WASHINGTON -- Investors searching for higher yields from rock-solid investments were put on hold again last week by the Federal Reserve, which pledged to keep interest rates low even as it scales back its extraordinary monetary easing.
While the Fed is not expected to raise its benchmark overnight interest rate for nearly two years, savers may be able to build reliable income streams by investing in mortgage-backed securities issued by Fannie Mae and Freddie Mac, the taxpayer-owned mortgage finance companies. Their bonds are considered to be safe and they beat the rates paid on U.S. Treasury securities and bank account deposits, say analysts.
Ironically, these are the very same types of securities that were blamed for being part of the problems that precipitated the 2008-2009 financial crisis. But with quasi-governmental status and federal backing, none of the bonds went bad despite problems in the housing market and the economy. Both of these government-sponsored enterprises still issue mortgage-backed securities, with current rates above U.S. Treasuries, and they have not missed a payment.
With the five-year U.S. Treasury note yielding about 1.7 percent, an investor can expect a mortgage-backed bond from Freddie Mac or Fannie Mae with the same maturity to yield about 1 percentage point to 1.5 percentage point more, Franco Castagliuolo, a portfolio manager at Fidelity Investments, said.
Federal regulators placed both mortgage giants under conservatorship in 2008 and supplied massive government assistance; analysts who follow Fannie and Freddie say these securities carry an implicit government guarantee and are seen as safe. In the wake of the mortgage and housing crisis, these quasi-governmental loan packagers have been handling a larger share of the mortgage market.
About two-thirds of all mortgages being issued now are being packaged into securities by Freddie Mac and Fannie Mae.
Risk Free, Somewhat
Investors who buy mortgage-backed securities from Fannie Mae and Freddie Mac and hold those bonds until they mature will get their full investment back; there is no "principal risk."
Still, there are other concerns. One risk is holding securities with low interest rates in a rising interest-rate environment, Castagliuolo said. That could leave the money of bondholders stuck in low-yielding instruments while new issues pay better rates.
Owners of mortgage backed bonds also face refinance risk, though that tends to be more of an issue when rates are falling. In those periods, homeowners refinance and pay their loans off early, leaving the bondholder stuck with money they have to reinvest at lower rates.