Archive for December, 2007

Growth and Development- what have we learnt?

December 31, 2007

This Blog started with pointing to the evidence on growth and development and since then I have tried to cover a wide variety of issues.

I came across 2 pieces on growth and development. One is the transcript of reviewof Dani Rodrik’s latest book and second is a superb piece from Charles Kenny.

Dani Rodrik provides some ideas on how we have moved towards understanding what drives growth. He is quite critical of the way development agenda was handled initially and without understanding the context policies, suggestions etc were given.

Charles Kenny says we haven’t learnt anything in the last 60 years and much of the literature is the same as it was in 1960s ūüôā Reminds me of Avinash Dixit.


Understanding Credit Rating Agencies’ moves

December 31, 2007

Any financial crisis the credit rating agencies (CRA) are usually found wanting. They are equally blamed for any crisis whether it was the Enron crisis or the recent sub-prime crisis.

The allegation usually is that the rating accorded by the agencies usually are behind times and act after the crisis actually takes place i.e. they don’t downgrade a company/asset quickly enough. If they are following the company/asset they should be the first one to know of the¬†ills. If they downgrade the company after everyone knows there is a problem there is not much sense to have a CRA.

What is the purpose of a CRA? It is to reduce information asymmetry. In other words, they help demystify the various financial statements by using their various analysts and experts and help the investors in making a decision whether to take an exposure (loan, equity etc) in the company.

So instead of reading through the various documents, you see what a CRA has to say and decide. So they have a pretty important role to play, but have failed when it matters the most. It has been pointed time and again that they only give ratings to please their clients.

It is actually preposterous that they get most of their income from the companies they rate, so there is no real incentive to issue a negative rating. I mean why should I pay you if you give me a thumbs down?

I was just thinking, why do CRA then downgrade companies immediately when times are bad? Well, a downgrade means, a company can raise its hands and say “Hey, I am making losses/bankrupt and the CRA also says so”.¬† Meaning I cannot pay up and don’t bother me. So, a CRA helps the company either ways ūüôā

Will Cricket India ever learn?

December 31, 2007

The weekend was bitterly disappointing. The first test match against the Australia in a much-hyped series ended in 4 days with a thumping victory for the hosts.

It was so sick to see the famed batting line up fold up yet again to an attack which didn’t have the usual tormentors – Mcgrath, Gillespie, etc. The bowling line up just had one experienced campaigner- Brett Lee. He usually bowls 150 km/h plus, but he also bowled pretty slow and still was very effective.

Usually Indian team complains on foreign tours are- weather conditions and pitch.¬†This time they couldn’t as both the wicket (very low and slow) and weather (hot and humid – touching 50 degrees) was just what we see in India. I agree if the wicket was supporting swing etc but it was so much like playing in India.

Another is the experience bit. Why take people who have so much experience and have played earlier in Australia as well? It was as good as seeing a local side. No one was ready to stick it out. What is the point of having such stalwarts in the team if they make the same mistake over and over again? They should have atleast tried to better the first innings debacle. But no, they only did worse.

The batting was so slow that it would have put a sloth to shame. They can’t play pace, swing and now it seems spin as well. One should have seen them play Brad Hogg. Well, less said the better. They were playing as if some terror has broken loose. There was nothing in the wicket at all. The Aussie bowlers simply bowled an off stump line and we kept obliging.

Most would say it was just one test match and not much should be drawn from one loss. I don’t agree. It was too humiliating the way we batted. To loose by 337 runs in¬†ideal conditions is just not done.¬†¬†It is not a one day match where things are beyond your control. It is a 5 day test match where you can rectify your mistakes. But no, we just never learn.

No one barring Ganguly was ready to fight it out. I hate to say this- to see Sachin falling to Brett Lee in second innings was like seeing a debutant fall to an experienced campaigner. I mean most know if a bowler sets the fielding to encourage you to hook and bowls few shortpitch to begin with, the next ball is more likely to be a yorker or a simple outside the off stump ball. But Sachin obliged by slashing the ball and giving a catch to the wicketkeeper. He is in good form and should make Aussies pay.

Most were expecting this is the best chance India has to try and beat Australia. I am sure most must be eating their words.

Some were even doubting that our bowling wouldn’t be able to get out Australia twice in the test match, which is a necessary condition for winning a test match. So the best way was to bat out the Aussies. But I think the opposite happened- bowlers were the only saving grace in the match.

I don’t know whenever we expect something from Indian cricket team they disappoint the most. No one expected them to do wonders in the WC 2003 but they reached finals; in WC 2007 when all did, they went out in round one. Similarly the previous Australian series in 2003-04, they came out against all odds and almost one the series. And the twenty-20 triumph was least expected.

Even if the Indian team wins all the matches now (don’t take that seriously as 4-0 looks highly likely), this loss is another big big failure for the batting line-up to deliver when it matters. Highly disappointing.

Assorted Links

December 31, 2007

1.MR asks and answers– Why is New Zealand poorer than Australia?

2. WSJ Blog says analysts expect Fed to tighten rates in 2008. It also points after US (see this econbrowser post), home prices fall in UK.

3. Mankiw has become an editor of the Brookings Papers on Economic Activity. Watch out for the papers presented at the conferences. Mankiw also has an assignment for all.

4. Rodrik and Mankiw seem to be loggerheads again. Watch out.

5. TTR on Mao, the Management guru

6. ET has some interesting pieces today:

  • it¬†says using forex for infrastructure is a risky strategy.
  • about 60 new car models are going to be launched in India. God save the Indian public who is already facing¬†numerous jams¬†to commute.
  • In India elite colleges prefer to be elite, and the elite colleges in US¬†are offering their lectures etc online.
  • Brad de long offers 3 solutions for 3 crises

7. Here is some more from BS:

  • a terrific article on how bloggers are helping understanding Indian IPR.
  • AV Rajwade says finance now needs a flight to simplicity. I agree completely.
  • Anjuli Bhargava updates on Air-Deccan. Sad that the much-hyped low cost airline had to go this way.
  • Subir Gokarn says inclusiveness and inequality are different.

Economics of finding a house in Mumbai

December 28, 2007

Mumbai is a great city to work. The city, spirit and honesty at most times (taxis/autos run strictly on meter) is remarkable. Most are professional at their jobs and is usually a no hassle free place. But you need a home where you could go and sleep and that is where problems begin.

Finding a house to live in Mumbai is perhaps one of the toughest task one can be given. (The toughest of course is trying to reach workplace and home in the local train!). 

There are 2 ways you can live in a house-

1. either you buy one or
2. you take one on rent.

1. Buy:  Just forget it, atleast in these times. (I have posted the reasons here).

Moreover, builders are getting extremely adventurous these days. There is something called “super built-up area” which means the area quoted to you. This does not mean that your apartment would be of that area. The builder charges you for additional space you use like the stairs etc. The usual¬†difference between the two nowadays is 30-40%. This means :

a) Suppose the builder says the area is 1000 sq ft. So you pay 1000* the rate per square feet.
b) But the area you get to live in could be 600-700 sq. ft. So you pay 30-40% extra !! And when you complaint, the reason given is it is a standard.

2. On rent: As house prices increase, the rent has also been increasing. Moreover you can rent an apartment only for 11 months and for this the charges are:

a) The monthly rent (depends on the area)
b) Deposit (you need to submit a refundable deposit with the apartment owner for security reasons) – usually equal to 10 months rent. The deposit can be used by the owner for whatever purpose and you don’t get any interest. So in financial terms, you are worse off as your deposit would be of lower value after 11 months (because of¬†inflation)
c) The Broker charges- you can’t find a house without a broker in Mumbai. They know the area well and help you find the desired house. The owners also have to pay the broker as he gets them a rentee. So, a broker¬†takes money from both the sides which is fair as he is doing market making.

But his charges have increased from one month of rent you pay to 2 month rent. This means you actually pay for 13 months. There are number of brokers in an area and you should expect competition with some brokers offering lower charges and better services than others. But this is not the case. Instead, the charges have only increased over the years.

d) Other charges- Well, you wouldn’t find a nail inside most apartments which means all the stuff would have to be yours. So, add those expenses as well.

I don’t know what are the practices in other cities, and may be they are similar.¬†But because of scarcity of homes here, the process is a lot difficult.

To address the rising prices many changes need to be done. But I think something can be done to make living more affordable in Mumbai as far as renting business goes. 2 suggestions:

1.¬† It¬†is¬†a great area for the companies to get into- house broking. This will help both the sides- the rentor and rentee. The competition would drive the broking fee down and would help both sides. It will also make the pricing more transparent. As of now, you just don’t know what is the right rent in the area. The industry would also become more organised and have better standards.

2. Another suggestion is to make buildings whose purpose is only to give apartments for rent. To buy a house is increasingly becoming a very costly preposition for those living in Mumbai. [A 2 bedroom apartment (It is usually called 2 BHK ‚Äď 2 bedrooms, one hall and a kitchen; don‚Äôt be misled by the word hall, it could be smaller than the room J) costs Rs 50 ¬†lakhs plus in even the most far flung areas.] Mumbai invites huge migration because of opportunities and such options could be of great help. The person can simply walk into the office of the builder and check if there is any apartment available for rent. This would save brokerage costs as well. Some might argue that buildings with rented apartments are least maintained. Well, the builder can add a maintenance cost to the rent as well. I am sure most want to live in clean surroundings. The maintenance charge can be a fraction of the rent. This makes the pricing also more transparent.

Assorted Links

December 28, 2007

1. MR points to what we have learned in growth theory

2. WSJ Blog points to Barclays report saying sub-prime crisis losses could be over USD 700 billion. It points to some good commentary over next ECB rate decision

3. Econbrowser explains the latest PPP study by ADB.

4. Ajay Shah points to a cool internship program being offered at Finance Ministry. Here is another one at RBI.

A must read case study for all finance students

December 27, 2007

I had posted about an article by Dean Foster a while ago where he talks about regulating hedge funds.  On seeing his website I came across this gem of a paper which is actually an experiment all finance students should undergo.

It is titled “Being Warren Buffet”¬†and¬†is¬†based on the dice game most students take in a finance course. The paper¬†explains the importance of variance¬†while looking at returns (which is often forgotten by most).

I can go on and explain the paper but that would take huge time. It is better if people simply download the paper and read it.

Why double standards regarding sovereign wealth funds?

December 27, 2007

The sub-prime crisis is actually an eye-opener for not just the way it has frozen economies but also on the policies. The questions are being asked on monetary policy, fiscal policy etc.

The developed world has always chided the developing for their lax policies and this sub-prime crisis actually points to their lax policies. In the name of financial innovation, unpronounceable, nonviable mortgages were sold (mainly to get higher bonuses) and it all came to an end (still more bonuses are being given than last year). 

I just want to point out to another double standard , that of capital infusion by sovereign wealth funds (Middle east, Chinese, Singapore etc). I don’t know why isn’t anyone actually criticising their policies. Most articles actually point to the growing power of SWFs. Well, we don’t have a choice do we?

Not long back (read in good times) they criticised the SWFs, Chinese (their financial sector is not developed, currency is overvalued etc). When times are bad they have opened up to the Chinese and the other middle east money blatantly.

What is bad is bad, you can’t change your stance because you are in trouble. If all this capital infusion was happening behind curtains it was fine, but all is known to the public.

Why can’t they refuse and instead take losses on their books? Where is the corporate governance?¬†¬†Why the double standards?

Update : Rodrik points to this interesting related article

Assorted Links

December 27, 2007

1. WSJ Blog says inflation concerns rising.

2. WSJ Blog points FT person of the year was Jean Claude Trichet.

3. Houseprices continue to fall. Mankiw shows an excellent graph on the same. When will this happen in Mumbai?

4. Mankiw points to a behavioral finance solution to the sub-prime crisis.

5. Rodrik deconstructed by the media.

6. I pointed to a new asset class y’day – the lawsuits (see here). Fin Rounds points to another – divorce settlement financing!

7. JRV on importance of short selling

8. TTR comments on recent pumping of capital by Chinese in Foreign Banks.

What is Financial Product Service Commission?

December 26, 2007

Elizabeth Warren, a Harvard Law Professor suggests time has come to take a look at setting a Financial Product Service Commission. Her idea is here. The snapshot of the idea is:

In the US today it is not possible to buy a toaster that has a 1-in-5 chance of bursting into flames and burning down a customer‚Äôs house. But it is possible to refinance an existing home with a mortgage that has the same 1-in-5 chance of putting the family out on the street‚ÄĒwithout ever disclosing¬†that fact to the homeowner

The difference between the two markets is regulation. Although considered an epithet in Washington since Ronald Reagan swept into the White House, the Rword supports a booming market in tangible consumer goods. Nearly every product sold in America has passed basic safety regulations well in advance of being put on store shelves. Credit products, by comparison, are regulated by a tattered patchwork of federal and state laws that have failed to adapt to changing markets. Moreover, thanks to effective regulation, innovation in the market for physical products has led to more safety and cutting-edge features. By comparison, innovation in financial products has produced incomprehensible terms and sharp practices that have left families at the mercy of those who write the contracts.

She suggests that on the lines of US Consumer Product Safety Commission (CPSC), we must have a FPSC. Read the paper for further ideas.

The proposal couldn’t have been more timely. Financial Products are really complex and people don’t read even simple loan documents fully. And if you expect that they would read the complex terms that come with a much more complex loan (¬†NINJA, no doc , Negams ¬†etc), we are expecting a bit too much. The caveat emptor principle cannot work in financial products as it requires a lot of effort to understand and monitor the developments. Even the best financial brains fail repeatedly trying to understand financial markets.

Great thinking.

Assorted Links

December 26, 2007

It being a  holiday season, blogging is going to be dull. Hence. assorted links are not going to be as exciting. Anyways here are a few links:

1. MR points to an interesting paper on credit booms. He also points to the emergence of a new asset class- law cases.

2. Econbrowser on how to prevent next bout of looting.

3. Ajay Shah commentson SEBI’s recent move on short selling.

What do you prefer- malls or homes?

December 24, 2007

Navi Mumbai(earlier known as New Bombay) was built to ease the population pressures in Mumbai. Navi Mumbai took time to pick-up but is now a 1.6 million city. While building Navi Mumbai, an effort was made to do some planning before the construction (I am told it is the second planned town in India after Chandigarh, it is funny  how we built towns in the country without any planning).

Within Navi Mumbai, Vashi has emerged as a major township and most people living in Navi Mumbai flock to Vashi over the weekends. The township was quite pleasant till a while back but it seems planning has been sent for a toss now.

Mumbai has developed around its local train network and as a result maximum crowding is around the stations. Also, you would find the local market, bus stand, residential apartments etc all around the railway station. The local train is the best way to commute in Mumbai and all this means stations are always crowded and messy.

So, in Navi Mumbai an effort was made to have minimal construction around the stations. A lot of open space was preserved around the railway stations in an effort to keep the stations efficient. The concept was pretty revolutionary to begin with and the railway stations became a hit. People came from Mumbai to see the stations and quite a few movies were shot around the area.

It was also planned to make Vashi’s railway station an information technology hub. There are a few companies housed there but I am told the concept did not take-off as expected.

However, the area around the station is seeing huge activity these days. There are a number of shopping malls being set up. At present there are 2 malls around the station (one is not fully functional) and about 4 more are coming up. Inside the township, there are 2 malls and couple of more coming up.

I keep wondering do we need these malls? That too at a time when¬†housing prices in Mumbai and Navi Mumbai¬†are zooming through the roof. (Economist even says¬†don’t buy any property in Mumbai). The analysts often quip that it is a demand-supply issue and as demand is¬†continued to be more in Mumbai, the prices continue to rise. But how would supply problems be eased if already scarce land is given for shopping malls. (Again, I do not say malls are not needed. They are needed as they provide huge benefits to consumers, but there has to be a balance)

Another problem is the nature of housing market in Navi Mumbai (In Mumbai it is slightly better because of some reputed builders). It is just too opaque and information asymmetry is at its highest. The transcation costs are extremely high and one is continuously scared about the quality of the product (the house that is).

There is an urgent need to regulate the housing markets especially in metros. There is a feeling that housing prices are artificially jacked up in these town as no one knows the correct price. Finding a decent place to live in Mumbai is a real nightmare. Most have no options but go through it, pay the brokers through their nose as it seems there is always a shortage of homes.

Mumbai has always been famous for its shortage of space and as a result the homes you find here are much smaller than available elsewhere for a similar price. However, now even finding those small homes is becoming a problem. As migration continues (every aspiring model, actor, finance professional etc wants to come to the city), the problem is only getting bigger.

The house is a basic need and when you add the infrastructure problems, the problem is extremely complex. The day there is a problem in the local trains and if it is a working day, only a miracle can help you reach home (for which you have already paid a fortune) at the right time.  Hats off to the management of local trains who work day in day out trying to minimise the problems, but the problems are quite common.

Lot needs to be done, before attempting to make Mumbai an IFC. It is too far fetched an idea.

Bill Poole defends Fed move

December 24, 2007

William Poole (President St Louis Fed) defends the Fed’s moves to cut rates in his speech. The speech is quite dated (30th Nov., 2007) but is a good read.

His basic idea is similar to many in the Fed who believe that it is Fed’s responsibility is also to ensure that the economy doesn’t¬†slip into a recession and the rate cuts were precisely for the same¬†reason. The economy cannot be left stranded because of few wrong decisions.

All these points are well taken. But the way Fed handled the crisis is a complete no-no. It just waited for too long for the crisis to take shape and intervened when most FOMC members said they would not. This subprime crisis is a lesson for central bankers.

It is important they take on the role of financial supervisors asap. They do follow developments in financial markets which has not been enough. There is a need to expand the role of Central Banks.

Assorted Links

December 24, 2007

1. Ajay Shah has done a good analysis of equity markets using IFCI issue. He also points to importance of weather derivatives.

2. WSJ Blog points to an interesting discussion on housing. It also points to an economist’s view saying US economy to face stagflation lite situation. Read this¬†poetry on CDOs as well.

3. Time for Mankiw’s advice on recession. He points to this interesting analysis showing incumbent party’s voting share increases if the economy is doing well.

4. PSD Blog points to a paer showing creative destruction working in banking sector.

5. EPSA Blog reflects on salt workers in Gujarat.

6. Econbrowser points to 4 reasons why recession may be averted.

Anyone can be a Hedge Fund manager it seems

December 20, 2007

This is an amusing piece from Dean P. Foster (of Wharton) where by using humour he points to an important point- hedge funds need to be regulated.

Scarcely a day goes by without another story of some large hedge fund blowing up due to bad bets. While many of the latest hedge fund casualties are linked to the subprime mortgage crisis, investors should not be lulled into thinking that the problem will be solved once the mortgage mess is mopped up.

Hedge funds are risky for another reason. It is extremely difficult to tell, based on past performance, whether a fund is being run by true financial wizards, by no-talent managers who happen to get lucky or by outright scam artists.

He then shows how easy it is to become a hedge fund manager and make huge returns by riding on his luck. The logic is simple:

take a position that yields high returns with high probability and extremely poor returns with low probability, and keep your fingers crossed. Credit default swaps are one example, so are bets on interest rate spreads. Such strategies are risky but not fraudulent; the manager can always argue that his opinion about the odds differed from the market odds (he was simply engaging in arbitrage).

The suggestions are common stuff- should be registered with regulators, should publish their financial statements regularly etc.

Nice and simple.

Fed’s manna from heaven seems to be ending

December 20, 2007

Yesterday I had pointed to a Charles Possner (Philadelphia Fed President) interview where he raised inflation pressures appear more broad based.

Today I read this recent speech from Jeff Lacker (Richmond Fed President) where he also suggests inflationary risks are building up:

As measured by the 12-month change in the PCE price index, inflation was 3.5 percent ending in June 2006. That measure of inflation fell to 1.8 percent in August 2007. Similarly, core inflation, which omits volatile food and energy prices, was 2.5 percent in August 2006, and then declined to 1.8 percent in August 2007.

Those declines were heartening, and when the financial market turmoil intensified in August the improving inflation picture allowed even an inflation hawk to endorse an easier monetary policy stance. Since August, however, the inflation picture has deteriorated.

In September and October, the overall PCE price index rose at a 3.3 percent annual rate, and the core index rose at a 2.6 percent rate. Judging by the closely related consumer price index, the numbers for November will be even worse. Now these numbers do display transitory swings, so I wouldn’t extrapolate them forward indefinitely. Still, I have to say that I am uncomfortable with the inflation picture, and disappointed that the improvement we saw earlier this year was not more lasting.

So now Fed members are getting concerned about rising inflation. He ends the speech by saying:

Going forward, markets expect oil prices to back off slightly from their current level, and I hope they are right. If energy prices fail to decline, monetary policy decisions will be that much more difficult in 2008.

This is the stance of many a economists and analysts (like me)- What will Fed do if inflation risks materialise and subprime woes continue? Which way will it swing?

Actually all this points to an irony. Fed is taking all these steps to prevent economy from slowing down but a slowdown would actually help inflation from rising. Inflation is expected to rise on account of rising food prices but can be moderated due to a slowdown in the economy. Slowdown means less demand and as a result prices do not increase as much.

Interesting times certainly.

Assorted Links

December 20, 2007

1.¬†Fed released¬†the result of the first TAF operations held yesterday. Here are economists’ reactions.

2. WSJ Blog points¬†to US Senator Charles Schumer ‘s speech on 4 subprime myths:

1. The Myth of Vastly Expanded Home Ownership from Subprime Lending
2. The Myth of the Unqualified Borrower
3. The Myth That Borrowers Can Easily Obtain Perfect Knowledge of The Terms of Their Mortgage Loans
4. The Myth that the Free Market Alone Will Fix Everything


3. Numerous suggestions are being floated to fix this subprime mess. Read Summers’ advice¬†(suggest fiscal policy intervention) and Fisch et al ‘s suggestion (taking a cue from Savings & Loan crisis, provides excellent advice). Eminent economists comment on whether fiscal measures would help.

4. TTR on dangers of rupee appreciation, and on whether the Central Bank intervention would work or not.

5. Ajay Shah says capital controls are futile.

Activity in forex and derivatives markets

December 19, 2007

BIS has released the final reportof its triennial (once in three years) survey on forex and derivatives market activity in 2007. The statistics of the survey findings are here. The press release presents a summary of the findings:

  • First, average daily turnover has grown by an unprecedented 71% since April 2004, to $3.2 trillion. This increase was much stronger than the one observed between 2001 and 2004.
  • Second, growth in turnover was broad-based across instruments. More than half of the increase in turnover can be accounted for by the growth in foreign exchange swaps, which rose 82% compared with 44% over the previous three-year period. Changes in hedging activity may have been one factor underlying the increasing importance of foreign exchange swap instruments.
  • Third, the composition of turnover by counterparty changed substantially. Transactions between reporting dealers and non-reporting financial institutions, such as hedge funds, mutual funds, pension funds and insurance companies, more than doubled between April 2004 and April 2007 and contributed more than half of the increase in aggregate turnover.
  • Fourth, the currency composition of turnover has become more diversified over the past three years. The share of the four largest currencies fell, although the US¬†dollar/euro continued to be the most traded currency pair. The most notable increases in share were for the Australian and New Zealand dollars, which have attracted attention from investors as high-yielding currencies, and the Hong Kong dollar, which has benefited from being associated with the economic expansion of China. More broadly, the share of emerging market currencies in total turnover has increased, to almost 20% in April 2007 from less than 15% in April 2004.
  • Finally, the geographical distribution of foreign exchange trading did not change significantly. Among countries with major financial centres, Singapore, Switzerland and the United Kingdom gained market share, while the shares of Japan and the United States dropped. In some cases, changing shares reflected the relocation of desks.

Fed handling of subprime crisis

December 19, 2007

This article in New York Times is an eye-opener to the way Fed handled the sub-prime crisis. There were concerns early on but Fed continued to ignore the risks. 

Late Ned Gramlich and others had pointed to the risky mortgage business (He even¬†wrote a book on the same)¬† but “Mr. Greenspan argued that the Fed was ill-suited to investigate deceptive lending practices”. Greenspan’s view was Fed can’t check on fraudulent practices.

Fed also ignored the risks from the rising housing prices. Moreover, a New York Fed study said there was no bubble and the costs of the housing bubble bust was pretty small.

Accordingly, they conclude that market fundamentals are strong enough to explain the recent path of home prices and that no bubble exists. Nevertheless, weakening fundamentals could have an impact on home values on the east and west coasts, where the new housing supply appears to be relatively inelastic. However, prices in these regions have typically been volatile, and previous declines have not had a sizable negative effect on the overall economy.

I am sure the authors would need to revisit and update their research work.

Assorted Links

December 19, 2007

1. MR points to different views on sub-prime crisis

2. All WSJ Blog’s assorted links¬†are a good read

3. PSD Blog points to the world’s largest untapped market

4. Ajay Shah discusses whether rupee appreciation has led to large scale job loss.

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