Volcker’s rule on rules

Oct 29, 2010 17:29 UTC

Former Fed chairman Paul Volcker has some advice for financial regulators writing rules to define new limits on banks’ ability to trade for their own accounts: be as vague as possible. At least that’s the message in this WSJ piece by Deborah Solomon (for which, to be upfront, Volcker declined to comment).

At first pass, that sounds a little nuts. If Dodd-Frank means to clamp down on proprietary trading at institutions that receive federal guarantees (like deposit insurance), then why wouldn’t regulations spell out, as specifically as possible, what those banks aren’t allowed to do? Solomon explains:

Mr. Volcker’s concern, according to several people familiar with the matter, is that narrow or prescriptive rules would invite gamesmanship on the part of banks and could allow firms to evade the rule’s intent. Already, some banks and their lobbyists are seeking to sway regulators and encourage them to narrowly define certain types of trading activities, according to government officials.

By being less specific, the logic goes, regulators will better be able to adapt to changing circumstances—and to banks’ tactics. Solomon compares this approach to the one the government already employs in the realm of money laundering. Another good example is insider trading law. It’s never been particularly clear what is, and what isn’t, insider trading. This can lead to bumpy prosecutions, but it does serve the important purpose of preserving flexibility. Leaving a fair amount of case-by-case judgment in the system lets regulators tap what Michael Polanyi called “tacit knowledge,” or the thing Supreme Court Justice Potter Stewart was getting at when he wrote of pornography: “”I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it.”

In this Bloomberg column, Michael Lewis gives us reason to think this might be a good way to go. He writes:

The banks have no intention of ceasing their prop trading. They are merely disguising the activity, by giving it some other name. A former employee of JPMorgan, for instance, wrote to say that the unit he recently worked for, called the Chief Investment Office, advertised itself largely as a hedging operation but was in fact making massive bets with JPMorgan’s capital. And it would of course continue to do so. JPMorgan didn’t respond to a request for comment.

One conclusion: to have the best chance of ferreting out prop trading, regulators are going to need a lot of leeway in deciding what they go after.

Interestingly, though, Lewis comes to a different conclusion. He doesn’t opt for vague rules, but rather very strict, draconian ones that would change the face of finance more dramatically than most people probably imagine Dodd-Frank doing:

There’s a simple, straightforward way… to construe the Dodd-Frank language, and it would reform Wall Street in a single stroke: to ban any sort of position-taking at the giant publicly owned banks… If that means that Goldman Sachs is no longer allowed to make markets in corporate bonds, so be it. You can be Charles Schwab, and advise investors; or you can be Citadel, and run trading positions. But if you are Citadel you will be privately owned. And if you blow up your firm, you will blow up yourself in the bargain.

If you have little faith in regulators’ ability to keep up with Wall Street innovation* behavior and to use flexible rules to their fullest, then maybe Lewis’s approach is the smarter one. I’m sympathetic to that argument; I’ve voted to chop up overly large and entwined financial institutions before. But I don’t know if at this point that path is politically feasible. Dodd-Frank could have broken up the banks, but it didn’t. And I’m not sure that since the bill passed, the political clout of the be-tough-on-Wall-Street camp has grown.

Yet that camp is, admirably, still fighting. A group of senators, led by Carl Levin, recently wrote a letter to the new Financial Stability Oversight Council, urging regulators to really crack down and not let Dodd-Frank get watered down in the rule-making. It’s a good thing for people to hear, but so is Volcker’s message—that often the toughest rules are the ones that specifically prohibit the least.

*I regret having used this word, so I have gone back and changed it.


I think Volcker is broadly correct in insisting on a principles-based ban rather than a narrowly defined one. The clearer and more detailed the regulation, the easier it is for market participants to arbitrage it. The problem however with this idea is that ignores regulatory capture – If we had a constant supply of Paul Volckers to enforce the vague rule, I’d sign up for it. As Steve Waldman says here http://www.interfluidity.com/v2/215.html  : “An enduring truth about financial regulation is this: Given the discretion to do so, financial regulators will always do the wrong thing.”

Lewis is also correct in that the only way to make clear rules that cannot be gamed is if they are draconian as I argue here: http://www.macroresilience.com/2009/12/0 5/regulatory-arbitrage-and-the-efficienc y-resilience-tradeoff/

You’ve essentially hit upon why solving the incentive problem in banks via regulations is almost impossible. The only valid solution is to ensure that banks take their losses.

Posted by macroresilience | Report as abusive

Why economists are(n’t) the answer to all our problems

Oct 27, 2010 13:45 UTC

Over at the Curious Capitalist, my former colleague Steve Gandel asks me to react to this NYT article about how economists manage to disagree on such fundamental questions as whether the government should spend more or less money in response to economic malaise. I’ve been perplexed by this sort of thing before. In this post from August, I worried about the influence of ideology, and then decided that maybe the bigger take-away is that we should spend less time listening to economists, who, after all, represent just one possible lens onto the world of human behavior, decision-making and social dynamics:

[T]he economy is as much a product of sociology and policy as it is pure-form economics. Yet we’d not expect a sociologist or a political scientist to be able to write a computer model to accurately capture system-wide decision-making. The conclusion I’ve come to: while economists may have an important perspective on whether it’s time for stimulus or austerity, maybe we should stop looking to them as if they are people who are in the ultimate position to know.

After rereading my post, I started to wonder how economics and its famously flawed assumption of rational behavior came to dominate the discussion. If confidence is such an important part of getting the economy growing again, then why aren’t we taking advice from legions of social psychologists? If multinational corporations are back to profitability but still not adding jobs, then why aren’t we asking the organizational behavior experts for their models?

In search of an answer, I took a cue from Steve: I called Justin. He had all sorts of interesting things to say, like how economists after WWI thought long and hard about why they hadn’t played a larger role in the war effort (ostensibly hoping to do better next time), and how in the 1960s economists moved to get everyone working from the same basic model partly because a unified voice would be more influential. That is to say, economics won out over other social sciences, at least in part, because the discipline got its act together. (Justin may fill in more of the details later, but, if not, you’ve always got his history-packed book to turn to.)

So what do we do now that economics doesn’t, in fact, have all the answers? Well, some of us try to shoe-horn other approaches, like psychology, back into the picture. And some of us denounce academic economics altogether. But most of us just listen to the debate among economists and don’t quite understand how it can be happening because these are the guys and gals who are supposed to know this stuff. We have so completely absorbed the economic world view in so many aspects of our lives—public policy is determined by cost-benefit analysis, doing good in the world has become return on social investment, efficiency has morphed from the best way to reach a goal to the goal itself—that it doesn’t even occur to us that there could be a more illustrative starting point for asking a question or framing a debate.

That’s one idea, anyway. The economists disagree because they don’t have the tools to see the big picture. And most of us can’t see that.



One side is wrong in this argument. This accounting identity for GDP:

GDP = C + I + G + NI

is true for any one currency. It can be rearranged into:

Private Savings = Public Deficits

Until all economists accept basic accounting, the profession is doomed to disagreements.

Mr. E
Counter Insurgency, Deficit Terrorist Unit

Posted by MrE23 | Report as abusive

The U.S. Chamber of Commerce is not the same thing as American business

Oct 25, 2010 21:00 UTC

I don’t understand why everyone is so surprised to find out that large corporations are funneling massive amounts of money to the U.S. Chamber of Commerce. Last week’s NYT report has been making the Internet rounds, and while I appreciate the point that the Chamber is much more partisan than its non-profit status would suggest—70 of the Chamber’s 93 midterm campaign ads either support Republican candidates or attack their opponents, despite the Chamber’s promise to the Federal Election Commission that it only talks about issues—there’s also a curious amount of wonderment at big-company donations. Yes, Wall Street firms sent millions of dollars to the Chamber when financial re-regulation was on the table, and the insurance industry got out its checkbook when it was time to talk healthcare reform. Why would anyone be surprised?

The more counterintuitive and telling story, which the Times only flicks at, is how unsatisfied certain businesspeople are growing with the U.S. Chamber. A couple of weeks ago, New Hampshire’s Greater Hudson Chamber of Commerce decided to break ties with the national organization, because, in the words of the Nashua Telegraph:

[I]t felt recent political advertisements by the national chamber in support of specific parties and candidates were in “direct conflict” with the foundation of the Hudson chamber. Jerry Mayotte, executive vice president of the Greater Hudson Chamber of Commerce, said the Hudson group is a nonpartisan organization. He said he can’t remember the last time they chose not to renew their membership.

Last year, the Chamber of Commerce of Eastern Connecticut did the same thing. Tony Sheridan, the group’s president and CEO recently explained why:

“My issue with the national chamber is their willingness to take a very narrow slice of a piece of complicated legislation – and it’s generally the most negative spin they’re taking, like health care, when we all know that the health-care system is broken – and claim that the sky is falling, instead of using the money to educate people,” Sheridan said.

During financial re-reform, a number of local and regional chambers, including the South Carolina Small Business Chamber of Commerce and the U.S. Women’s Chamber of Commerce, tried to get out a similar message when it came to the proposed Consumer Finance Protection Agency. In one op-ed, the CEO of the U.S. Women’s Chamber wrote:

The U.S. Women’s Chamber of Commerce disagrees with the U.S. Chamber’s big business scare tactics regarding the benefits of a strong, independent Consumer Federal Protection Agency.  The U.S. Chamber would have small businesses believe that protecting the rights of bank and non-bank lenders to deceive, manipulate and bet against small businesses is good for the economy and good for our future – all evidence to the contrary.

The big take-away: the U.S. Chamber of Commerce is not the same thing as American business. It’s easy for the U.S. Chamber—in fact, it’s easy for any well-funded lobbying group—to say that they speak for an entire population. That’s probably never going to be true. And in the case of the U.S. Chamber, it seems to be less true with each passing day.


First of all, corporations don’t decide anything, they don’t speak. THE people who manage them do. If the CEO, and top management of a corporation decide to fund one political view or another, they are making that decision based on their personal bias. So, the average stockholder is funding the CEO’s personal political views.

A CEO should not have the right to use corporate money to fund his own political agenda. A Wall Street banker can use corporate money to weaken financial regulation, loot the company for his own personal gain, and the stockholder is left to pay the bill for the lobbying, and a falling share price.

IN the middle of this decade, the management of big financials were looting the companies, manipulating profit and loss statements to give themselves huge compensation packages. When the house of cards came apart, the stockholders were left with almost nothing, but the guys at the top still kept their ill gotten gains.

One other point. We need to quit lumping big financials with the rest of corporate America. There are good corporations out there in manufacturing, energy, agriculture, etc, who are doing things that make Americans lives better. Do not paint them with the same brush as the people who run the big financials on Wall Street.

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The less you know about finance the better

Oct 25, 2010 11:52 UTC

Everywhere you turn these days, some bigwig policymaker is talking about the importance of financial literacy education. Here’s Ben Bernanke doing it. And there’s Tim Geithner and Arne Duncan. Even the President. It’s easy to understand why we feel like we need this, what with all the bad financial decision-making of recent years. The only problem is, there’s a fair amount of evidence that a lot of what we do to teach better financial habits, like courses in high school, doesn’t work. Some research has shown that financial education is more likely to stick if it’s focused on one topic and comes right before a person makes a related decision—learning about mortgages as you’re house shopping, say, or getting a lesson in compounding interest along with your credit card.

But maybe there’s a simpler approach. Maybe we should ignore real-world complexity altogether and just teach people financial rules of thumb.

A presentation at that microfinance conference last week got me going on this train of thought (although I’m by no means the first to ride it). In this experiment, researchers taught one group of small-time entrepreneurs in the Dominican Republic formal accounting, including double-entry bookkeeping, cash and working capital management and investment decision-making. Another group was taught simple rules of thumb, like “keep personal and business accounts separate” and “write everything down.” The results:

People who were offered rule-of-thumb based training showed significant improvements in the way they managed their finances as a result of the training relative to the control group which was not offered training. They were more likely to keep accounting records, calculate monthly revenues and separate their books for the business and the home. Improvements along these dimensions are on the order of a 10% increase. In contrast, we did not find any significant changes for the people in the basic accounting training. It appears that in this context, the rule-of-thumb training is more likely to be implemented by the clients than the basic accounting training.

When I caught up with Greg Fischer to ask what the U.S. consumer-class take-away might be, he was appropriately modest about his findings and hesitated to draw any universal conclusions. I lack such compunction, so let me say that I think this result contains a very important piece of wisdom. People live complicated, busy lives and the learning they are most likely to put to use is that which is simple to remember and implement. In Fischer’s study, some microentrepreneurs received follow-up training at their place of business: an educator stopped by to reinforce concepts and to answer questions. Once this happened, the group that received the formal accounting training applied what they had learned. But unless we want to set up a system in which your high school consumer finance teacher pops back up just in time for your first mortgage, rules of thumb might be the way to go.

And, actually, we already have many them. We just need to dig them out of the dustbin we tossed them into during the free-money euphoria. For example, don’t spend more than 2 1/2 times your annual salary on a house. And don’t take out more student loan debt than you expect to earn in your first year on the job (assuming you have the option). As Jack Bogle once said: ”Your bond position should equal your age. I won’t tell you this is the best investment advice you’ll ever get, but the number of pieces of advice that are worse is infinite.” It’s not terribly complicated to figure out what we need to teach. We just need to jump to it.


There was no arms waiving. No sulking and skulking around. No driving us supporters mad. It proves that he CAN do it..even when it’s not all in his favour. It’s nothing to do with being languid. It’s called application to the cause.

The real revolution in microfinance

Oct 22, 2010 13:48 UTC

People often talk (and write) about how commercialization is changing the nature of microfinance. Yet increasingly it looks like an even more fundamental shift is afoot. Microfinanciers are finally figuring out what their customers want.

The well-worn story of microfinance goes something like this. Lend a poor person in a poor country a little bit of money, and that person can invest in a business—by buying a sewing machine, say, or another cow. Over the long run, that person pulls himself out of poverty with the income generated by his endeavor.

One reason this story involves a loan is because in most countries it’s a whole lot easier to lend money than it is to take deposits. (The latter requires a banking license, which the former doesn’t.) But there’s another reason loan-making is at the center of traditional microfinance: the people who started this work more than 30 years ago assumed that since mainstream banks didn’t lend to poor people, there was a massive, untapped demand for borrowing.

The thing is, no one ever really asked poor people if business loans were the most important financial product they were missing. That’s now starting to change, thanks in part to a recent wave of academic research. As it turns out, poor people lead complicated financial lives and they need money for all sorts of things.

Thursday I was at this conference, where Dean Karlan of Yale talked about research he’s been doing with Jonathan Zinman of Dartmouth. In interviews with microfinance recipients in the Philippines, the pair discovered that some 46% of borrowers used a decent chunk of their business loan to pay down other debt and about 28% spent part of the money on a big household purchase—even though fewer than 4% of people in either category ever admitted this to their bank. (Disclosure: I was at this conference because I am now doing work for the Financial Access Initiative, which co-sponsored the event.)

This sort of finding—which quantifies what many practitioners have long suspected was the case—is having an impact on how microfinanciers go about their business. “We’re an industry built on assumptions, and we’ve gotten to a point where we have to test those,” said Carlos Danel, a co-founder of the Mexican microfinance behemoth Banco Compartamos. ”Research is showing us that we actually don’t know a lot about the customers we serve.” That’s why Compartamos is conducting a 4-year study with Karlan and other researchers to find out how customers use microfinance products, and how those products do—or don’t—change their lives.

As Danel put it, microfinance is an industry that was born out of supply—one that came from people thinking about what organizations were capable of doing. Now, he said, the challenge is to figure out what poor people around the world actually need.


I would go one step further. Not only are we just beginning to understand the complex financial lives of the poor and only now adapting to their needs, what we are seeing is that microfinance has a different impact than was once assumed. The narrative you discuss has people believe that microfinance is a “pull yourself up by your bootstraps” story. The reality is that the impact is much more nuanced. Microfinance loans smooth consumption, so that the person who earns 14 dollars on Monday and nothing the rest of the week can actually live on $2 a day. It is called smoothing consumption, and I have written about it:


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Why do people care so much about the minimum wage?

Oct 20, 2010 20:40 UTC

Over at my old Time.com stomping grounds, Adam Cohen has written a fascinating article about the movement to have the federal minimum wage declared unconstitutional. This goes hand-in-hand with the emergence of the minimum wage as a campaign issue in the midterm elections. My question: Why do people care so much?

For much of its recent history, the federal minimum wage hasn’t even been all that binding. State minimum-wage laws have led to higher pay, or companies paid more on their own. According to the Labor Department, only 980,000 people made the federal minimum wage last year. Even when you add in the 2.6 million workers who made less (people like tip-collecting waitresses and teenagers just working for the summer), you still only wind up with 4.9 percent of all hourly-paid employees– and just 2.9% of the total U.S. wage-earning workforce.

Yes, it’s true, in Econ 101 we all learn that price floors disrupt the most efficient allocation of resources in a marketplace. When it comes to low-wage workers, that leads to companies hiring fewer people than they would otherwise, leaving some folks who want jobs without them.

But those who make it beyond one semester of economics find out that the world doesn’t always work the way a rudimentary model would predict. In fact, in recent years economists have struggled to find explanations for real-world situations in which higher wages do not, in fact, lead to lower employment. One theory: a higher wage forces employers to invest in their employees and figure out ways to make them more efficient (i.e., valuable). As Richard Florida likes to argue, boosting efficiency in low-wage (mostly service sector) jobs is exactly what we should be doing right now.

But I digress. Back to my original question: Why do people care so much about an economic policy that doesn’t seem to have much of an impact on the economy? One reason might be because of the anchoring effect of the minimum wage. Even if only a few people are earning the minimum wage, its existence still sends a signal to the market that this is about what it should cost to hire an unskilled worker. That tinkers with the expectations of both companies and workers. Or, what I might be quicker to believe: talking about the minimum wage—whether you want to increase it or abolish it—is a proxy for saying “I care about struggling workers,” or “I don’t want government telling business what to do.”

The problem with using the minimum wage to have this debate, though, is that no matter who wins, the victory will be hollow. If we want to help low-income families, we could do a lot more than change a wage many of them don’t make anyway. And if we want to minimize government intervention in free enterprise, we might choose a battle that is meaningful to companies outside of such a narrow range—half of all minimum-wage workers have jobs in the leisure and hospitality industries.

Although maybe saying that just goes to show how naive I am about politics. Maybe in that realm the best battles to fight are the ones that are the least likely to change the status quo no matter what the outcome is.


One wonders what the Roberts court would do if presented with a case arguing that the minimum wage is unconstitutional. Post Bush v Gore I have no confidence in the judiciary and if anything the Supreme Court is worse now than it was then.

Posted by mfritter | Report as abusive

Congress forces Bank of America to offer better service

Oct 19, 2010 19:03 UTC

Remember back when the big banks were telling us that re-regulating consumer finance with legislation such as the CARD Act and Dodd-Frank bill would severely disrupt the banks’ business models, and lead to horrible outcomes for ordinary Joes? Well, in Bank of America’s event-packed earnings call this morning, executives laid out how, exactly, the company’s consumer finance business has been forced to change in response to the new regulatory environment. From the press release:

As a result of the legislation and other changes in the environment, the company is changing the way its consumer bank does business, focusing on a relationship enhancement strategy designed to incent customers to bring more business and to make pricing more upfront and transparent. This change moves away from a dependence on penalty fees, which the industry had adopted over the years, and provides the customer with a better banking experience. These changes are expected to result in additional revenue.

So, let’s see. We’re getting 1) more transparent financial products; 2) better banking service; and 3) a boost to B of A’s bottom line. How could Congress have done this to us?!

Granted, the transition isn’t super-smooth. B of A would have reported a net profit today instead of a loss had it not been for a $10.4 billion “goodwill impairment” charge related to a new limit on how much the company is allowed to collect when people use debit cards at cash registers. (“Goodwill impairment” is a kind of made-up thing that you can read about here.)

And I’ll be the first to admit that “upfront and transparent” pricing might very well mean higher pricing, especially for people who are used to getting a free ride when it comes to financial services–like those of us who pay off our credit card balances each month, thereby borrowing at no cost. On CNBC this morning, B of A CEO Brian Moynihan was pretty darn clear: “Instead of charging penalty fees, we’ll charge monthly fees.”

Yet, as I’ve long argued, there is nothing wrong with that. If my bank wants to charge me for a service that I am receiving—credit card usage, paper statements, a low-balance checking account—why would I be upset? Just clearly tell me what the price of the service is, and then I’ll make a decision about whether or not I want to buy it. Old-fashioned, I know, but still so beautiful. I understand that many people continue to feel the effects of the recession, and that the idea of paying more for anything right now is a painful one. But, in the long run, it only seems fair that people pay for the services they get.

UPDATE: Kevin Drum digs this post, invoking Hayek along the way. Then one of his commenters smartly breaks things down according to demand elasticity.


I think it is excellent that BofA will now provide up-front fees. As a former banking employee, I can attest that customers always want the fees clear and concise, and they want to know what they are paying for. Unfortunately though, I think BofA will lose many consumers because they will now see exactly how expensive it is to bank there, and I believe BofA will lose revenues because they relied on these “fine print” fees.

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Is culture to blame for poverty?

Oct 18, 2010 18:16 UTC

Hello, Reuters readers. Thank you, Felix, for inviting me and Justin to guest blog while you’re away. I promise to make the most of my newfound form of procrastination.

Over the weekend, the NYT ran a piece about academics rediscovering the “culture of poverty.” The story goes that for decades it was taboo to offer social, as opposed to economic, explanations about why particular people and neighborhoods were poor—unless, of course, you belonged to a certain camp of conservative critic. According to the Times:

The reticence was a legacy of the ugly battles that erupted after Daniel Patrick Moynihan, then an assistant labor secretary in the Johnson administration, introduced the idea of a “culture of poverty” to the public in a startling 1965 report. Although Moynihan didn’t coin the phrase (that distinction belongs to the anthropologist Oscar Lewis), his description of the urban black family as caught in an inescapable “tangle of pathology” of unmarried mothers and welfare dependency was seen as attributing self-perpetuating moral deficiencies to black people, as if blaming them for their own misfortune.

Now, it seems, culture is again fair play. Over the past few years, culture-informed explorations of poverty have been seeping into the research literature. High-profile examples include these Princeton/Brookings papers about unmarried parents and this special issue of The Annals of the American Academy of Political and Social Science (which led to a recent Congressional briefing). Nobel-winning economist George Akerlof goes down this path in his new book, Identity Economics: he and co-author Rachel Kranton argue that students decide how much to invest in their education (i.e., their earning potential) partly by whether they see themselves as fitting into the culture of the “nerd,” the “jock” or the “burnout.”

I’m all for understanding the nature of poverty, but the culture lens makes me nervous. Maybe that’s because right after I read Identity Economics, I read The Trouble With Diversity, by Walter Benn Michaels, an English professor at the University of Illinois at Chicago. One of the main arguments of that book is that there is a lurking danger in turning a conversation about economics (poor people don’t have money) into a conversation about culture (poor people have different values and make different life decisions). The big risk: since Americans are loathe to judge one culture as superior to another, we will come to accept poverty as a valid alternative. You’re not poor because you can’t get a job that pays enough to cover your bills (a failure of education, the free market, etc)—you’re poor because you are part of a different culture, which, in diversity-committed America, we all have to respect.

The other thing that worries me about the culture frame is that so much rests on the categories we use to try to capture “culture.” Akerlof’s nerd-jock-burnout rubric is clear-cut and colorful. But is that where the truly useful information lies?

One of the best things I’ve ever read about the nature of poverty is Kathryn Edin and Laura Lein’s 1997 book, Making Ends Meet. Edin and Lein, a sociologist and anthropologist, spent long periods of time interviewing poor single mothers—most of whom both received welfare checks and undertook some sort of paid work. When deciding the right balance between welfare and work, the mothers certainly took into account which paid better. But they also considered which would allow them to be better mothers by spending more time with their children, and which would provide a more predictable (even if lower) stream of income. Devotion to full-time motherhood definitely reads as a cultural value. But does the preference for income predictability?

If we look at poverty in terms of culture, we might be missing an important part of the puzzle. Let’s not forget something else that Daniel Patrick Moynihan once said: “The reason people are poor is that they don’t have money.” Sometimes an economic problem is just an economic problem.


@TFF: I like that distinction between things we can control and those we can’t.

@Curmudgeon: Nice to see you, as always.

Posted by BarbaraKiviat | Report as abusive


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