“Zombie Mortgages” Mean Delay of Housing and Economic Recovery Well Past 2014

A new research piece from Barclays raises some far reaching implications.

Many economic pundits forecast the housing market will bottom in 2012 and start recovering thereafter. I’d like to know exactly how that happens when the odds of a Eurobanking crisis is the next six months look high, and it’s bound to blow back to the US.

But even the more realistic pundits (meaning those not in the employ of financial firms) may be unduly optimistic. For instance, Martin Wolf was one of the hosts of a Financial Times conference last week, and mentioned that he thought whoever would win in 2012 would look like a winner: the recovery will eventually take hold, and he believes, per Carmen Reinhart and Kenneth Rogoff, that the housing market will bottom in 2014 and a recovery will kick in then.

The person sitting next to me leaned over and said, “Japan”. And he is more likely to be right, for two (at least) two reasons. The first is, as the Barclays report indicates, via American Banker, that there is a very large shadow inventory and that is not adequately reflected in most tallies of how many homes will need to clear, ex more radical action to stem foreclosures (I would not hold my breath on that one). Second is that the inability to foreclose and the resulting “zombie” mortgages are not due simply to servicer discretion but due to likely difficulties in foreclosing due to chain of title problems. Why have foreclosures slowed down dramatically in New York, for instance? Because it appears that the requirement that the foreclosing attorney certify the accuracy of documents submitted to the court has thrown a wrench in the process. Now mind you, this measure does not increase the liability an attorney faces, but it makes it easier for opposing counsel to challenge the validity of submissions to the court (and false submissions are sanctionable).

Our Tom Adams has estimated that it would cost $20,000 to $40,000 more per foreclosure (no typo) to dispense with robosigning and prepare court documents properly in judicial foreclosure states. Think that might not have something to do with why foreclosures have slowed down a lot? Needless to say, I don’t buy the line that the government is leaning on banks to slow foreclosures, particularly when Fannie and Freddie have consistently pushed for faster foreclosures.

From Kate Berry at American Banker via e-mail:

Delinquencies on credit cards and auto loans have largely fallen back to levels seen before the recession, but debt-strapped consumers are still struggling with “zombie mortgages,” says Dean Maki, managing director and chief economist at Barclays Capital.

Zombie mortgages are home loans that are worth more than the underlying collateral of the house, Maki says. The backlog of zombie mortgages is impeding a recovery in home sales, because many sellers are stuck with loans they cannot repay even if they sell their home. Meanwhile, that backlog is encouraging buyers to delay purchases of new homes in the hopes that housing prices will drop even further.

“What we have is an overhang of zombie mortgages,” Maki said in an interview Wednesday. “It’s a housing market problem rather than an overall household indebtedness problem. Unlike the zombies that stagger around in the movies, these contracts will not remain forever undead.”

About 20 million borrowers are trapped in these zombie or “underwater” mortgages, in which they owe more than their home is worth. When those loans become delinquent, they are often referred to as limbo loans, because the government has urged mortgage servicers to hold off on foreclosures.

But the longer a borrower fails to make mortgage payments, the higher the likelihood that the loan will eventually go into foreclosure. And it will take years for many of them to go through the foreclosure process or for the loans to be restructured through modifications, further prolonging the glut of properties on the market and depressing housing prices.

Banks and mortgage servicers are trying to avoid exacerbating the situation by not putting all of their real-estate owned properties on the market at once.

“There’s a lot of inventory but it will come through methodically over three to four years, which will prohibit any price appreciation,” says Evan Gentry, the CEO of G8 Capital LLC, a Ladera Ranch, Calif., buyer of distressed properties.

More than 2.1 million homes are in the process of foreclosure and another 1.8 million homeowners were 90 days or more past due on their mortgage at the end of August, according to Lender Processing Services Inc.

Maki says that any policy initiatives that delay or threaten the resolution of “zombie mortgages” should be viewed as bad news, since such policies could ultimately delay a broad economic recovery.

He argues that investors should pay more attention to the foreclosure process and any local upturn in residential construction than to overall household debt levels.

If homebuilders continue to hold off on construction, an eventual rebound “could be quite strong,” Maki says. “We see the potential for a stronger cyclical recovery once the ‘zombie mortgages’ and the associated foreclosure pipeline are relegated to the history books.”

There are some interesting assumptions in the article. The first (and this is in all analyses of the housing market) is to assume that household formations continue in line with historical patterns. But we’ve seen a rise in people having to move in with relatives in this downturn. If unemployment continues to be high, we may not only see a persistent shift in attitudes towards renting versus owning, but towards nuclear v. extended families. It also seems to ignore how important second homes were in the last cycle, and it isn’t clear that we’ll see as strong a vacation home market as we once had. Second is that it ignores the looming and still unresolved chain of title issues. No one has come up with a way to cut the Gordian knot of mortgages that were not properly conveyed to securitization trusts. There are a lot of homes that cannot be foreclosed upon (legally, anyhow) until this issue is resolved.

But regardless of the particularly, the general focus is correct: the US has never had an economic recovery without housing playing a large role, and there is no good reason to think that pattern will change.

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  1. Brian

    An additional factor is that there is a tremendous amount of friction in the Asset management /property preservation / repair to market side of the business. I am working for a contractor on that part of the business, and the banks are creating metrics for their asset managers that are designed to maximize return and minimize upfront costs, so much of our work is done in response to emergent situations, often responding to issues that we brought to their attention and bid weeks or months before. This draws out the process, and the neglect of many issues result in higher costs later.

    This is reflected in the Zombie Mortgage Phenomenon. All houses need constant upkeep and investment. People who think they will lose their home do not do this work. The housing stock is degrading, from the large number of poorly kept REOs. to the vacant homes stripped for copper (2 more this week!) to the underwater mortgages, to the reduced income family that simply cannot afford a new roof or gutter repair when first needed.

    THis if course drives down demand, drives up costs to the banks, which slows down the clearance of the oversupplied market. We work with 2 of the 3 brokers that manage and list Fannie and Freddie homes in our area, and they are understaffed, and as fast as these things are selling, we’re getting new homes added faster.

    2014 is excessively optimistic. 2020 is more likely, sooner if we change immigration laws. (Increased rental demands from immigration will help the low- mid end)

    1. Skippy

      Yep, today’s cash savings is tomorrows variance blow out.

      Skippy…end of project reconciliation screw job attempts vs the pocketed variances for just such occasions…lol.

    2. TM

      You’re assuming housing spply remains constant.

      I’m willing to bet that a lot of those houses and neighborhoods will get bulldozed before 2020 to reduce supply.

      1. ambrit

        Dear TM;
        Yes friend, our local city government is fiddling around trying to perfect a method to systemize demolition of “blighted” housing. As an aditional sign of the times, a lot of previously on the market houses are being brougnt up to liveability by owners and small contractors, while the home sale rate isn’t rising signifigantly. Any figures anet rental rate deflation out there?

    3. Ray Phenicie

      “the banks are creating metrics for their asset managers that are designed to maximize return and minimize upfront costs, so much of our work is done in response to emergent situations, often responding to issues that we brought to their attention and bid weeks or months before. This draws out the process, and the neglect of many issues result in higher costs later. ”

      thank you (!) for pointing that out-this should be placed on large billboards around every major city until everyone catches on. Houses are not really much different that cars, refrigerators, ranges, furnaces, or other durable goods that may have a relatively long life (more than seven years) but ultimately move to a value of zero or less-demolition of a building is costly. The unique thing about a house, or any building that is well constructed, is that the structure can be repaired to prolong the expected life span. Thanks again for educating everyone in such a succinct manner.

    4. PaulR

      The article gives a first rate update on the mortgage situation and Brian’s note is an excellent micro insight into the issues involved as banks seek to minimize their losses and ride the line between smart asset management and penny-wise, pound-foolish, as we used to say!
      When is Yves going to open her fund-raising campaign? I’m on.

  2. rjs

    homes are not an appreciating asset any more than a car or other durable is, & they are no more like to “recover” to their former high prices than are dutch tulip bulbs going to recover to the prices they sold for in 1637…houses deteriorate over time & eventually are torn down, just as automobiles deteriorate & are eventually junked…originally, the reason houses seemed to appreciate in value was the inflation of the 70s; because money depreciated faster than houses, houses went up in price…if inflation was 100% per year, cars would appear to go up in price every year too; you could then buy a car & drive it three years & sell it for more than you bought it for…

    1. Jim A.

      And yet a large number of property owners, lenders, and government policies seem to assume that if they can just hold on for another year, the appreciation fairy will be resurrected and everything will be fine. Yes housing is more durable than a car, and has a greater utility (and therefore a higher bottom price) than tulips. But after the crash, we’re unlikely to see the crazy levels of speculation and therefore the crazy levels of appreciation for a generation or more. Because there will be a radically reduced ability to speculate using borrowed money.

    2. Ron

      Good points. The idea that suddenly America will start creating large tract housing on open rural landscapes or vast desert plains is more American Dream nonsense.

    3. geerussell

      When comparing housing to other durable goods like cars how do you account for the value of the underlying land and location?

  3. Mark P.

    1920 is indeed more like it. Dean Maki at Barclays Capital needs to stop hitting the hopium crack pipe.

    This is a good article by Yves, giving some sense of the vast scope of the housing market’s problems. And yet it doesn’t even mention two giant factors that’ll crush delusional hopes like Mr. Maki’s:-

    [1] Americans have to be able to afford to buy homes. History shows that the norm for home prices, sans real estate credit Ponzi, is usually about three times a buyer’s annual income.

    Since U.S. median annual household income is $46,000 — for those Americans who have incomes — we’re nowhere near those prices in most areas.

    [2] There’s a giant demographic overhang, as Baby Boomers pass into their post-family years, retirement, and ultimately senescence. Many Boomers may want to sell their current homes and size down. Not only may they now be trapped by their homes’ fallen market values, however, but also there are — there always were — going to be substantially fewer buyers than sellers.

    There are 96 million baby boomers as opposed to 50 million generation X-ers. Given that simple fact, the real estate future cannot look like the real estate past. Possibly, as TM comments, bulldozing homes and neighborhoods may come into play as a strategy.

    1. Escariot

      Echoing the above, and, too, the potential for an emerging societal reluctance to get saddled with real estate. The future job market, likely not robust, will require people to be mobile, able to migrate to the jobs easily, to relocate, to adjust to fluctuating circumstances. The group think after this mess is not going to want to go out and borrow like it did. We are likely going to be a little shy about getting back in that situation.

      The last incentive (and largest marketing tool of RE agents) is the tax deduction for mortgages on primary residences. What if one of these 9-9-9 ers gets in and they do away with that? Then it’s going to be a tough sell.

      But even IF the market comes back people are going to think small. They will get what they need and can easily resell. McMansions are likely a thing of the past, less square footage, less materials, less labor needed, less revenue for the wider economy per unit built.

      The ‘rebound’ will be slow and steady.

      1. flory

        Reluctance to be saddled with real estate will have to do with more than just job mobility. The entire generation of children who’ve seen their familes, neighborhoods and communities torn apart because of the destruction of the real estate market will likely be highly reluctant to saddle themselves with such an illiquid asset. We’re raising a generation of renters.

    2. Out of the Frying Pan

      Yes, but how many Gen-Y’ers are there? My recollection is that it’s closer to the baby boom size. They’re entering or in their 20s now.

      Add those to Gen X, and what do you get?

      1. Ron

        A high percentage of potential homebuyers are loaded with education debt and many others are the victims of the recent credit cycle trapped with large mortgage debt. The new worry is that Prime mortgage default rates are soaring focused on high value housing, think Calif million dollar coastal properties. It was easy to pump up the housing values in Calif but the bucket of potential buyers for these million dollar plus homes is tiny in relation to the number that is and will continue to come to market. The government has focused on the lower end but PrimeX is now showing signs of stress similar to ABX back in 2008 a clear signal that the larger wave is about to hit.

        1. Mark P.

          Thank you for bring up the fact that higher education has become the new bubble, replacing real estate.

          The student debt market is now much larger than the credit card debt market in the U.S., heading towards $1 trillion in size. Generation Y won’t be riding in like the cavalry to rescue the real estate market.

          That’s because those getting a 4-year degree at a for-profit college emerge with an an average cumulative debt of $27,510. Consequently, the smaller demographic of young people who graduate and then actually find a job have their ability to borrow already impaired — unlike previous generations of graduates who came out with either no debt or very little debt.

          And unlike mortgage debt, of course, those burdened by student debt cannot escape by walking away from their home or declaring bankruptcy. The federal government is the ultimate enforcer and it’s punitive. Above all, student debt can be pursued indefinitely. —

          ‘What Happens If You Default on Your Student Loans’

          Why so punitive? Well, unlike real estate — where a body of long-existing legal constraints and precedents had to be worked around — it’s arguable that financialized capitalism was able to construct this whole mechanism from the ground up. Hence, it was so constructed with Congress’s active help, with the rationalization presumably being that the whole machine would build what would have been generations of good little workers — or American debt slaves — if the economy as a whole could have continued as it was.

          Members of congress have done well for themselves building this debt-slavery machine. In one well-known instance, speaker John Boehner received $172,000 of campaign money from private student-loan companies during 2003 and 2004 and in return helped to deliver the legislation the student-loan industry then wanted.


          And yet — as with the real estate market — debts that cannot be repaid will not be repaid. We are now starting to hit that point.


          ‘Sharp Uptick in Federal Student Loan Default Rates
          More than half the increase is from students who attended for-profit colleges’

          Sep. 12, 2011

          ‘New data released by the U.S. Department of Education shows a sharp increase in the rate at which student loan borrowers are defaulting. The official “two-year cohort default rates” show that 8.8 percent of student loan borrowers who entered repayment in 2009 had defaulted by the end of 2010, up from 7 percent for those entering repayment in 2008. Across all colleges, about 320,000 borrowers who entered repayment in 2009 defaulted by the end of 2010 – 81,000 more than the 239,000 borrowers who entered repayment in 2008 and defaulted by the end of 2009. More than half of this increase came from students who attended for-profit schools: about 49,000 of the 81,000.’


          And so it goes.

    1. Yves Smith Post author

      Thanks for asking, but I alerted my tech guy, he ran a virua/malware check and the answer is no. You are apparently getting an erroneous reading. His message:

      The site seems to be clean. I ran few checks and also manually looked through the code:
      and separate one from google: http://www.google.com/safebrowsing/diagnostic?site=www.nakedcapitalism.com/2011/10/zombie-mortgages-mean-delay-of-housing-and-economic-recovery-well-past-2014.html

      What throws some anti-viruses off and may mark page as suspicious as the code that embed wiki-invest widget. The code itself is not malicious and fine, it’s just they way it’s written is causing a false-positive for the malware checks.

  4. Middle Seaman

    Finances are not my forte, but it seems to me that “recovery” as discussed above is assumed to happen withing the distorted framework of our current economy. That is, 40% financial, declining production and, therefore, the “recovery” will mean another make believe economy.

    May be.

  5. Crazy Horse

    Not to repeat my earlier posts, but its time for a new Homestead Act. Any foreclosed home that remains unsold for six months should be required to transfer to a pool of homes available for Homesteading. One house per customer, first come first served, $100 dollar transfer fee, Homesteader must “prove up” on the home by bringing it up to code standards or otherwise improving it.

    1. ambrit

      Dear Crazy Horse;
      (I’ll need some help from the Home Island Brits on this.) There were ‘Squatters Rights’ laws in England that helped homeless types aquire shelter. Are these laws still extant? How did they work out? (Views from both sides welcomed.) America has inherited so much from the Homeland, why not this too?

      1. Crazy Horse

        I’m not aware of the origin of the idea of Homesteading, but I’m sure if it originated in the UK there are plenty of opportunities for it to be revived there.

        In the US it served two functions:
        1- Ethnic cleansing. Offer a farmer the opportunity to clear the remaining buffalo and Indians off the land and you have a ready made excuse for genocide by the army if (when) the original owners resist.
        2- Class conflict escape valve. With an endless frontier in front of them, homesteaders chose the threat of scalping by a few Indians who had survived the white man diseases over a lifetime of being scalped by their masters in Boston or back on the Continent.

        A new Homestead Act would defuse some of the class conflict pressure in the USA, but believe me the 1% has plenty of other ways to continue it. Personally I’m in favor of scalping banksters rather than homeowners.

  6. Paul Tioxon

    I just had a wikivest trojan horse blocked by my aegis. Anybody have a problem with them? Are they snooping for anti-ows clientele?

    1. TheTrader

      Likely that’s a false positive… site seems to be clean, but wikiinvest embedding script appears to be causing some anti-viruses to complain.

      1. Yves Smith Post author

        TheTrader is correct, I asked my tech guy, who ran checks. His message:

        The site seems to be clean. I ran few checks and also manually looked through the code:
        and separate one from google: http://www.google.com/safebrowsing/diagnostic?site=www.nakedcapitalism.com/2011/10/zombie-mortgages-mean-delay-of-housing-and-economic-recovery-well-past-2014.html

        What throws some anti-viruses off and may mark page as suspicious as the code that embed wiki-invest widget. The code itself is not malicious and fine, it’s just they way it’s written is causing a false-positive for the malware checks.

  7. pratik

    really very good insights in this article… very informative and also eye opener for all the persons who are making the economies getting into the sea of borrowings..

  8. Susan the other

    There is a way to resolve millions of clouded titles due to faulty securitization and other mishandling of documents. It could be expedited if state governments and federal agencies coordinated their efforts behind a coherent plan. Every title currently held by a homeowner with a mortgage loan (over 20 million) could be automatically granted a quiet title by the state authorities. Within 6 months (or a year) anyone making a claim to that title (those who invested in the mortgages) could step forward and be given the opportunity to renegotiate the loan with the homeowner. The law of contracts would apply (federal law – UCC) so that both sides would have to negotiate in good faith. If it cannot be done sort of this way, it probably cannot be resolved.

  9. ambrit

    Re. the trojan horse. I haven’t encountered it. Could it be sophisticated enough to target only those with ‘suficient funds’ to be worth seducing? (The first comment out of my mouth once when a telemarketer tried to ‘sign me up’ for an investment seminar was; “You obviously haven’t seen my credit rating, have you.”)

  10. someguy

    We also have falling birthrates with the economic decline, discussed on NPR Marketplace last night. This trend is expected to continue. No babies = no house upgrade.

  11. jake chase

    $20 to $40 K more per foreclosure? Preparing the documents properly takes about 2 hours, assuming the foreclosing party can establish its chain of title. If it can’t, you could not do the foreclosures at any price, except by continuing fraud, which of course costs more.

    The real problem with housing is the prices, which still greatly exceed potential buyers’ ability to service even the low interest loans now available to those who are credit worthy. Until prices are allowed to come down to relate sensibly to stagnant income levels, there isn’t going to be any US housing recovery.

    So, all this talk about a recovery is predicated on increasing demand overseas for corporate drek manufactured in China and Mexico. Sales to Brazil and India do less than one would think for the US housing market, except perhaps in the Hamptons and along the California coast.

  12. drinkof

    While the 2 hours estimate assumes that the file is all in one place, as it were, the $20,000 to $40,000 estimate is very high. The work is much less time-consuming if they’re not done piecemeal. Done in aggregate, as a high profile, high transparency mass production, this could be done much more cleanly; our internal estimates are:

    – 10% – can’t be reconstructed right at any price
    – 10% – $5,000+
    – 65% – $2,000
    – 15% – $300

    The 15% occurs where the banks (certain old school community banks, mostly) kept real records, insisted on signed copies, backchecked everything. Their process would mainly be walking over to a set of cabinets and running copies.

    The analogy for the rest is oil well fire capping. Even the Red Adair company experts used to take a year to cap a well; in the aftermath of Iraq War 1, facing 1,000 intentionally set fires, they got that down to about 3 weeks, simple factor of mass production.

    As to whether we’d get the will to do this? Who knows, but en masse it would be painful, but could be done.

    1. Yves Smith Post author


      Do you know what you are talking about? These are securitized mortgages.

      You need to:

      Find the Pooling and Servicing agreement for the relevant securitization.

      Find the section which discusses the conveyance chain (as in the named intermediary parties). Also check as to whether the PSA contemplated allowing the originator to retain the note (most Chase deals did, IIRC WaMu did, fuggedabout the rest).

      Find the closing date and the cutoff date.

      See if the PSA allowed for endorsement in blank (note even if it did, you need to see each party in the conveyance chain as signatories).

      Check to see if governing law for the trust was New York or Delaware.

      Obtain the note. It should be in the collateral file (with the trustee, who is not the servicer) but probably isn’t.

      Compare the note with the requirements of the PSA. Oh, and if it was a New York trust, the PSA may say the final endorsement was to the trustee, but that’s wrong, it needs to be endorsed to the trust.

      Now go see if the signatures are the right ones, in the right order, and everything was done before the cutoff date.

      This does not take 2 hours even in a best case scenario. You need to gather documents and read them against each other. And it needs to be a somewhat competent person, probably at least a paralegal, more likely a young attorney since PSA language was non-standard.

      Oh, and you ALSO have to have someone with personal knowledge verify the amount owed, remember? And those records happen to be completely screwed up in a lot of cases, maintained by a zillion people. The only person who MIGHT do as a stand in is someone with general knowledge of all the systems, provided they could vouch for their integrity in testimony. So you now will have to turn very senior people into robosigners. How is that gonna work? I’d quit if someone did that to me.

      This is not just filling out documents, the legal requirements for court evidence is actually pretty high. As it should be.

      1. just me

        Your estimate was for judicial foreclosure states — any thoughts for nonjudicial foreclosure states like California?

        Thinking of this earlier post of yours about the San Diego County MERS case going to the Supreme Court (not much confidence): http://www.nakedcapitalism.com/2011/08/mers-case-filed-with-supreme-court.html

        The Gomes case had been discussed earlier on Daily Kos when it lost on appeal (pre Supreme Court):


        But, more ominously, the court also held that if all someone challenging a foreclosure has is the belief that their loan might not have been transferred properly as part of the securitization process, that homeowner has nothing at all and cannot come into court to challenge the sale of their residence. Effectively, this decision sharply reduces the ability of California homeowners, who normally don’t have access to the internal files of their lenders, to get the foothold they need to actually prove they are right — the foothold called “discovery.” This part of the ruling not only affects non-judicial foreclosure, it is likely to bleed over into judicial foreclosures as well.

        This means that at least for now, the show the note defense is now likely dead here in California.

        1. LucyLulu

          Even assuming one is in California……..

          One can obtain a copy of the promissory note and thus check the endorsements. I believe the current numbers are that 60-65% of mortgages outstanding have been securitized. Of those, roughly 90% were securitized into NY trusts, which require endorsement over to the trusts. Blank endorsements are not allowed, nor are ex-post-facto endorsements legal. I can’t cite numbers on how many notes have been correctly endorsed into the trusts but the numbers are very low, some experts in the field claim they have never seen a single one.

          That makes at least 50% of mortgages in non-judicial states contestable, assuming the homeowner has access to legal aid. And THAT is where one finds the big rub. I live in a non-judicial state as well, and as my sister, an attorney in a rather large firm says, nobody wants this business. With the lack of awards of damages, attorneys are unwilling to take these cases on a contingency basis, at best the attorneys will only recoup legal fees (assuming they win, and if they lose, they don’t get paid at all), and homeowners who face foreclosure typically have no funds to pay an attorney. Attorneys need to get paid for their work, just like everybody else.

          IMO, if a deal is negotiated with the state AG’s, the money should go towards legal aid for homeowners….. especially since there will be grossly inadequate funds to provide sufficient mortgage relief in a manner that is fair to all affected. Proving lack of legal standing to enforce the debt, in turn, would impose a far greater penalty on the banks. Collateral damage would also be incurred, e.g. investors in MBS, but think of how angry investors would be at the banks, and perhaps regulators and the judicial system for (intentional) failure to resolve the matter prior to the statute of limitations running out!

          1. just me

            You wrote “One can obtain a copy of the promissory note” — isn’t that exactly what show me the note was all about, and what banks/servicers rebuffed? Maybe I misunderstood Gomes? I thought the owner could not get discovery and argued on that basis.

      2. SidFinster

        While I agree that this is a lot of work, I doubt it will cost USD 20-40K per mortgage – in part because the work can be done in bulk, but mostly because there are a lot of small legal shops that need money as badly as the rest of us do.

  13. dilbert dogbert

    Re: Living with relatives and family formation
    I think a big head of steam is building on these two fronts. If the economy and jobs starts showing some promise, housing and marriages and babies will give the end of WW2 a run for its money. I hope so.
    No matter how good your relationships are with mom and dad or other relatives, everyone wants their own place. The old parent/child attitudes will come into play resulting in tensions. Part of the flow of living is marriage and children. Apartment living with kids is tough. This is why I see a coming boom. I can’t see the timing.

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