guaranteed.
2. B.Federal Farm Credit Banks consolidated systemwide bonds.The Farm Credit System is a government-sponsored enterprise, so its debt lacks a federal guarantee.
3. C.Fannie Mae debentures.Fannie Mae is a government-sponsored enterprise. Its obligations are not backed by the full faith and credit of the United States.
4. D.Ginnie Mae pass-through certificates.Correct. Ginnie Mae is a wholly owned government corporation and its guarantee is a direct obligation of the United States.

Why: Only one widely held agency mortgage security is directly guaranteed by the United States government: Ginnie Mae pass-through certificates. Ginnie Mae is a wholly owned government corporation within the Department of Housing and Urban Development, and its guarantee of timely payment of principal and interest is a direct federal obligation. The Federal Home Loan Banks, the Farm Credit System and Fannie Mae are government-sponsored enterprises. Their debt is high quality and widely treated as near-government paper, but it is not guaranteed by the United States Treasury.

Interest received on GNMA pass-through certificates is:

1. A.Exempt from federal income tax but taxable at the state levelThat inverted pattern belongs to municipal securities, and even then only for federal purposes.
2. B.Taxable federally but exempt from state and local income taxThat is the treatment of direct Treasury obligations, not of GNMA pass-throughs.
3. C.Exempt from federal, state, and local income taxTriple exemption is associated with in-state municipal bonds, never with agency mortgage securities.
4. D.Fully taxable at the federal, state, and local levelsCorrect. Only the credit backing resembles a Treasury; the tax treatment does not.

Why: Ginnie Mae certificates are backed by the full faith and credit of the US government, but that guarantee concerns credit, not taxes. The interest is fully taxable at the federal, state, and local levels. The clue is that the security is an agency mortgage pass-through, not a direct Treasury obligation.