Satyajit Das: It’s All Greek to Me!

Yves here. In case you managed to miss it, there is supposedly an agreement for Greece to get €130 billion. But then we learn that Greece will still need more dough if it meets its target of reducing government debt to GDP to 120% by 2020 (and why is debt to GDP of 120% seen as sustainable then when it is not seen as sustainable now? And leaked documents further note that Greece might not meet its targets (duh!) and its debt to GDP could instead by 160% of GDP, which would require bailouts of nearly twice the amount now contemplated. And “discussions” are continuing in Brussels into the early morning, which says this deal is about as done as the US mortgage settlement.

By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

The Greek Prime Minister spoke of a choice between “austerity” and “disorder”. He got both, as the Greek Parliament based the European Union (“EU”) agreed to severe budget cuts and outside rioters protested the plan.

In great dramas, sub-plots support the main story. The story of “hairshirts” (the Greek economic plan) and “haircuts” (the writedown of Greek debt or PSI – Private Sector Involvement) are little more an intriguing side show in the broader European debt crisis.

With Greece increasingly doomed, the real significance of the negotiations is that they provide a template for future European sovereign restructurings. No one buys the oft-stated European leaders’ position that Greece’s position is unique or exceptional. Portugal is first in the line of fire, with the Irish, Spanish and Italians watching anxiously.

In July 2011, the Institute of International Finance (“IIF”), a lobby group representing major banks and investors, proposed a complex plan entailing investors suffering a loss of around 21% on the value of their Greek bond holdings. On 27 October 2011, banks and investors were “invited” to accept a 50% write down under threat of larger losses if they did not agree. The write-down was structured as a “voluntary” exchange of maturing Greek bonds for new bonds, to avoid triggering credit default swaps (“CDS”) contracts, a form of credit insurance.

Greece has around Euro 350 billion in debt including Euro 70 billion in bailout loans and around Euro 80 billion in bonds held by the European Central Bank (“ECB”). A 50% haircut of the remaining Euro 200 billion equated to reduction of Euro 100 billion. As around Euro 85 billion is held by Greek banks and pension funds, the reduction of Euro 100 billion was less than 30% of outstanding debt, as only private investors are covered and bonds held by official institutions such as the ECB are excluded.

Following protracted negotiations, the Greek government has agreed on a new austerity package. The bond exchange is likely to proceed with bond holders’ writing off 53.5%, equating to losses of over 70-75%.

The Troika – the European Union (“EU”), European Central Bank (“ECB”), the International Monetary Fund (“IMF”) – needs to reduce the level of Greek debt to a “sustainable” 120% of gross domestic product (“GDP”) by 2020. The bond deal and the latest budget cuts are designed to achieve this paving the way for a second financing package for Greece to enabling Greece to repay a Euro 14.5 billion bond on 20 March 2012. Deterioration in Greece’s finances required the bigger writedowns and greater budget cuts.

But even the greater austerity and larger losses to lenders will probably leave Greek debt above the target level, requiring delicate financial engineering to at least cosmetically reach the target. In the end, the fancy footwork yielded an irrelevant 120.5% of GDP.
The 120% level is largely meaningless, being a political construct designed to avoid drawing unwelcome attention to Italy whose debt levels are around this level.

There is no certainty that the agreement reached can be implemented. The IIF represents around 50% of banks and investors.

Investors with Greek bonds naturally want to minimise losses. Investors who have hedged by reinsuring the Greek bonds prefer default to a voluntary restructuring, allowing them to trigger their insurance and cover losses. Hedge funds who bought into Greek bonds, at prices around 30%, want a result which gives them a profit.

The deeper losses will increase resistance to the deal, especially from hedge funds who may prefer to take their chances in a default.

One option is to unilaterally insert collective action clauses (“CACs”) into existing bond contracts, allowing a supermajority of lenders to bind the minority.

A complicating factor is the ECB’s refusal to take losses. With direct holdings of Greek bonds of Euro 40 billion as well as additional loans to banks secured over Greek bonds, the ECB’s capital of Euro 5 billion (scheduled to increase to Euro 10 billion) is insufficient to absorb losses. As the CAC would force the ECB to share in losses, a special arrangement will exempt them from the effects of any CAC to the further detriment of already resistant private lenders.

The special treatment of the ECB means that commercial lenders are effectively subordinated to official lenders, a position which has been avoided to date. Given that after any restructuring, the bulk of its debt will be held by official lenders, such as the ECB and IMF, it is unlikely that Greece will be able to return to financial markets for a long time, which probably in reality was always the case. But this will discourage commercial investment in risky European debt, such as that of Portugal, Ireland, Spain and Italy, adding to the contagion pressures.

Any agreement is also likely to face legal challenges from lenders, which would complicate proceedings.

Another complication is the extremely tight timetable that must be followed to ensure the arrangements are implemented in time. There is little margin for error.

If the new agreement cannot be implemented, then the Troika could extend the necessary money to meet the March maturity and continue negotiations, although this would be difficult. Alternatively, they could arrange an orderly default. Another outcome is that Greece unilaterally declares a debt moratorium and leaves the Euro.

Voluntary or involuntary default, large voluntary losses, and/or CACs all increase the risk that credit insurance contracts may be triggered with increased threat of contagion.
This agreement is unlikely to be the definitive resolution everyone seeks.

Greece has consistently failed to meet economic forecasts. Despite measures by the Greek government, debt continues to increase. According to the EU statistics office, Greece’s debt reached 159.1% of GDP in the third quarter of 2011, up from 138.8% a year earlier and 154.7% in the previous quarter.

Greece may get through the March 2012 maturity but the arbitrary 120% debt to GDP ratio, the best case under the plan, is unsustainable, even in the unlikely case that it is met. The Greek economy, which has been in recession for years, shrank by 7% in later part of 2011. Budget revenues for January 2012 fell 7% from the same time last year, a fall of Euro 1 billion. This compares to a budget target for an 8.9% annual increase. Value-added tax receipts decreased by 18.7% in the same period compared to January 2011.

Greece’s financial position will deteriorate and it will miss key milestones – debt levels, budget deficits, growth, asset sales and structural reforms. The projected reductions in debt are based on optimistic assumption of growth which are unrealistic given the severity of the income cuts and shrinkage in government spending.

With elections due in April 2012, government support for the austerity plan cannot be assumed, in face of a serious recession and increasing social unrest.

A similar pattern is already evident in Portugal, Spain and Italy with debt, budget and growth targets, largely unrealistic, being missed. Popular resistance to reforms and austerity is also predictably rising. Prime Minister Maria Monti has made it clear that Italy cannot take more austerity, which has barely started to be implemented.

Even if the Greek “rescue” is agreed, the Euro-zone still need to finalise the Euro 500 billion rescue system by April 2012’s IMF meetings. The fund is designed to create the much vaunted firewall to prevent Euro-Zone instability from spreading.

There are suggestions that the size of the bailout fund could be increased. But Germany, Finland and the Netherlands, the only remaining AAA rated members of the Euro-Zone, are reluctant to increase their commitments. The credit ratings downgrade of many other member nations, including France and Austria, has increasingly highlighted the risks of increasing their exposure.

The IMF is trying to marshal additional funds from members to support a European bailout. At the World Economic Forum, IMF head Christine Lagarde said that she was attending “with my little bag, to actually collect a bit of money”.

Following direct approaches by Lagarde, China and Japan have mouthed platitudes about “help”. Any support has been made conditional upon the Euro-Zone members increasing their commitments, in the knowledge that it is presently unlikely. Tellingly, China Investment Corp (“CIC”), the country’s sovereign wealth fund, and influential Chinese central bankers have rejected suggestions of purchasing European government debt. One official stating that: “We may be poor, but we aren’t stupid”.

The US has ruled out contributions, though is shouting encouragement from the sidelines. The US Congress still hasn’t approved the previous round of additional IMF commitments.

Everyone knows the amount of money available is insufficient to deal with the problems.
History suggests that a write-down of debt for distressed borrowers is frequently followed by others.

The entire trajectory of discussions, plans and negotiations largely ignores Greece. There is no longer any pretence of “assisting” Greece. It is about ensuring that German and French banks minimise their losses. It is probable that no funds will be released to Greece but rather placed in a special account from where it will be used to meet the country’s debt obligations.

Germany and the Netherlands has suggested that the EU assume control of Greek finances and elections be suspended in favour of a technocratic government, having the confidence of Berlin, Paris and Brussels. In the end, the communique required Greece to pass a humiliating law giving priority to debt repayment over other government obligation. The Trioka will establish a permanent presence in Greece to oversee the process. The loss of Greece’s sovereignty has not been well received, at least in Athens.

Subplots connect main plots in thematic terms or provide minor diversions or comic relief. The light relief in this instance come from a group of hedge funds who have threatened to take action in the European Court of Human Rights alleging that Greece has violated bondholders “rights”.

In the end, Greece may live to default another day. Other embattled European nations will be scrutinising the Athenian sub-plot extremely closely as to clues as to their future as they await the battles that lie ahead.

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  1. jake chase

    I am a huge fan of Das but one must be careful in applying logic to financial conundrums. In the end, money remains infinite and available at the touch of a mouse. I would not be betting against more extend and pretend, inasmuch as the alternative would make 2008 look like a dip. Of course, this hardly augurs well for individual Greeks, or Portugese, Spaniards, Italians or Americans either. As for default, the CDS exposure of American banks suggests that is not a real option. Helicopter Ben is undoubtedly fully engaged and cares not a wit for Congressional id**ts, to whom money is what shows up in lobbyist carryon luggage.

    1. Dan B

      “In the end, money remains infinite and available at the touch of a mouse.” Yes, a great point. I’d add that natural resources, primarily oil, are not subject to extend and pretend or creation at the click of a mouse. Greece, Portugal et al are in severe energy deficit. The basic issue is that they can not much longer operate, maintain and repair, let alone grow their economies. No grwoth = no debt repayment, but a lot of human tragedies and, in their end, their economies shrink anyway. A question historians will ask of our time is, “Why did it take them so long to realize that they’d hit the limits to grwoth?

      1. Susan the other

        We need only look to the way a colony, a biological colony of bacteria or aspen trees, limits its growth. Old forests gradually thin out the spaces between trees. Bacteria frequently eat themselves to death. I conclude trees have brains.

        1. CautlinO

          “I conclude trees have brains.”

          They certainly have us well trained. I have some direct knowledge about the extent to which walnut and almond orchards are able to extract work and investment from humans. They’re almost as efficient as banks.

      2. Eric Lam

        I agree with your opinion.
        In the meanwhile, I think that it is really pathetic for Greece. It is unbelievable that the country is near the edge of bankrupt. It it were in the ancient time, a country without money must been defeated. Nowadays we just talking about her recover plan and wait her return the money she own. In this case, Greece wasn’t been defeated just because we would gain more of her returning the money than really defeat her.

        I think the following article is relevant to the topic.

  2. UnBeliever

    Yves – how about a comparitive piece on Iceland? Surely we are past the point where any of this is in the interests of the people of Greece.

  3. Jim Haygood

    ‘As around Euro 85 billion is held by Greek banks and pension funds, the reduction of Euro 100 billion was less than 30% of outstanding debt, as only private investors are covered and bonds held by official institutions such as the ECB are excluded.’

    Are you certain about this? Other reports say that Greek banks and pension funds will have to be recapitalized after recognizing losses on the proposed bond swap. Otherwise the abandonment of pari passu treatment would create multiple levels of subordination.

    A related question is whether the indenture of the ECB’s newly swapped bonds has been posted? Everyone’s talking about this fait accompli swap, but Yves has yet to report on the juicy bits.

    Finally, one report this morning says that EFSF will have to raise 70 billion euros to fund the coming swap, including sweeteners. As I recall, EFSF has done only small bond issues before, in the 3-5 billion range, and most of its vaporware capital consists of pledges. (I’d really like to see EFSF’s current balance sheet.)

    Has anyone in Brussels thought to ring up the rating agencies — especially grinches like S&P — and make sure EFSF’s AAA rating is still copacetic?

    My guess is that a 70 billion euro EFSF auction will resemble a cross between a Chinese fire drill and a drunken goat rodeo.

    Lalaland, comrades — it ain’t a place, it’s a state of mind!

    1. Susan the other

      If there were an authentic financial ratio, which has so far eluded us to the level of oxymoron, wouldn’t it be worked backwards from full employment to the amount a financial “system” needs to survive and operate (not fraudulently or unconscionably) to provide the overall benefits essential to a society and then backwards again to the amount of money necessary for the system to manage – and only thereby could a reasonable “ratio” of anything be determined? So if you are in a total mess, as now, you have to start going backwards from where you want to be to figure out what you need to get there or stay there. If we were given the old inadequate provenance trail of the “financial ratios” necessary for social well being wouldn’t they seem irrelevant and wrong in this new age?

  4. Johnny Lunch Box

    GDP is the Gross Domestic Product and if most of the GDP is created by stimulus then the real Net earnings on the GDP will never pay down a GDP that is already over 140%. Alice from Wonderland is Dead. The Tin Man is coming.

    1. Johnny Lunch Box

      GDP is the Gross Domestic Product and if most of the GDP is created by Government stimulus then the real Net earnings on the GDP will never pay down a debt ratio that is already over 140% of the GDP. Alice from Wonderland is Dead. The Tin Man is coming.

  5. Yancey Ward

    The Greek people will have to take matters into their own hands. They will not be able to borrow from any external source to spend on themselves for anything. All this deal does is lend Greece money to pay off external, official lenders, and Greeks aren’t even allowed to put their hands on these funds. In addition, they must tax their people and put some of these funds into these same hands-off accounts to pay the external, official lenders. I simply don’t see the actual benefit to the Greeks themselves. Since austerity is coming one way or another, I think it time for the Greek people to cut the external, official lenders off at the knees. A straight-up debt servicing moratorium/default would be a refreshing instance of honesty for all involved, regardless of how much they wish to continue lying.

    1. Maju

      Cuban model is the way: Cuba does not borrow from any external sources and is doing very well compared with Greece and most peripheral Europe.

  6. DiSc

    The misspelling of Italian names by foreigners is a global emergency. Monti is called Mario, not Maria.
    Ah, I will drink a capucinno over it.

  7. Maju

    I don’t think this is actually setting any precedents because what they are doing to Greece can hardly be done to any other member state – and in the Greek case is also likely to backfire in no time.

    What they are trying to do is, by means of this debt scare, which every day is more obvious that is induced and unreal, to impose some sort of ultra-Thatcherism, destroying with the debt and crisis pretext the achievements of the popular struggles of all the 20th century and even the 19th if they can.

    In brief: debt is not really important, class war is. And it is class war intiated and persecuted from the Bourgeoisie (the 1% or 10% or whatever you wish) against the Working Class (at least the 90%).

    But to me it looks like opening the Gates of Hell: we have no idea what can happen next and in any case it won’t be good.

  8. Filthy-Rich

    the Institute of International Finance (“IIF”), a lobby group representing major banks and investors, proposed a complex plan entailing investors suffering a loss of around 21% on the value of their Greek bond holdings &
    a group of hedge funds who have threatened to take action in the European Court of Human Rights alleging that Greece has violated bondholders “rights”.

    Who ARE these “private investors” and “hedge funds” anyway? Let’s name some names! And how were they able to saddle Greece with all this debt in the first place? And if people in the Greek Goverment are responsible for these deals why aren’t there Interpol warrants for their arrests a la Iceland’s warrant for Sigurdur Einarsson?

    Yes a comparison to Iceland would indeed be welcomed.

    1. William Neil

      Dear Filthy-Rich:

      Your questions sent me scrambling for my Goldman Sachs folder and clippings. Here are a few articles that may be relevant to answering your question:

      From Feb. 26, 2010, NYTimes: “Fed Reviewing Goldman’s Moves on Greek Debt,” by Nelson D. Schwartz. The first sentence reads that the “Federal Reserve is examining the financial strategems devised by Goldman Sachs and other big banks to help Greece mask its ballooning debt over the last decade.” Here’s the link at;

      Or another from my pile, from Feb. 25th, 2010, the lead story of that Thursday: “Banks Bet Greece Defaults on Debt They Helped Hide,” here’s the link…at

      And, a bit deeper in my folder, another front page story, the lead story, in fact, from February 14, 2010, two years ago, “Wall Street Helped to Mask Debts Shaking Europe,” where I highlighted the following from Page A-16:

      “Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere. In dozens of deals across the Continent,banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Greece, for example,traded away the rights to airport fees and lottery proceeds in years to come.”

      Here’s the link:

      I did lose track of the outcomes on these leads about Wall Street lending, but I do believe, and not surprisingly, that no one has been indicted and no one certainly gone to jail over them. I don’t recall seeing the outcome of the Federal Reserve “examination.” But maybe someone else does and if they don’t, maybe I should get back on the trail to see what happened.

      1. Filthy-Rich

        Willaim Neil, thanks for the links!

        Unfortunately as you mentioned the trail goes cold after these. Here are some snippets of interest from two of them:

        “In 2001, Goldman helped Athens quietly borrow billions by creating a derivative that essentially transformed a loan into a currency trade that did not have to be disclosed under European rules. The deal helped Greece stay within the limits on deficit spending that were key to Greece joining the euro, the common European currency now used by 16 countries. Goldman earned $300 million in fees from the transaction, according to several bankers familiar with the deal. In 2005, Goldman sold the derivative, known as a currency swap, to the National Bank of Greece, before restructuring it into a British legal entity called Titlos in 2008.”

        And also this: “But even before that issue became apparent, a little-known company backed by Goldman, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust. Last September [2009], the company, the Markit Group of London, introduced the iTraxx SovX Western Europe index, which is based on such swaps and let traders gamble on Greece shortly before the crisis.”

        So it looks like we would have to sleuth back to 2001 to see who in Greece’s gov’t cut the deals w/ GS in the first place. But I’m not holding my breath waiting for Helicopter Ben to do anything that would “upset the markets” while his buds continue their squeeze on Greece.

        In the words of Otter in Animal House, “I think that this situation absolutely requires a really futile and stupid gesture be done on somebody’s part!” :-)

  9. Hugh

    I am curious why no questions are being asked of US banks which sold CDS on this steaming sh*tpile. It’s not like the risks weren’t obvious, indeed inevitable. But I guess this is just another aspect of kleptocracy. Why wouldn’t US banks sell CDS to cover cr*p. If it works out, they pocket free money, and if it doesn’t, they drop it on Helicopter Ben, really a no lose proposition from where they are sitting.

    1. tawal

      Hugh, Here’s likely a piece of the puzzle from a recent article from Ellen Brown at global research:

      “Some observers question whether a Greek default would be that bad. According to a comment on Forbes on October 10, 2011:

      [T]he gross notional value of Greek CDS contracts as of last week was €54.34 billion, according to the latest report from data repository Depository Trust & Clearing Corporation (DTCC). DTCC is able to undertake internal netting analysis due to having data on essentially all of the CDS market. And it reported that the net losses would be an order of magnitude lower, with the maximum amount of funds that would move from one bank to another in connection with the settlement of CDS claims in a default being just €2.68 billion, total. If DTCC’s analysis is correct, the CDS market for Greek debt would not much magnify the consequences of a Greek default—unless it stimulated contagion that affected other European countries.”

  10. Susan the other

    Actually the benefits of default mean the US taxpayer pays because our Treasury Dept. will back those CDS obligations at tax payer expense because no insurer can cover them. I’m annoyed. Which sorts of animal are the US banks, are they commercial lenders or official lenders? We are led to believe that official lenders are government lenders. But here’s the EZ catch 22: there are no government lenders in the EU. The ECB is a quasi-sanctioned agreement between many different governments to pony up a little cash for this or that. It was never intended to bail out a complete bankruptcy of the EZ. Under what definition of “bank” is the ECB a bank? Only the old countries still have what could be called sovereign debt via their national banks. And the German and French banks played fastest and loosest with this half-baked system. This whole circus is to insure they get some of their money back. No funds will even be released to Greece. Even though Greece is now starting to starve.

  11. BobbyO

    The Dow soars while Greece is being dismantled. We compared the treatment of Greece to post WWI Germany, wondering what happened to good old fashioned invasion, rape and pillage when it comes to war. Anyone else notice overall, we have economic war today?

    1. Marley

      Not surprising… the neo-liberal bias is so deeply engrained. They have no idea what they are really cheering – a belligerent addiction to a bankrupt economic philosophy. I wish I could game them all… all the believers in “the market” and “confidence fairies” … on day there will be an alternative.

    2. Kraken

      One of the reasons the US gov’t refused to break up the “too big to fail banks” after the GFC, was because they have come to rely on them to wage economic warfare around the globe. They have become an important component of “full spectrum dominance”.

  12. craazyman

    Well it’s Chinese to me at this point!

    The more I read, the more confused I get.

    And if I keep reading like I’ve been doing, I’ll get so confused my brain will seize up and smoke will start coming out of my ears. I’m at the point I can’t even load up on SFK. I’m paralyzed with indecsion and confusion.

    Where do these Eurocrats think Greece’s growth will come from? They must have a theory, at least. You’d think so. But maybe they don’t.

    I have over-estimated people before. On many occassions, in my youth, I swore things couldn’t possibly be as repulsively stupid and repugnantly parastically soulless as they seemed, on the surface to my young mind. There must have been some adult in charge with a high-minded ethical conscience, steering the situation. And then I eventually realized, there was nobody. Not even the wizard of Oz. Nothing. Nada. Zilch. Zero. Nothing but corrupt and licentious assholes praying on whoever and whatever they could. These moments made me gasp in incredulity. Somehow I’m still capable of that gasp. I don’t know why that is, because I should have come to terms with cynicism years ago. It must be something having to do with faith in the unseen, in people capable of far more than me.

  13. reslez

    Germany and the Netherlands has suggested that the EU assume control of Greek finances and elections be suspended in favour of a technocratic government

    If this isn’t a holy s**t moment I don’t know what is. Two EU members unilaterally decide to overthrow the democratic government of another country… and this is the mindset these technocrats have. They think some stupid debt (a wholly imaginary, human-constructed concept) is worth destroying the democratic government of a free people.

    If I were Greek I would not stand for it either.

    1. Robert Dudek

      They are afraid of what will result from the April elections, which may finally see the traitorous members of the governement marginalised and an immediate declaration of default.

  14. Kukulkan

    The write-down was structured as a “voluntary” exchange of maturing Greek bonds for new bonds, to avoid triggering credit default swaps (“CDS”) contracts, a form of credit insurance.

    Isn’t this exactly what CDCs are for? Those who sold the CDS basically said “If the Greek government defaults on their bonds, we’ll cover your losses.” Well, the Greek government is defaulting, time to pay up. If they’re not going to pay up, then why were those who bought the CDCs giving them money?

    Either CDCs kick in and cover a situation like this, in which case the bond-holders agree to a write-down, collect on their CDCs (and congratulate themselves for being prudent enough to have purchased the CDCs in the first place), and Greece gets to start rebuilding its economy, freed of an excessive debt burden.

    Or, the CDCs don’t kick in and those who sold them are revealed to have essentially engaged in fraud and to have collected payments for nothing. If they’re not going to pay up when the pre-defined circumstances arise, then obviously the product is worthless and should be banned — or at least heavily regulated — as a form of snake-oil.

    If those who sold the CDCs can’t pay up, then they’re idiots who shouldn’t have sold them in the first place. Given such a blatant lack of fiduciary responsibility, why do they still have jobs?

  15. falun bong

    Ten years ago a government, especially a European government, would have buckled long ago in the face of so many riots.
    This is the lesson, and the elites have learned it well. These days you can squeeze the people more than ever before, and just ignore their cries when they’re being crushed.
    The Americans have it really figured out…just warp reality through the media so the people actually cheer on each new turn of the screw. And when in doubt just find a new foreign bugiman to hate and kill.
    This can and will continue on for much much longer. Print, squeeze, deceive, hate…print, squeeze, deceive, hate.

  16. chas

    And the poor banks that bought Greek bonds are only going to get 50 cents or whatever on the dollar? But what did they use to buy those bonds? You guessed it — money printed out of thin air. 50% of something is a whole lot better than 100% of nothing.

    Too bad Greece can’t repay them with more money printed out of thin air. Or can they? By the way, how do you tell real money from money printed out of thin air (funny money)?

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