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Carping about TARP-ing.

Is TARP a fabulous success? No! But it isn't a failure, either. Look here, for example. The TED spread is a standard measure of financial confidence—roughly the amount of extra interest a bank needs to pay another bank to lend to it rather than to the U.S. government, which is (supposedly, anyway) super-safe. In normal times, it is around 0.5. During the height of the financial crisis, it was around 4.5. Now it's tad below 1. Other indicators are consistent with TED. The purpose of TARP was to unfreeze the credit system. If it is not yet fully liquid, at least it has melted a bit. Mission Accomplished, as President Bush might say.

You might say that the credit system would have thawed by itself and TARP was wasteful and unnecessary and did nothing but generate a tsunami of moral hazard that will crest in the future. You might say that TARP thawed the credit system but a cheaper, more modest program could have done the same. You might say that the improvement of the indicators will last only as long as the Fed and Treasury pull the strings on the marionettes. But you don't really know, do you? By the usual standards for evaluating government interventions, which is to say crummy standards, TARP has done okay. The safest thing to say is that it is too soon to tell, but by the same token it is too soon to tell that TARP has failed. Enjoy the good indicators (yes, while the real economy collapses around us, but that is another topic) and stop complaining.

So why all the carping? Congress, in its usual way, fulminates and snarls en route to its next disbursement of funds. Here are the criticisms, and some comments.

1. Treasury hasn't compelled the banks to use TARP money to make loans to consumers and businesses. Maybe, but there is a good reason for this. The banks are insolvent. They are using the funds to become solvent. If they were just to lend them out again, the banking system would not emerge from life-support.

2. Treasury hasn't compelled the banks to hold off on foreclosures. Maybe, but if the banks are insolvent or near insolvent, and they held off on foreclosures, then they would become even more insolvent. Holding off on foreclosures means giving up an asset or some portion of its value. Treasury probably believes that fixing the banking system should take priority over helping homeowners, many of whom should never have bought a house in the first place.

3. Treasury hasn't compelled executives to accept lower paychecks. Maybe again, but I suspect there are good reasons here as well. TARP doesn't give government any sticks; only carrots. If executives won't take pay cuts as a condition for receiving funds, then Treasury's only option is not to give the funds, which means not solving the banking crisis. Treasury has avoided wasting a lot of time that would be needed to achieve a largely symbolic and potentially harmful goal.

4. Treasury shouldn't have bailed out the auto industry. I like this argument better but the problem is that it is possible that giving money to the auto industry would help the financial system more than its next best use, such as giving the money to some other banks somewhere. The automakers have more debt than plenty of banks. Still, one suspects that the auto bailout was a stimulus measure, not a credit-thawing measure.

5. Treasury hasn't been "transparent" enough. Everyone likes transparency. But what would a transparent Treasury look like (nothing!)? It would say that we gave money to bank X rather than bank Y because X's balance sheet is a bit better (or worse), or it has better executives, or it has a lot of key assets, or some such thing. It might as well say that it consulted the entrails of a rabbit. These are judgment calls, and while it's always good to have more information, this additional information would just generate more disagreement among the critics. Okay, okay! More transparency, please!

6. Treasury has wasted our money. It will get much of it back, perhaps even a return on it, maybe even a higher return than we taxpayers have obtained through our private investments.

7. Treasury was supposed to use TARP funds to buy mortgage-related securities, not to purchase preferred stock in banks and other financial institutions (and automakers). But the statute authorized Treasury to do what it wanted with the funds, and although Treasury initially planned to use the funds to buy mortgage-related securities, it quickly realized that buying stock was a better way to revive the banking system. Well, good for them! They changed their minds when they were persuaded that their first idea was no good (though it may turn out to be good after all).

8. Treasury should have exerted more control over banks. And told them to do what, exactly? Loan to which corner grocery, set what interest rate on CDs?

As one can see, the criticisms are not all consistent with each other. If we want Treasury to compel banks to give its money to homeowners, then a lot of that money will disappear, which just means that fixing the financial system will be more costly. Maybe this is a good use of money, maybe not, but it would have made more sense to give Treasury a one-dimensional mission—fix the financial system—than to ask it to redistribute wealth from various bad guys to various good guys. Anyway, Treasury has, wisely, I think, decided that it will stick to fixing the financial system. If it sent a lot of money to homeowners, so the foreclosure rate dipped by a fraction, while the financial system fell apart, no one would give it much credit.

There is a real basis for congressional carping, however, and one that has received little attention so far. The problem is not one of competence and technology, but of distribution. Congress has given enormous power to Treasury to disburse funds as it sees fit. There are a lot of ways of spending this money that is consistent with fixing the financial system. You could give the money to Bank X or to Bank Y. You could give the money to automakers in Detroit or boat makers in Rhode Island. You could buy up a type of securities that institution Z happens to own or another type that institution W happens to own. It's even possible that if you pay banks not to foreclose, in effect transferring money into the pockets of defaulting homeowners, you will avoid eroding the value of the housing stock, buck up the securities based on it, and improve the balance sheets of banks. In short, Treasury can, in the course of fixing the financial system, choose to rescue/benefit/enrich some people rather than other people. Treasury has clearly not chosen the people that the various complaining members of Congress care about—maybe people in their districts, or certain types of people who are likely to vote for them. Why not? Maybe because doing so would be just too costly. Or maybe because the Republicans who currently run Treasury have another group of people they'd rather benefit. We just don't know. All that Congress knows is that the funds could have gone into someone else's pockets.

You might say that Congress has no one to blame but itself. TARP put few constraints on Treasury, even fewer than the original 3-page Treasury proposal. Why didn't Congress compel Treasury by statute to spend the money in a way that it would like? Because it just wasn't possible to agree to legislation that would both give Treasury the necessary discretion to save the financial system and set out the winners and losers in advance (except via side payments to wooden arrow makers and the like). With the next $350 billion disbursement, expect the same.

Charlie (Colorado) (mail):
Don't worry, Eric, it'll start being a success as soon as the press and Congress figure the Obama Administration owns it now.
1.15.2009 12:54am
Thoughtful (mail):
If the TED were unusually high, then leaving the market alone would likely have seen the TED revert to the mean. So the market doing what it likely would have done anyway is now seen as justifying a massive tax-payer funded transfer of money to politically favored entities. Surely a stronger argument is needed.
1.15.2009 1:43am
Brian K (mail):
Treasury probably believes that fixing the banking system should take priority over helping homeowners, many of whom should never have bought a house in the first place.

so the government should fix the banking system when they give out bad loans they shouldn't have, but when people buy a house they shouldn't have (using those same bad loans) the government should just give them the finger?
1.15.2009 2:59am
MnZ:
Thoughtful said:


If the TED were unusually high, then leaving the market alone would likely have seen the TED revert to the mean. So the market doing what it likely would have done anyway is now seen as justifying a massive tax-payer funded transfer of money to politically favored entities. Surely a stronger argument is needed.


All roads might lead to Rome, but surely some roads are better to take than others.

Brian K, he didn't say that the government shouldn't help homeowners. He said that fixing the banking system should take priority over helping overstretched homeowners. Besides, many more homeowners would be overstretched if more banks started to collapse.
1.15.2009 5:24am
TCO:
HOw about the crit that Congrss should let banks fail and especially places like Goldman that are big trading desks. That the system is deisgned for this social Darwinism and that stopping it is bad immediatley and in the future. And instead don't have any TARP at all.

Like..DUH.
1.15.2009 7:50am
Alan Gunn (mail):

But you don't really know, do you?

Right. And you don't either. If your best argument is post hoc ergo propter hoc, you don't have a case.
1.15.2009 7:51am
Glocksman:
As far as executive pay limits go, don't the senior execs and the board of directors have a fiduciary duty to act in the best interests of the bank and not their own pocketbooks?

If so and if Congress had made exec pay limits part of TARP and a bank refused to ask for money because the execs didn't want a pay cut, and the bank failed because of the refusal to ask for bailout money, wouldn't that be grounds for a shareholder lawsuit against the CEO and/or the board of directors?
1.15.2009 8:14am
pireader (mail):
To Professor Posner --

Agree with your overall assessment -- things have gotten better -- but must disagree on points 1 and 3.

On point 1. From September 2008 onwards, bank lending froze after Lehman collapsed. Deprived of normal credit flows, businesses and consumers started hoarding cash, slowing down their spending dramatically. Thus, the current recession.

More-agressive action on troubled banks back in September (starting with Lehman) might have stopped that. Specifically, if Washingtion/ London/ Frankfurt had forthrightly and quickly nationalized their busted banks, removing the impaired assets to the governments' balance sheet and re-capitalizing them, then the banks might have continued normal lending. No doubt there'd still have been some kind of slowdown, but not so deep. (E.g., the 40% drop in auto sales was completely unnecessary.)

That's the real complaint #1 about TARP -- half-hearted.

On point 3. People justifiably want accountability for this mess; but the TARP bailouts haven't demanded it. Twenty years ago, the Reagan administration and Fed summarily removed the boards and top managements of the institutions they bailed out (e.g., Continental Illinois).
If TARP's bailed-out banks had new top management teams, there'd be less agitation to regulate their pay.
1.15.2009 8:16am
pireader (mail):
To Thoughtful --

Why do you believe that things would have gotten better over the past few months without a bailout?

The Hoover administration tried your approach in the last similar financial crisis (1930-33). Matters kept spiralling downwards for four years, wiping out a quarter of the economy. And helped bring really-ugly regimes to power in Germany and Japan, with even worse cosequences.

Even a poorly-managed bailout seems better than that.
1.15.2009 8:19am
paul lukasiak (mail):
so the government should fix the banking system when they give out bad loans they shouldn't have, but when people buy a house they shouldn't have (using those same bad loans) the government should just give them the finger?

what makes it even worse is that the banks/mortgage brokers charged homebuyers up front for the "service" of determining the creditworthiness of the buyer ("points" and "origination fees"). Moreover, homeowners who questioned whether they could afford the home were told not to worry about it -- that owning a home was a good (and infallible) investment, and that the worst that could happen is that they'd have to sell the house at a profit and pocket a nice chunk of cash.
1.15.2009 8:33am
devil's advocate (mail):

And you don't either. If your best argument is post hoc...


I think credit where credit is due [sorry -- well, not really]. It is not particularly inductive or arbitrary ergo propter hoc to see that with a government put option on all major banks they are going to be less worried about lending to one another.

So the obvious problem with the credit crunch, if the government's concern is lending to business, small business, residential home buyers, student loans, etc, there is no put option on these.

But, for that very reason, you can't treat improved bank health as measured by the TED as some logical precursor to lending and economic vitality in other sectors of the economy. There is no put option on home mortgages or business financing, instead there is threatening and strong arming of those who hold existing debt in these sectors without the carrot of massive TARP funding.

Now, I don't think we should have TARPed the banks, so I'm not outright advocating widening the scope of its beneficiaries except to the extent that once accepts it is a legitmate aim, and was the actual Congressional target of the TARP, to promote lending to consumers and non-financial businesses. If that is the measure of its success, it has failed miserably and I think the TED benchmark offers no trickle-down future.

If the TARP was about saving banks so treasury didn't have to print money for the FDIC and because of the semantic and structural repercussions of not saving them, then you might say it succeeded.

But, if what you want is lending to everybody else, the banks have not been in that business to the extent imagined. They are loan originators and loan servicers, not lenders -- esp. towards the margins, e.g. subprime (and some prime is the new subprime).

True, people with preeminent qualifications can get a cheap loan right at the moment and I think it is good that the market rewards careful financial behavior at a time when risky behavior has proven unrewarding.

But the real problem is that you can't even define the spread between high quality and low quality credit. There simply isn't any of the later because, anyone charging the necessary risk premium would be rounded up and shot by Barney Frank, who is making the problem worse by adding political risk to the economic risk already inherent in such lending.

If you have failed to protect the interests of lenders, and instead have threatened those interests, as Barney Frank and company do daily, is it any wonder that the market for CDOs, Collateralized Debt Obligations, has completely dried up.

And mendacious populists like Frank portraying the servicing banks, which is to say the folks who got the vast majority of the TARP money and on top of that orginated and sold a similar majority of the 'toxic' debt, as caught between usurious bond holders and innocent homeowners has to take the cake.

As long as the debate revolves around 'emergency' measures that require the abrogation of contract I expect a depression instead of a recession regardless of the TED spread.

The wealth that flowed into our markets from abroad will seek safer returns if investing in contract debt in the US reflects the same kind of arbitrary market and political risks as investing in oil exploration in Venezuela.

Brian
1.15.2009 9:00am
Houston Lawyer:
I just want to add my vote to no bailing out of anyone who borrowed more money than he could afford to buy a house. Those people have already cost me money by bidding up the price of real estate. So I've already had to pay more for my house because of those people and probably pay more in property taxes based on the inflated value of said house. Somehow I'm not sympathetic to having my federal taxes raised as well to pay for this idiocy.
1.15.2009 9:33am
Alexia:
Logic like this scares me. We ran out of credit, so interest rates *should* be rising as the market tightens. That's how markets function.

Keeping interest rates artificially low is what brought all this upon us. TARP is only delaying the inevitable.

We spend and consume more than we produce. We can't sustain that.
1.15.2009 9:56am
Alexia:
To PLReader: The Hoover administration tried your approach in the last similar financial crisis (1930-33).

That's simply not true. Almost every New Deal program was an expansion of a program that Hoover had started.

There is no evidence to indicate that those programs, under any administration, did anything except prolong the Depression.
1.15.2009 10:02am
PersonFromPorlock:
Banking confidence, as measured by the TED spread, would be a more convincing measure of financial health if banks hadn't already proven how easily gulled - indeed, self-gulling - they are.
1.15.2009 10:36am
gran habano:
"Besides, many more homeowners would be overstretched if more banks started to collapse."
.
.
.

How so? If my bank collapses, somebody else will pick up my note. Bad notes will be scrapped, and should be, with the bank failing if it's holding too many bad notes.

I'd hoped to click into these comments and see this blogger getting disemboweled over this post, particularly over his "the government is eventually gonna make money off this" rap.

We needed a ruthless housecleaning, but we got more debt, and the way forward is a pure unknown, and even on libertarian blogs seems to include expanded government and a decline of our liberty.

Back in the day, Dodd and perhaps Frank mighta been run out of town, as Bush/McCain seemingly were in the recent election, over this issue. But today, poor Instaguy is out there on his own, fighting the good fight. This is a troubling time.
1.15.2009 10:43am
Elliot123 (mail):
"so the government should fix the banking system when they give out bad loans they shouldn't have, but when people buy a house they shouldn't have (using those same bad loans) the government should just give them the finger?"

Yes. if money is being given ut, those house buyers aren't as important to the economy as the banks.
1.15.2009 10:58am
GD:
$700 Billion? Having decided to bailout Wall Street, our country will never be able to say no to a bailout again. The cost is many times $700 Billion and the damage to our Nation's future immense. All done to avoid a severe recession/mild depression which was well deserved given the excesses of this decade.
1.15.2009 11:12am
TGGP (mail) (www):
1.15.2009 11:12am
MnZ:

How so? If my bank collapses, somebody else will pick up my note. Bad notes will be scrapped, and should be, with the bank failing if it's holding too many bad notes.


Yes, someone would love to pick up your note (which is an asset to banks). The question is who wants to pick up your, your employer's, your local grocer's, your town's, etc. deposits (which are liabilities to the bank)? If depositors are in a panic and running on the bank, then no one will want to pick up the deposits.


We needed a ruthless housecleaning, but we got more debt, and the way forward is a pure unknown, and even on libertarian blogs seems to include expanded government and a decline of our liberty.


Sounds like the Andrew Mellon approach...
1.15.2009 11:25am
MnZ:

If depositors are in a panic and running on the bank, then no one will want to pick up the deposits.


I should clarify: No one will want to pick up the deposits at face value. There might be a discount offered, but that discount could be extreme +50%.
1.15.2009 11:27am
guest890:

4. Treasury shouldn't have bailed out the auto industry. I like this argument better but the problem is that it is possible that giving money to the auto industry would help the financial system more than its next best use, such as giving the money to some other banks somewhere.


"It is possible"? A lot of things are possible. The burden of justifying these measures should go to those in favor of spending billions of dollars in taxpayer money, and "it is possible that..." doesn't cut it. Your post assumes that it's a given that the money will be spent somewhere. Why is that a given?

How's this for you: "It is possible" that throwing money at failing automakers constitutes a giant broken window fallacy. But hey, everything's good because the glassmaker auto workers are getting employed, right?
1.15.2009 11:41am
Eric Rasmusen (mail) (www):
Good post! Keep writing on this.
1.15.2009 11:56am
gran habano:
"The question is who wants to pick up your, your employer's, your local grocer's, your town's, etc. deposits (which are liabilities to the bank)?"

Didn't we already have a mechanism to deal with insured deposits, and might that existing mechanism also outline all that was required to deal with the bank failures you're implying as the prime problem here?

Schematically then, we didn't need TARP, and the blogger's long essay is a quest for a need.

How about:
Failed banks get taken over.
*Insured depositers get paid.
Assets get reassigned.
Shareholders take it hard and deep.
Executives/Boards get the chair (or as near to it as the law allows).

You know... a housecleaning. But the first sentence above is precursor to the others, and we're going into debt to make sure we don't go there, evidently.

* Yeah I know... insured depositers won't likely get paid off as quickly as Paulson's buddies are, but we'll get it done.
1.15.2009 1:20pm
Dan Weber (www):
so the government should fix the banking system when they give out bad loans they shouldn't have, but when people buy a house they shouldn't have (using those same bad loans) the government should just give them the finger?

If the government were to "bail out" homeowners the way that it "bailed out" banks, we'd see some random sample of homeowners put into bankruptcy (Lehman), some sold off to their neighbors at pennies on the dollar (Bear), some getting too-good deals (Citi), but most of them being massively diluted so that they own a fraction of what they did before.

I know there is this sense that since government "helped" the banks that they should "help" homeowners. But you really should think if you want that "help."

(And I would probably accept mortgage cramdowns, if done the right way.)
1.15.2009 1:49pm
devil's advocate (mail):
Not to mention I wonder how the TED spread for Citi debt is right at the moment or if $3.60 a share is a sign of success.

I too think cramdowns, within the discipline of bankruptcy, the normative rather than exceptional practice and the residential exemption the policy mistake. There is a degree of concern that any changes will be viewed as an attack on contract, although I think that mostly a matter of discourse (and I don't recall too many banks complaining that the 2005 bankruptcy changes were an assault on the contracts of the borrowers).

As long as the wart interest is part of the negotiated reorganization and the process reflects common bankruptcy practice, this is not a robin hood undertaking. It actually is a forum designed to determine whether reorganization (mortgage modification) or liquidation (foreclosure) is appropriate to the particularized circumstances.

And having banks and lienholders as partners in the home equity is not an attractive proposition to someone who is trying to shave a few points on their mortgage, so the moral hazard is actually reduced.

Yes, bankruptcy, is more turtle like than the populist hares on the Financial Services Committee would like, but given a 53% redefault rate for modified mortgages in the last 6 months maybe slow and steady wins the race.
1.15.2009 4:05pm
Charlie (Colorado) (mail):
The thing I hate about this whole argument is that people won't do a little research in order to understand what actually happened. I spent probably a month on it, and got to this piece at PJM last year. But let's try a couple pieces.

First, we "didn't run out of credit": credit isn't a "thing" like money. Its the willingness of someone to bet that a loan of their money will be repaid, with enough interest to compensate for the chance that it won't be repaid. The credit freeze was an interval when it was impossible to evaluate how credit-worthy companies were because no one had any idea what some big assts (mortgage backed securities) and liabilities (credit-default swaps) were worth. The TED spread and the LIBOR, while indicative, weren't the whole story: the money available for let at any price dried up.

Second, the underlying crisis wasn't entirely because of a lack of regulation, and especially not of deregulation. (If it was, name the regulation that went away.) It very plausibly was in fact because of greater regulation: government requirements that banks both grant riskier loans and that the interest couldn't be adjusted to match the risk, so called "anti-redlining" regulations. The existence of MBS's and CDS's was the market's and financial engineers's response: the need was for financial instruments to average out the risk of the relatively better and worse quality loans the government was forcing banks, by regulation, to make.

Third, the collapse started with the discovery that securities sold by FNMA and FMC really weren't as good as a Treasury bond, although they'd been sold wink-wink-nudge-nudge as being so. That triggered CDO's, which in tern triggered the realization that no one knew what the underlying MBS's were worth.

In other words, the initial crisis, and the need for a governmental response, came down to "you broke it, you bought it."
1.15.2009 4:18pm
Brian K (mail):
I know there is this sense that since government "helped" the banks that they should "help" homeowners. But you really should think if you want that "help."

somehow i don't think the government is going to "help" several million homeowners in exactly the same way it helped a few discrete entities. but nice try...
1.15.2009 8:23pm
MnZ:
gran habano,

There are at least three flies in the ointment. First, before the bailout legislation, FDIC insurance was pretty useless to businesses of any size. If a business needs to pay 200 employees $1,500 each, then that business needs to put $300,000 into an account. Second, some economists have argued that one of the nagging problems caused by the bank failures of the 1930s was the destruction of the credit infrastructure. When a bank went under, both the good and bad loan officers were put out of work.
1.16.2009 12:31am
TruePath (mail) (www):
First, at least as I read the post it isn't trying to argue that TARP is a great success or express confidence in any of these defenses of it but rather merely to point out that so far the criticisms of TARP have lacked enough evidence to make them anything but guesswork and speculation. I can't speak for all the criticisms but this is politics so it's a valid evidence based critique coming from congress that would have surprised me.

Brian K:


Treasury probably believes that fixing the banking system should take priority over helping homeowners, many of whom should never have bought a house in the first place.

so the government should fix the banking system when they give out bad loans they shouldn't have, but when people buy a house they shouldn't have (using those same bad loans) the government should just give them the finger?


I find comments like this totally mind blowing. I mean it's as if you witnessed a man leap into a freezing lake to save a child and you criticized him because he happened to splash a woman standing nearby but not the man in the suit standing several feed away. In an emergency you do what you can to fix the situation. Dithering about the fact that the best fix happens to benefit bankers not poor people would just hurt everyone more.

Glocksman


As far as executive pay limits go, don't the senior execs and the board of directors have a fiduciary duty to act in the best interests of the bank and not their own pocketbooks?

If so and if Congress had made exec pay limits part of TARP and a bank refused to ask for money because the execs didn't want a pay cut, and the bank failed because of the refusal to ask for bailout money, wouldn't that be grounds for a shareholder lawsuit against the CEO and/or the board of directors?


Interesting argument but while I don't know the law here I'm pretty confident you are wrong.

Executives have a fiduciary duty to shareholders in their official capacity. As private individuals they are not required to structure all their decisions to further corporate profits. If so then it would be illegal to accept any pay for their job.

I think it's safe to conclude that corporate executives in general don't have a legal duty to voluntarily give up their pay to maximize shareholder value. Presumably then these executives, while not refusing to take the government money per see, could simply refuse to accept a reduction in pay forcing the government to either try to explicitly void a valid contract or not offer the bailout to that company.
1.16.2009 6:30am
gran habano:
MnZ,

Sure, there are some "flies in the ointment" if we let banks fail, but job security for loan officers isn't one that can't be picked out clean.

And yes, the business waiting for the $300k to make payroll is at risk, and I can accept that perhaps a cash infusion to banks MIGHT be a way to alleviate that risk (did it, though, and is that the best way to address this, particularly with the famous "moral hazard" attached?), but on the other hand, loans WERE being made out there... it was just getting tighter, as expected ( I hope), since easy credit is the root of this problem, I hope we can agree.

The only certainty here is the huge new public debt load, and the declining economy. That's sad.

And looks like they're gettin' ready to whoop through the next phase of this larceny.
1.16.2009 10:56am
Brian K (mail):
In an emergency you do what you can to fix the situation. Dithering about the fact that the best fix happens to benefit bankers not poor people would just hurt everyone more.

there are a whole lot of assumptions hidden in this statement that are not self evidently true. how great was the "emergency"? is the plan as it currently is really the "best" fix? would helping some homeowners really hurt everyone more? and as posner pointed out above the reason bankers were chosen as the primary beneficiaries could very possibly be due to politics and not because it is the "best".
1.16.2009 11:28am
Elliot123 (mail):
"posner pointed out above the reason bankers were chosen as the primary beneficiaries could very possibly be due to politics and not because it is the "best"."

Banks were chosen because they had the greatest effect on the credit markets and the liquidity necessary to maintain an economy. That's how "best" was defined.

If there is some other "best," how is it defined, and what sector of the economy is it? Also note that politics and "best" may both point to the same thing.

We can always acknowledge uncertainty, and it's an honest acknowledgement, but policy makers can't choose "I don't know for sure" as an option.
1.16.2009 10:51pm

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