Ginnie Maes - 100% Guaranteed but Not Risk-Free
As I walked past a sidewalk café recently, I unwittingly overheard a man tell an older lady, "Ginnie Maes yield more than CDs, but they’re just as safe because they’re also 100% guaranteed by the government." Although my neck surely swiveled as I walked past, etiquette precluded me from pulling up a chair. Therefore, I can only speculate that the man was a securities salesman who was attempting to convince this lady to forsake her CDs in favor of higher-yielding mortgages backed by the Government National Mortgage Association – a governmental institution colloquially referred to as Ginnie Mae.
In asserting that Ginnie Maes are "just as safe," this man was undoubtedly drawing a parallel between federal deposit insurance and the fact that mortgages backed by the GNMA are guaranteed as to timely payment of principal and interest. In truth, people who purchase GNMAs and/or the funds that invest in them bear several risks not borne by the typical CD investor.
To wit: GNMAs are priced to the market, so unlike bank CDs their values fluctuate continuously. GNMAs are also subject to prepayment risk. When interest rates are low, mortgage refinancing activity increases which forces mortgage investors to reinvest their funds at inopportune times. Conversely, when interest rates are high and mortgage investors would love to be able to reinvest their funds, refinancing and prepayment activity slows dramatically. This is known as extension risk. Therefore, GNMAs do fall in value when rates rise, but they tend not to rise very much in value when rates fall.
So while GNMAs are, in fact, guaranteed as to the timely repayment of principal and interest, they are not really very CD-like.
