The Fourteenth Banker Blog

December 27, 2010

On Corruption

Filed under: Running Commentary — thefourteenthbanker @ 11:57 AM

Perhaps it is time to explain the tone of my Holiday Greeting, in which I expressed optimism.

Happy Holidays to all. It has been an eventful year. This is the season of hope and, despite all the matters that we have criticized over this past year, I am full of hope. There are well-meaning people all around us. Those that are not well-meaning, are generally uninformed, misinformed, or unskillful in their thinking. All of these things can change. We are in an evolutionary process. At times it will seem like we are stepping back. Yet we are moving forward.

While I have been enjoying the presence of friends and family and relaxing in the spirit and ambiance of the season, the media and blogosphere have continued to do heavy lifting.  We will get to that in a minute.  But first, my reason for optimism. Given the religious nature of Christmas itself, it is entirely appropriate to look to our spiritual traditions to consider the circumstances of our present day. The trend that encourages me has been a theme of all major spiritual traditions, which emphasize the ideas of “light” and “truth” as essentially redemptive. They are redemptive in our present day lives in two ways. The first is that the realization of truth is essentially healing inwardly (spiritual world). The second is that the truth moves us to action and provides impetus to heal ourselves and others outwardly (material world). And these two are synergistic. Inward strength enables outward action.

(As an aside, I would invite readers to share along these lines from their spiritual traditions or personal reflections)

So while I have rested, others have reported. The steady exposure of corruptions in our system, the light that shines unwavering on the regimes of corruption, will have its effect. There is developing a common understanding that the system we have today is broken and that we must find the means to make it constructive.  Here are some of the worthy stories of the last 10 days.

First off, on the theme of corruption, it would be silly to assume that they corruption we see in the financial system is anything other than a reflection of the corruption of power more generally. Here are two examples. In this first, it is reported that the revolving door between government and industry is as active in the realm of the military as in the financial realm. The Boston Globe highlights that the normal path for retiring senior military officers, whose pensions are already generous, is to go to work in influential and non-transparent ways for defense contractors.

The Globe analyzed the career paths of 750 of the highest ranking generals and admirals who retired during the last two decades and found that, for most, moving into what many in Washington call the “rent-a-general’’ business is all but irresistible.

From 2004 through 2008, 80 percent of retiring three- and four-star officers went to work as consultants or defense executives, according to the Globe analysis.

The article goes on to illustrate how these retiring officers have inside tracks into the Pentagon and wield influence without disclosure of their financial conflicts of interests. This does remind me of one aspect of the banking business, which is that “don’t ask, don’t tell” is much more than a policy regarding gays in the military. It is the practice of people who know that there are ethical issues or conflicts of interest and consciously choose to do nothing about them because of mutual benefit.

A second example of corruption generally is in relation to academia and industry.  This is a video interview so I can’t quote it here, but the gist is that economists that opine on regulatory matters, have undisclosed financial conflicts of interest with the companies that would be affected by regulation.

Another outstanding piece from recent days is this written interview with Bill Black, from Parker and Spitzer. It is succinct and readable. The emergence of Black as a very articulate and visible critic of the culture of fraud is significant. One feature of our system of media is that for messages to get out, they have to be repeated over and over. Many academics do their research, publish a paper, perhaps write a book, and then their voice fades. Black is showing an endurance which provides hope that he can move the needle of perception. What is different about Black’s approach is that he is very clear and specific in his charges. He does not generalize. He is very specific about how certain frauds work. This will make general denials less effective.

There was also a meaningful judicial ruling against Wells Fargo. Hat tip Naked Capitalism.

What makes this ruling interesting is that although it set aside a minor part of the jury award, a $1.6 million issue, to be subject to a new trial, is that it was punitive as a result of the judge’s determination that the fraud was systematic. It is unusual to award the payment of the plaintiff’s attorney’s fees, or to order disgorgement of fees paid for services (the other component of the additional $15 million plus is interest on the $29.9 million). The basis for awarding attorneys’ fees? The bank is such a menace to society that having counsel root it out is a public service. From the Minneapolis Star Tribune (hat tip reader Ted L):

The judge said that the nonprofits’ lawyers, led by Minneapolis litigator Mike Ciresi, provided a “public benefit” by bringing the bank’s wrongdoing to light. Thus, Monahan said, the bank must pay the plaintiffs’ attorneys fees and costs, which Ciresi’s firm estimated at more than $15 million…

Terry Fruth, a Minneapolis attorney who has been watching the case closely on behalf of his clients, said Monahan’s post-trial order could help other investors prove similar claims against the bank.

“The judge didn’t just find that Wells Fargo acted with disregard to the rights and interests of the particular plaintiffs,” Fruth said of Monahan. “He said the way it ran the program was with disregard to the rights of the customers. … He has made a finding that is going to bind Wells Fargo in other cases.”

The judge also seems to understand full well how banking works in America:

…Wells Fargo Chairman and CEO John Stumpf and retired Chairman Richard Kovacevich… said they knew nothing about problems in the securities-lending program in 2007. Stumpf said he didn’t know the bank even had such a program.

Monahan said that he found the executives’ statements “to be almost childlike” and that he accepts “that one of the primary functions of subordinates in today’s corporate America is to shield their ultimate superiors from accumulating embarrassing information….

“Wells Fargo was fully aware of the increased risk it was injecting into the securities lending program, that its line managers were not reasonably managing that risk, and that its actions and inactions had the potential for inflicting enormous harm on plaintiffs.”

When the program got into trouble, the judge said, “Wells Fargo’s attitude and conduct … was primarily to shield itself, and its favored customers, from the consequences.”

The judge made very astute observations about how business works these days. Executives create the environment in which unethical business practices can flourish, but want to keep a level of plausible deniability. That is a pretense.

Finally for today, this article about how the FinReg was effectively diluted. The source is a Barron’s article but Yves Smith provides the commentary. Here’s a quote to whet your appetite.

But since there has been a singular lack of appetite to do adequate forensics into what caused the crisis, since it might prove to be embarrassing to people still in powerful positions, regulators can follow the inertial course of listening to the palaver that the financial services industry puts forward to allow it to continue looting.

So back to my original premise, all this bad news is reason for hope, in that it shines light in dark, hidden places. This light will shape the common understanding, and the common understanding will shape future choices. However, it will be up to us to make those choices. If there is any unifying theme to these articles, it is that those in positions of power are not the ones that will support change in the system. Rather change in the system can only come through action on the part of the vast majority of citizens who do not have a stake in the status quo.

 

 

 

December 24, 2010

Happy Holidays!

Filed under: Running Commentary — thefourteenthbanker @ 8:51 PM

Happy Holiday’s to all. It has been an eventful year. This is the season of hope and, despite all the matters that we have criticized over this past year, I am full of hope. There are well-meaning people all around us. Those that are not well-meaning, are generally uninformed, misinformed, or unskillful in their thinking. All of these things can change. We are in an evolutionary process. At times it will seem like we are stepping back. Yet we are moving forward.

December 18, 2010

Wikileaks Puts the Lie to Myth of Liquidity

Filed under: Running Commentary — thefourteenthbanker @ 6:59 PM

As I have blogged about the last couple times, the never-ending bailout serves the purpose of transferring wealth into the banking system in order to prop it up, prop up the markets, and prop up the economic power structure. I think that has been fairly obvious. Today we have a “smoking gun”, released with the Wikileaks cables. Hat Tip to Credit Writedowns.

From the WikiLeaks cables as published in the Guardian today regarding a meeting with the US Ambassador to the United Kingdom and the Bank of England Governor Mervyn King on 17 Mar 2008:

Systemic Insolvency Is Now The Problem

————————————–

2. (C/NF) King said that liquidity is necessary but not sufficient in the current market crisis because the global banking system is undercapitalized due to being over leveraged. He said it is hard to look at the big four UK banks (Royal Bank of Scotland, Barclays, HSBC, and Lloyds TSB) and not think they need more capital. A coordinated effort among central banks and finance ministers may be needed to develop a plan to recapitalize the banking system.

Unblocking Illiquid Mortgage-Backed Securities

——————————————— –

3. (C/NF) King said it is also imperative to find a way for banks to sell off unwanted illiquid securities, including mortgage backed securities, without resorting to sales at distressed valuations. He said sales at distressed values only serve to lower the floor to which banks must mark down their assets (mark to market), thereby forcing unwarranted additional write downs.

What does this prove? That it was widely known in government circles by the time Bear Stearns went bust that the global banking system was effectively insolvent – and that banks’ unloading garbage assets at inflated prices was seen as critical in preventing the whole global economy from collapsing. It’s good to see this confirmed in writing.

Read the rest of the Credit Writedowns post. I don’t need to steal their thunder. Suffice to say that the Emperor of the Treasury has no clothes.

 

December 17, 2010

Sell Your Soul To The Devil This Christmas

Filed under: Running Commentary — thefourteenthbanker @ 9:47 AM

Krugman and Ritholtz are singing from the same songbook today.  Ritholz points out that the subprime debacle was a creation of Wall Street, not caused by Federal Government housing policies, per se.

Federal Reserve Board data show that:

-More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.
-Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.
-Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.

Krugman points out the disinformation campaign that is going on in his post on the Wall Street Whitewash.

It’s a straightforward story, but a story that the Republican members of the commission don’t want told. Literally.

Last week, reports Shahien Nasiripour of The Huffington Post, all four Republicans on the commission voted to exclude the following terms from the report: “deregulation,” “shadow banking,” “interconnection,” and, yes, “Wall Street.”

When Democratic members refused to go along with this insistence that the story of Hamlet be told without the prince, the Republicans went ahead and issued their own report, which did, indeed, avoid using any of the banned terms.

And to add a timely note on the incoming legislative power shift, this one says it all.

Last week, Spencer Bachus, the incoming G.O.P. chairman of the House Financial Services Committee, told The Birmingham News that “in Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks.”

Maybe it is time to buy bank stocks for the short ride, if you don’t mind selling your soul.

 

 

 

December 15, 2010

That Didn’t Take Long

Filed under: Running Commentary — thefourteenthbanker @ 5:59 PM

Two days ago I posted on some comments I heard on C-Span about the Fed taking on interest rate Tail Risk. The particulars were that if rates jumped 25-50 bps, the market value of the Fed’s holdings would drop by a sufficient amount to wipe out their capital.  Yesterday rates jumped, and Zero Hedge posted this.

Today we get a brief glimpse of what will happen to the Fed’s balance sheet when rates surge. In the span of one day, the Fed took an $8 billion unrealized loss on its $1.07 trillion in Bonds, TIPS and Agencies. It also likely experienced a comparable loss on its MBS portfolio. It’s a good thing the Fed has $57 billion in capital accounts. Which means 4 days like today, and all of the Fed’s equity buffer is wiped out. What happens next is up to congress.

Today rates jumped again on the long end of the curve with the 30 year Treasury jumping 8 bps and 10 years jumping 5 bps.

The Fed does not mark-to-market, so it is not insolvent.  But, it bought these assets at market value at times when it was working to suppress interest rates and therefore prop up bond prices.  With rates moving, the assumption of this risk is panning out as planned. It is an unaccounted for gift to those from whom the bonds were purchased.

 

December 13, 2010

Why Would The AEI Say Today the Federal Reserve Close To Insolvent?

Filed under: Running Commentary — thefourteenthbanker @ 3:10 PM

I was listening today to several American Enterprise Institute fellows on C-Span.  They were discussing the recent revelations about the Federal Reserve programs and under what conditions the Federal Reserve might be considered insolvent.  Isn’t it remarkable that such a conversation would even take place?  The discussion was theoretical in that it is an accounting question. The Federal Reserve does not have publicly traded stock to serve as a barometer of its health. It does not have debt rated by anybody to help people understand the strength of it’s balance sheet (BS).

We do however know something about its assets and its financial statements are public. The speakers basically had two points to make in the segments I listened to.

First, the Fed does not mark its holdings to market.  We do not really know what they are worth today or at a future point in time.  Perhaps these holdings are not so far underwater on a market value basis to make the Fed insolvent if marked to market today. In any case, the incestuous relationship with the rest of USG means that the cross guarantees of Fannie, Freddie, and others protects the Fed’s assets to some extent. Of course, those guarantees are dependent on the borrowing ability of the US Treasury, which these days requires the monetization of debt by the Fed, the largest holder of Treasury debt in the world. So that all sounds pretty good.

The second point is that in taking on this TRILLION plus in MBS, the Fed has taken on a huge tail risk in that should interest rates rise, the bonds cannot be sold for as much as they can in today’s, or three weeks ago’s bond market. The AEI estimates that a 50 bps rise in interest rates across the yield curve would make the Fed insolvent on a mark to market basis.  That may be as little as a 25 bps rise today. But so what? The Fed does not have to mark to market.

I guess my point is this. The Fed intentionally took on assets that create mark to market accounting solvency risk in a sufficient amount that a little tick up in interest rates makes those bonds worth sufficiently less to negate all the capital at the Fed. It took on a massive Fat Tail risk in these asset purchases? Why? To transfer wealth to the sellers of this paper, be they US banks, foreign banks, foreign governments. It was a transfer of wealth for the purpose of saving the financial system upon which the wealthy depend.

“Heckuva job, Bennie!”

December 9, 2010

Free Market Upside Down

Filed under: Running Commentary — thefourteenthbanker @ 6:25 AM

This article by Michael Hudson (h/t Zero Hedge) does a nice job of discussing the hijacking of the notions of Free Enterprise or Free Markets. The context is a discussion of the Deficit Reduction Commission and the implication that there are commonly held beliefs about what is the nature of the free market. The general discussion is worth reading, but the highlight for me, which also relates to the just negotiated tax break extensions, is this discussion on financing in times of war.

Smith: Wars should be financed on a pay-as-you-go basis, not by borrowing
If the shade of Adam Smith were to reappear today, he would be equally disturbed by the failure of the Bowles-Simpson commission to address the issue of war debts dealt. Smith’s argument against waging foreign wars was basically an argument that they were not worth the debt burden and the associated taxes to pay interest on it. These payments transferred income from taxpayers to creditors – largely foreign creditors, the Dutch in Smith’s day, Asians today.

Neither Bowles-Simpson nor President Obama acknowledge the extent to which the federal debt – and indeed, most of America’s rise in foreign debt for decades on end – has stemmed from overseas military spending. During the Vietnam War years of the 1960s and ‘70s, the military deficit accounted for the entire rise in U.S. foreign debt, as private sector trade and investment was exactly in balance.

Smith wrote that even a land tax could not finance governments or “compensate the further accumulation of the public debt in the next war.” His argument was that to free the economy from taxes, nations should avoid wars. And the best way to do this was to wage them on a pay-as-you-go basis. Borrowing rather than taxing led the population not to feel the real cost of war – and thus deterred it from making an economically informed choice.

So the Bush-Obama administration has taken a fiscal stance diametrically opposed to that of the patron saint of free enterprise. While escalating war in Afghanistan and maintaining over 850 military bases around the world, the administration has run up the national debt that Smith decried. By shifting the tax burden off property and off rent-seeking monopolies – above all, off the financial sector – this policy has raised America’s cost of living and doing business, thereby undercutting its competitive power and running up larger and larger foreign debt.

Robert Reich also has relevant commentary that provides some statistical information that is relevant to Hudson’s article.

Here’s the real story. For three decades, an increasing share of the benefits of economic growth have gone to the top 1 percent. Thirty years ago, the top got 9 percent of total income. Now they take in almost a quarter. Meanwhile, the earnings of the typical worker have barely budged.

The policy positions taken by the USG in continuation of the policies of the last couple decades and most recently in a bow to the Republican wave, do not represent free market principles. Free market principles would not allow a combination of government policies and market abuses to concentrate wealth so much at the top of the spectrum that the vibrancy of the economy and the engines of small business growth are in permanent peril. A free market would permit creative destruction, promote competition, break up oligarchy and give the average citizen a fighting chance.

 

 

December 6, 2010

Bank Capital Discussion

Filed under: Running Commentary — thefourteenthbanker @ 12:49 PM

Simon Johnson has an excellent post on Baseline Scenario regarding the debate about bank capital. This debate is often in the background because there is a prevailing assumption that  super high leverage is and should be the norm for financial services. Why?

The debate in the last week became higher profile as a result of a piece on Jamie Dimon in the New York Times Magazine. Check out that cover. In the piece, Dimon is framed as a competent and reasonable man. He sounds reasonable. What he says is reasonable from within the paradigm he lives.

An example:

Dimon does not dispute that mortgage lenders and investment banks deserve a lot of the blame. But regulatory lapses and excess leverage throughout the system, he says, contributed as well. What gets him riled is his sense that Washington is captive to a binary, us-against-them environment in which bankers are cast as villains. Perhaps naïvely, he was disappointed that political concerns played a large role in shaping the legislation. (An example is that Dodd-Frank limited bank investment in hedge funds, even though the latter were peripheral to the crisis.) In contrast, Dimon admires the approach of the members of the Basel Committee, the international regulators who are imposing heightened capital requirements, because they are asking the questions that, in theory, bankers ask of themselves: how much capital do banks need to withstand the inevitable downturn, and what is an acceptable level of risk?

Basel is a very minor tweak in capital requirements. Simon Johnson’s take?

There is one problem, however. Basel may have asked the right question, but it did not come up with the right answers, mainly because it allows banks to remain dangerously leveraged, setting equity requirements way too low.

My beef is with the way the argument is conducted. This has become typical in our media bite culture. Make a quick assertion, repeat it endlessly, and people buy it. Here is the argument bankers are making about capital, in Simon’s words:

Bankers tell us that they must be allowed to maintain high leverage because this is part of the business of banking. They assert that economies will suffer if they are made to fund more of their investments with equity, there will be credit crunches, terrible things will happen. We clearly must examine these statements carefully before agreeing.

To summarize Simon’s point, he is saying that high leverage is a result of a combination of government policy that promotes leverage in a variety of ways, such as regulation, the tax code, implicit guarantees for TBTF institutions, and private interests that benefit from leverage because of the large profits and compensation it can bring to bankers and shareholders. I agree with Simon on this. The leverage that exists in the system is natural because of the assumptions that all of us are operating under. If you throw out the assumption that high leverage is the norm, is necessary for the economy, and that reducing leverage will cause a crisis, than you are no longer bound by the logical end point of those assumptions, which is to not rock the boat. You can ask, “why”? And you can realize that there are alternatives.

The existing banking system will persuasively argue its book every time. That does not mean anyone else has to buy it. If there is to be a banking model that is less leveraged and produces less fragility for the system, society has to choose it.

December 2, 2010

Fed Document Dump First Step To End American Deceptionalism

Filed under: Running Commentary — thefourteenthbanker @ 10:26 AM

According to the Wall Street Journal’s very abbreviated reporting on the document dump, the Federal Reserve’s loans at the depths of the crisis included the following:

  • Goldman Sachs borrowed from the Fed 84 times, to a maximum single amount of $18 Billion.  This would be in addition to the TARP bailout funds of $10 Billion and a pass through of bailout money from AIG of perhaps $12.9 Billion.
  • Morgan Stanley borrowed from the Fed 212 times up to $60 Billion. Morgan’s TARP bailout was $10 Billion
  • JP Morgan borrowed $17.7 Billion in addition to its TARP bailout of $25 Billion, and AIG pass through of some amount (they are lumped into “other”)
  • Bank of America borrowed 118 times ranging up to $11 Billion in addition to its TARP bailout of $15 Billion and Merrill’s $10 Billion, and their combined AIG pass through of $12 Billion.

There is better reporting on Huffington Post with what appears will be a live stream of updates.

  • Huffington highlights the extreme favorable terms these loans were made on.  The annual interest rate for emergency borrowing was 1/10 of 1%.
  • 18 Primary Dealers on Wall Street pledged $1.3 Trillion in non investment grade paper to secure Fed borrowings.  Rates on these loans were 1/2 of 1% per annum.
  • Nine large money market managers tapped the Fed for a total of $2.4 Trillion

Here is a graphic of the AIG pass throughs.

So these are a few highlights. What is obvious is that yes, the entire system would have collapsed without a bailout or a resolution authority and there was no time to set up a resolution authority. These firms had to borrow money from the Fed despite the fact that all other firms were borrowing from the Fed and were therefore able to make good on their interbank borrowings, counter party positions, and collateral postings. Even JPM and Goldman chose to borrow even while their clients were being propped up by the Fed. So they were all over leveraged and they were all short cash.

So call it what it is.  Wall Street on the dole. This money was cheap, almost free. For comparison’s sake, Warren Buffet invested $5 Billion in Goldman Sachs. This was equity, not debt, and was not secured. So it is not exactly comparable. But Warren negotiated a return of 10% per annum and the right to buy $5 Billion of stock at $115 per share. The profit on the stock was not locked in and I’m not sure what he did with it, but the price of Goldman stock today is $158. So if he flipped it today he would flip 43 million shares at a profit of $43 per share.  That is another $1.86 Billion in compensation. So it looks to me like that Goldman money would have cost about 25% per annum.  This is very rough math but you get the point. Less than 1% per annum paid to the Fed is a direct subsidy.

So what does that mean for today? It means these banks, their shareholders, and their bondholders owe the American people for their existence. They should act like it.

 

 

 

December 1, 2010

Fed Release Coming – Fed Hunter Matt Stoller Is On The Job

Filed under: Running Commentary — thefourteenthbanker @ 9:40 AM

At noon today the New York Federal Reserve Bank will release its bail out data. It is good to know that Fed Watchdog Matt Stoller is on the job.  He has this quality piece today on Naked Capitalism and will be examining the report and bringing us analysis. Here is a teaser:

This is a tremendous step forward. Of the many castle walls the Fed used to keep the rabble out, secrecy and complexity were critical. The Fed couldn’t keep its dealings secret, and financial bloggers are constantly explaining, explaining, and explaining. Those walls have fallen. A lack of public debate was another. That too has fallen. A monopoly of public information dissemination, via personal contacts between bankers and outlets like the Washington Post (whose owner in the 1930s was Hoover’s Federal Reserve Chairman), has broken down as well through internet communities.

Gradually, a new generation of politicians is gaining the confidence that the people themselves through their elected representatives should be making critical decisions about economic efficiency and banking. The Fed is adapting to these changes, building up its communication staff and doing town hall style meetings. Bernanke is on TV all the time, a far cry from the days when the Federal Reserve head simply refused to even brief Congress. In some ways, the hardest part of the fight is generating public debate, but that has been accomplished. The structure of our monetary system is now up for grabs.

As we move forward in this debate, it is important to understand that Sarah Palin is coming from a genuinely rooted tradition in American economic debates, from the era of the late 19th century, when Wall Street came together to finance railroad mega-corporations. Her argument is one against the mutability of money; she rejects the idea that money is a political object, because that implies that it is collective decision-making that determines property values and ultimately the social hierarchy. She believes in a natural and fixed social hierarchy, which is a very conservative idea deeply held by the business class.

Palin is using the lack of legitimacy of the modern Fed, the failed technocratic screw-ups and the elitist tendencies, to push for the equivalent of societal debtor’s prison. She is speaking for creditors, and many of the conservative forces within the Federal Reserve agree with her. It is important to understand that reflexively defending the Federal Reserve, which is what the Democratic establishment is doing, is a foolish and anti-populist attempt to pretend that the Fed is a legitimate decision-making body. It isn’t. It is powerful, but not legitimate.

Stoller is on the right track here. The issue is power and its incestuous nature. Perhaps this information will begin to separate the populists from the populists. There is a brand on populism in ascendency that is naive. It believes that the notion of small, efficient, and non-intrusive government is necessarily democratic, and Constitutional. It can be, if it fulfills its functions relating to freedom, equality, and justice. This is where the Sarah Palin Tea Party will be tested. For if it simply suggests that government disengage and allow the economic masters free rein in a rigged marketplace, then it is not really populist at all. It will really stand for economic “exceptionalism” within our population, where some that rise to the top get to stay there by any means including by the use of some exempt and secretive arms of government.

On the other hand, as Stoller points out, there is the Ron Paul wing of the Tea Party, which does stand for equal economic opportunity.

The Fed is actually one point of contention between the right-wing billionaire Koch family and the Ron Paul libertarians; the Koch’s are supportive of Federal Reserve-tied scholars, and Paul’s people are not (the Palin tea party had no involvement in the Audit the Fed fight, the Ron Paul tea party was the driving force on the right for that legislation).

So perhaps between this release on the upcoming Wikileaks release on a major bank, if it happens, more light will be shed on the sharing of power and money by the economic elites, who prefer to bail out the richest 10% at the expense of the other 90%.  See Ireland for details.

 

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