Who Holds What: Are The Fed Numbers Flawed?

With U.S. investors stampeding into equity mutual funds, it seems obvious that individuals have increased their stake in the stock market. But not according to the Federal Reserve. The Fed's oft-quoted Flow of Funds data shows that households sold $168.4 billion of individual stocks in 1995 and only bought about $88 billion worth of equity mutual funds. The implication: Households are lightening up their overall equity ownership.

Many executives in the financial-services industry say that such an inference doesn't ring true. In fact, the Fed may be undercounting the purchase of mutual funds by households, and it is overcounting households' sale of equities. While the Fed possesses detailed information on the buying and selling of equities for such institutions as banks, insurance companies, and mutual funds, it has no transaction-derived data for American households.

MUDDYING THE NUMBERS. How does the Fed determine the individual stock ownership of households? After figuring out the total amount of equity issued during the year and tallying the amount of stock retired through corporate buybacks and mergers, Fed economists subtract the net purchases and sales of equities by the institutional investors. What's left is dumped into the household category. "If we're wrong in any of the other categories, then we'd be wrong in the household sector," says Joel Lander, an economist at the Federal Reserve. "But its hard to imagine that we're too far off."

Perhaps. But even if the data in all of the institutional categories is right on, the Fed muddies the numbers for the household sector by failing to set up a separate category for nonprofit corporations. Market transactions by nonprofits ends up in the household numbers. Many nonprofits are net sellers of stock because of the need to fund their many projects. A likely result is an overstatement of the sale of stock by households.

The Fed also excludes an important component in its calculation of mutual-fund purchases by households. The money held in defined-contribution plans such as 401(k)s is excluded from the household sector and appears in a category the Fed calls pension plans. As more people put more of their 401(k) money into equity funds, the Fed's numbers on pension plans go through the roof--and the numbers for the household sector miss a larger and larger chunk of stock ownership.


WRONG CATEGORY. Two economists, James M. Poterba of Massachusetts Institute of Technology and Andrew A. Samwick of Dartmouth College, rejiggered some of the Fed's categories to come up with a revised figure for the ownership of stocks by the household sector. They included equity held in 401(k)s, variable annuities, and other types of investments. Their figures show individuals owning 64% of all outstanding equity, compared with about 50% for the Fed (chart).

The Fed's overall data is top-notch. The problem is that some of the buying and selling falls into the wrong categories. And any inference that the individual's passion for the stock market is waning is just wrong.

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