Guest Post: Who’s Bullying Who?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Harvard economics professor Greg Mankiw asks: Is the White house Bullying Hedge Funds?

Professor Mankiw cites prominent hedge fund manager Clifford Asness who struck back at the Obama administration, saying hedge funds had the right and responsibility to hold out on last week’s Chrysler LLC restructuring deal:

“Managers have a fiduciary obligation to look after their clients’ money as best they can, not to support the President, nor to oppose him, nor otherwise advance their political views,” Asness, who oversees about $20 billion at AQR Capital Management, LLC wrote in an undated letter.

Asness, who made his reputation and fortune in quantitative investing where computer models select stocks and bonds, spoke out days after Obama forced the automaker into bankruptcy protection and called several holdout lenders “speculators.”

In a rare flash of anger, Obama scolded a small group of holdouts on Thursday and said he does not stand with these people when everyone else is making sacrifices.

The secretive and powerful $1.3 trillion hedge fund industry is seething in private. Asness responded more publicly.

In a letter, widely circulated on Wall Street and obtained by Reuters, Asness complained that Obama has gotten the industry all wrong and effectively misunderstands what investment managers must do for their clients.

“Let’s be clear, it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can,” Asness wrote.

“If they give away their clients’ money to share the ‘sacrifice,’ they are stealing.”

A spokesman for the firm said Asness wrote the letter.

While Asness said his firm is not involved in the Chrysler matter, he decided to speak out because he is “aghast at the President’s comments.”

Known for writing detailed letters to investors, Asness did the same here. He also worried about the consequences.

“It’s really a bad idea to speak out. Angering the President is a mistake and, my views will annoy half my clients,” he predicted.

Still, he felt he needed to respond widely because no one else was. Industry managers are reacting with anger to the President’s words and demands, Asness said, but he also said they were buckling to demands.

“One by one the managers and banks are said to be caving to the President’s wishes out of justifiable fear,” he said.

As he went on, his tone became ever more insistent.

He said it was untrue hedge funds benefited from taxpayer money.

“Last but not least, the President screaming that the hedge funds are looking for an unjustified taxpayer-funded bailout is the big lie writ large,” he wrote. “Find me a hedge fund that has been bailed out.”

He closed the letter by saying the system usually fixes itself: “Most importantly, it is not an owned lackey of the oval office to be scolded for disobedience by the President.”

I don’t know why Mr. Asness is so upset. The reality is while publicly scolding hedge funds and threatening to regulate them, the Obama administration has been privately pandering to them and other private equity funds.

Back in April, we learned that one of the president’s top economic advisers, Lawrence Summers, received about $5.2 million over the past year in compensation from hedge fund D.E. Shaw, and also received hundreds of thousands of dollars in speaking fees from major financial institutions.

Moreover, the Obama administration has been courting private funds to invest in ailing U.S. banks. Coming off one of their worst years ever, some private equity firms, notably J.C. Flowers and the Carlyle Group, are bent on putting their funds to work in the banking industry, but the Fed is setting limits:

The Fed does not mind if private equity firms have a minority interest in banks — the Obama administration even wants them to invest. But the Fed will not let them take control, a stance the firms are lobbying regulators mightily to change, especially given that stress test results to be released Thursday are expected to show a glaring need for capital in the banking system.

It’s not personal, Fed officials say. It’s just that as the nation recovers from one of the worst banking crises in history, the Federal Reserve wants to make sure that it does not set the stage for the next financial implosion by turning banks over to private equity firms, some of the riskiest players in the business world.

So while Mr. Flowers was able to buy the bank here with his own money, he cannot tap into the billions his firm, J. C. Flowers & Company, has raised.

How this battle — and others being fought in the aftermath of the economic crisis — plays out will help determine the future shape of the financial industry.

For all the talk of the banking crisis, Mr. Flowers and other giant private equity players are circling distressed banks around the country, competing to buy into the industry. Bidding wars are now breaking out among private equity firms, including the Carlyle Group, which is going up against Mr. Flowers’s firm for a stake in BankUnited of Florida.

They and other investors see banks as the recession’s biggest prize: potential money machines that could one day generate fabulous returns, particularly after the federal government eats the losses of failed banks, then heavily subsidizes their sale. But like Mr. Flowers, some of them would prefer to take over the banks completely, replace their managements and take all the profit.

“I don’t think the Republic is going to be brought to its knees if private equity owns banks, personally,” Mr. Flowers said from his Midtown Manhattan office with its expansive views of Central Park. “We invest around the world — Japan, Germany, England, no problem.”

The Fed is resisting this pitch, for several reasons. Current law prohibits mixing banking and commerce, based on a fear that if industrialists own banks, they will dominate and try to manipulate the economy, as they did during the early-20th-century heyday of John Pierpont Morgan.

The government also wants the ability to stabilize a teetering bank by drawing on the funds of its parent company. That is hard to do with private equity firms, which have numerous businesses owned by funds, each of which is walled off to protect investors.

For these reasons, banks generally cannot be owned by nonfinancial companies like the Carlyle Group, whose assets are as varied as an interest in Dunkin’ Donuts and United Defense Industries, a maker of combat vehicles and missile launchers.

The equity firms counter that banking desperately needs cash if the economy is going to recover, and that they are the only big sources of money around. An executive at the Carlyle Group said the industry had an estimated $400 billion in “dry powder,” or ready-to-invest reserves.

To push their case at the White House, the Treasury and the Fed, Mr. Flowers and others in his industry have enlisted an all-star cast of advisers, lobbyists and lawyers. They include H. Rodgin Cohen, chairman of the Sullivan & Cromwell law firm and Wall Street éminence grise, and Randal K. Quarles, a managing director of the Carlyle Group and a Treasury under secretary in the administration of President George W. Bush. Part of their strategy, Mr. Flowers said, is to persuade the Treasury secretary, Timothy F. Geithner, to pressure the Fed to back down.

“Chris is obviously a get-it-done type of person — and he wants to get this done,” said Mr. Cohen, who represents Mr. Flowers. “He believes, as I do, that it is unfortunate to deprive the banking system in the United States of this key source of capital.”

While they press their case, the firms have found some ways around the rules.

They have formed so-called club deals, in which teams of private equity firms and other investors each buy up to the legal limit of a bank — about a quarter or a third, depending on the type of bank — with their individual pieces adding up to 100 percent control. IndyMac, the failed California bank, was sold by the Federal Deposit Insurance Corporation last fall to one such club, which includes funds controlled by Mr. Flowers; the hedge fund billionaires George Soros and John Paulson; and Michael S. Dell, founder of the Dell computer company. The investors are barred from acting in concert to, in effect, take control of the bank — an unwieldy arrangement but one that regulators insist they can enforce.

As part of the IndyMac deal, the F.D.I.C. agreed to take most of the risk from future losses on loans acquired by the partnership — leading Mr. Flowers to quip at one investor forum in New York in January that “the government has all the downside and we have all the upside.”

Mr. Flowers has come up with another way around the restrictions. There is no limit on an individual’s taking over a bank, so he purchased all of the First National Bank of Cainesville in his own name and with his own funds. But that deprives him of the billions his equity firm has set aside to buy banks, so his new bank sits in this tiny town, waiting for a change in the rules.

First National — whose second story is boarded up and whose $17 million in assets are worth about a third of what Mr. Flowers paid for an Upper East Side town house in 2006 — seems an unlikely launching pad for a new American banking empire.

It is so tradition-minded that it refused to change the spelling of its name, even after the town did so back in 1925 to honor its founder, Peter Cain.

Suddenly, in February, the First National Bank name was dropped and “Flowers Bank” was painted on the window. New bank executives showed up, passing out packs of promotional sunflower seeds with the bank’s new logo, urging the mostly elderly town residents to get ready to “Grow with Us.”

“Everyone wonders, who is this Flowers guy?” said Lefty McLain, as he finished up the ham, mashed potatoes and butter beans lunch special at the Little Store, an all-in-one restaurant, deli, pool hall and gossip post here in the one-block downtown.

Mr. Flowers, while still in his 20s, founded Goldman Sachs’s financial services merger business, helping line up the $62 billion merger of NationsBank and BankAmerica (now Bank of America) and the $34 billion takeover of Wells Fargo by Norwest.

By 1998, he had left Goldman to start his own business, focusing at first overseas, with the 2000 purchase from the Japanese government of the failed Long-Term Credit Bank of Japan, which was renamed Shinsei Bank, its name meaning “new life.”

Mr. Flowers, now 51, made a sizable chunk of his fortune when he and his partners took the bank public four years later. But the deal left some in Japan steaming, as they wondered how an American businessman could make such an enormous profit when the government was never repaid most of the trillions of yen it had spent bailing out the failed bank. The bank is now in trouble again, from investments in subprime mortgages that went sour and exposure to Lehman Brothers, which went bankrupt.

His holding in Hypo Real Estate in Germany is also suffering because of bad real estate investments, even after Mr. Flowers and Shinsei poured money into it. German regulators are threatening to take over Hypo and force Mr. Flowers out.

These kinds of high-risk investments make United States banking officials nervous, though Mr. Flowers points out, accurately, that many Japanese banks are struggling, not just Shinsei.

The private equity firms are pitching to regulators a way to let them take control of banks while respecting banking traditions. Essentially, they would separate the entities — they call them silos — that buy the banks, walling off their other private equity investments from any newly created bank holding company.

Fed officials will not speak about banks for the record, but they have told the firms that they view the silo concept as little more than a subterfuge.

Mr. Flowers and other executives have lobbied hard; their efforts have included a recent meeting with William C. Dudley, chairman of the New York Fed. At the meeting, Mr. Flowers and his colleagues bragged about how they could raise as much as $10 billion in 48 hours to help with a bank takeover if they were given the chance, according to one executive in attendance.

Mr. Flowers, in an interview, said he was confident he would prevail. Even if he cannot make the Fed reverse its policy, he will consider it a victory if the Fed approves an individual deal.

He has estimated his banking empire will one day earn at least a 35 percent return on banks it has bought in the United States. “I find it to be an extraordinary time to invest,” he said.

He was even more blunt when he spoke to an industry group in New York earlier this year. “Lowlife grave dancers like me will make a fortune,” he predicted.

Will it be private equity to the rescue? I doubt the Fed will let private equity firms control banks. The standard private equity business model doesn’t fit the banking industry.

But if they did allow PE firms to rescue banks, they should do it with tight regulations and with the condition that public pension funds co-invest along with them at substantially lower fees (0.5% management fee and 5% performance fee instead of the regular 2 and 20).

The way I see it, the large hedge funds and private equity funds made billions off public pension funds during the great pension con job. Mr. Asness publicly denounces the President of the United States but he neglects to mention that it was the pension contributions from GM, Chrysler and millions of other workers in the private and public sector that enriched him and many other fund managers that collected their hefty fees.

What I would like to know is who is looking after the best interests of those common workers? Do they even realize they are getting bullied from all angles, including by their pension plans?

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  1. Brick

    It seems like a dangerous argument either way because ultimately it comes full circle back to the individual citizen. You can argue that the hedge fund money invested in Chrysler was obtained from the pension funds, so the hedge fund in a way is protecting the rights of those who paid into their pension. You could argue that if the hedge funds loose out, pensions lose out which means more has to paid into pensions which affects jobs. I have no doubt that hedge funds skimmed loads of money from pension funds, and there would be some poetic justice if they suffered, but some of the facts don’t add up.

    The total amount of debt those hedge funds was protecting is rumoured to be 285 million, which in the scheme of Chrysler debt is small. Are all funds being punished then for the actions of a few and is the administration really just firing a warning shot across the bows of hedge funds. Despite misgivings about many hedge fund strategies many of which seem to be outright gambling and problems with excessive leverage, a properly run hedge fund should smooth volatility in markets by taking market neutral positions.

    The administration will argue that it is protecting jobs in the automobile and supplier industries and yet if you look into the detail of what is being suggested the deal is not really that great for the US automobile workers. My deep concern is that by protecting automobile workers the administration may have placed other workers at risk. If you were looking to fund the debt in a big US company would your prices now be rising knowing that the risk of you loosing all of your investment has probably risen.

    While I agree on the redistribution of wealth and don’t really want to see a bunch of gamblers in charge of banks, effectively tearing up contracts deeply worries me. How long will it be before they tear up a contract which directly affects us as individuals? While the administration has the common worker’s welfare utmost in their mind I cannot help feeling it is being selective in the common worker it helps. There has been no help for the house builder industry and all the common workers who have lost their jobs there.

    Sorry Leo, while I sympathise with a lot of what you are saying, some of specifics of the administrations actions seem prejudiced and rather like a bull in a china shop.

  2. attempter

    Boy, this just gets more sickening every time I hear it. The word “bully” is just right, because one of the traits of bullies is that they truly belive they have a right to prey on others, and become sincerely outraged if anyone ever tries to impose limits on them, let alone actually fight back.

    We have to point out again, nothing in all of history is more of an artificially sustained hothouse flower than something like a hedge fund or private equity firm. It could not exist at all except through the radical action of the government in enabling its existence. If the government withdrew its active support, these and entire rest of the FIRE sector, and every cent of their wealth, would cease to exist immediately.

    So it seems to me there is nothing these persons could do which would be too much to show their gratitude to such an infinite benefactor. Government should literally be God to them.

    And yet government asks them for so little! Just pennies in campaign contributions and lobbying! And, as in this case, maybe a tiny little sacrifice once in awhile.

    So nothing could possibly be more responsible vis their shareholders than to respond reasonably when their infinite benefactor asks them for a modest sacrifice.

    That they respond with such gutter loutishness is an (anti)aesthetic gloss on how utterly, irremediably rotten the entire system has become.

  3. The Epicurean Dealmaker

    Do not conflate hedge funds and private equity funds. They are two very different types of investment vehicle, with different investment strategies and behaviors. While oversimplified, it perhaps is useful to think of the former as relatively short-term traders of securities, and the latter as intermediate- to long-term (but temporary) owners of businesses. FYI.

  4. only-a-bird


    No insight to offer here but I do have some naive questions … probably dumb, but after all I’m only-a-bird:

    1. Flowers – Where’s this future 35% banking industry profit going to come from -perhaps payday loans and extortionist banking fees? Certainly more Americans will be become more fleece-able in this way for the foreseeable future.The only place where growth and jobs are really prevalent are in emerging markets – so is Flowers counting on inflation to vacuum up Asian savings to the extent that the average Chinese worker will go into debt and need payday loans?

    2. If hedge funds really want to get into banking (w/o regulation and other boring constrictions) why not sink some of their excess cash into popularizing online offshore banking with the general public and take their business profits outside the system?

    Thanks for the insightful post by the way!

  5. Harlem Dad


    Great post. I learned much more about the Financial Industry’s hold on Washington. Unfortunately, I also learned (as I do each day that I read NC) that I really know nothing about how this country works.

    I used to really believe that even big banks and the law firms that serviced them deserved the money they got because they _earned_ it by being smart and taking risks in a Capitalist system.

    Now I wonder if Capitalism as I understood it ever really existed at all?

    Frankly I’m scared. Not for myself, but for the world my daughter will inherit in about 12 years or so.

    And my left knee is jerking like crazy!

    Tim in Sugar Hill

  6. DownSouth


    I didn’t know whether to post this comment here or on the following post “The Banks and Orwell,” because it seems to be germane to both threads.

    In the comments to “The Banks and Orwell,” carol765 said that the US government and fed have decided to…

    “- try to influence the long term interest rate (getting it down so mortgage rates get to historic lows, stimulating buying of houses; reducing other borrowing costs, so people/companies keep borrowing)”

    While it may indeed be true that mortgage rates have come down somewhat, I don’t see the same happening with other borrowing costs to companies and people. In fact, just the opposite seems to be happening. Most of the evidence I have seen is annecdotal, but it seems there is growing evidence that credit card interest rates and fees are actually on the rise. Also, last night I saw the following report “The Ripple Effect” on CBS Evening News. Boat dealer Robert Tronio says (1)many of his customers can’t get financing and (2)that in March the banks increased the interest rate he must pay to “put boats on the showroom floor” by 7%.

    I think this explains why guys like Flowers are chomping at the bit to get into the banking business. He certainly knows a fixed game when he sees it, and he wants to get in on the fix. Your post sums it up nicely with this:

    They and other investors see banks as the recession’s biggest prize: potential money machines that could one day generate fabulous returns, particularly after the federal government eats the losses of failed banks, then heavily subsidizes their sale.But lacking from your post is one key factor, and that is that this “money machine” is going to be fueled in large part by borrowing money almost for free from the Federal Government and then loaning it back out to businesses and households at exorbitant rates.

    The CBS Evening News piece traces the feeding chain, how the sales generated by Tronio support the boat manufacturer, the suppliers to the boat manufacturer and on the bottom of the chain the employees. One laid-off employee relates how his 19-year-old son makes half his $800/mo. mortgage payment on a house that is now worth $50,000 less than when he bought it.

    But Tronio is no idiot, and he sums up concisely what will be the eventual outcome if we are unable to bust up the criminal regulatory class currently charged with overseeing a criminal financial class:

    It’s a domino effect. If they push too hard, all the dominoes are going to fall.

  7. Cash212

    I used to enjoy your blog but lately it’s become a copy/paste job with a brief bit of inane commentary.

    Hedge funds and private equity funds are usually investing private capital and will have to do so on a unlevered (or less levered) basis going forward. In one form or another they are merely stewards of people’s savings and get paid to efficiently allocate capital.

    Some funds succeed, others fail but how many hedgefund bailouts have their been so far? Obviously there are some funds that wish to benefit from the Bush/Obama theft/bailouts but to suppose that hedge and PE fund are some monolithic entity is not fair- most just want to compete on an equal footing without govt meddling.

  8. DownSouth

    Harlem Dad said…”Now I wonder if Capitalism as I understood it ever really existed at all?”

    Even before the American Revolution class interest expressed itself in American politics, and the privileged class resisted revolutionary sentiment by appeals to law and order. Speaking of the American Tories, Parrington declares: “Compressed in a sentence it (American Tory philosophy) was the expression of the will to power. Its motive was economic class interest and its object the exploitation of society through the instrumentality of the state. Stated thus, the philosophy does not appear to advantage; it lays itself open to unpleasant criticism by those who are not its beneficiaries. In consequence much ingenuity in tailoring was necessary to provide it with garments to cover its nakedness. Embroidered with patriotism, loyalty, law and order, it made a very respectable appearance and when it put on the stately robes of the British constitution it was enormously impressive.”~
    –Vernon Louis Parrington, Main Currents in American Thought: Vol. I, The Colonial Mind

  9. TheTuss

    “Find me a hedge fund that has been bailed out by tax-payer money???”

    How about the biggest of them all Goldman Sachs and AIG?

    Give me a break.

    Whaa whaaa whaa

    A rich man’s crisis.

    F*** off!

  10. Harlem Dad


    Thanks for the quote. Well. I guess that settles that.

    I’m reminded of Benjamin Franklin’s reply after the Constitutional Convention when someone asked “what kind of government have you given us?”

    He said: “A Republic, if you can keep it.”

    A somewhat less well-known, and currently out of favor, comment from Thomas Jefferson may become apt in the not-so-near future:

    “The Tree of Liberty needs to be watered from time to time with the blood of tyrants and patriots.”

    I’m still hoping it doesn’t come to that.

    Tim in Sugar Hill

  11. Leo Kolivakis

    Brick wrote: "Sorry Leo, while I sympathize with a lot of what you are saying, some of specifics of the administrations actions seem prejudiced and rather like a bull in a china shop."

    >>I agree, they muddled it up, pandering to banks, hedge funds and private equity firms. Instead of listening to guys like Krugman and Stiglitz, they are bending over backwards to make the private fund managers and banks happy.

    But it is important to remember that these alternative investment funds made billions as public pension plans plowed billions into them.

    Sure some performed well and deserved their fees, but most were just big fat asset gatherers collecting the 2% management fee for tuning on the lights while they sold beta and charged outrageous alpha fees.

    The majority of PE funds and hedge funds are not worth their weight in salt. They talk the talk but offer little in the way of true alpha. They are just good marketing machines.

    And as far as bailouts, Goldman and others got bailed out big time. In fact, the whole hedge fund industry got bailed out as the Fed and the Treasury bailed out the big banks. Before that, hedge funds were hemorrhaging.


    The line between hedge funds and PE funds is blurring. Hedge funds do not have the skill set that PE funds have, but most PE funds are stacked with investment banking types who are good at financial engineering but don't know the first thing about operaing a company and turning it around.

    Why do PE funds want to buy banks? One word: SPREAD. If you can borrow at zero from the Fed and lend it out at 4 or 5%, you are printing money and charging alpha fees for it…thank you very much!

    Will be back later today.



  12. kackermann

    I second TheTuss.

    Hey, does anyone know the quickest way to become systemmically important?

    The only reason I ask is because it appears the government is going to accomodate this vaunted class of corporation. Moral hazzard is the prize.

    These banks should start advertising investment returns as a percentage of Treasury receipts with 0 risk.

  13. AP

    Cash212 provided a rare, dissenting voice against what awareness is being raised. When I see posters like this, it’s compelling why they post their defense of a completely corrupt, broken, and maliciously manipulated system. Thanks for the sliver of humor on a Thursday morning.

  14. Leo Kolivakis

    AP wrote: "Cash212 provided a rare, dissenting voice against what awareness is being raised. When I see posters like this, it's compelling why they post their defense of a completely corrupt, broken, and maliciously manipulated system. Thanks for the sliver of humor on a Thursday morning."


    I have to laugh. If anything, Naked Capitalism is all about dissenting voices and if you have been reading my blog, I have been hammering away at pension funds who took on reckless risks with other people's money.

    I use to work at two of the largest pension funds in Canada and I allocated to the best hedge funds and PE funds in the world. I know who produces real, consistent alpha and who is just marketing themselves to dumb pension funds that get excited with brand names and slick presentations touting the benefits of alternative investments.

    The sad fact is that very few hedge funds and PE funds deliver true alpha – in most cases it's leveraged beta. Take away the leverage and you are taking away their oxgen.

    Cash212 talks about unlevered hedge funds, but depending on the strategy, leverage can be as high as 10 to 1 and in some cases a lot worse.

    Hedge fund strategies vary but I can tell you that very few market neutral funds use no leverage. Most are levered to enhance their returns. This is not necessarily bad as long as the manager is experienced enough to know when to crank it up and when to dial it down.

    Unlike pension funds, the best hedge funds know how to manage their risk. They will cut losses and protect their gains, focusing on minimizing downside risk. The reason they focus on risk is because they have skin in the game and their incentives: if they do not perform, they don't get paid performance fees. That's why hedge funds that lost 30% or more folded in 2008.

    As for PE funds, it will take them longer to recover because they need a sustained recovery in the stock market and economy before they can recover.

    But whatever happens, going forward, the best pension funds will be scrutinizing their allocations to hedge funds and PE funds, making sure they are paying fees for true alpha. Also, look for a compression is fees as the big funds look for better terms.

    My post was to make you all aware that hedge funds can cry foul, but the truth is that they and PE funds made a killing with their outrageous fees (don't get me started on mutual funds who charge and underperform index funds!).

    I find it ironic that hedge funds and PE funds benefitted from GM and Chrysler's pension plans and some tried to squeeze these companies on their debt.

    Yeah, I know, managers have a ficuciary obligation to their investors …and to their own pockets.



  15. Hugh

    On the one hand I hear that hedge funds have all this cash ready to go, but with all the bargains out there I would think they would have spent some of it by now. So this has me wondering if they really are that much better off than the rest of the financial sector or if they are in as bad shape as everyone else but, like the banks, will act as if they are solvent until proven otherwise.

    As for Flowers, why shouldn’t he act with complete arrogance toward government. Everyone else in the financial industry does, and so far it has cost them nothing.

  16. Ray

    Totally shocking. ‘If you need me, I’m here with my speculating billions.’ If the seduction works, it’s the road to a corporatist state, or worse.

  17. Greg Hall

    How is it bullying when you lose at a negotiation? They had the option of accepting a discounted number and opted instead to hold out to see if a court settlement might get a higher sum. They took a risk. It reminds me Monte Hall asking, “Will you keep the $, or opt for door #3?” It’s time for all these babies to quit whining and take their medicine–they’ve lost dollars for their clients, period. The auto industry is in the tank. The only way to extract optimal value is a total liquidation. Well, that’s just not in the national interest. So, have a great day, Mr. Asness.

  18. Ray

    If private equity/hedge funds control banks, as Flowers wishes, it would merely displace one type of reckless risk taker (bankers and shadow bankers) with another. And, as I implied above, with PE’s combined ownership of production firms PLUS banks, the country’s economy becomes hostage to these “new leaders.” Do THEY know what’s best for America?

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