Regression versus correlation All readers will be aware of the notion and definition of correlation. The correlation between two variables measures the degree of linear association between them. If it is stated that y and x are correlated, it means that y and x are being treated in a completely symmetrical way. Thus, it is not implied that changes in x cause changes in y, or indeed that changes in y cause changes in x. Rather, it is simply stated that there is evidence for a linear relationship between the two variables, and that movements in the two are on average related to an extent given by the correlation coefficient. In regression, the dependent variable (y) and the independent variable(s) (xs) are treated very differently. The y variable is assumed to be random or ‘stochastic’ in some way, i.e. to have a probability distribution. The x variables are, however, assumed to have fixed (‘non-stochastic’) values in repeated samples.1 Regression as a tool is more flexible and more powerful than correlation.
Wall Street Isn't Fixed: TBTF Is Alive And More Dangerous Than Ever Submitted by Tyler Durden on 08/06/2014 18:33 -0400 AIG BAC Bank of America Bank of America Bank Run Bear Stearns CDS Citigroup Discount Window Fail fixed Fractional Reserve Banking Free Money Gambling LBO Lehman Main Street Meltdown Merrill Merrill Lynch Momentum Chasing Moral Hazard Morgan Stanley None TARP Too Big To Fail in Share 2 Submitted by David Stockman via Contra Corner blog, Practically since the day Lehman went down in September 2008 Washington has been conducting a monumental farce. It has beenpretending to up-root the causesof the thundering financial crisis which struck that month and toenact measures insuring that it would never happen again. In fact, however,official policy has done just the opposite. The Fed’s massive money printing campaignhas perpetuated and drastically enlargedthe Wall Street casino, making the pre-crisis gamblers in CDOs, CDSand other derivatives appear like pikers compared to the present momentum chasing madness. In a nutshell, the Fed’s prolonged regime of ZIRP and wealth effects based “puts” under risk assets has destroyed two-way markets. The market’s natural mechanism of risk containment and stabilization—-short sellers—has been driven from the casino. Accordingly, carry-trade speculators engorged with free money funding have taken the market to lunatic heights, while leaving it vulnerable to aviolentcollapse upon an unexpecteddrop because the market’s naturalbraking mechanism—shortsellers taking profits—-has been eviscerated. At the same time,the giant regulatory diversion known as Dodd-Frank has actually permitted theTBTF banks to geteven bigger and more dangerous. Indeed, JPM and BAC were taken to their present unmanageable size by regulators—ostensibly fighting the last outbreak of TBTF—who imposed or acquiesced to the shotgun mergers of late 2008. So now these sameregulators, who have spent four years stumbling around in the Dodd-Frank puzzle palace confecting thousands of pages of indecipherable regulations, slam their wards for not having sufficiently robust “living wills”. C’mon! This is just another Washington double-shuffle. The very idea that $2 trillion global bankingbehemoths like JPMorgan or Bankof America couldbe entrusted to write-upstandby plans fortheir ownorderly and antiseptic bankruptcy is not onlyjust plain stupid; italso drips with political cynicism and cowardice. If they are too big to fail, they are too big to exist. Period. Indeed, it is utterly amazing that adult legislators and regulators could even take the idea of a “living will” seriously—-let alone believe that they could possibly thwart the recurrence of another outbreak of so-called “financial contagion”. Yet so thick is the beltway cynicism and so complete is the K-Street domination of policy-making thata trite bureaucratic gimmick like the “living will” has become a major component of so-called macro-prudential policy. So there is nothing to do except go back to the fundamentals. First and foremost, the September 2008 meltdown was not a main street banking problem; it was a crisis confined to the canyons of Wall Street, owing to the fact that the gambling houses domiciled there had massively bloated their balance sheets with toxic assets and risky derivatives trades, and then funded these balance sheets leveraged at 30:1 with huge amounts of “hot money” in the form of repo and unsecured wholesale loans. As I demonstrated in the Great Deformation, the “bank run” was almostentirely in the Wall Street wholesale market. By contrast, therewas neverany danger ofretail runs at the corner branch bank offices, and the overwhelming majority of the7,000 main street banks did not own the kind oftoxic securitized assets that were roilingWall Street. In fact, the wholesale market runs in the canyons of Wall Street were actually a positive, economically therapeutic event.They had already taken out three of the recklessgambling houses—- Bear Stearns, Lehman and Merrill Lynch—-andwere fixingto finish off the remainder, that is, Goldman and Morgan Stanley. Had the market been allowed to finish off the work of the economic gods in late September 2008, the TBTF problem would have been substantially alleviated. Today there might have existed a half dozen “sons of Goldman” in the form of MA, trading, investment banking and asset management boutiques—run by chastened veterans who lost their lunch during the 2008 Wall Street cleansing. The excuse for Washington’s massive intervention against the free market in the form of TARP and the Fed’s monumental flood of liquidity, of course, is that the US economy was about to be annihilated by something called financial “contagion”. But that is a specious urban legend invented by the crony capitalists who controlled the Treasury and the money-printers who had fueled the housing and credit bubble at the Fed. As I have also shown, for example,AIG’s dozens of insurance subsidiaries were money good and would have been protected in bankruptcy by insurance regulators and capital maintenance rules, while settlement ofthe holding company’s fraudulent CDS insurance would have beenparceled out pennies on the dollar by a Chapter 11 judge to the dozen giant global banks who had stupidly attempted to turn toxic CDOs into AAA credits. Likewise, FDIC could have liquidated Citigroup’s regulated bank, while allowing the gamblers who bought thestock, bonds and other obligations of the holding company to face their just deserts. In short, TBTF became a “problem” to be ostensibly remediedwith bureaucratic malarkey like living wills primarily because Washington made it a problem—- by means ofits panicked bailouts ofWall Street in the fall of 2008. Indeed, the true solution to TBTF is always and everywhere toallow the free market to cleanse its own excesses and imbalances and toimpose financial discipline and demiseupon outbreaks ofreckless gambling and leverage when they occur. Unfortunately, even if Washington were to refrain from ad hoc bailouts, the free market cure would be perennially compromised by the giant moral hazard posed by deposit insurance and the Fed’s cheap money discount window. Owing to these policyinstitutions, which systematically encourage excessive gambling by their beneficiaries, US banksare inherent wards of the state—including the easily abused privilege of fractional reserve banking conferred byregulatory charters. The right thing to do would be to abolish these sources of moral hazard and tell the K-Street financial lobbies to fold up theirplush tents because their employers are now all expected to sink or swim on the free market. Needless to say, the chances that Washington would permit the Wall Street gambling houses to bereturned to the unfettered free market that they profess to defend—are somewhere between slim and none. Accordingly, a second best solution is warranted, and it could readily be done.And it would be far more effective than the lunacy of living wills and all the other bureaucraticmumbo-jumbo that has come out of Dodd-Frank. First, Washington shouldre-enacta strict version of Glass- Steagall. Only “narrow banks” which take deposits and make consumer and business loans would have access to the Fed’s discount window. By contrast, propriety trading, underwriting, merchant banking, asset management and all the rest of the financial services sectors would be banned at regulated banks and sent back to the free market where they belong. Secondly, a ceiling on regulated bank size would be established —perhaps measured at 1% of GDP or $200 billion in terms of asset scale.There are no demonstrated economies of scale in deposit and loan banking above that size, anyway. Stated differently, banks wishing to indulge in the moral hazard of deposit insurance and accessing the Fed’s discount window would not have to prove they were not “too big to fail” or that they had a viable “living will”. Instead, a TBTF law would do it for them in the form of a statutory cap on the size of regulated banks. To be sure, Wall Street would scream that such a regime would interfere with the ability of small business and American consumers to get cheap loans.But in a national economy that has gone through a rolling 30-year LBO resulting in $60 trillion of credit market debt outstanding and which sportsleverage ratios against income in all sectors that are off the historical charts—that complaint has no merit. Making debt more expensive and permitting it to beeconomically priced on the free market is, in fact, just what is needed to eventually cure the nation’s debt-ridden economic malaise.
What's Up With Inflation? Submitted by Tyler Durden on 07/25/2013 12:02 -0400 Bureau of Labor Statistics CPI ETC Gross Domestic Product Mars Medicare None Personal Consumption Purchasing Power Reality Submitted by Charles Hugh-Smith of OfTwoMinds blog , Purchasing power and exposure to real costs are more realistic measures of inflation than the consumer price index. That the official rate of inflation doesn't reflect reality is easily intuited by anyone paying college tuition and healthcare out of pocket. The debate over the accuracy of the official consumer price index (CPI) and personal consumption expenditures (PCE--the so-called core rate of inflation) has raged for years, with no resolution in sight. The CPI calculates inflation based on the prices of a basket of goods and services that are adjusted by hedonics, i.e. improvements that are not reflected in the price of the goods. Housing costs are largely calculated on equivalent rent, i.e. what homeowners reckon they would pay if they were renting their house. The CPI attempts to measure the relative weight of each component: Many argue that these weightings skew the CPI lower, as do hedonic adjustments. The motivation for this skew is transparent: since the government increases Social Security benefits and Federal employees' pay annually to keep up with inflation (the cost of living allowance or COLA), a low rate of inflation keeps these increases modest. Over time, an artificially low CPI/COLA lowers government expenditures (and deficits, provided tax revenues rise at rates above official inflation). Those claiming the weighting is accurate face a blizzard of legitimate questions. For example, if healthcare is 18% of the U.S. GDP, i.e. 18 cents of every dollar goes to healthcare, then how can a mere 7% wedge of the CPI devoted to healthcare be remotely accurate? Those claiming that the CPI is more or less accurate point to the inflation rate posted by The Billion Prices Project @MIT as real-world evidence. The Billion Prices Project collects real-world prices from online retailers for thousands of goods. The Project's rate of annual inflation closely tracks the official CPI, though recently it has diverged, climbing above 2.5% annually while the CPI is below 1.5%. The fatal flaw in The Billion Prices Project is that it does not track the real-world cost of big-ticket services such as healthcare or tuition that dominate household budgets for those who have to pay for these services. Those claiming the CPI grossly underestimates inflation often compare the current CPI with the CPI methodology of the 1980s. Using the old methodology, inflation is more like 9% rather than 1.5%. Critics of this comparison claim the old methodologies were flawed and the new method is statistically superior. Another way to track inflation is via households' actual spending as reflected in their budgets. Intuit collects anonymous spending data from 2 million users of Mint.com and posts the results: Presenting Inflation... the rise in expenses 2011 - 2013 (Zero Hedge). This data suggests the cost of daycare, healthcare insurance, kids' activities and tuition have skyrocketed in the past few years, making a mockery of the official annual inflation rate of 1.5% to 2%. Chartist Doug Short recently published this graph plotting college tuition, medical care and the cost of a new car. According to the Bureau of Labor Statistics Inflation Calculator , $1 in 1980 = $2.83 in 2013. For example, the average cost of a new car in 1980 was $7,200, so the inflation-adjusted price in 2013 would be $20,376. The actual average price today is around $31,000, so after adjusting for inflation the current average price of a new car is higher than in 1980. This chart reflects the real increases in cost: In my analysis, the debate over inflation misses two key points. What really matters is not the rate of inflation, which can be endlessly debated, but the purchasing power of earned income, i.e. wages. Instead of fruitlessly arguing over hedonic adjustments and the weighting of components, we should ask: how many hours of labor (at the average hourly rate for full-time workers) does it take to buy a loaf of bread, a new car, a gallon of gasoline, a new TV, a new house, college tuition and fees, etc., and compare that to how many hours of labor it took to buy all those goods and services in the past. This methodology eliminates hedonics (i.e. the computer you buy today is much faster than the one you bought 10 years ago), as this adjustment plays no part in the actual costs of manufacture or the consumer's decision: we don't have a choice to buy a computer with 1990-era specs, so the hedonic adjustment is merely a tool for gaming the CPI. We should also recognize that the experience of inflation differs in each economic class. Government employees who pay a small percentage of their real healthcare insurance costs (or none at all) will experience little of the actual inflation in healthcare costs; it's the government agencies that are exposed to the real costs of healthcare insurance, which is why municipalities and agencies exposed to the skyrocketing costs of healthcare insurance are under financial pressure. A retiree is naturally focused on the out-of-pocket share of medication costs; the soaring cost of college tuition is so remote it might as well be occurring on Mars. Consider this real-world example. Let's say a household earning $60,000 a year (median household income is around $50,000) is suddenly exposed to the real cost of rising healthcare insurance. Maybe the primary wage earner lost the job that provided health coverage and now has to pay the full costs out of pocket as a contract worker. In any event, their healthcare insurance now costs $500 more per month than it did last year. (By happenstance, this is how much my own healthcare insurance costs have risen since 2008.) This $500/month means the household is paying $6,000 or 10% of its gross income more for the same coverage it received last year. The household's annual rate of inflation just from healthcare costs is 12%, since net income is closer to $50,000 and the $6,000 in extra spending isn't buying any new good or service. Let's say the household is paying $500 more per month for healthcare insurance than it was five years ago. That works out to an annual rate of 2.4% just from healthcare insurance inflation alone. Any other increases in costs would push that rate higher. In other words, those households with zero exposure to college tuition and the full costs of daycare, medical care and healthcare insurance may well experience low inflation, while the household paying the full costs of daycare, college tuition and healthcare insurance will experience soaring inflation. If we analyze inflation by purchasing power (which declines as real income stagnates and prices rise) and by exposure to real costs, we find the incomes of the upper 5% have typically outpaced CPI inflation, so the purchasing power of the high-income family has not suffered (unless of course they have no healthcare insurance and they have to pay the full real costs of a medical crisis. In that case they might be bankrupt.) Households that receive multiple government subsidies and direct payments have little exposure to healthcare, since they are covered by Medicaid, and modest exposure to housing if they receive Section 8 benefits. Retirees on Medicare also have limited exposure to the real-world costs of their care paid by the government. If we analyze inflation by these two metrics, we find the middle class is increasingly exposed to skyrocketing real-world prices. Pundits in the top 5% have the luxury of pontificating on the accuracy of the CPI while those protected by government subsidies and coverage have the luxury of wondering what all the fuss is about. Only those 100% exposed to the real costs experience the full fury of actual inflation. 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Jim Trippon on June 11, 2012: China’s central bank, The People’s Bank of China, cut the one-year borrowing interest rate 25 basis points, from 6.56 percent to 6.31 percent, on Thursday, June 7th. Along with this cut, the central bank cut the one year deposit rate also by 25 basis points, to 3.25 percent. China’s policy makers had been easing with other measures, but had thus far resisted moving the benchmark interest rate. This was the first rate cut since 2008, during the global financial crisis. The rate cut was initially viewed with optimism by investors, but second thoughts about the move foreshadowing worsening data overcame this initial hope. The rate cut was considered a surprise mostly because China’s policy makers hadn’t talked about such a move, but more so because the talk from Chinese leadership had been about fiscal measures with hints of other more pressing monetary concerns, chiefly money supply, along with other indications of concern over credit availability. Still, the benchmark interest rate cut was always there in the policy makers’ bag of remedies, and Beijing made it clear they were not going to sit idly by if the economic data continued to worsen. A Global Indicator? Many observers took the China’s interest rate cut as a sign that more– and major– stimulus moves would be on the way from the world’s leading economies. The pall which Europe has cast over global growth remains a factor not only in slowing the world’s economies, but the growing pessimism about whether the EU will be able to successfully restrict the damage from its failing member economies, and the possible drastic measures it may need to enact to save them, is having its effect on global investor sentiment as well. China isn’t immune to this, either. The Asian markets were in the worry mode about China, the bellwether economy in their region, while global observers awaited May economic data for China. Where Is Inflation? April inflation was 3.4 percent, and May data was expected to show 3.2 percent inflation in China. Although those outside China often misread the actions and intentions of Beijing’s policy makers, the expectations that observers had that China was still concerned with inflation, which it has largely successfully battled, were based on signals from China’s leadership itself. The specter of a sudden re-ignition of too-rapid growth has been on the minds of policy makers, thus they didn’t broadcast anything about a coming benchmark rate cut. Given the experience of inflation that occurred coming out of the global recession of 2008 and 2009, this fear seemed reasonable by Beijing. So while observers were duly surprised by the rate cut, it’s assured that the cut isn’t something the policy makers entered into lightly. A lower consumer price index in the coming months was no doubt anticipated by Chinese leadership, which would presage further slowing. China, despite what its critics maintain, has tried to get in front of recent economic developments yet without overreacting. In addition to the rate cut, the central bank has instituted a relaxing of the banking rules to allow the banks greater autonomy and flexibility in determining lending and deposit rates. This will allow the banks to be more competitive, a long-term structural change sought by Beijing. Growth Expectations Data soon to be released is expected to show the sixth consecutive quarter of contracting growth for China’s GDP. A Reuters poll of analysts came up with a forecast of 7.9 percent for the second quarter. Although this is a relatively weak number for China, given its 10 percent and 9 percent annual GDP growth rates for the last couple of years, it still stands in stark contrast to the developed world’s meager growth of 1 percent or 2 percent in the US, and the negative growth or recession underway in Europe. The moves China is making on the interest rate front may shore up growth, especially as we move through the year, to keep the annual GDP growth rate from actually falling much below 8 percent On The Horizon Beijing is at least both vigilant and active concerning policy measures. It should be pointed out that China doesn’t have the impediment of having to clear its decisions within a contentious framework of several competing members, as the EU does. That said, critics have underestimated just how proactive on economic policy China can, and has demonstrated, it will be. Related: Vanguard Emerging Markets ETF (NYSEARCA:VWO), ProShares Ultra Short FTSE/Xinhua China 25 ETF (NYSEARCA:FXP), iShares FTSE/Xinhua China 25 Index (NYSEARCA:FXI), iShares MSCI Emerging Markets Index (NYSEARCA:EEM), Vanguard Total Stock Market ETF (NYSEARCA:VTI).
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