What is Agency Debentures
Agency debentures are debts, or bonds, issued by a United States federal agency or a government-sponsored enterprise (GSE). Rather than being backed by collateral, these debts rely on the creditworthiness and integrity of the debt’s issuer.
Debts issued by an actual federal agency, such as the Department of Agriculture are backed by “the full faith and credit of the U.S. government.” Agency debentures which are issued by a GSE on the other hand, are only implicitly guaranteed.
BREAKING DOWN Agency Debentures
Agency debentures issued by a government-sponsored enterprise (GSE) are considered implicitly guaranteed. Even if that enterprise suddenly finds itself unable to repay its debts, it may borrow money directly from the U.S. Treasury. Still, agency debentures issued by GSEs are considered to have some credit risk, because the U.S. Treasury is not obligated to lend that entity money.
It is also possible to purchase agency debentures as an investment strategy. This strategy can be a low-risk form of investing. Bonds issued directly through a government agency, not through a GSE, and are guaranteed to pay a fixed-rate of interest and the bond’s full principal when the bond matures. The minimum level of investment for an agency bond is generally $10,000, with the ability to increase that amount in increments of $5,000.
Familiar Examples of Agency Debentures
Agency debentures drew widespread attention during the mortgage and credit crisis of 2008. The crisis brought into focus problems inherent in GSEs. The problem was the GSE using the implicit guarantee of a bailout by the U.S. Treasury while operating as private enterprise. The two most commonly referenced examples were Fannie Mae, also known as Federal National Mortgage Association Corporation (FNMA), and Freddie Mac, also known as Federal Home Loan Mortgage Corporation (FHLMC).
Leading up to the financial crisis these two entities made enormous profits by borrowing money at low rates, thanks to their implicit backing by the U.S. Treasury, and dealing in the secondary mortgage market. When the mortgage market collapsed, Fannie Mae and Freddie Mac both faced potential bankruptcy. Both entities held an enormous share of mortgages at the time.
The collapse of Freddie and Fannie would have led to the collapse of the housing market. The U.S. Treasury decided they were "too big to fail" and stepped in with a bailout worth $187 billion as a way to keep the entities from going bankrupt. The federal government has since taken over both of these entities to prevent something similar in the future.