Q: I've been interested in Ginnie Maes and was very glad to see your article about them in the Feb. 24 issue of The Washington Post. However, I note you say "about as safe as Treasury paper." What does the "about" mean? Also, a friend tells me Ginnie Maes are sometimes hard to get rid of. Is he right about this?
A: Ginnie Maes (a pool of government-guaranteed, mortgage-backed securities) are backed by the full faith and credit of the United States, so they really are as safe as Treasury bills, notes and bonds. I used the word "about" rather cavalierly, but, in fact, there are minor differences between Ginnie Mae certificates and Treasury paper.
Ginnie Maes are issued by the Government National Mortgage Association, an agency of the federal government, rather than by the government itself. If there were a rash of mortgage defaults sufficient to deplete GNMA reserves, action would be required to transfer additional funds to the association. While I am not implying that this in any way reduces security, it may introduce a delay.
Ginnie Maes usually are not hard to get rid of; the secondary market is very active and the certificates are considered quite liquid. But what your friend may be referring to is the possibility of loss if the interest-rate picture changes and you want to sell the certificates before maturity.
Although Ginnie Mae certificates are not bonds, they act that way in terms of their reaction to changing interest rates. If interest rates go up after you buy, the market value of your Ginnie Mae certificate will go down. This will make absolutely no difference if you hold the securities to maturity, when the remaining face value will be returned to you. (By "remaining," I mean the balance due after subtracting from the original face amount the principal that has been repaid to you as a part of each monthly payment.)
But if you want to get rid of the certificates before maturity, you will have to accept a market valuation that will be either more or less than the remaining face value, depending on whether interest rates have gone up or down.
This situation points up the various meanings of "security." I consider Ginnie Maes completely safe in the context of the possibility of default on either interest or principal. But a government guarantee offers no protection against market risk -- fluctuations in market value between the issue and maturity dates.
There are other characteristics peculiar to Ginnie Maes of which you should be aware. If you buy a Treasury bond, it has a predetermined life and a specified rate of return; interest at that rate will be paid to you every six months on the full face value of the bond until it reaches maturity, when the full principal will be returned.
But a Ginnie Mae certificate is supported by mortgages, and those mortgages work just like the mortgage on your own home. That is, each month's payment represents interest on the unpaid balance and a piece of the principal as well. So while the rate of return remains constant, it is paid on a continually decreasing balance.
As part of the principal is returned to you each month, you must find an alternative place to invest it -- and, of course, there is no assurance that available yields will be the same as you are getting on the certificate. This could be good or bad, depending on whether rates generally are higher or lower than when you first bought the certificate. The uncertainty, however, must be considered a disadvantage.
That uncertainty is compounded by the fact that mortgages can be paid off early. If interest rates rise after you buy the certificate, the homeowners are not going to pay off the mortgages (unless they sell); so you'll be locked in at the low original rate for the long haul.
On the other hand, if interest rates fall steeply -- as they have recently -- many homeowners will refinance their high-rate mortgages, paying off the old balances. In turn, you will get larger chunks of your principal back and have to reinvest the money, almost certainly at lower yields.
Despite what I have said here, I like Ginnie Maes, particularly for retirees looking for a fixed yield with maximum safety. But it's important that you understand these characteristics of the Ginne Mae market before you buy.