What are Gnomes
Gnomes were 15-year, fixed-rate, pass-through securities offered by the cash program of the Federal Home Loan Mortgage Corporation or Freddie Mac. The securities offered under this program had a maturity of 15 years.
BREAKING DOWN Gnomes
As pass-through securities, gnomes pooled debt obligations, or fixed-income securities, backed by a package of assets, and passed income obligations from the person or entity that owes the debt, to the shareholders. A mortgage-backed certificate is one example of a pass through.
A servicing intermediary collects the monthly payments from issuers and, after deducting a fee, remits or passes them through to the holders of the pass-through security. It is also known as a "pass-through certificate."
Gnomes existed under the Freddie Mac cash program: Freddie Mac bought mortgages for cash, then formed a pool of mortgages and sells mortgage participation certificates, representing undivided interest, or an identical percentage interest or share, in these mortgages. Investors sold their mortgages through Freddie Mac's cash program.
The Origin of the Name Gnomes, and Their Legacy
In a 2013, Investopedia published a fanciful post titled Elves And Gnomes: Fairy Tale Investment Terms. "Surprisingly, some of the best known magical creatures in literature can also be found on Wall Street," wrote contributor Andrew Beattie.
The article examined colloquial names such as Leprechaun Leader and Smurf. Gnomes, Beattie said, "are so diverse that even the investing world has two kinds. The first type of gnome simply refers to the 15-year pass-through securities offered under Freddie Mac's cash program. These may be called gnomes because the name just sounds neat, but it could also be a nod to the fact that Freddie Mac investments are generally quite stable, thus scaring off volatility gremlins."
The second, he said, refers to the "Gnomes of Zürich," the nickname given to Swiss bankers by British labor ministers during the 1964 sterling crisis.
Other articles from around the same time pointed to a 1980s Freddie Mac marketing campaign, known as "The Gnomes Know," which highlighted the agency's expertise in mortgage securities.
In 2012, a few years after the subprime mortgage crisis, Louis Hyman, professor of history at Cornell, wrote in Bloomberg that, for him, "a magazine advertisement in 1984 explains where it all went wrong. In a bizarre ad in the American Bankers Association journal, the chief financial officer of Freddie Mac, Leland Brendsel, appears to be consulting with gnomes on how to oversee America’s mortgage-backed securities markets."
Given the havoc that such securities would eventually cause across the U.S. economy, Hyman noted that "perhaps the gnomes should have advised" Brendsel that "magic is, after all, better wielded by magicians than financiers."