The Major Players in the Bond Market - dummies

The Major Players in the Bond Market

By Eric Tyson

Every year, millions — yes, literally millions — of bonds are issued by thousands of different governments, government agencies, municipalities, financial institutions, and corporations. They all pay interest. In many cases, the interest rates aren’t all that much different from each other. In most cases, the risk that the issuer will default — fail to pay back your principal — is minute. So why, as a lender of money, would you want to choose one type of issuer over another? Glad you asked!

Following are some important considerations about each of the major kinds of bonds, categorized by who issues them. We’re just going to scratch the surface right now.

  • Supporting (enabling?) your Uncle Sam with Treasury bonds: When the government issues bonds, it promises to repay the bond buyers over time. The more bonds the government issues, the greater its debt. Voters may groan about the national debt, but they generally don’t see it as an immediate problem.

All Treasury Bonds are backed by the “full faith and credit” of the federal government. Despite its huge debt, the United States of America is not going bankrupt anytime soon. And for that reason, Treasury bonds have traditionally been referred to as “risk-free.” Careful! That does not mean that the prices of Treasury bonds do not fluctuate.

  • Collecting corporate debt: Bonds issued by for-profit companies are riskier than government bonds but tend to compensate for that added risk by paying higher rates of interest. (If they didn’t, why would you or anyone else want to take the extra risk?) For the past few decades, corporate bonds in the aggregate have tended to pay about a percentage point higher than Treasuries of similar maturity.
  • Demystifying those government and government-like agencies: Federal agencies, such as the Government National Mortgage Association (Ginnie Mae), and government-sponsored enterprises (GSEs), such as the Federal Home Loan Banks, issue a good chunk of the bonds on the market. Even though these bonds can differ quite a bit, they are collectively referred to as agency bonds.

Agencies are sometimes part of the actual government, and sometimes a cross between government and private industry. In the case of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), they have been, following the mortgage crisis of 2008, somewhat in limbo.

To varying degrees, Congress and the Treasury should serve as protective big brothers if one of these agencies or GSEs were to take a financial beating and couldn’t pay off its debt obligations.

  • Going cosmopolitan with municipal bonds: The bond market, unlike the stock market, is overwhelmingly institutional. In other words, most bonds are held by insurance companies, pension funds, endowment funds, and mutual funds. The only exception is the municipal bond market.

Municipal bonds (munis) are issued by cities, states, and counties. They are used to raise money for either the general day-to-day needs of the citizenry (schools, roads, sewer systems) or for specific projects (a new bridge, a sports stadium).