Federal Reserve information designed to track investor demand for municipal bonds grossly underreports the amount of debt outstanding and retail purchases, in some instances by more than $100 billion, according to analysts at Smith Barney Inc.
For 1992 and 1993, "the amount of tax-exempt bonds reported to be outstanding is much too low -- at least 10% below the actual amount of bonds outstanding," George D. Friedlander and Bart Mosley wrote in a recent issue of the firm's Credit Market Comment.
In addition, the amount of bonds held by households, defined as individual investors who purchase bonds outright and unit investment trusts, is off by roughly 25% for yearend 1993, according to Smith Barney estimates.
For example, while the Fed's Flow of Funds Accounts information shows that municipal bond holdings for the household sector declined by about $28 billion in 1993, Smith Barney analysts estimate that the sector's holdings of tax-exempt bonds increased by $86 billion, a difference of $114 billion.
For 1992, the Fed information shows that the household sector held $508 billion of municipals, compared with a Smith Barney estimate of $559 billion. By yearend 1993, the Fed estimates that $1,258 billion of bonds were outstanding, while Smith Barney puts the figure at $1,412 billion.
"We know from personal experience how important the household sector has been during this time period," said Mosley, a quantitative strategist in Smith Barney's municipal bond department.
He explained that direct retail buying of municipals has helped shore up the market in recent years. This has been especially true in 1994 as bond fund purchases have waned in part due to redemptions caused Fed tightening.
The Smith Barney analysts believe the reason for the disparity lies in the way the Federal Reserve accounts for outstanding refunded bonds, or advance refunded securities. The Fed derives the bulk of its data for this category based on the change in SLUGS, which are Treasury securities that issuers purchase from the federal government. The securities are used to fund escrow accounts that pay for advance refunded securities.
This method was very accurate until recently, the Smith Barney analysts say. But with declining interest rates in 1992 and 1993, issuers began purchasing Treasuries for escrow accounts in the open market rather than from the government.
"The Fed thus undercounts the amount of municipal bonds outstanding by the magnitude of refundings that were done using open market purchases," the Smith Barney analysts said. The analysts say they have discussed their findings with the Fed, but have not received a response.
"I think they need to go to a new set of reporting devices," said Friedlander, a managing director in the portfolio strategy, high net worth department at Smith Barney. He declined to give specifics.
The Federal Reserve's Flow of Funds Accounts is a comprehensive quarterly report comprising estimates of the amounts of assets and liabilities of various sectors of the economy.
"We do know of defeasance with Treasuries, but we don't have good numbers on it," a Federal Reserve official said Tuesday.
"The Fed doesn't collect this data," the official said, noting that information on which the flow of funds is based comes from a variety of sources. These include municipalities, the Census Bureau, banks, insurance companies, and municipal brokers.
"Some people have said we're as much as $400 billion off. Some have said we're too high in some areas," the official said.
The official said the agency agrees with Smith Barney that a rise in the use of open market Treasuries to fund escrow accounts has caused a problem in calculating the amount of outstanding debt.
"We have been reviewing this much more intensely in the last year. But I'm not convinced by the amount we're off," the Federal Reserve official said. Fed figures cannot be revised until a definite means of collecting it is determined, the official added.
"We have to base [the report and revisions] on hard data that we can replicate. We're aware of the problem. We've been talking to industry sources," the official said. "We want to go to a method that's clearly superior. We don't want to revise in one direction one year and then change in another one."
