Government Sponsored Enterprises, known as GSEs, are privately owned corporations created by Congress to provide funding and help to reduce the cost of capital for certain borrowing sectors of the economy such as homeowners, students and farmers. GSE securities are generally perceived to carry the implicit backing of the U.S. Government, but they are not direct obligations of the U.S. Government.

Through the creation of GSEs, the government has sought to address various public policy concerns regarding the ability of members of these groups to borrow sufficient funds at affordable rates. GSEs are also sometimes referred to as federal agencies or federally sponsored agencies. The reader should note, however, that there are organizational differences among the GSEs although all are established with a public purpose: Student Loan Marketing Association (Sallie Mae), Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) are privately owned corporations, while the Federal Home Loan Banks and the Federal Farm Credit Banks are systems comprising regional banks.

All GSE debt is sponsored but not guaranteed by the federal government, whereas government agencies such as Government National Mortgage Association (Ginnie Mae) are divisions of the government whose securities are backed by the full faith and credit of the United States. To conduct their lending business, GSEs have significant funding requirements. While many are stockholder-owned companies that can raise equity capital, most GSEs rely primarily on debt financing to fund their day-to-day operations. Among the most active issuers of debt securities are: Federal Home Loan Banks, Freddie Mac, Fannie Mae, Federal Farm Credit Banks, Sallie Mae and Tennessee Valley Authority (TVA). Supranational and international institutions, such as the World Bank, also issue debt securities.

Buyers of GSE-issued debt securities include domestic and international banks, pension funds, mutual funds, hedge funds, insurance companies, foundations, other corporations, state and local governments, foreign central banks, institutional investors and individual investors.

Secondary Market
GSEs are most suitable for purchasing and holding to maturity. However, investors may find it necessary to dispose of their holding prior to maturity. GSE obligations are traded in the secondary market, which provides an opportunity for investors to sell their holding at the prevailing market levels, which may be worth more or less than the original amount invested. The secondary market for any particular GSE-issued debt security may be affected by factors such as its maturity, structure and issue size. In some cases, liquidity may be limited.

Tax Status
The interest on obligations of GSEs is subject to federal income taxes, thus they are referred to as "taxable securities". They are also subject to federal capital gains tax, estate and gift taxes. Several GSEs provide state and local tax relief. Investors should consult their tax advisors when applying GSEs to their particular situation.

Federal and Congressional Oversight
To assure that the GSEs continue to fulfill their public mission of reducing borrowing costs for certain groups, their activities are monitored and periodically reviewed by their respective regulators and congressional oversight committees. In recent years, Congress has, from time to time, also considered reevaluating and/or modifying the nature of their federal status and broadening the authority of agencies like the Office of Federal Housing Enterprise Oversight (OFHEO) to oversee certain GSEs. Public criticism of the GSEs can obviously create some level of political uncertainty and price volatility in these markets. This "political headline" risk has so far never affected the current credit of outstanding GSE debt, but it can impact trading spreads and temporarily disrupt liquidity in the GSE market.
Investors should therefore remain cognizant that, as large as the GSE debt market has become, Congress and other federal oversight authorities will continue to play a key role in assuring that the GSEs do their utmost to fulfill their missions, maintain their high credit ratings and adhere to their charters. At times this may create a certain amount of short-term volatility in these markets. Yet, responsible federal oversight ultimately helps strengthen the long-term viability of the GSE debt market.

U.S. Federally Related Agencies
U.S. Federally Related Agencies differ from GSEs in that they are federally owned, and thus have a closer relationship to the U.S. Government. The Tennessee Valley Authority is one example of a U.S. Federally Related Agency and is explained later. Although both GSEs and U.S. Federally Related Agencies are established by acts of Congress, GSEs are sponsored by the U.S. Government whereas U.S. Federally Related Agencies are wholly owned by the U.S. Government.