Government Sponsored Entities

Money market securities are generally issued by firms that have a very strong credit rating. This is because investors do not want their investments to be volatile when they invest in money markets. Hence, they prefer to buy securities only from companies that have a strong credit rating.

The government is the most preferable issuer for investors who invest in the money market. This is largely because of the fact that the chances of government default are much lower as compared to that of private entities.

However, it needs to be understood that in the United States, there are certain entities called government-sponsored entities. The securities issued by these entities are also actively traded in the money market.

In this article, we will have a closer look at what government-sponsored entities are and how they are involved with the money market.

What are Government Sponsored Entities?

In the United States, there are some quasi-government entities like Freddie Mac, Fannie Mae, and Sallie Mae. These entities have been created in order to provide adequate financing to certain sectors of the economy such as education, agriculture, and housing.

These entities are private entities and hence can raise money from the financial markets. However, they also have a sovereign guarantee. This means that if they are unable to pay back the funds, then the government will pay it back on their behalf. These entities can be called quasi-government entities since they are private but also have the backing of the government.

Since there is a sovereign guarantee of the United States government, these entities have a high credit rating and hence are able to issue securities and raise money from the money market.

Why do Government Sponsored Entities Raise Money from the Money Market?

Sectors such as education, housing, and agriculture generally require long-term finance. Hence, many investors find it difficult to believe that government-sponsored entities are important players in the money market.

However, these entities do issue short-term securities in large amounts. The balance sheets of these entities run into hundreds of billions of dollars and almost 25% of this outstanding debt is short-term debt.

Here are some of the reasons why these entities raise debt by issuing short-term securities.

1. Government-sponsored agencies hold a lot of debt which is long-term in nature. However, the interest rate on this debt resets periodically. Hence, these entities use short-term debt to fund such loans. This is done in order to ensure that there is no mismatch between the interest receivable and interest payable.

   Since these government-sponsored entities have a large portfolio of loans with variable rates, they tend to issue short-term securities quite often. There are some government-sponsored entities that issue short-term debt on a weekly basis.

2. Many times, government-sponsored entities do not want to issue long-term debt because they feel that the current interest rate is too high and that the interest rate is likely to go down in the near future. Hence, in such situations, they issue short-term debt in the interim. This short-term debt is meant to help them lower the interest payable since once the interest rate is lowered, then the company will issue long-term debt.

3. Government-sponsored entities are considered to have sovereign backing. Hence, they can borrow money from the money markets at a rate that is slightly above the rate offered by treasury bills. Since the spread between the risk-free rate and the actual interest payable is so low, issuing short-term securities in the money market turns out to be an attractive proposition for government-sponsored entities as well.

There are many other reasons why government-sponsored entities issue short-term debt. They issue a wide variety of short-term debt. Some of the debt which they issue matures overnight while other debt can take as long as 180 days to mature.

Who Invests in Securities Issued By Government Sponsored Entities?

The government-sponsored entities are sold via a dealer network. This dealer network is aware of the debt issuance schedule of these entities. As a result, these dealers contact their clients and are able to aggregate the demand for such debt.

Once the aggregation has been completed, these securities are then purchased by dealers who then resell them to their clients. Hence, dealers are the primary and the largest customers of government-sponsored entities.

There are many other types of investors who purchase these securities. For instance, there are money market funds, pension funds, insurance companies, and also commercial banks which purchase these securities for their treasury operations.

Since these securities are sold in large denominations, a direct sale to individuals is quite rare. It is common for government-sponsored entities to issue short-term securities in large denominations such as $25000 which can make it unaffordable for individual investors.

The fact of the matter is that government-sponsored entities have a lot of incentives to issue debt and raise short-term money from the money markets. These loans are cheap and easily available with fewer transaction costs.

Similarly, money market investors also have many reasons why they choose to invest in debt issued by government-sponsored entities. The biggest reason is that they can earn additional interest by taking on very little additional risk.