Felix Salmon

When financiers align themselves against Wall Street

Felix Salmon
Jan 13, 2014 16:25 UTC

It’s more than 18 months since Mortgage Resolution Partners (MRP) first came to general public attention, and since I wrote three substantial posts explaining exactly why, as the headline of the first post says, “using eminent domain for liens is a bad idea”. The idea is still a bad one, but it lives on — and now Shaila Dewan has delivered a 2,500-word piece in the NYT about its status in Richmond, California — the town where it is closest to being enacted.

Like most of the discussion of this issue in the press, Dewan’s article fails to make what, to me, is the key distinction here — between seizing mortgages and seizing houses. Seizing houses where the owners are underwater on their mortgages is, at least in principle, a good idea. You buy the house in a short sale at a fair market value. All of the proceeds go to the mortgage lender. You then sell (or rent) the house back to its current owner, for a little more than you paid for it but a lot less than the mortgage was for. The homeowner now has equity again, and a much reduced mortgage, and the risk of foreclosure has gone down substantially. If municipal powers of eminent domain can help you do this, then by all means use them.

Disappointingly, that’s not what’s being proposed. Instead, the idea being shopped around various cities, including Richmond, is that MRP, along with the municipalities, will seize the mortgage under eminent domain. They will then issue a new mortgage to replace the old one, which gives the homeowner back some equity. There are lots of problems with this idea; they haven’t changed at all since 18 months ago. The main ones are, firstly, that the plan does nothing to address the problem of second liens; and, secondly, that the whole scheme is based on a huge lie. The plan only works if the mortgage can be seized for a price which is substantially less than the value of the property. But in fact, nearly all of these mortgages are worth substantially more than the value of the property; indeed, many of them are worth more than the face value of the mortgage. And so the eminent domain plan is not a plan to acquire property at fair market value; in fact, it’s a plan to gift mortgages to a private company, Mortgage Resolution Partners, at prices well below what those mortgages are actually worth.

Why doesn’t Dewan explain the issue this way? That’s easy: it’s because she’s a reporter, she’s reporting what she sees, and that’s simply not the way that the contours of the debate are drawn in the real world. If you travel to a town like Richmond, you don’t find a debate about the distinction between seizing mortgages and seizing houses; you don’t even find a debate about what the fair market value of a mortgage is, if the house in question is underwater. Instead, you find a simple face-off, between poor and angry locals, on the one hand, and well-funded corporate interests, on the other. In that situation, it’s hard not to sympathize — as Dewan clearly does — with the humans, especially when the corporations are churning out misinformation in the form of robocalls about the way the plan would give MRP the ability to “take houses on the cheap,” and bus in fraternity brothers from neighboring towns to demonstrate against a City Council vote.

The difference between the two sides is especially stark in Richmond, where the mayor, Gayle McLaughlin, is a member of the Green Party and an anti-Chevron activist who refused corporate campaign donations and is a veteran of tough fights against faceless corporate interests. And while MRP’s plan is self-serving and unlikely to make a huge amount of difference in any case, it’s easy to see why McLaughlin believes that something is better than nothing:

Homes in the city lost 66 percent of their value, on average, and are still worth less than half what they were at their peak, in January 2006. Some 16 percent of homeowners lost their homes in foreclosure, leaving so many scars on neighborhoods that the city began fining banks $1,000 a day if they failed to maintain their property; the city has collected $1.5 million so far.

This explains why the MRP scheme is still alive, despite the astonishing level of opposition it has managed to elicit. Indeed, it might be more accurate to say that the MRP scheme has managed to stay alive precisely because of the astonishing level of opposition it has managed to elicit. The banks and investors and realtors and financial-services industry groups who oppose MRP’s plan are exactly the people most to blame for the real-estate crisis which devastated towns like Richmond — which can itself seem to be a good prima facie reason to adopt any plan they’re complaining about.

MRP, here, is tapping into a deep vein of resentment and mistrust, and the financial services industry, with its heavy-handed opposition, is in many ways playing straight into MRP’s hand. The problem, for the industry, is that it really doesn’t have any constructive solutions to Richmond’s problems — and as a result, all it can offer is sticks without carrots. (When Richmond attempted a bond offering, to refinance old economic development bonds, it was met with no takers.) MRP itself, of course, is very much part of the financial-services industry, and would love to make an enormous amount of money from its scheme. But it’s not hard for MRP to persuade the likes of McLaughlin that it’s on her side — all it needs to do is point to the squeals of pain coming from banks, investors, and the like. If the plan is bad for them, it must be good for Richmond, right?

In that sense, what we’re seeing here is the current spate of bank prosecutions effectively being played out at the micro-local scale. (In Richmond, for instance, which has a population of more than 100,000 people, a mere 624 homes would be included in the scheme.) For prosecutors, attacking financiers is a move with all upside and no downside: whether you’re slapping JP Morgan with billions of dollars in fine or merely settling a silly case with Blackrock for $400,000, if you’re causing money to flow back to taxpayers from Wall Street then you’re generally perceived as doing god’s work. And the same phenomenon has opened up an opportunity for MRP — which is being supported by the likes of Evercore Partners and Westwood Capital — to paint itself as being on the side of the angels. Municipalities, however, should beware financiers spouting anti-Wall Street rhetoric. The MRP plan might be the only chance that a city like Richmond has to try to address its foreclosure crisis head-on. But that doesn’t make it a good idea.

10 Reasons Barry Ritholtz Is Wrong About Gold

Felix Salmon
Jan 11, 2014 23:24 UTC

Barry Ritholtz has been receiving a lot of praise for his 2,500-word Bloomberg listicle “10 Reasons the Gold Bugs Lost Their Shirts”. Which is weird, because it’s deeply flawed. Here, then, are the top ten places he goes wrong:

1. The title. Ritholtz frames his entire piece as a “post-mortem” examining a “debacle” which resulted in certain investors losing their shirts. But he never identifies a single such investor. The rest of the article is effectively moot if people haven’t lost a lot of money on gold. And so it’s telling that no sooner is the concept raised than it is dropped. Yes, the gold price has fallen from its highs. But without knowing where people bought, and whether they have sold, it’s a case of overstretch to thereby deduce that many gold investors have lost most of their money, as Ritholtz’s headline implies.

2. Any idiot can make money in the past. Every year, the FT’s John Authers extolls the astonishing returns posted by Hindsight Capital LLC, two of whose spectacular 2013 trades involved shorting gold. Hindsight Capital, of course, is a joke: its positions are revealed only at the end of the year, when we know exactly what happened. But Ritholtz seems to be absolutely serious here:

As an investor, I am a gold agnostic: When used properly, the metal is a potentially valuable tool in an investment arsenal. There are times when it makes for a profitable part of a portfolio, as in the 2000s. There are periods when it is a speculative and dangerous trade — such as the 2010s.

The only thing that Ritholtz is saying, here, is that the price of gold went up, and then it went down. His self-identification as “a gold agnostic” basically amounts to saying that it’s a good idea to own gold when it’s going up, and a bad idea to own gold when it’s going down. On that basis, it seems, it was a good thing to own gold in the 2000s, and a bad thing to own gold in the 2010s. To put it mildly, this is not helpful.

3. He relies on tautology. Ritholtz goes into a lot of detail about the exact movements of the gold price, telling us that it peaked above $1,900 per ounce. “Unless something radically changes in the near future,” he intones, “that may very well be the peak for this secular cycle.” Well, yes. Gold is currently trading somewhere in the $1,250 range: if it shoots back up above $1,900, then I’m pretty sure that would count as something radically changing. But is it reasonable to worry about a sudden radical change, and to therefore hold on to a long gold position? Ritholtz never says. All he tells us is that “some gold fans may argue that the cycle is not over yet, and they may be correct.” Thanks.

4. He criticizes a phantom. Ritholtz says that he has found, in gold, “a teachable moment of what not to do in a trade”. One would think that before you criticize a trade, it is reasonably important to know what that trade is. But that doesn’t stop Barry! Specifically, the standard goldbug trade, it seems to me, consists of putting lots of money into gold, and keeping it there. If you’ve been doing that for decades, you’re still feeling pretty smug right now, and can quite easily ride out the current market downturn. The trade that Ritholtz is criticizing, on the other hand, seems to comprise buying gold at $1,900 and then selling it at $1,200. Although he never quite comes out and identifies it that specifically. Without identifying exactly what (or whose) bad behavior you’re learning from, it’s pretty hard to draw useful lessons.

5. He blames Wall Street for the run-up in gold prices. “On Wall Street, storytelling is a big part of the sales process, and gold was no different,” says Ritholtz in his second lesson. He follows up in the third: “Salesmen always need something to sell. In GLD, they found the found a perfect vehicle to pull in the masses.” The story here — the narrative that Ritholtz is selling, if you will — is that a group of latter-day Jordan Belforts were hitting the phones, telling their schmuck clients to load up on gold ETFs, and making millions in the process. The problem with this story is simple: it isn’t true. The big gold salesmen weren’t Wall Street brokers extolling the efficiency of newfangled ETFs; rather, they were the likes of Glenn Beck and Ron Paul. The Cash4Gold people might have made money from a rising gold price; Merrill Lynch and Morgan Stanley, not so much. Indeed, the main reason for the popularity of the GLD ETF was precisely that it didn’t involve paying substantial commissions to middlemen, be they on Wall Street or elsewhere.

6. He confuses an investment with a trade. Ritholtz quite rightly points to the many periods in the past where gold has gone up and then has gone down. “Everything,” he says, “eventually goes to hell”. But that is not the same thing: the price of gold is still higher than it was during many of the previous peaks. The real lesson here is that in order to be a gold investor, you need a stomach strong enough to withstand these big cycles. Ritholtz’s lesson, by contrast, is the exact opposite: “Everything Eventually Becomes a Trade”. Or, to put it another way, if anything you hold ever goes down in value, then you’re not a long-term investor, you’re just a failed short-term trader. Ritholtz is a trader by profession, so it’s natural for him to think that way. But it’s not how gold investors think.

7. He turns a virtue into a vice. “What would make you reverse your biggest present holding?” asks Ritholtz. “If your answer to that question is, “Nothing,” you have a huge, devastating flaw in your approach to investing.” This is pretty much the worst advice that any investor can receive. To be sure, if you’re putting on a trade, and you expect and hope to take profits by exiting your position in the foreseeable future, then it’s a very good idea to have an exit strategy at the same time that you enter the position. But if, on the other hand, you’re doing something sensible like putting all your retirement savings into a Vanguard target-date fund, then the lack of an exit strategy is a very good thing. You don’t want to panic and sell when the market goes down; indeed, the entire structure of the fund makes sense only if you hold it all the way through your retirement. Ritholtz, like all money managers, complains about fickle clients who withdraw their money at the first sign of underperformance. But if he keeps on writing like this, you can hardly blame them.

8. He encourages market timing. “Every position,” writes Ritholtz, “no matter how compelling the underlying story, should have an exit strategy.” The idea that you should just buy and hold, he says, is “an especially money-losing attitude when holding a commodity” — even though he himself admits that “gold has no fundamentals” and that commodities “lack an objective measure of cheap or dear”. In other words, he’s advocating a market-timing strategy — buying low, selling high — in the absence of any useful information about the best time to buy or the best time to sell. Attempts to time the market are the main reason for the existence of the “behavior gap”: the difference between investment returns, on the one hand, and investor returns, on the other. Here’s a chart from Betterment showing just how big that gap has been estimated to be:


In other words, if you follow Ritholtz’s advice, you’re likely to underperform the asset classes you’re invested in by 1.5% or more. Probably much more, frankly, if you’re the kind of person who likes to play in classes like commodities. I don’t think much of gold as a buy-and-hold investment, but I’m quite sure that attempting to trade in and out of gold is going to be a much worse idea.

9. He shows no conception of hedges, or optimal portfolio allocation strategies. Ritholtz enjoys taking a hammer to what he calls “End-of-World Tales, Conspiracy Theories and Other Such Nonsense”. But while he’s shooting fish in a barrel, he misses the one genuinely good reason for including gold in a portfolio — which is that it’s a reasonably good hedge against various tail-risk events. And indeed, when the entire world imploded in 2008-9, the price of gold helped anybody who owned it as a part of their portfolio to handily outperform the market. Hedges are like insurance: they’re there to help protect you in the unlikely event that a low-probability unexpected event suddenly knocks you sideways. Judging the gold price on its own, as Ritholtz does, is silly — especially in the context of a world where the stock market has been resurgent and portfolios in general have done extremely well. That’s exactly the time when you aren’t reliant on your hedge. And that’s why I’m skeptical that investors in gold have really lost their shirts. Sure, if you’re invested in nothing but gold, then your portfolio will have gone down in 2013, while everybody else’s went up. But for someone with say a 5% allocation to gold, just in case everything goes wrong, then last year was probably a very good one, overall.

10. If all else fails, resort to nonsense:

The concept of situational awareness comes from military theory, particularly aviation, representing the idea that a pilot needs to be fully cognizant of all the elements occurring in three-dimensional space, as well as those about to occur in the near future. For the investor, situational awareness means not getting too caught up in the moment, and understanding the continuum of time. Instead of thinking of any event as a single instance in time like a photograph, consider instead a series of instances more akin to a video.

I have a vision of Ritholtz at his advisory shop, putting an arm around some young protégé’s shoulders, and telling him, “my son, you show promise. But what you lack is an understanding of the continuum of time“. To this, the only reasonable response is a slap in the face.


Interesting, all these comments about be censored out of Barry’s blog comments. I suffered the same fate from Mr. Continuum of Time and am fine with it.

Got to keep up appearances to keep the new Bloomberg gig of his!

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The shame of Cooper Union

Felix Salmon
Jan 11, 2014 06:12 UTC

The Cooper Union Board of Trustees today managed to snatch defeat from the jaws of victory. It was a depressing and yet entirely predictable vote, which resulted in a depressing and yet entirely predictable statement.

You might remember the tragedy of Cooper Union — the way in which a unique and irreplaceable institution was destroyed by the inflated egos of overpaid technocrats. Well, after many months of outcry and outrage, a glimpse of hope appeared in December: a detailed and hopeful 54-page Working Group Report was submitted to the board, explaining how the institution could still, amazingly continue without charging tuition. Today, the board voted on whether to adopt the report.

As Kevin Slavin explains, the stakes could hardly be higher:

If the vote goes one way, a new, lean, careful Cooper Union will tiptoe forward, tuition-free. It will require equal parts deep sacrifice, wild ambition, and straightforward pragmatism. And it will uphold a 150+ year tradition of free undergraduate education.

If it goes the other way, all of that will disappear. Not just the free tuition, but everything that was built on it. In its place we’ll find a tragic fraud. A joke. A zombie.

There’s nothing particularly pleasant about the Working Group Report, except for the way in which it shows just how imaginative and resourceful the Cooper Union community can be. A huge amount of work went into this thing, from a group of people who had one big thing in common: they love Cooper Union, and they know that when it starts to charge tuition, it will die. The student protests which raged all summer were never about a bunch of kids wanting something for nothing. Instead, they were a desperate attempt to protect something much more important and much more ineffable — something Slavin does a great job of putting into words in his post.

For any of us who experienced the free Cooper Union, we know what made it high quality, when it was already lean and poor.

It wasn’t the compensation for the professors, who work for far less than they could make doing most anything else. It wasn’t the studio space for the artists; in 1990, my sculpture studio was half of a 6-foot desk in a hallway. It wasn’t the dorms (we never had them when I was there, and we never wanted Cooper’s money to get spent for them.) It wasn’t state of the art labs for the engineers…

And it wasn’t the idea that we, individually, didn’t have to pay. I wouldn’t have had to pay if I’d gone elsewhere (and I had that choice.) Had I gone elsewhere, I wouldn’t have had to work as hard to help support myself.

But Cooper Union chose me, and I chose Cooper Union. I didn’t go because it was free for me. I chose Cooper Union because it was free for everyone. And anyone who actually experienced that knows that the only way to jeopardize the quality of the education there is to charge for it…

For many of us, Cooper wasn’t even the cheapest way to go to school. And it certainly didn’t offer the best facilities, campus, labs, studios, athletics, or dorm life. It was always about immense sacrifices.

So the question is: why did we go? We went not because of the financial value of free — that is, zero tuition — but rather, because of the academic value of free…

At Cooper Union I was paid poorly, and I was proud of it. I would have worked all day just to be able to teach at Cooper Union at night. I would never have done that in an institution that charged their students.

Because “free” affects far more than than a fiscal bottom line. It affects the intentions, behavior, ambition, and performance of everyone in the system. In other words, it determines the academic quality.

The minute that Cooper starts charging tuition, it loses its soul. It becomes a second-choice college in the most expensive part of the most expensive city in the world, which will never regain the kind of love and loyalty among its students and teachers that produced the summer’s sit-ins and the fall’s Working Group Report.

Now on some kind of objective basis, looked at by passionless bureaucrats, it might actually be a better university. The students will have more space and light, the teachers will be better paid, the engineering labs will be more spiffily outfitted. Slavin’s post is addressed to a fellow trustee who was making exactly this argument — that adopting the plan would cause Cooper to become a “low quality institution”. But as I wrote back in April, high-quality universities are actually much more commonplace than the institution which has proudly stood in Astor Place for the past 150 years. And when Cooper Union starts charging tuition in an attempt to match its “competitors”, it will in the process lose something much more important.

After all, the quality of tertiary education has never born any relationship to its cost. Americans have never paid more to go to college, but few would argue that today’s undergrads are therefore better educated than their counterparts of yesteryear. When the Cooper trustees talk about “ensuring the quality of the academic program”, they’re talking about something which means pretty much whatever you want it to mean. And they’re also adopting the language of every other public and private university in America. Rather than proudly holding themselves out to be different, unique, special, in exactly the way that Cooper has done for well over a century.

As Slavin says, Cooper Union will always have shortcomings. But only if it’s free will those shortcomings be “a source of pride, of worthy sacrifice, a reason to fight, and strive, and someday, to give back”.

Instead, Cooper Union has dissolved into utter banality: “The board will constitute a group of trustees to work with faculty, students, administration, staff, alumni and friends,” we are told, “to clarify the mission for the 21st century and to develop a strategic plan for implementing the mission.”

Worse, for all the pro forma expressions of goodwill in the statement, the Trustees’ decision was foreordained, by dint of the bar they set:

The board has reluctantly concluded that the Working Group recommendations cannot — by themselves — be prudently adopted as a means to assure the institution’s financial sustainability into the future.

What this ignores is that exactly the same thing can be said of the alternative course of action — charging tuition. No one really has a clue what Cooper’s finances will look like once tuition starts being charged, how much they will be improved or even whether they will be improved. It seems obvious that if you charge tuition, then you’ll at least be financially better off than if you don’t charge tuition — but in the real world, especially if you have a genuinely needs-blind admissions policy, that’s not necessarily the case. Charging tuition requires a whole new cohort of highly-paid administrators, and could well end up making very little difference to the bottom line.

The result is that we have a very real chance, now, that Cooper Union will end up with the worst of both worlds. Here’s Slavin again (his post really is extremely good, you should read it):

There are deep sacrifices to be made in the Working Group’s plan. But those of us who went to a tuition-free Cooper Union know from sacrifices. And we know the difference between sacrifices made on principle, and sacrifices made on discount. We back the painful financial plan that addresses principles.

Attending a free school of sacrifices taught me something about what free meant. Building a half-price school of sacrifices is to succumb to the culture of Cubic Zirconium and Corinthian Leather.

The point here could not be clearer. The Working Group’s proposals make sense if, and only if, Cooper Union remains free. And yet no sooner does the board meet to double down on its decision to charge tuition, than it takes those proposals as ideas to be imposed even on students paying $20,000 per year:

The Working Group plan puts forward a number of recommendations that are worth pursuing under any financial model…

While we cannot now restore the full tuition scholarship, the board will commit itself to exploring Working Group recommendations.

This is not going to work. What’s more, the trustees have to know, in their heart of hearts, that it is not going to work. Something which is romantic and beautiful when it’s free becomes simply shabby if you start trying to charge tens of thousands of dollars a year for it. The current students know it, the current faculty know it, and prospective students certainly know it: already applications to Cooper have plunged. The trustees know it too; but they will ultimately always vote in accordance with the preferences of their overpaid president, and his dreams of “building a global brand”.

The stated reason why the Trustees didn’t adopt the Working Group plan is that it’s fiscally risky — but this is a group of trustees, remember, which seriously considered closing the entire school down, for a few years, as a solution to its financial problems. There are risks with any plan — but only one plan keeps Cooper free, at least for the time being: only one plan preserves the founding vision of Peter Cooper. It was incumbent on the Trustees to at least give that plan a shot. And they failed to do so. For shame.


unique and irreplaceable institution was destroyed”

The vast majority of people have never heard of it, so I what is unique and irreplaceable about it? Every college is “irreplaceable”? What do you even mean by that?

Is the University of Minnesota Duluth Campus “irreplaceable”? What about its Crookston campus? Morris? Tuition at the university of Minnesota has risen from $6,400 in 2013 dollars in 1962 to $56,000 today. More or less 9 times as much. Is that not notable?

Campuses around the nation have these exact same problems with keeping up with the Joneses and state of the art expensive buildings. Why should Cooper Union be different?

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Under the weather

Felix Salmon
Jan 10, 2014 15:26 UTC

13 months ago, the Hurricane Sandy jobs report was released — the one for November 2012. Analysts were bracing themselves: a lot of people hadn’t been able to work that month, due to bad weather. But in the end, the report was not that bad: 146,000 new jobs were created in the month, and the unemployment rate nudged down to 7.7%. Markets, which had been expecting a mere 80,000 new jobs, were positively surprised.

This month, the story is the exact opposite. Yes, we knew there was bad weather in December, but no one expected it to have a huge impact on job creation. And yet the actual jobs report for the month is a huge disappointment: there were just 74,000 new jobs created, and the labor participation rate fell sharply yet again. On top of that, substantially all of the jobs which were created were in low-wage sectors.

Once you take into account the weather, however, the December report wasn’t that bad. A whopping 273,000 people were counted as “Employed – Nonagriculture industries, Bad weather, With a job not at work”, which is to say that they did not get counted in the payrolls figures even though they’re employed. Most of the time, that number is in the 25,000 to 50,000 range, and although it always spikes in the winter, this was the worst December for weather-related absence from work since 1977.

None of this is an exact science. The January 2011 jobs report, for instance, showed a weak gain of 36,000 in the headline payrolls number — but would have looked insanely strong if you added in the 886,000 people who couldn’t get to work, and weren’t paid, because of the snowstorms that month. That’s not just bigger than this month’s figure of 273,000; it’s also vastly bigger than the Hurricane Sandy figure of 369,000 in November 2012. And sometimes the numbers can be much bigger still: the record was set in January 1996, when 1,846,000 people were kept off payrolls by stormy weather, and the headline number on the employment report was a negative 201,000.

Still, when the weather series starts going skewy, the signal-to-noise ratio in the jobs report, which is pretty low to begin with, tends to drop even further. As a result, the Fed is unlikely to pay too much attention to this report. We’ve already started the taper now, so the important signal has already been set by the Fed: it doesn’t need to reduce the pace of bond-buying even further at this month’s meeting, the last one with Ben Bernanke as chairman. He’ll probably just hand over the reins to Janet Yellen and let her decide how aggressively to pull on them over the rest of the year. Certainly, with Yellen as chair and Stan Fischer as vice chair, the Fed has more than enough credibility: it can draw out the taper as long as it likes, in an attempt to help support the pace at which jobs are being created.

It’s worth remembering that when it comes to monetary policy, the markets are still looking almost exclusively at the jobs report: no one is remotely worried about inflation figures. So long as we continue to see underwhelming job creation, the Fed’s going to keep its foot on the accelerator. Especially if the weather is particularly awful.


That is why short-term numbers are so meaningless. Only annual figures make sense.

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Blameless Blackrock

Felix Salmon
Jan 10, 2014 08:31 UTC

If you want a good test of whether someone is an ideologue on the subject of bank prosecutions, just have them look at today’s agreement between Eric Schneiderman, the New York attorney general, and Blackrock. If they think it makes perfect sense, and that Schneiderman should have pursued this line of prosecution, and that Blackrock has been behaving badly, then they will never find a bank prosecution they don’t love. Because this thing is an utter farce.

To read the NYT coverage of the deal, the problem was that Blackrock was trying to get advance inside information on analyst upgrades and downgrades:

Analysts’ changing assessments on the public companies they follow can make a stock plummet or soar, so receiving such information ahead of other investors can be highly profitable for traders.

As a result, regulatory rules require brokerage firms to limit the information flow from research departments to prevent the potential for trading ahead of analyst reports.

But if you read the actual settlement document, it rapidly becomes clear that that’s not what Blackrock was doing at all. Although the AG seems to be doing its very best to obscure that fact.

The entity at the heart of this settlement is a quant-shop subsidiary of Blackrock called Scientific Active Equities, or SAE, which manages an impressive $80 billion. SAE, like all quant shops, constantly monitors a large number of information streams, and then trades when the streams display certain pre-set characteristics. It’s basically a set of if-then rules: various patterns trigger various different buy or sell orders.

Most, but not all, of the information streams that SAE monitors are wholly public information: momentum, earnings, trading volume, that kind of thing. But there was one stream which was non-public: a periodic survey that SAE would send out to its brokers. Brokers talk to big investors all the time, of course: that’s their job. And they’d happily talk to any investor working for any $80 billion subsidiary of Blackrock. But SAE is a quant shop, and it’s hard for a computer to have a short conversation with an analyst. So instead, SAE would send out a questionnaire — which was very clear, at the top, that it was asking only for public information, which had already been disclosed in research notes, investor calls, and the like. What’s more, even if that was a CYA disclaimer, which everybody was happy to ignore, the questions in the questionnaire are exactly the kind of questions that a sell-side client would ask of a sell-side analyst on a phone call. And as Matt Levine points out, neither Schneiderman nor anybody else is looking to put an end to such phone calls.

But here’s the thing: if a human was asking such questions, they might be fishing for a hint about a possible future upgrade or downgrade. When a computer asks such questions, it isn’t. The point of the questionnaire was emphatically not to try to get inside information on which brokers might be upgrading or downgrading which firms. Instead, it was trying to get a feel for how analyst sentiment in aggregate might be changing, especially around earnings season. Once you added all of the survey responses up and put them all together, then they received a weight of about 5% in the SAE quantitative trading model. But any individual survey response was negligible. An analyst could have said “I’m going to downgrade Stock X tomorrow”, as an answer to the questionnaire, and the SAE model wouldn’t even notice: that’s not the kind of signal it was looking for. A human would notice and care about such a thing, but SAE’s buying and selling decisions aren’t made by humans.

SAE — and I quote the document here — “aggregated and averaged the survey responses before converting them into signals. These signals were expressed as numeric values that were used in SAE’s quantitative trading models”. (My emphasis.) You can’t get insider information from aggregated and averaged survey responses, it’s impossible. And yet, that notwithstanding, Schneiderman still says that the information from the surveys could have been “used to trade ahead of the market reaction to upcoming analyst reports”. This is insane.

Now it’s true that the survey measured analysts’ sentiment — in aggregate. And because it did so on a regular basis, SAE (or its computers) could tell when sentiment — again, in aggregate — was turning. Sometimes, it takes a while for such sentiment to show up in the form of detailed research notes. And in that sense, SAE could take a position in a stock, expecting that the full change in sentiment wouldn’t be fully priced into the market until after at least a few such notes had been published. Which means that Schneiderman is not really accusing SAE of trading on advance knowledge about specific upgrades or downgrades. He’s just worried, to quote a later part of the document, that SAE “could obtain information not generally available in already published analyst reports”.

But it’s investors’ job to obtain information not generally available in already published analyst reports! That information can come from lots of places, including analysts — who, as Levine says, do rather more than just “spend their days in caves writing lengthy reports that they release once a quarter or so”. Indeed, the act of answering questions from clients — or even just filling out SAE questionnaires — is an integral part of the analysis process: it helps analysts get their thoughts in order, and focus on what the clients think is most important. Analysts spend most of their day on the phone to clients — and all of those clients are receiving information not generally available in already published reports. If SAE also received such information, that proves nothing beyond the fact that it’s a client.

Yet according to Schneiderman, SAE’s surveys “violated provisions of the Martin Act, Article 23-A of the General Business Law, and violated provisions of § 63(12) of the Executive Law”. None of these provisions are quoted, and Blackrock was not asked to admit to any violations. But it seems to me that if the surveys really did violate such provisions, then Schneiderman would have been rather more explicit about exactly which part of which law was being broken.

Now it’s in Blackrock’s interest to have good relations with Schneiderman, and so, at the AG’s request, it has stopped sending out the surveys. (And even before it stopped sending them out, it gave them a weight of zero in its algorithms.) But really, Blackrock and SAE did absolutely nothing wrong. And it’s a minor scandal that Schneiderman is bullying them around and forcing them to cease an entirely legitimate business practice. Efficient markets require investors who put work into gathering information, analyzing it, and acting on it. That’s exactly what SAE was doing. It ought to have been receiving praise from Schneiderman, not brickbats.



Short answer: You’re right, Reg FD pertains to corporate disclosure.

Long answer: Analysts cannot show one opinion to favored institutions and another to retail investors. (Should be Reg HB for Mr Blodget). That’s one thing BlackRock was trying to tease out of the data–data that only they received.

Black Rock said they’ve stopped doing it and paid for the AG’s costs. What’s the problem? Is that bullying?

Is the story of finance for the last 15 years one where heavy-handed regulators and investigators bully the largest financial operators in the world?

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Why Zions needs to bite the bullet and sell its CDOs

Felix Salmon
Jan 9, 2014 15:15 UTC

It’s hardly news that in the run-up to the financial crisis, some banks created highly-toxic collateralized debt obligations, and other banks bought those highly toxic CDOs and put them on their balance sheets. The result was that when the crisis hit, and the CDOs plunged in value, a lot of banks needed to take a lot of write-downs.

Certain banks, however, holding certain CDOs, managed to avoid taking any write-downs, and instead quietly just held on to those instruments, keeping them on their books at 100 cents on the dollar. Essentially, they bought complex financial instruments, and then treated them for accounting purposes as though they were their own loans, being held to maturity, which therefore didn’t need to be marked to market. And regulators allowed them to get away with it — until now.

Nick Dunbar has a very good explainer of what’s been going on with these CDOs — specifically, the ones which include obscure creatures known as trust preferred securities. And Floyd Norris has the best short description of exactly what TruPS are, and how they became CDOs:

Trust-preferred securities became popular with bank holding companies in the 1990s because bank regulators allowed them to be treated as capital by the issuing bank, just like common stock, but they were treated as debt securities by the Internal Revenue Service, allowing the issuing bank to deduct interest payments from income on its tax return. The C.D.O.’s were created to allow many small banks to issue such securities, with the buyers reassured by the apparent diversification.

These gruesome instruments actually helped some banks get through the crisis: if you issued TruPS, then you could (and almost certainly did) suspend interest payments for as long as five years, without penalty. But we’re now getting to the end of that five-year period, and, as Norris says, “it is unclear how many of them will be able to make back payments before the periods end this year and in 2015”. Which means that TruPS CDOs, like many other financial innovations of the 2000s, have notably failed to bounce back to their pre-crisis valuations.

As Dunbar says, these things have no place on banks’ balance sheets. And, gloriously, the Volcker Rule has ensured that they’re being kicked off those balance sheets. (Better late than never.) Under the rule, CDOs of TruPS are categorized as a “covered fund”, which banks aren’t allowed to own.

The problem is that certain banks, most notably Zions Bancorp, still own billions of dollars of these things, and have never written them down. If and when they do so, they’re going to have to take hundreds of millions of dollars in losses. And so out come the lobbyists — and out come the silly pieces of legislation, seeking to create a massive carve-out from the Volcker Rule, which would allow Zions and others to hold on to these TruPS CDOs indefinitely.

Even if your goal is to keep the TruPS CDOs on banks’ balance sheets, this legislation is a dreadful way of doing so — since, as Norris notes, the proposed law goes much further than that, and effectively allows banks not only to hold the old instruments, but even to create brand-new ones. Talk about not learning our lesson. But in any case, Zions and the other banks which bought these instruments should, finally, be forced to rid themselves of them. Zions is never going to be happy about taking a loss, but now’s not a bad time for banks in general to be taking losses. And frankly, all of these gruesome CDOs should have been jettisoned from banks’ balance sheets years ago. Let’s hope this legislation goes nowhere, and that these ugly reminders of pre-crash “financial innovation” finally start being held by buy-siders who mark to market, rather than by banks claiming that they’re worth 100 cents on the dollar.

The invincible JP Morgan

Felix Salmon
Jan 8, 2014 16:11 UTC

When JP Morgan paid its record $13 billion fine for problems with its mortgage securitizations, the bank came out of the experience surprisingly unscathed, in large part because Wall Street reckoned that the real guilt lay mainly in the actions of companies that JP Morgan had bought (Bear Stearns and WaMu) rather than in any actions undertaken on its own watch. There was a feeling that the bank was being unfairly singled out for punishment — a feeling which, at least in part, was justified.

The latest $2 billion fine, however, which also comes with a deferred prosecution agreement, is entirely on JP Morgan’s shoulders — and still, as Peter Eavis reports, it’s being “taken in stride” by the giant bank. It really seems that CNBC is right, and that profits really do cleanse all sins. How is it that a $450 million fine sufficed to defenestrate the CEO of Barclays, but that Jamie Dimon, overseeing some $20 billion of fines plus a deferred prosecution agreement just in the space of one year, seems to be made of teflon?

To answer that question it’s worth looking at the details of what exactly JP Morgan did wrong in this case. The key part of the Deferred Prosecution Packet is Exhibit C, the Statement of Facts, all of which have been “admitted and stipulated” by JP Morgan itself. And it certainly lays out some jaw-dropping behavior on the part of the bank, which oversaw Madoff’s main bank account for more than 20 years: between 1986 and 2008, account #140-081703 received a jaw-dropping $150 billion in total deposits and transfers, and showed a balance of $5.6 billion in August 2008. Even when you’re as big as JP Morgan, that’s a bank account you notice.

Except, maybe, not so much:

With respect to JPMC’s requirement that a client relationship manager certify that the client relationship complied with all “legal and regulatory-based policies, a JPMC banker (“Madoff Banker 1”) signed the periodic certifications beginning in or about the mid-1990s through his retirement in early 2008…

During his tenure at JPMC, Madoff Banker 1 periodically visited Madoff’s offices… Madoff Banker 1 believed that the 703 account was primarily a Madoff Securities broker-dealer operating account, used to pay for rent and other routine expenses. Madoff Banker 1 also believed that the average balance in Madoff Securities’ demand deposit account was “probably [in the] tens of millions.”

This is sheer unmitigated — and, yes, probably criminal — incompetence. It takes a very special kind of banker to not notice that an account has more than a billion dollars in it, for a period of roughly four years, from 2005 through most of 2008. As Matt Levine says, “Madoff Banker 1 is like the one banker on earth who underestimated his client’s business by a factor of 100 or so. ‘Boss, I’ve made the firm thousands of dollars this year,’ he probably said, ‘and I deserve a bonus of at least $200.’”

The incompetence doesn’t stop there. At the beginning of January 2007, the account — which, remember, JP Morgan officially considered to be used “for rent and other routine expenses” — saw inflows of $757.2 million in one day. This tripped all manner of automated red flags, but the investigation into those red flags consisted of — get this — visiting the Madoff website. That’s it.

Was there other suspicious activity in this account? Of course there was: lots of it. As far back as December 2001, a client of JP Morgan’s private bank, who also held a huge amount of money with Madoff, moved an astonishing $6.8 billion in and out of that 703 account. In one month. You just can’t do that without generating all manner of suspicious activity reports from JP Morgan to bank regulators. And yet, somehow, impossibly, no such report was generated.

Similarly, in 2007, JP Morgan’s private bank conducted due diligence on Madoff — after all, many of its clients wanted in on Madoff’s amazing funds — and concluded that the numbers “didn’t add up”. And still no hint of running any problems up the chain to either JP Morgan’s regulators or Madoff’s. The same thing happened again in 2008, at an entity called Chase Alternative Asset Management.

And then in late 2008, shortly before the whole Madoff enterprise imploded, JP Morgan bankers in London became so suspicious of the whole enterprise that they sent two different reports to the UK’s Serious Organized Crime Agency. Yet none of this information made it to US regulators.

Levine has a relatively benign explanation for all this: he says that JP Morgan comprises “more or less independent” businesses, which naturally don’t speak to each other, or inform each others’ regulators when they smell something suspicious.

But sometimes the different bits of JP Morgan did talk: for instance, in June 2007 there was a meeting about Madoff in Manhattan, which included the investment bank’s chief risk officer; the Hedge Fund Underwriting Committee (which included “executives from various of JPMC’s lines of business”); the London Equity Exotics Desk (which later examined Madoff in detail and concluded he was probably a fraud); the investment banks’s Global Head of Equities; executives from the broker-dealer; and other people who had direct credit relationships with Madoff. The meeting concluded that JP Morgan wasn’t going to do a big deal with Madoff based simply on Madoff saying “trust me”, and not allowing any direct due diligence. But while JP Morgan was careful with its own investments, and ultimately took out most of the money it had with Madoff before the firm collapsed, once again it saw no reason to tell regulators about its suspicions.

And specifically, there’s one individual within JP Morgan, identified as the “Senior IB Compliance Officer”, who had all of the information from London, who was responsible for passing suspicions on to US regulators, and who ended up doing nothing beyond having “an impromptu conversation in a hallway” with a few colleagues.

The government doesn’t show — it doesn’t need to show — that if JP Morgan had done what it was supposed to do, then US regulators would have cracked down on Madoff before the Ponzi scheme collapsed under its own weight. The point is that regulators can only do their job if they’re given the information they’re required by law to receive — and JP Morgan (not Bear Stearns, not Washington Mutual, but JP Morgan itself) utterly failed, over many years, to provide them with that information.

And yet, to Eavis’s point, JP Morgan is now effectively untouchable by the government. Sure, it can be fined billions of dollars; it can even be slapped with a deferred prosecution agreement. But the fines just come out of the pot of money devoted to paying such things — it’s known as “legal reserves” — and so long as the bank can show that it makes good profits after reserving for fines, Wall Street seems happy for the bank to make few if any major changes. Jamie Dimon remains as CEO, answering to a board chaired by himself; the bank remains one of the biggest in the world; and while prosecutors are winning countless battles against the bank, it’s abundantly clear that the bank is going to win the war.

When did JP Morgan effectively become too big to regulate? How is it that Jamie Dimon and his starry-eyed shareholders have been able to see off forces which toppled many other banks and CEOs? That’s an article I’d love to read — the story of how, with some combination of luck and aggression, Dimon held on to his position as the most powerful bank CEO in the world — even as other banks, and other CEOs, fell steadily by the wayside.

In the face of a determined regulatory onslaught over the past 18 months, from mortgage-related prosecutions to the Volcker Rule, JP Morgan’s share price has gone steadily up and to the right, almost doubling over that period. In the view of Wall Street, that share price is Dimon’s vindication, and his ultimate shield. The lesson of yesterday’s news cycle is that no one can pierce it. Not even the Justice Department.


“The government doesn’t show — it doesn’t need to show — that if JP Morgan had done what it was supposed to do, then US regulators would have cracked down on Madoff before the Ponzi scheme collapsed under its own weight.”

The suspicious activity that JPMorgan failed to file was in fact filed earlier:

“12 Years Before Madoff Was Arrested, A Major JP Morgan Chase Competitor Filed A Suspicious Activity Report”

http://www.forbes.com/sites/robertlenzne r/2014/01/08/12-years-before-madoff-was- arrested-a-major-jp-morgan-chase-competi tor-filed-a-suspicious-activity-report/

“In 1996, some 12 years before Bernie Madoff was arrested for the largest Ponzi scheme in history, a JP Morgan Chase competitor, rumored to be Deutsche Bank DB -3.66%, filed a suspicious activity report on Madoff with regulators, closed its Madoff account and turned over its Madoff deposits to JPMC.”

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NYT vs Pirrong and Irwin: David Kocieniewski responds

Felix Salmon
Jan 8, 2014 05:01 UTC

At the end of December, I wrote about the non-scandal of Scott Irwin and Craig Pirrong, a response to a hit-piece in the NYT by David Kocieniewski. Later that week, Kocieniewski offered to answer questions about his article, so I provided some. Here are my questions, along with Kocieniewski’s answer:

Q: Concerning “Academics Who Defend Wall St. Reap Reward,” I would love Mr. Kocieniewski to respond to criticisms of his piece by myself, Craig Pirrong and others, including, but not limited to:

-Why does Mr. Kocieniewski believe that the money flowing to the University of Illinois business school is a reward for research by Scott Irwin, when Mr. Irwin doesn’t teach at the business school?

-Does Mr. Kocieniewski believe that Irwin has violated the A.E.A. code of ethics? If not, does he believe that the A.E.A. code of ethics doesn’t go far enough? What would he like it to say?

-Does Mr. Kocieniewski believe that Mr. Pirrong is anything other than a straight shooter when it comes to his own opinions? Does he believe that Mr. Pirrong’s opinions are shaped by the money he’s getting from consulting contracts?

-Mr. Kocieniewski says that “major financial companies have funded magazines and websites to promote academics with friendly points of view.” Which companies? Which magazines? Which websites?

-Would Mr. Kocieniewski agree with Mr. Pirrong that most of Mr. Pirrong’s consulting engagements “have been adverse to commodity traders and banks?”

-Mr. Kocieniewski says that Mr. Pirrong has written “a flurry of influential letters to federal agencies.” How many is a flurry?

More generally, does Mr. Kocieniewski believe that Mr. Irwin and Mr. Pirrong are especially worthy of being singled out in this article and in this manner? Or was this just a case of finding a couple of professors at public universities which could be FOIAed? — Felix Salmon, Reuters columnist, New York

A: Despite the disclosure requirements of the American Economic Association and the University of Houston, Mr. Pirrong did not release details of his paid consulting work with 11 different clients until The New York Times filed repeated requests under the Freedom of Information Act. Among the businesses paying him were the world’s largest commodities exchange, the Chicago Mercantile Exchange, and one of the largest commodity trading houses, Trafigura.

Mr. Pirrong was also a paid consultant of a Wall Street group, the International Swaps and Derivatives Association, which is funded by Goldman Sachs, Morgan Stanley and other major traders, at the time the association was quoting his research extensively in a lawsuit that for two years blocked attempts to regulate speculation.

Mr. Pirrong declined to answer questions about how much he was paid or the nature of some of his consulting work. The article nonetheless cited one instance in which his findings went against the interests of the Wall Street affiliated group that had funded his research.

Mr. Irwin, as the article notes, did report his financial ties in his disclosure form with the University of Illinois. In describing the Chicago Mercantile Exchange’s dealings with the University of Illinois, the article also pointed out that Mr. Irwin’s only direct request for money from the C.M.E. was denied.

Emails obtained under the Freedom of Information Act nonetheless show a close relationship between the exchange’s public relations and research departments and the university’s academics — helping Mr. Irwin get his opinion pieces placed in newspapers, trying to schedule him to testify at congressional hearings and, when that failed, using his research to shape its executives’ testimony.

The university development office was also involved in scheduling Mr. Irwin to speak at the C.M.E. at the same time its fund-raisers were soliciting donations from the exchange for the business school, the emails show. Last fall, the C.M.E. also named Mr. Irwin to its Agricultural Markets Advisory Council, the emails show. Mr. Irwin subsequently said that he, like other academics on the committee, is paid a $10,000 annual stipend.

Finally, while friends and colleagues of Mr. Pirrong and Mr. Irwin may complain that they are being singled out for scrutiny, public records show just the opposite. Since this debate began more than five years ago, there have been many media references to the financial ties of those who have argued that speculation is responsible for price increases — whether they were academics performing industry funded research or hedge fund managers whose holdings in autos and airlines would benefit from regulation that might reduce oil prices. By reporting where the financial interests of Mr. Pirrong, Mr. Irwin and the universities that employ them intersect with those of speculators, the article gives readers additional information that they may wish to consider when weighing the professors’ public statements. — David Kocieniewski

The failure of Kocieniewski to answer any of my specific questions more or less speaks for itself; I won’t belabor it, except to note the irony involved in him complaining about Pirrong doing the exact same thing.

I will push back against the “friends and colleagues” line, however: I, for one, am a friend of neither Pirrong nor Irwin. To my knowledge, I have never met either of them. And I don’t think that, say, Thomas Sowell has, either.

It’s also worth mulling over the idea that Kocieniewski’s article was merely designed to provide “additional information” for readers who might have noticed that the 21st paragraph of a Financial Times article in August 2011 drew a passing connection between an academic, Kenneth Singleton of Stanford, and the Air Transport Association of America. I’m sure that both of those readers appreciated the new light that Mr Kocieniewski shed on this issue from his platform on the front page of the NYT. Still, I can’t quite understand how public records could possibly demonstrate that Pirrong and Irwin were not being singled out for scrutiny, as Kocieniewski avers. After all, Kocieniewski himself was the person singling them out. It’s rather worrying that he now seems to deny that he was doing any such thing.


“1. He is typically deceptive in invoking the AEA disclosure policy. This relates to articles submitted to journals. I submitted no article relating to speculation or commodities generally to any journal that received financial support from anyone. So the AEA policy is not relevant and Kocieniewski is dishonest in insinuating it is. Or maybe it’s just that he doesn’t know what the policy is, and doesn’t care.” – Pirrong

Well, no. From the American Economic Association Disclosure Policy –

(7) “The AEA urges its members and other economists to apply the above principles in other publications: scholarly journals, op–ed pieces, newspaper and magazine columns, radio and television commentaries, as well as in testimony before federal and state legislative committees and other agencies.”

Pirrong’s response appears to be stupidly and carelessly wrong or stupidly dishonest.

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Why movie studios happily violate journalists’ copyright

Felix Salmon
Jan 7, 2014 19:18 UTC

The white-goods queen of Eighth Avenue asks my opinion on @aoscott adgate. I take requests, over here, so: is it kosher for a movie producer to selectively quote from the Twitter feed of the NYT’s movie reviewer, in a print ad, even when the reviewer in question explicitly said he would not give permission?

The simple answer is no. The tweet from Tony Scott was used in the NYT print ad precisely because he’s a public figure of authority to NYT readers. As a public figure, he’s entitled to determine when and whether he’s used to promote some commercial interest. Besides, the use of the tweet is arguably a violation both of copyright and of Twitter’s terms of service (which say that tweets can’t be used in advertising “without explicit permission of the original content creator”).

The more complicated answer, however, is that this is a form of blurb, and blurbs from publications have been used — without either the publication or the author’s explicit consent — for decades. Reviewers write reviews, journalists write articles, and then producers happily pick a word or two and slap it in huge type across their ads or marquees. The more high-minded journalists have always disliked this practice, but have been largely powerless to prevent it. And when a play or a movie wants to spend tens of thousands of dollars on an ad buy, where the ad in question features such blurbs, the producers (or media buyers) in question are always welcomed with open arms.

In any organization, the bits of the business which bring in the money tend to be the bits of the business with the most power and influence. At high-minded publications like the NYT, the ad side is grown-up enough to stop itself from trying to directly interfere with what the edit side produces. But still, products like the NYT’s thick annual “Summer Movies” section are entirely driven by the massive quantity of ads that they generate. There’s an unspoken rule that the coverage in such supplements is going to generally be upbeat and fluffy — that it’s going to make readers want to see the movies being written about.

And even if the ad side has no control at all over the edit side, it does at least enforce reciprocity: that the edit side won’t seek to control what the ad side allows to be printed. If there’s a fight between ad and edit over whether or not NYT reviews can be selectively quoted in movie ads, then ultimately the ad side is going to make the final determination. And whatever the clients (the movie studios) want, is very likely to end up being exactly what the clients get.

For me, then, the fact that the ad used a tweet rather than a formal review is not such a big deal. In some way it’s more interesting that the use of a tweet spurred vastly more discussion and outrage than any highly-selective blurb, culled from a more traditional source, has done in years. You’d think that tweets were more easy-come, easy-go — that people wouldn’t care as much about tweets as intellectual property. But it seems that they do! At least, they do when those tweets start appearing in print.

In a world where the brands of individual journalists have never been more valuable, and where the money flowing from print ad revenues has never been lower, this storm in a teacup might be a sign that the balance of power is changing. It may be a sign that the big ad buyers don’t have quite as much ability to dictate the rules as they used to. Or, it might just be a slow news week. Frankly, I suspect that the movie studios are going to continue to produce whatever ads they want to produce, and that the NYT is going to continue to publish just about anything that the studios would like them to publish. Just so long as the ads in question don’t use dirty words or show too much skin.


I’m surprised that this article discusses copyrights and quoting another person and manages not to discuss fair use. When the reviewer comments on the movie, they may use a line or two in their review. They can do so under fair use. While I don’t believe that using a reviewer’s quote in a movie ad is definitely a fair use, I do believe that the argument should at least be acknowledged.

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