David R. Henderson  

Judiciary Dishonesty

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This weekend, I spoke on free trade at the Club for Growth's annual meeting in Palm Beach this weekend. At dinner last night, I heard an amazing story from Steve King, a Republican congressman from Iowa. I was amazed at two levels: (1) the story itself and (2) the fact that he was not amazed.

King is a member of the House Judiciary Committee. Recently, the Committee has been meeting about the "cram down" bill, a proposed law that would give the power to judges in bankruptcy meetings to alter the terms of people's mortgages. King, realizing that the bill is likely to pass, was trying to minimize the harm it would do. So he offered an amendment that would prevent anyone from taking advantage of this special deal if he/she had engaged in any material misrepresentation during the original mortgage process. His amendment passed by a vote of 21-3.

But later the staff of the Committee, who report to Chairman John Conyers, altered the amendment, after it had been voted on, to state that no one could take advantage of the special deal if he/she had been convicted of fraud. Of course, there's a huge difference. What they voted for is very different from the language that the staffers substituted without the permission of those who voted.

I was shocked. I asked King if there was anything he could do about this dishonest behavior on the part of Conyers's staffers. He said that there wasn't.


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COMMENTS (26 to date)
Ed Hanson writes:

David
I, like you find it amazing if true. However, it may be necessary to return to Rep. King for clarification as to where the words or intent that mentions "convicted of fraud."

I have looked and cannot find it, but I have no great experience in such searches. Perhaps the good readers of EconLog can find what I could not. Here is some of my search.

The mark-up of the King amendment can be found at

http://judiciary.house.gov/hearings/transcripts/amendments/AKing090127.pdf

Here is how this amendment looks on the bill HR 200, Section 6, reported by the committee from Thomas.

http://thomas.loc.gov/cgi-bin/query/D?c111:2:./temp/~c1114tHAWN::

"`(11) whenever the plan modifies a claim in accordance with section 1322(b)(11), the court finds that such modification is in good faith and that the debtor did not obtain the extension, renewal, or refinancing of credit that gives rise to a modified claim by the debtor's material misrepresentation, false pretenses, or actual fraud.'."

It reads just as the King amendment mark-up reads. And as I said I can find nothing that reads about a conviction. Because I have no legal training, maybe I should ask if there are any lawyers out there.

Steve King writes:

Ed,
Your research is correct as is David's characterization from our dinner conversation. The Judiciary Committee staff changed the language and coupled the "Cram Down" legislation, which passed the Judiciary Committee, with two of Barney Frank's bills.

The bill then got a new number. That's why you can't track it on Thomas. Technically, they can bring a bill directly to the floor without committee action. This was an arrogant contemptuous action that disenfranchised 21 Members of the Judiciary Committee and every, bill paying, law abiding American.

In response, I challenged Chariman Conyers before the full committee, brought my amendment back to the Rules Committee twice, and went to the floor to speak several times. Mostly there is just no response from them. They know they're wrong. They have the votes to beat us fair and square every day. They cheat because it's easier.

I'm not finished with this issue and intend to press it at future openings.

David, thanks for putting this up. It gets too little coverage.

Steve King

Zhao W. writes:

As a Chinese, I find this totally amazing. I mean, Rep. King is replying as I was following the search link. You have a wonderful system. And I hope you keep it up. Sincerely.

Ed Hanson writes:

It is not just Zhao W. who finds this totally amazing. I do also.

Thank-you Rep. King for your response to my comment. I can not say I now understand what has happened in the House, fully, but I have gained great confidence. In the tradition with the best aspects of a Republic, where reliance on direct, diligent, and informed members of Congress in necessary and crucial, you are demonstrating that here and in the House.

Again, all I can say is thank-you. I will attempt to follow the issue.

Bob Murphy writes:

Is this par for the course, or is this behavior unheard of? I too am amazed when I learn of some practice in DC, but I don't have the experience to know if this has been going on for 50 years...

El Presidente writes:

David,

Aside from your moral outrage about the staffers' behavior, what about the policy? Would you be in favor of modifying deals based on material misrepresentation that the lender was involved in, or does that street only go one way? For instance, I have first-hand knowledge that many loan officers were involved in inflating reported borrower incomes then promising to refinance the loans at a later date to avoid payment shock. They never bothered telling the borrowers that they were performing illegal acts on behalf of the lenders who counseled them to persuade the borrower that they were the borrower's agent. And they failed to make clear that the borrower's ability to refinance would largely depend on market conditions, not solely the borrower's ability to make unusually low payments for the next two years of a 2/28 ARM with a teaser rate and a baloon rider. So, who's gonna go after the loan officers, the lenders' agents, for anything less than fraud which must be proven in a court of law? As a matter of policy, your desription leads me to believe they got it right. Though, like you, I don't approve of the way you say they achieved it.

The Snob writes:

El Pres:

If the agent says "let's just put this number down here, m'kay?" and the borrower goes along with it and signs, then they are a willing accomplice.

Likewise, if we start allowing borrowers to use the Flounder Defense ("You f---ed up. You trusted us!") to get their loans modified, then we can expect to see mortgage rates drifting up in the direction of credit card rates, which is just bully for those of us who'd like to leave the ranks of renters someday. There's a word for anyone who turned down a 5-6% 30-year fixed loan in favor of a 4.75% 5-year option ARM, it's "fool."

GU writes:

Shouldn't the headline read "Judiciary Committee Dishonesty"?

El Presidente writes:

The Snob,

If the agent says "let's just put this number down here, m'kay?" and the borrower goes along with it and signs, then they are a willing accomplice.

Then let's prosecute them both for conspiracy and nullify the contracts. Sound good?

Crawdad writes:

I don't have a problem with prosecuting people who colluded in falsifying mortgage papers at all. We are still living under the rule of law, no?; at least temporarily. I do have a few questions.

1. Are there Constitutional issues concerning this move to have judges basically rewrite contracts. Any precedent?

2. Questions concerning the discussion between The Snob and El Pres: How widespread is this? Any actual data or just speculation? What percentage of mortgages in danger of default resulted from misrepresentation? I personally hope the numbers are low. To think that so many regular people would act criminally is just too depressing.

One other thing I can't figure out, and this will reveal how little I know about this subject, is this: My wife and I have purchased and sold three houses over the years and built another on our own, then sold it. Each time the actual contracts were put together by a disinterested third party, a title company. At closing we had to review and initial/sign each statement as to costs, insurance, interest rate, etc. Not sure how you could get away with misrepresenting the terms of the loan in that situation. Does is work differently in other states? If nothing else there should be easy paper trails to follow if there was misrepresentation.

MHodak writes:

Crawdad,

You and El Pres are talking past each other on the "misrepresenting" thing.

You're saying that if the bank clearly laid out what the terms were, there would be no misrepresentation. That's legally correct. To the extent that the borrower didn't read or understand what they were signing, that is incompetence (in the general, not legal, sense), not misrepresentation.

El Pres is saying that the bank (or their representative) told borrower that they could qualify for a loan at the ARM rate that they could probably not otherwise afford at the fixed rate (and may not have been able to afford at any rate), then refinance the loan later, and the borrower believed them. In other words, he's redefining the legal sense of "misrepresenting" to mean "taking advantage of a person's ignorance or gullibility."

Woe on our society when El Pres's version of "misrepresentation" becomes a basis for voiding contracts between consenting adults.

El Presidente writes:

Crawdad,

This is gonna be a long one.

I don't have a problem with prosecuting people who colluded in falsifying mortgage papers at all. We are still living under the rule of law, no?; at least temporarily.

So, you are interested in paying taxes sufficient to cover hundreds of thousands of court cases which would prove fraud and invalidate the contracts leaving the banks holding devalued property, the borrower out on the street, and both parties paying fines or serving jail time while the value of neighboring properties declines as a result? That doesn't sound like the best idea.

1. Are there Constitutional issues concerning this move to have judges basically rewrite contracts. Any precedent?

Constitutional issues? Not really. Congress has the power to regulate interstate commerce. Since banking and trading securities are almost always intersate if not international activities, Congress can regulate them. Courts have traditionally performed this role as adjudicators of bankruptcies when contracts could not be honored. The use of cramdowns is unusual, but I don't think it is without precident. Any lawyers in the audience?

2. How widespread is this? Any actual data or just speculation? What percentage of mortgages in danger of default resulted from misrepresentation? I personally hope the numbers are low. To think that so many regular people would act criminally is just too depressing.

My personal experience is somewhere between "actual data" and "speculation". I was personally involved in several hundred loan closings at the height of the boom. I was careful who I would work for. I cut ties with at least six companies who employed loan officers that did the things I mentioned right in front of me. It was not rare at all. It was standard practice for many of the largest lenders to incentivize this behavior. IndyMac was one of them, and look where it got them. Countrywide did the same. Take a look at the numbers of NINA and NINJA loans originated during the boom. It is . . . anomalous, to put it politely. These are the so-called "liar loans" and they are the ones with the highest rates of default. I saw the numbers months ago. I just spent 20 minutes looking through my files and can't place my hands on them. I'll keep looking. Arnold probably has them handy.

These were used to provide stated income loans to borrowers who could documented their incomes but would not have qualified for the mortgage at current rates and prices if they did. And they were used by LOs to boost their commissions on borrowers that would have qualified for better loans. These loans carried higher rates, typically a 2/28 ARM with payment options and a teaser rate upfront. Then the LO would tack points on the back end and bury them in the yield-spread premium. The borrowers didn't know what was a good deal and what wasn't, and all they knew to do was to look through their closing costs to see if anything looked exorbitant. Of course, the real cost wasn't made clear and the teaser rate and payment options delayed the payment shock.

The bulk of my business was with A-paper borrowers. They expected me to fully inform them of what they were getting into and the lender required me to do so as part of my service agreement; and they paid me more because I was among the few who could accurately and efficiently explain 120 pages of legal documents in an hour or so.

The exact opposite was true with other lenders and agents. The borrowers didn't know what they were about to sign and the lenders and agents wanted to keep it that way. I lost a lot of business (tens of thousand of dollars per year) because I refused to participate in closing these loans or because I informed the borrowers of what they were about to do. I was clear with the LOs that they had better not do anything illegal or misleading in front of me because I had an obligation to stop the process if the borrower was misled or coerced.

There were a lot of borrowers who didn't realize it was illegal though one could assume they knew it wasn't entirely honest. In CA, the LOs and brokers were required to learn that it was illegal before they were allowed to do business.

Crawdad writes:

El Prez,

Thanks for responding.

I had this crazy thought that if the threat of prosecution was real and announced loudly by the government, we might drive a significant number of borrowers and lenders who played this criminal game into each other arms. By that, I mean they would take it upon themselves to rework the mortgages on their own, without the government getting overly involved. Crazy.

Back to the issue of the apparently widespread practice of "liar loans". I know this is after the fact and pissing up a rope, but if the practice was so common, one of those "secrets" that everyone knew, how did it stay under the radar for so long? No whistle blowers? No 60 Minutes expose'? No government intervention? If the "anamolies" in NINA and NINJA loans data are obvious even to a layperson, why was no one demanding investigations?

I know it's probably not very sensible, but where will the bailout of the homeowners, and ultimately, the lenders who perpetrated this fraud, leave us? Are we not incentivizing more of the same behavior, because we are definately not disincentivizing it? What do we do next time it all crashes? The moral hazard issues are massive and not even fully understood yet.

It also means we're chucking rule of law. The implications of that alone are terrifying.

El Presidente writes:

Crawdad,

Not so crazy, but it would have to be a credible threat which is pretty expensive too.

Well, too many people were benefitting from it for anybody who could stop it to want to try. It was a promise of downward redistribution through the market. People who couldn't afford homes were getting them. People who couldn't afford new cars could take out HELOCs to pay for them. Employers didn't have to pay higher wages to make it possible. Everybody in the business benefited from the volume and existing homeowners saw their equity baloon. Who's gonna ask questions? Well, I did, and I got fired for it.

The strange thing is that so long as the economy was headed up this seemed like it could go on forever, and very few people seriously questioned whether the economy itself was on a perpetual upward course. Seems like a pretty silly thing to believe . . . now. The perceived (not real) downward redistribution drove people to spend which seemed to pour fuel on the fire.

When we sit down with Humpty Dumpty and try to figure out how the pieces go back together, it becomes apparent that there was a very strong appetite for downward redistribution. The market did not do it effectively because the market is inherently opposed to it, and in the aftermath of its failure we are largely worse off.

The moral hazard problems are real, and I wouldn't discount them. However, what is the moral hazard of teaching people that their neighbor's carelessness will be permitted to harm them without hope of restitution? Does that build a stronger economy? When paramedics arrive on the scene of a car crash, they are less concerned with who was speeding and running a red light than whether anybody can be saved. Triage comes first, then we worry about assigning blame and exacting punishment. You can't put a dead man on trial.

The rule of law is an interesting concept. Police, prosecutors, judges, and private parties all have and exercise discretion in their application of law to circumstance. The rule of law does not require that every crime be punished or that every harm be compensated, but a truly effective government requires that all laws be enforceable or that those which are not enforceable be eliminated. Whether or not a law is enforceable depends on circumstances, which government can and should have an active role in shaping. This is why the starve the beast mantra invites trouble. It leaves us to devour each other, then nobody is there to stop it or fix it. Laissez faire and magical hands don't put Humpty Dumpty together again.

El Presidente writes:

MHodak,

Woe on our society when El Pres's version of "misrepresentation" becomes a basis for voiding contracts between consenting adults.

In my line of work I was expressly forbidden to give legal or financial advice. I could not present myself as the agent of either the lender or the borrower. My fee was in black and white and it was listed on the closing statement. I would point it out to the borrower and if the were being charged more than I was being paid, I told them.

Loan officers were certainly agents of the lender, not the borrower. Yet they stated to the borrower that they were working for the borrower and that they would "shop" the borrowers around to find them the "best" deal. In other words, they are offering financial advice without disclosing their conflict of interest. Lenders counseled loan officers to do this. Those are material representations that are false, misleading, and fraudulent. If you are waiting for woe, you missed the bus. It's already illegal.

Crawdad writes:

El Prez,

See, now you've lost me.

"The moral hazard problems are real, and I wouldn't discount them. However, what is the moral hazard of teaching people that their neighbor's carelessness will be permitted to harm them without hope of restitution?"

Exactly what restitution will all the "forgotten men and women" recieve after being forced to pay for the bailout of people who acted carelessly and/or criminally in the housing market and the world of finance? The truth is, they have no recourse or hope of restitution when this thing is over, if it ever does end.

Going along with your medical metaphor, isn't the rule, first do no harm? I've been trying to educate myself on economics, reading books, blogs, journals etc. The one thing I've learned for certain is that no one and I mean no one fully understands how we got here or how to get out us of it. NO ONE.

Economists are debating back and forth and all I see happening is they just keep raising more questions. And all of them end up basing much, if not most, of their theories on their political priors. I read for instance, a comment by the most recent Nobel winner, Krugman, that he wondered how he had ended up working for Reagan's administration, because he believed in the welfare state. "BELIEVED". He openly admits that his bias drives his economics, and it is clearly visible in his NYT's column.

Let me try to explain how I was using rule of law in relation to the current circumstances. I know police, judges, etc. probably exercise some discretion in following any particular law. But, surely there is a limit to that discretion, or we are just living at the whim of authority. This not my point however.

A little self disclosure. Last year, my brother lost his house. Made some dumb financial decisions, got in over his head, bankruptcy, garnished wages, you know the routine. While it was a personal tragedy and devastating to him, he has moved on.

One thing that made it easier was that he and everyone else involved, the bankruptcy lawyer, the judge and the bank knew the laws going in - it was impersonal. Now we are in a situation where some judges, and political agents will arbitrarily decide that everyone who comes to them after "this" day will be helped, but if you lost your house last week, or month, or year . . .tough. Now you are no longer under the rule of law, it's personal. It's laying the ground work for massive resentment, which could lead to who knows where. There are already protests going on across the country over this thing. Small now, but I see them growing as this progresses.

Do not discount so easily the folks who come on here and voice their resentment at what is going on with all the bailouts. The other day, when the Obama Administration announced that people with mortgages of up to $730,000 could recieve help if they were in default, I, in my little
$200,000 house, felt my own hackles raise up a little.

El Presidente writes:

Crawdad,

Exactly what restitution will all the "forgotten men and women" recieve after being forced to pay for the bailout of people who acted carelessly and/or criminally in the housing market and the world of finance?

This requires a little explanation.

The fallout of the housing crisis will hit the innocent one way or another. It is unavoidable. The magnitude and duration of the impact can be affected. What I'm saying is that we can't cordon off the 'evildoers' and let their wickedness devour them. Their past actions will continue to bleed out into the market whether or not we prosecute them. The phenomenon of capitalization of value is what makes your house more valuable when your neighbor sells high and less when your neighbor sells low. Neither occurence depends on your behavior but both can affect your financial position.

Should we try to keep your neighbor from defaulting and the bank from having to sell their home at temporarily dismal prices while the market adjusts, or should we "punish" them by robbing you of more equity? When this bleeds into output markets, consumer demand dries up and the cycle then bleeds into input markets where employment and investment decline, and all the losses stack up against international trade as prices decline against the real cost of transporting goods all over the world. Like I said, you can't put a dead man on trial. If we can't revive our economy, placing blame will be useless. This is where the genesis of the problem is relevant and where both theory and observation must be employed. We aren't just looking to see who is to blame, but more how it happened.

There is actually a tremendous amount of concensus about what happend and how, just not about who was responsible and what should be done about it. When you see us debating, we are more often debating the periphery, not the core. The distinction is important because we cannot judge policies as being good or bad, efficient or inefficient, effective or ineffective, until we define objectives with which to judge them. The economists who write here have differeing objectives, thus their policy preferences vary as well. This doesn't mean we necessarily disagree about which policy takes us to which end, but rather to which end we aspire.

The debate is fierce and the dispute is real, but we are actively engaged in a manner that most physical scientists are not. We are not cloustered in a laboratory. That's why this is messy. There are certain propositions that can strongly influence a person to take one view or another, but debating helps us to understand the ways in which several have merit. If you delve into economic modeling, you will begin to understand that the methods we use hold some things in place and let others vary. Then we compare the models with observations and attempt to determine how well or poorly the models resemble our observations. The debate gives us a variety of circumstance to test against the available data. This is how we form better explanations. I despair that this causes you concern because it is actually quite productive and healthy. The presence of disagreement doesn't mean that nobody knows. It means that less than everybody is persuaded. Don't be discouraged.

Your concern over who gets assistance is well taken and I can't tell you for certain how they arrived at their decision. I have some ideas, but I would just be speculating.

Crawdad writes:

Last point.

I get where you are coming from, just not sure that the bailouts will, in the end, make the situation better or worse than if another path had been taken.

As to that consensus of how we got here. Most everyone I've read seems to agree that the problem at the root of all others lies with the housing market; over priced and hence a major misallocation of capital.

Are not the bailouts just an attempt to maintain the status quo? In other words, the bailout will leave us in the same place once the dust settles; an inflated housing price bubble waiting for the next needle. Except of course, that we will have compounded the problem exponentially by borrowing and spending hundreds of billions of dollars, which will have major repercusions on the economy in the near future.

This is another of those moral hazard problems - ignore the future to fix now, just hope for the best. I offer Obama's very, very optimistic projections on the budget as an example. I keep thinking about the old adage about saving for a rainy day. What happens if some other unforeseen crisis comes along next year?

And how do prices re-adjust when we keep pumping "good money after bad". Sooner or later, the prices will have to come down until they reach a level which people are willing to pay. It would seem to me that new buyers, especially in certain markets - CA,FL,AZ and the other places where prices were hyper inflated - will remain wary of getting into the market now that we've thrown a huge dose of uncertainty into the mix. This on top of the fact that buyers who have been prudent; saving and waiting will also be adversely affected in that they will be kept out of the market due to the same inflated prices. A market they would have been able to jump into if prices were allowed to adjust downward.

I see no reason to think we're getting out of this without major pain.

El Presidente writes:

MHodak,

I get where you are coming from, just not sure that the bailouts will, in the end, make the situation better or worse than if another path had been taken.

I wouldn't lump them all together. They have different effects.

This on top of the fact that buyers who have been prudent; saving and waiting will also be adversely affected in that they will be kept out of the market due to the same inflated prices. A market they would have been able to jump into if prices were allowed to adjust downward.

Perhaps at the margins, but housing prices have corrected dramatically. Some have lost as much as 50% of their appraised value in just a couple of years. We are not at risk of reinflating the bubble. We are at risk of accelerating broad price deflation, which is bad in general for production that relies on contracts. It makes it very difficult to plan for profits and business gets much more precarious.

I see no reason to think we're getting out of this without major pain.

Agreed. It already hurts. I think we'd prefer to limit the pain.

Who Me writes:

I think the discussion on the specifics of the amendment misses two things.

First, the original point of the article, which was that the amendment was deliberately altered, after the fact and more importantly after 21 committeemembers voted for it. By forwarding this amendment to the House, Conyers and his staffers are engaging in fraudulently pretending that the committee voted for their version of the amendment instead of Rep. King's.

Second, 21 members of the committee voted for the amendment, so there appears to be significant support for that specific position. That doesn't mean the position is the correct one, but it does mean that the position has significant support that Rep. Conyers has undermined by he and his staffers' dishonesty.

Woody Tanaka writes:

Regardless of whether Conyers change was procedurally proper, I strongly believe that the Conyers change is the correct one -- require a conviction. I think that all King is doing here is opening a loophole for his banking buddies to halt the relief that the taxpayers need.

How much will these bank people spend to now investigate for so-called "misrepresentations" that will now suddenly spring up? Expect tons of so-called "misrepresentations" to suddenly appear that were not so material when it came time for the bank to take the homeowner's money, but will now be a big deal, when they can be used to prevent homeowners from getting a break.

Paul A'Barge writes:

[Comment removed pending confirmation of email address. Email the webmaster@econlib.org to request restoring this comment. A valid email address is required to post comments on EconLog.--Econlib Ed.]

Michael Weicher writes:

I am an attorney and deal extensively with real estate litigation, foreclosures, and mortgage fraud claims. I agree with the congressman that the process and "cheating" was disgusting.
As to the actual effect of the change, it may or may not be a significant difference in practice. The initial provision would likely require some kind of factual finding (or trial?) by the court and the costs of investigation and prosecution by the lender's attorney. With thousands of foreclosures, the lenders may not pursue this and the judges may set a high standard for a "fraud" finding.
Now, however, "Conviction" implies a criminal conviction - not just a factual finding by a judge, or liability under a fraud claim. The number of bankrupt borrowers who have criminal convictions for fraud on the loan in question will be a negligible fraction of debtors.
In either case the usefulness of the provision looks small to me, but I think the process is the bigger problem.

ruaqtpi2 writes:

I have to agree with Mr. Weicher; the efforts to prove fraudulent information or obtain a conviction are too much to bear for a system that will be processing such a high volume of mortgages.

Who in the process stands to gain by pursuing the facts? Our benevolent leaders - in their infinite wisdom - decided to increase FannieMae funding guarantees tenfold, so bankers and mortgage companies have little to risk in doing refinance deals with risky borrowers. And given the cash incentives to lenders ($1000+ per mortgage), we can expect to see another round of "creative" refinancing deals. We're reinflating the housing bubble, and government will stand ready once again to bail out these "responsible" homeowners.

I also agree that the bigger legislative problem is the way that significant changes to wording can be made after the amendment had been voted on. From a practical standpoint, the wording change effectively takes the "teeth" out of the amendment, making the amendment nearly useless.

Of course, if government would stay out of this, and let lenders take the responsibility to ensure credit worthiness of borrowers, we wouldn't have to go through the bailout process and deal with the unintended consequences.

drjohn writes:

The cram down bill jeopardizes the foundation of monetary transaction. Why would anyone loan anyone else money is judges could simply evaporate the debt for any reason?

John H. writes:

Did I miss something in the discussion about the 'new' bill vs. the 'old' bill ("The bill then got a new number. That's why you can't track it on Thomas. Technically, they can bring a bill directly to the floor without committee action. This was an arrogant contemptuous action that disenfranchised 21 Members of the Judiciary Committee and every, bill paying, law abiding American." March 9, 2009)

So what is the number of the 'new' bill?

----------

I am not a lawyer but Mark Twain (?) said, "You don't have to eat the whole egg to tell it's rotten". Any part of loan documentation that is not true should be construed as fraud (credit card debt, income, assets, marriage status, debt, expenses, etc.) and any one of the above, easy to verify items, should disqualify a mortgage holder for any assistance of any kind. The mortgage holder verifies that they have read and understand all of the loan documentation and attests that provided information is true and correct - at least that is what happened when I purchased property. You lied -- you are out of luck. Slam Dunk!

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