Why does Ginnie Mae do this?

The bottom line reason why they do this is that it allows more mortgages to be financed, which results in higher home ownership rates.

Capital markets have a finite amount of liquidity at various levels of risk, duration, and required return. By guaranteeing the MBS, Ginnie Mae can sell this MBS in an area of the capital market where there is much more investor demand, and a larger market of people willing to purchase these MBS's.

Please see the graph attached:

I have this graph of Ginnie Mae spreads vs. the US 10 year Treasury Swaps (spreads?). Can you explain what exactly is being graphed, and why the two components are compared to each other?

(ie. What are Ginnie Mae spreads and why are they graphed against the USSW10?)

Attached Images

ginnemaespreads.JPG (56.1 KB, 5 views)

GNMA spreads are often mapped against the 10 year treasury in order to get a snapshot of capital market risk tolerance, as measured against two kinds of notes that both carry government gurantees. Both the GNMA and Treasury paper carry the full faith and credit of the govt, but there are underlying differences in terms of what the money is being used for, the comparative liquidity of the bonds, LIBOR, as well as some other details (bank pass through fees on GNMA paper, the vitatality of the housing market, etc).

Let me take a step back and discuss each of these two curves in detail, and perhaps my explanation will clarify itself a bit more....

I would attribute the declining yield on the 10 yr UST to a flight to quality. During uncertain times such as these, people often flock to treasuries because they are considered safe, and are extremely liquid... there is always a market for them, they are pretty much as liquid as cash is.

The increasing yield on the GNMA spread reflects the inverse of this... as investors become more fearful, they prefer Treasuries to GNMA. Although both are guaranteed by the government, there is MUCH more liquidity in the Treasuries market.

Another factor that might be driving this is the unknown future state of the mortgage market. With the collapse of subprime, and a freeze on the CDO-based creation of mortgage capital, some might be anticipating the government stepping in to provide this capital for mortgages. In order to accomplish this, the government would have to step into this hole in the capital market and fill it by issuing new GNMA, Fannie, and Freddie bonds. A flood of new bond issuance would increase supply, which would result in the market demanding higher yields.

Thanks for your well explained reply. Let me see if I followed you correctly and extrapolate a few more questions.

A higher demand for Treasuries increases the price of the treasuries, which decreases the required rate of return? So the demand factor is the main reason why the interest rate for USSW10 decreased?

The source of this rise in Ginnie Mae spreads is the increase in perceived risk for holding Ginnie Mae MBS instruments? The higher perceived risk requires a higher yield? And this higher perceived risk results from the perception that Ginnie Mae MBS's are less liquid than Treasuries? Or they are truly less liquid than Treasuries?

I acknowledge I am asking a million questions but here's two more:
1) What exactly does "Ginnie Mae Spread" refer to? (ie what is the index rate for the Ginnie Mae instruments? and
2) (finally) Are 10 YR Treasury Swaps the same thing as regular old 10 YR Treasuries?


Thank you again, You have already been very helpful

You got it!

Yes, I do think there is more liquidity in treasuries than there is in GNMA paper. I could be wrong!! I just think that, in times of fear, a lot of people instinctually move their money into treasuries just because they are "treasuries", even if there are other government underwritten bonds out there that may offer higher returns. Case in point, a lot of 401K's offer "treasuries only" funds to specifically market to the the investor looking for a safe haven.

I do need to qualify my reply because I'm not really a "bond guy". I understand the economics behind it, but my application of terminology might be a little off... anyone out there reading please feel free to correct anything I may be misstating!

I believe the Ginnie Mae spread IS the differential between it and an equivalent duration treasury note. The word "spread" differs from the word "swap" in that it implies that you are comparing a rate to some sort of index rate.

The term "swap" is similar... its just used to compare two bonds of similar face value, and they do not have to be "index" rates.

Your graph is displaying yields, they just use the terms "spread" and "swap" as a hypothetical implication of the yield differential if you were to exchange one for the other.

Thanks,
I understand that GNMA instruments are not one homogenous product. This leads me to question: when GNMA spreads are referred to, is the average of all the GNMA products considered?