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LQD: Learning from the Swedish banking crisis

by Starvid Tue Mar 18th, 2008 at 05:31:56 AM EST

The current US financial crisis is often compared to the Japanese one, but one might argue that a better comparison is the Swedish crisis of the early 90's, which by the way was the worst one we had since the depression which isn't little considering the constant crisis we had during the 70's.

It was so bad it probably crossed the line from recession and went into depression territory. For example, GDP fell by 6 %, housing prices fell by a quarter and several banks were nationalised.

Promoted by Colman, with a little reformatting.


On a more personal level, I had just started school back then and remember how they cut the milk from school lunches - only water was available.

I'm apparently not the only to have seen this connection. So has Justin Fox of Time:

While the econoscribes of the U.S. (me included) were writing Thursday about what the President's Working Group on Financial Markets had to say about the current financial crisis, a guy who may know more about dealing with financial disaster than anybody in Washington was giving a speech on "kriser i det finansiella systemet" to the Swedish Economics Association in Stockholm.

I'm talking about Stefan Ingves, who is currently Governor of the Bank of Sweden (the country's central bank) but was more importantly one of the chief engineers of the most successful financial bailout and restructuring of the 20th century. This happened in Sweden in the early 1990s, when Ingves was Under-Secretary and Head of the Financial Markets Department at the Ministry of Finance. What befell Sweden between 1990 and 1993 was a full-fledged depression: Housing prices fell 20-25%, real GDP dropped 6%. But by quickly taking over and recapitalizing insolvent banks, Swedish authorities kept it from becoming a long, dragged-out affair like the Great Depression in the U.S. or Japan's lost decade in the 1990s.

And Paul Krugman:

Forbidden Swedes?

Justin Fox suggests that we learn from the way Sweden dealt with its financial crisis at the beginning of the 90s. I'm looking into it.

What Justin doesn't mention, however, is that (according to Reinhart and Rogoff) the resolution of Sweden's financial crisis imposed a fiscal burden -- that is, required a taxpayer-financed bailout -- equal to 6 percent of GDP. That would be $850 billion in America today. Just saying.


What (I think) Krugman doesn't mention here is that the bailout meant that the State became a bank owner, and that the banks were later sold at a profit. But I'm not sure the profits were larger than the costs of the bailout. Looking at the cost of the bailout, it doesn't seem wholly unlikely that the whole thing payed for itself, especially as the State still own shares in one of the banks.

Another person noting the similarites is David Rosenberg of Merril Lynch:

The Japanese credit crisis is usually cited as the benchmark for what not to do. But few cite Sweden's crisis as a template on what might actually work. ... the Swedish authorities realized early on that a banking crisis cannot be resolved until the problem is properly defined. That means assessing who the "bad" and "good" houses of issues are and be willing to allow the "bad houses" to fail (as an aside, "good houses" do not necessarily imply "big" houses).

... Sweden established a Bank Support Authority to undertake "reality testing" on the loan books of Sweden's largest banks and had a "board of valuation" experts go in and value the assets on the books of all the lenders. Call it invasive if you will, but then again, the government was doing the work that market players could not or would not do - value the collateral and do it quickly. This is similar to what Barney Frank is proposing in the US mortgage sector today. ...

It should also be noted that it was Sweden's equivalent of the US Treasury, and not the central bank, that played the primary role in this crisis management stage (though the Riksbank maintained an accommodative monetary stance and lowered interest rates right through to December 1993, more than a year after the markets had bottomed). And, it obviously required the heavy hand of government intervention; there are solid grounds for this when there is market failure in the private sector, in this case, insufficient information regarding the quality of financial sector balance sheets. ...

But the best stuff here probably comes straight from the horse's mouth, in a recent speech on the similarities of the US and Swedish crises, held by Stefan Ingves, Governor of the Bank of Sweden, who back in the days played a crucial role in cleaning up the Swedish banking mess.

There are similarities between today's financial turmoil and the Swedish bank crisis

[...]

Some common denominators for the period prior to the outbreak of the crisis include a rapid increase in property and share prices, the fact that the current account deficit was large and growing and that economic growth had declined from an earlier high level. One important difference is that the exchange rate regime has not played a prominent role in the US case.

Too low risk premiums and abstruse risks

But it is also possible to find more specific parallels to the Swedish bank crisis. In both cases lending has increased rapidly at the same time as the banks have underestimated and therefore not taken sufficient payment for the credit risks. In Sweden this was linked to the banks - after decades of credit regulation - lacking a developed strategy for managing and pricing credit risk. When deregulation came in the mid-1980s they were quite simply unused to loan losses. But such tendencies could also be seen prior to the recent market turmoil. For a long time, risk premiums for credit risk-related securities were remarkably low. The uncertainty has led to an increase.

But, there are also other parallels. This includes in particular the arrangements that made the banks' real risk-taking more abstruse. The banks' formal and informal promises of loans to special investment vehicles meant that the problems quickly bounced back into the banks' balance sheets.

[...]

The structures were a side-effect of the desire to avoid regulation

It is also interesting that the abstruse structures, which led to the current financial turmoil and the bank crisis in the 1990s, were in both cases partly due to so-called regulatory arbitrage. The most recent wave of securitisation of the banks' credit portfolios was partly propelled by deficiencies in the capital adequacy rules. Through securitisation the banks could easily avoid a lot of expensive capital adequacy. Since 2004 a new capital adequacy regime, Basel II, has applied. This is more finely meshed and does not allow the same possibilities to avoid capital adequacy through securitisation. However, it has not yet been implemented in all countries, such as the United States, for instance.

The Swedish finance companies were in their day the result of regulatory arbitrage. Prior to the abolition of credit regulation in Sweden, the finance companies were often used as a means for the banks to get round the credit restrictions. This "grey" credit market was once substantial and an important source of additional income for the banks.

[...]

Credit insurances existed then as now

One can also observe another similarity, namely the occurrence of so-called credit insurances. A company that sold credit insurances to the Swedish banks in the 1980s and 1990s was Svenska Kredit. Many banks bought insurances against losses from their loans to property companies from this company. When the property market crashed, Svenska Kredit was unable to meet all of its obligations and consequently went bankrupt. This in turn fuelled the problems for the banks.

There are parallels between the Swedish credit insurance companies of that time and the current so-called monolines. These are large insurance companies which are specialised in insuring various types of bond loan. Those who have bought the companies' insurances have traditionally been municipalities, federal states and other bond issuers with poorer credit ratings. The insurance has meant that the bond loans have received better credit ratings and it has been possible to sell them at better rates. In July 2007 the outstanding volume of bonds insured by monolines amounted to a value of USD 3,300 billion.

In recent years these monolines have increasingly been used to insure securities issues with a subprime content. This has meant that they have also begun to experience problems. This risks in turn having repercussions for the securities they have insured and ultimately for those who have invested in them.

Of course, there are also some essential differences between the most recent financial turbulence and the Swedish bank crisis. This applies to both the nature and the scope of the crisis. But, as you will note, there are many and striking similarities in the way people have acted.  Or as Voltaire is supposed to have said "While history may never repeat itself - man always does!"

[...]

PS. Justin Fox adds:
I just got off the phone with the abovementioned Kenneth Rogoff, who is convinced that Congress will end up spending trillions of dollars sloppily bailing out the mortgage business, so an $850 billion price tag attached to a cleanup that resolves most of the current credit problems, wipes out the shareholders of insolvent institutions, and leaves us with a more rational regulatory setup (as the Swedish bailout seems to have done) actually sounds like a pretty good deal to me.

Display:
As flagged on DK right now, EJ Dionne has this in the WaPo this morning:


The Street on Welfare

Never do I want to hear again from my conservative friends about how brilliant capitalists are, how much they deserve their seven-figure salaries and how government should keep its hands off the private economy.

The Wall Street titans have turned into a bunch of welfare clients. They are desperate to be bailed out by government from their own incompetence, and from the deregulatory regime for which they lobbied so hard. They have lost "confidence" in each other, you see, because none of these oh-so-wise captains of the universe have any idea what kinds of devalued securities sit in one another's portfolios.

So they have stopped investing. The biggest, most respected investment firms threaten to come crashing down. You can't have that. It's just fine to make it harder for the average Joe to file for bankruptcy, as did that wretched bankruptcy bill passed by Congress in 2005 at the request of the credit card industry. But the big guys are "too big to fail," because they could bring us all down with them.

Rescuing them is, sadly, probably necessary, but can we please ensure that:

(i) it doesn't happen again (ie reregulate their asses off);
(ii) those to blame are wiped out (grab in public hands most of the equity of all the entities bailed out, forbid the top management of any of them from ever working in banking again, with as few exceptions as possible, kill all golden parachutes);
(iii) both the discourse and the practice of deregulation are blamed for the mess

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Mar 18th, 2008 at 05:53:20 AM EST
Hear hear, and if there could be some regulation over the bonus system that would be good too (if a trader gets some percentage of the earnings in a good year, should he not pay a percentage of the losses in a bad one?).

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Tue Mar 18th, 2008 at 08:56:51 AM EST
[ Parent ]
er, yes!

unless of course he has the right connections...

and some damaging evidence up his sleeve, to half-nelson the pols with.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Tue Mar 18th, 2008 at 09:30:50 AM EST
[ Parent ]
What an absolutely, astoundingly subversively good idea!

Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Tue Mar 18th, 2008 at 03:51:29 PM EST
[ Parent ]
Surely it's the case that we should measure necessity on a case-by-case basis, though, isn't it?  Was Bear Stearns really critical to our survival?  (Maybe so, and in that case a bailout is warranted to save the banking system, but I'm skeptical of the apparent need to deem everything on Wall Street as "Too Big to Fail," as we're seeing more and more of in the press.)  As you know, socializing the losses this way has a tendency to sometimes leave taxpayers subsidizing amazing levels of dumbfuckery -- the American air carriers, the American car makers, etc -- as the expense of obviously superior products.  The moral hazard argument is a fair one.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 18th, 2008 at 09:23:53 AM EST
[ Parent ]
I don't know why a medium-sized institution whose
main businesses included capital markets (equities and fixed income), investment banking, wealth management, and prime brokerage clearing services.
is critical.

Retail banking and commercial banking are critical, Bear Stearns engaged in none of them.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris

by Migeru (migeru at eurotrib dot com) on Tue Mar 18th, 2008 at 09:28:26 AM EST
[ Parent ]
That was my thought.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 18th, 2008 at 09:34:35 AM EST
[ Parent ]
Critical to whom?

The people who own it all, of course.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 18th, 2008 at 09:40:29 AM EST
[ Parent ]
Fool, watch the pendulum on teevee and repeat, Bear is too big to fail.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 18th, 2008 at 09:50:48 AM EST
[ Parent ]
in American politics and economic policy: rich people must not be taxed, and rich people must not lose money.

Why? Because the wealthy pay for elections in Amerika, every part of them which count.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Tue Mar 18th, 2008 at 10:42:31 AM EST
[ Parent ]
Well, now, that's JP Morgan.

The previous owners got kicked out and they are not happy.

by Francois in Paris on Tue Mar 18th, 2008 at 03:35:07 PM EST
[ Parent ]
All the more frightening that Bernanke is wasting unbelievable amounts of rate & treasury ammo, defending doomed outposts, and he will be powerless when the real citadels will collapse (think Citigroup, largest bank of the free world ™ by balance sheet).

The guy may have done a lot of econometrics, but he has never read sun tzu.

Pierre

by Pierre on Tue Mar 18th, 2008 at 11:04:34 AM EST
[ Parent ]
I keep hearing hints that Citibank probably isn't worth defending, apart from a purely symbolic effort.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Tue Mar 18th, 2008 at 11:10:57 AM EST
[ Parent ]
It appears JP Morgan was interested in buying Bear Stearns primarily because of its prime brokerage business. Should (say) Lehman Brothers fail we'd be talking some serious investment banking (Lehman Brothers is the largest underwriter of mortgage-backed securities), but again still not retail or commercial banking which are the sectors that, if they fail, can send the economy into depression all by themselves.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 18th, 2008 at 11:14:10 AM EST
[ Parent ]
European Tribune - LQD: Learning from the Swedish banking crisis
 Or as Voltaire is supposed to have said "While history may never repeat itself - man always does!"

Or as Karl Marx said,"History repeats itself, first as tragedy, second as farce."

I think we have reached the farcical stage...

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 18th, 2008 at 06:37:56 AM EST
:)

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 18th, 2008 at 07:07:21 AM EST
European Tribune - LQD: Learning from the Swedish banking crisis
The Japanese credit crisis is usually cited as the benchmark for what not to do. But few cite Sweden's crisis as a template on what might actually work. ... the Swedish authorities realized early on that a banking crisis cannot be resolved until the problem is properly defined. That means assessing who the "bad" and "good" houses of issues are and be willing to allow the "bad houses" to fail (as an aside, "good houses" do not necessarily imply "big" houses).

Why should the Americans look to Sweden for an example?

Wikipedia: Emergency Banking Act

The Emergency Banking Act (also known as the Emergency Banking Relief Act) was an act of the United States Congress spearheaded by President Franklin D. Roosevelt during the Great Depression. It was passed on March 9, 1933. The act allowed a plan that would close down insolvent banks and reorganize and reopen those banks strong enough to survive.

On March 5, 1933, the day after Roosevelt's inauguration, he called a special session of Congress which instituted a mandatory four-day bank holiday. This act provided for the reopening of banks after federal inspectors had declared them to be financially secure.

...

Within 300 days of the act's passage, 5,000 banks had passed inspection and were reopened. Roughly two-thirds of U.S. banks quickly reopened under this act, and faith in banking institutions was somewhat restored.

Most banks were, in fact, allowed to reopen after the 4-day bank holiday.

The problem is Americans are not allowed to look at their own history and realize that the New Deal and Keynesianism work. And even if they were allowed they probably would wrinkle their nose and balk at the "Socialism".

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris

by Migeru (migeru at eurotrib dot com) on Tue Mar 18th, 2008 at 07:29:17 AM EST
Well, I hear you, but you may get an objection that financial systems have changed so much since then it may not be very good evidence.
Whereas Sweden, well, that was long after then end of Bretton Woods...

Anyway, your general point is true, you're not allowed to stand for what actually works in the US, or if you do you are no longer one of the "serious people".

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Tue Mar 18th, 2008 at 08:54:38 AM EST
[ Parent ]
Times Online: Which bank is going to follow the Bear?
However, Chris Whalen, of the Wall Street consultancy Institutional Risk Analytics, said ...

... that should the US Federal Reserve, the US Treasury and the Securities and Exchange Commission not devise a broad rescue plan to address the credit turmoil on Wall Street this weekend, "I would not be surprised to see an emergency bank holiday announced. That hasn't happened since Roosevelt." During the Depression, 75 years ago almost to the day, Franklin Roosevelt declared a four-day bank holiday, which stemmed a frantic run on banks. Mr Whalen added that should banks such as Lehman continue to be unable to sell the billions of dollars of mortgage-backed securities held, they were doomed. He said: "Broker dealers have to be able to get rid of assets. If they are illiquid, they die."



It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 18th, 2008 at 11:16:42 AM EST
[ Parent ]
History is for you pansies on the other side of the ocean.  The new season of American Idol is just getting ramped up, after all, and we all want to know more about this hooker Spitzer was forking five grand per hour over to.  Priorities.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 18th, 2008 at 09:31:52 AM EST
[ Parent ]
The same thing, naturally, happened in Finland. Tough times - and I had just started a company to do computer graphic animation. But we survived.

My business partner had a company in derivatives (he's an AI guy), but saw it all coming and switched to rental properties. Another close and loaded friend strongly advised me in the late 80s to invest in the rising market (for the first time in my life). I did for a year and then got out. I realised I would rather invest in creativity. My friend was investing in art too, and at his invitation, I took my then girlfriend on a wonderful sailing trip off the Lydian coast. We were unofficially married at a windy 9 knots speed by the French-Canadian captain, with the bride looking distinctly green. We were somewhere off Rhodes.

Also on board the 12 meter boat were a corporate lawyer and a major bank CEO and his wife. A little over two years later, the bank CEO was disgraced, the lawyer succumbed to alcoholism, and my friend escaped to NY with part of his art collection, leaving total business chaos behind in which he more or less lost everything to margin calls.

The Finnish banking system was at that time roughly divided into two cabals based on the historical investments of the principle industrial families in timber, paper, ship-building and metal. The two groups were KOP (Kansallis Osake Pankki or National Bank Corporation and SYP (Suomen Yhdys Pankk). A few smaller banks and cooperative banks had grown up during the 80s including bad boy SKOP, who did most of the later damage. These new banks marketed aggressively and began to threaten the two traditional powerhouses who preferred to keep it all in the back room with cigars and brandy.

After the crash, everything went into rapid evolution that is still felt today, with massive state intervention and pawnbroking. The Finnish banking system today is part of the new Nordic landscape. The Icelandic banks have been also very active, as I predicted several years ago in an article on Kaupthing conducted in Reykjavik.

For account holders with computers, banking is a cinch these days. You can do almost everything online or in front of an ATM. Two newcomers are challenging the banks and setting up new style freestanding ATMs in kiosks and non-standard locations (kiosks are everywhere and sell everything from newspapers to bus passes)

Long forgotten is the multimillion mark Wolff Olin rebranding of SYP as Merita that lasted less than 24 months.

You can't be me, I'm taken

by Sven Triloqvist on Tue Mar 18th, 2008 at 07:37:03 AM EST
Sven Triloqvist:
The Icelandic banks have been also very active, as I predicted several years ago in an article on Kaupthing conducted in Reykjavik.

IMHO the Icelandic banking system is a colossal illusion, and an accident waiting to happen: a pyrmaid of credit teetering on a lump of volacnic slag surrounded by fish.

The Icelanders are a crew of financial Vikings who have been busy raping and pillaging an unbelievably credulous financial community.

And good luck to them, I say!

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 18th, 2008 at 08:49:33 AM EST
[ Parent ]
even just temporarily?

Not gonna happen.

Nope, they'll be content to finance, with taxpayers money, deals which allow private, wealthy interests to retain profitable control of the banking sector.

I think back in the thirties they called this an aspect of fascism. Now a bipartisan consensus in Amerika calls it good economic governance.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Tue Mar 18th, 2008 at 10:37:57 AM EST
redstar:
Not gonna happen.

Absolutely.

At least in the UK - even under NuLabour -nationalisation, while painful, is still conceivable.

In fact, the legislation they put in place for Northern Rock is open ended....

The question Francois a Paris and I are debating is whether it is politically possible in the US to bail out the banks and not the poor bloody mortgagees....

He reckons it is, I don't think so.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Mar 18th, 2008 at 10:57:24 AM EST
[ Parent ]
The question Francois a Paris and I are debating is whether it is politically possible in the US to bail out the banks and not the poor bloody mortgagees....

While there were quite a few poor folks who were victims of fraud, let's not pretend as though this mess was a product of Wall Street simply preying on poor people.  Many, if not most, of the homebuyers were middle- and upper-middle-class households operating under the belief that they could make a whole bunch of money flipping houses indefinitely, unaware that, yes, house prices can and will fall.

I'm not in favor of bailing out non-mission-critical financial institutions, nor am I in favor of bailing out those who are essentially gambling addicts with incomes much higher than my own.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 18th, 2008 at 11:22:15 AM EST
[ Parent ]
Drew J Jones:
Many, if not most, of the homebuyers were middle- and upper-middle-class households operating under the belief that they could make a whole bunch of money flipping houses indefinitely, unaware that, yes, house prices can and will fall.
Wouldn't those have been the "prime" borrowers? Wasn't "subprime" mortgage lending a textbook case of predatory lending?

Wikipedia: Subprime lending

Generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:

  • Two or more loan payments paid past 30 days due in the last 12 months, or one or more loan payments paid past 90 days due the last 36 months;
  • Judgment, foreclosure, repossession, or non-payment of a loan in the prior 48 months;
  • Bankruptcy in the last 7 years;
  • Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of less than 620 (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood.
Oh, by the way, the owner of AmeriQuest died yesterday... Like Ken Lay, he got off easy.
Roland E. Arnall (1939 - March 17, 2008) was a U.S. Ambassador to the Netherlands, named to that post after becoming the billionaire owner of Ameriquest, which was once one of the United States's leading wholesale sub-prime lenders. The company was one of the largest privately held retail mortgage lenders in the United States. In early 2006, the company announced a $325 million settlement with state attorneys general and law enforcement agencies and financial regulators in 49 states and the District of Columbia over allegations of predatory lending practices. Ameriquest faced allegations that, among other things, it misled and overcharged borrowers, and falsified loan applications.[citation needed]


It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 18th, 2008 at 11:32:40 AM EST
[ Parent ]
About Ken Lay: did anyone ever produce a corpse?  I'm sceptical...

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.
by poemless on Tue Mar 18th, 2008 at 12:45:34 PM EST
[ Parent ]
Precisely. And this dude conveniently resigned as Ambassador to the Netherlands 10 days before his death, for "health reasons" though not his own but his son's health.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 18th, 2008 at 12:47:46 PM EST
[ Parent ]
check the flights to south America, it's the traditional hideout for people who lean to the right.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Tue Mar 18th, 2008 at 12:51:34 PM EST
[ Parent ]
lol  http://www.kenlayisalive.org/

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.
by poemless on Tue Mar 18th, 2008 at 01:01:27 PM EST
[ Parent ]


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