Daily Digest - July 18: Welcoming the Regulators

Jul 18, 2013Rachel Goldfarb

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Finally, Bank Regulators Have Had Enough (ProPublica)

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Finally, Bank Regulators Have Had Enough (ProPublica)

Jesse Eisinger looks at the new rules regulators are finally pushing through, which place more stringent capital ratio requirements on U.S. banks. He argues that this higher standard will advantage U.S. banks in the international market, because it will protect them from crises.

Elizabeth Warren’s New Fight: Why Even the Tea Party Backs It! (Salon)

David Dayen explains why Senator Warren's 21st Century Glass-Steagal Act is drawing such broad bipartisan support. Everyone, left and right, is tired of seeing big finance put people's money at risk for the sake of profit.

High Profits Signal Danger for Big Banks (NYT)

Simon Johnson argues that it's hard to accept the notion that regulation will harm the financial industry's business model when banks continue to report such high profits. That's encouraging to reformers as further regulations come down the pipe.

A New Season for Reform (The Nation)

William Greider sees the possibilities of real financial reform emerging in the current Congress. No one has ended too big to fail yet, but a coalition is forming that might be willing to fight back against Wall Street.

Bernanke Builds In Leeway on Bond Buying (WSJ)

Jon Hilsenrath and Victoria McGrane report that in his first of two days of congressional testimony, Ben Bernanke stated that the Fed's timeline for tapering its bond-buying program is flexible and will change if growth, inflation, and the markets call for it.

Sorry, Deficit Hawks: The Debt Crisis Ended Before It Could Begin (The Atlantic)

Matthew O'Brien points out that the deficit no longer needs fixing, much to the dismay of those pushing austerity policies. New Congressional Budget Office figures cut short-term concerns, and he argues that the long-term changes needed can wait.

Will Immigration Reform Protect Workers? (Reuters)

Josh Eidelson questions whether immigration reform might have the side effect of protecting workers whose employers have used their immigration status against them when they try to organize. Comprehensive reform should reduce some of the risks of retaliation.

New on Next New Deal

Brooks’s Recovery Gender Swap

Roosevelt Institute Fellow Mike Konczal looks at how men and women are doing in the search for employment in the weak recovery. He finds that men are not suffering in the manner David Brooks suggested in his recent column.

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Daily Digest - July 15: When Patents Increase Inequality

Jul 15, 2013Rachel Goldfarb

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How Intellectual Property Reinforces Inequality (NYT)

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How Intellectual Property Reinforces Inequality (NYT)

Roosevelt Institute Chief Economist and Senior Fellow Joseph Stiglitz applauds the Supreme Court's decision in the Myriad Genetics case. He says Myriad's patent on the BCRA genes was a horrible manifestation of inequality of healthcare access and thus economic inequality.

The Feds are Finally Cracking Down on Ratings Agencies. What Took so Long? (WaPo)

Roosevelt Institute Fellow Mike Konczal explains how ratings agencies became so deeply tied into our financial system over the past thirty years. Reform is clearly necessary after their involvement in the financial crisis, but systemic change moves very slowly.

The Food Stamp-Out (TAP)

Monica Potts says that food stamps were tied to farm subsidies because it would force Congress to consider the poor at the same time as big agriculture. Splitting the two puts the long-term future of this successful program at risk.

Yes, You Should Be Totally Outraged By the Farm Bill (The Atlantic)

Derek Thompson argues that the reason the House can pass a Farm Bill without SNAP is because it has no time to think about the poor. Elected officials in both parties spend so much time fundraising that they rarely speak to constituents on food stamps.

Hunger Games, U.S.A. (NYT)

Paul Krugman shows that it is impossible to tie SNAP to our continued unemployment problems. With that claim debunked, he struggles to understand why the House Republicans wants to make things even more difficult for people in poverty by cutting food stamps.

Every Day, Low Wages (Working Economics)

David Cooper discusses why Wal-Mart's of bullying Washington, DC over their living wage bill is particularly offensive. Wal-Mart has massive profits, and could maintain them and pass this cost on to the consumer by increasing prices by only 1%.

A Deeper Dive into Sequestration’s Impact on Head Start (On the Economy)

Jared Bernstein sees three immediate impacts: kids whose early education is interrupted, faculty members who lose jobs, and parents who have to find new childcare arrangements or risk losing their jobs.

Meet The People Who Lost Their Housing Thanks To Budget Cuts (ThinkProgress)

Bryce Covert reports on the struggles of those seeking and administering Section 8 housing vouchers under sequestration. So far, authorities are slowing their waiting lists, but cuts to voucher amounts and the overall number of vouchers could be coming.

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Daily Digest - July 12: Stand Up for Workers and Wages

Jul 12, 2013Rachel Goldfarb

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Wal-Mart Won’t Open 3 D.C. Stores Due to Wage Law (Bloomberg TV)

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Wal-Mart Won’t Open 3 D.C. Stores Due to Wage Law (Bloomberg TV)

Erik Schatzker speaks to Roosevelt Institute Fellow Dorian Warren on the D.C. living wage law. Dorian suggests that the mayor shouldn't veto the bill, because Wal-Mart's need to expand in new markets will overpower its distaste for higher wages.

An Oregon Trail to End Student Debt (The Nation)

Katrina vanden Heuvel sees Oregon's new model for financing post-secondary education as an example of how progressives can still achieve real innovative change. Instead of paying tuition up front, Oregon students will pay a percentage of their income for twenty years after graduation.

Want to Fix the US Student Loan Crisis? Put Colleges on the Hook (The Guardian)

Helaine Olen suggests that student loan risk should be put on the schools, by financially penalizing those with high default rates. The price of college needs to drop, but for now this would create an incentive to minimize loans in students' aid package.

Going Abroad With Dodd-Frank (TAP)

David Dayen carefully lays out the Commodity Futures Trading Commission's struggle with a rule regulating foreign derivative trades that is scheduled to be finalized today. He explains why it isn't likely to happen, and how this relates to the broader picture of financial regulation.

Senators Introduce Bill to Separate Trading Activities From Big Banks (NYT)

Peter Eavis reports on the 21st Century Glass-Steagal Act, sponsored by Senators Warren and McCain, and two others. Like the original, passed during President Franklin D. Roosevelt's first term, this bill would mandate a strict separation between banking and speculative activities.

The House Just Passed a Farm Bill with no Money for Food Stamps. What Does That Mean? (WaPo)

Brad Plumer looks at three options for what could happen now that the House has passed the SNAP-free farm bill. The scariest option would cause SNAP funding to lapse on September 30, leaving millions of people scrambling to afford groceries.

Child Care on the Third Shift (WaPo)

Brigid Schulte explains just how difficult it can be for low-wage workers to obtain child care. In retail and hospitality, the fastest growing sectors in today's economy, schedules are erratic and non-traditional, which only increases child care costs.

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Daily Digest - July 3: No One Really Needed That Insurance, Right?

Jul 3, 2013Rachel Goldfarb

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White House Delays Key Element of Health Care Law (AP)

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White House Delays Key Element of Health Care Law (AP)

Ricardo Alonoso-Zalvidar speaks to Roosevelt Institute Senior Fellow Richard Kirsch about the news that the administration is delaying implementation of the employer mandate. Kirsch is outraged about how this will affect employees who expected insurance on January 1, 2014.

Regulators to Beef Up Wall Street Rules…Thanks to Republicans?! (MoJo)

Erica Eichelberger asks Roosevelt Institute Fellow Mike Konczal why two Republicans on the FDIC want to tighten regulations on big banks' capital requirements. Konczal's explanation? They think it will reduce the blame on the FDIC if there is another bailout.

Murky Language Puts Homes Underwater (TAP)

David Dayen explains how banks are utilizing unclear language to make a loophole that allows them to dual-track homeowners, or continue pursuing foreclosure while the homeowner submits paperwork for mortgage modification. Until we fix this, people will continue to lose their homes.

How to Make Sure a Growing U.S. Economy Helps the Poor (Scholars Strategy Network)

Lane Kenworthy argues that the only way to ensure that economic growth helps the poor is to change the structure of the social safety net and tie benefits to growth. Otherwise, we leave swaths of people behind, which doesn't seem particularly American.

Making $7.75 an Hour, and Figuring There’s Little to Lose by Speaking Out (NYT)

Michael Powell talks to fast-food workers who are involved in the unionizing efforts in New York City. These workers have no fears about annoying their employers: what's the risk when you're making so little money to begin with?

Payroll Cards Are Under Scrutiny by New York’s Attorney General (NYT)

Jessica Silver-Greenberg reports that following Monday's story in the Times on payroll cards, the New York attorney general has opened an investigation. Employees must give explicit consent to be paid this way in New York, and why would anyone choose all those fees?

Hawaii Becomes Second State To Pass A Domestic Workers Bill Of Rights (ThinkProgress)

Bryce Covert discusses Hawaii's new law, which was signed on Tuesday and brings housekeepers, nannies and other domestic workers under the protection of labor laws such as the minimum wage, overtime, and anti-discrimination laws.

Oh, Right, the Jobs Crisis (The Nation)

John Nichols still sees the jobs crisis as the primary problem facing the U.S., and one that needs to be solved before many others. He's especially concerned with the groups that are struggling worst: people of color and young people.

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Daily Digest - June 24: The Crises' Common Threads

Jun 24, 2013Rachel Goldfarb

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A Wall Street Regulator’s Race Against Time (WaPo)

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A Wall Street Regulator’s Race Against Time (WaPo)

Roosevelt Institute Fellow Mike Konczal writes on Commodities Futures Trading Commission Chairman Gary Gensler's most important goal: regulating derivative trades that go through foreign affiliates. Such trades were a common thread in many recent financial crises and bailouts.

By Pivoting Away From Stimulus, Is The Federal Reserve Making the Same Mistake as Congress? (On The Economy)

Jared Bernstein is concerned that the Fed, which was the last group of policy makers speaking out on unemployment, is moving towards focusing on the budget deficit just like everyone else in Washington.

Et Tu, Bernanke? (NYT)

Paul Krugman also thinks that the Fed needs to spend more time on unemployment instead of the deficit. He worries that Bernanke’s talk of "tapering" will just serve to keep us in a low-grade depression for even longer.

3 Dangerous Myths About 'Revenue-Neutral' Tax Reform (The Fiscal Times)

Andrew Fieldhouse argues that revenue-neutral tax reform, which broadens the tax base and lowers rates, won't solve our problems. He wants to see reform that pushes back against income inequality and raises revenues to protect the social safety net.

John Boehner Is Dangerously Clueless About Economics (The Atlantic)

Matthew O'Brien thinks that the Speaker of the House prefers to ignore the empirical evidence against his favored economic policies. Boehner's continued call to immediately reign in the deficit goes against all the data that shows that austerity is limiting economic growth.

The Minimum-Wage Stimulus (Reuters)

Felix Salmon explains why we should implement Nick Hanauer's recent suggestion to raise the minimum wage to $15 per hour. He says it will be a win-win-win, and even better, it will be an effective stimulus to improve employment rates right now.

In All But Six States, You Can Be Fired For Being A Victim Of Domestic Violence (ThinkProgress)

Bryce Covert reports on the lack of protections for victims of domestic violence in the workplace, following a recent case in California where a teacher was fired after her abuser violated his restraining order by showing up at her school. He's in jail; she's out of a job.

Rowboats for Retirement (NYT)

Nancy Folbre supports recent proposals that we move towards some version of a federally defined pension plan, because the current system of 401(k)s and IRAs is not viable for low-income households. Individual accounts only work when you can afford to contribute.

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Daily Digest - June 5: Visiting the Bad Job Fair

Jun 5, 2013Rachel Goldfarb

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Fed’s Raskin Bemoans Quality of New Jobs (WSJ)

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Fed’s Raskin Bemoans Quality of New Jobs (WSJ)

Eric Morath and Victoria McGrane report that Federal Reserve Governor Sarah Bloom Raskin, a panelist at yesterday's Roosevelt Institute conference, said she became concerned about the kinds of jobs being created when she attended a job fair. The disconnect she's seeing is one where the jobs don't require the skills and education of the unemployed.

Rich Countries Are Creating More Jobs By Creating Worse Jobs (The Atlantic)

Tim Fernholz says that bad jobs (as measured by wages, benefits, and hours worked) make up the bulk of the jobs being created in advanced economies internationally. No surprise, the lack of good jobs is leading to a shrinking middle class.

White House Threatens to Veto Spending Plans Unless Broader Budget Deal Reached (WaPo)

Lori Montgomery writes that unless the House comes up with a budget plan that includes eliminating sequestration and sufficient stimulus to kick-start the economy, the administration is threatening to veto every single spending bill that crosses the president's desk.

AIG, Prudential Financial, and GE Capital Receive Preliminary Designation as "Systemically Important" Financial Institutions (Slate)

Matt Yglesias explains why these firms, which aren't really banks, should still be subject to higher scrutiny under Dodd-Frank. These companies hold bank risks, and are the reason regulating bank size isn't enough when we consider "Too Big To Fail."

Price-Gouging Cable Companies are our Latter-Day Robber Barons (The Guardian)

Heidi Moore accuses cable companies of creating an environment where a near-essential service is inaccessible to many households due to cost. Worse, no one in Washington is even trying to regulate this industry, allowing the oligopolies to set whatever prices they like.

From Lottery to Oligopoly in Wireless Spectrum (NYT)

Eduardo Porter suggests that as the F.C.C. auctions off the last chunk of the spectrum preferred by wireless companies, it should place limits on what companies can buy in order to encourage competition.

Detroit’s embarrassing new get-out-of-debt scheme (Salon)

Jillian Steinhauer writes that no government should have to sell off cultural artifacts to get out of debt, but the Emergency Manager of Detroit disagrees and is having the collection of the Detroit Institute of Arts appraised. Would he suggest Greece slap a price tag on the Acropolis?

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What Would the "Financial Instability" Argument Look Like For Any Other Industry?

May 7, 2013Mike Konczal

It’s becoming a surprisingly influential argument given that it hasn’t been well presented or argued, much less vetted and challenged. What is it? The argument that we should raise interest rates or otherwise contract monetary policy in order to preserve “financial stability.”

Brad Delong says critiquing this idea is “PRIORITY #1 RED FLAG OMEGA,” while Nick Rowe argues that this idea “may be influential. And that idea is horribly wrong.”

Here’s one version of the argument, from a recent speech by Narayana Kocherlakota:

“On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.”

Tim Duy and Ryan Avent commented on this speech, which essentially argued that that raising rates would certainly cause a problem, but rates at their current value could cause even bigger problems.

Let’s be clear on the terms: should we risk another immediate recession (“lower employment and prices”) to preserve a thing called “financial stability?” Five immediate problems jump out from this argument. Nick Rowe emphasized tackling this on an abstract level; I’m going to focus on practical stuff.

1. This whole story seems predicated on the idea that expansionary monetary policy was behind the housing bubble and collapse. I think there’s very little hard evidence for that. Also, the basic stories surrounding interest rates, as JW Mason mentioned in a guest post here, being too low for too long have some serious contradictions. (For instance, if the problem is a “global savings glut,” expansionary monetary policy should push against that by reducing capital inflows.) So if the idea is to risk another recession in order to not repeat the 2000s, we should work with a clearer story about what went wrong in the housing bubble.

2. The term “reaching for yield” is often deployed in these arguments. Low rates means that traders have to take on bigger risks in order to earn a rate of return that is acceptable. (Is there a minimum level of profit that finance must make on lending? And should we throw people out of work to make sure they make it? I hadn’t heard of that, but sounds like a nice gig.)

But either way, it isn’t clear that low rates drive reaching for yield. Yields are the difference between lending and funding rates. And as JW Mason again writes in an important post, banks’ funding costs are also affected by the policy rate. “Looking at the most recent cycle, the decline in the Fed Funds rate from around 5 percent in 2006-2007 to the zero of today has been associated with a 2.5 point fall in bank funding costs but only a 1.5 point fall in bank lending rates -- in other words, a one point increase in spreads.” If anything, the story is the opposite of what people are arguing.

3. The best empirical evidence at understanding the “reach for yield” phenomenon I’ve seen comes from Bo Becker and Victoria Ivashina from Harvard University, “Reaching for Yield in the Bond Market.” Here’s a Voxeu summary, and here’s the research pdf. They look at holdings of insurance companies, and find that, “conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds...It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding.”

This comes across as portfolio managers juking and manipulating capital requirements and the ratings agencies. The authors note that this is a major agency problem for insurance agencies. It was the strongest at the peak of the cycle, but went away during the recession.

Now if I told you we should keep the economy in a permanent recession because senior managers at insurance companies aren’t good at their basic job of monitoring mid-level portfolio managers you’d probably think I was crazy. And I would be. Especially since it seems that “reach for yield” is tied less to monetary policy and more to gaming ratings-based capital requirements.

4. If this is a serious problem, people should be talking about more serious forms of financial regulation. As a starter platform, we can raise capital requirements. Much of this “reach for yield” looks to be a regulatory arbitrage on ratings-based capital requirements, so, say, tripling the leverage requirement should net out the importance of the ratings agencies in capital requirements.

This is why a more coherent story about what we are concerned about when we think about “financial stability” would help. If we need to make the financial system less complex and prone to abusive practices, requiring parties of a derivatives contract to hold a stake in the underlying asset would do a lot. Are we worried about contagion? In that case, force banks to hold more capital as well as convertible instruments. About bad debts holding back the economy? Then reform the bankruptcy code, dropping the 2005 “reforms.” Some people are demanding more jail sentences, not only for the benefit of the public but for boards and shareholders who can’t keep their workers in line.

5. Because imagine this argument in the context of any other industry. Right now the interest rate is above where it needs to be to guarantee full employment. People are arguing that we should raise rates because banks might make loans, even though that is what the financial sector is supposed to do. (As Daniel Davies notes, “If the Federal Reserve sets out on a policy of lowering interest rates in order to encourage banks to make loans to the real economy, it is a bit weird for someone's main critique of the policy to be that it is encouraging banks to make loans.”)

Now imagine the government was going to take some land it owns containing oil and sell it to an oil company. Could you imagine someone saying, “We shouldn’t do this, because we can’t assume that oil companies are capable of drilling, refining and selling that oil” as a valid concern? Not concerns about random spills or global warming? But instead expressing concerns about whether the industry is capable of executing its most basic function.

Or take immigration. Imagine if a common response to letting a large number of high-skilled immigrants into the country would be “but we can’t assume that the labor market is capable of matching people with skills who want to work with employers who are willing to pay to complete jobs.” It’s tantamount to saying, “we shouldn’t assume that the labor market can do its basic function.”

It’s hard not to read the financial stability arguments as saying “look, we can’t trust the financial sector to accomplish its most basic goals.” If true, that’s a very significant problem that should cause everyone a lot of concern. It should make us ask why we even have a financial system if we can’t expect it to function, or function only by putting the entire economy at risk.

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It’s becoming a surprisingly influential argument given that it hasn’t been well presented or argued, much less vetted and challenged. What is it? The argument that we should raise interest rates or otherwise contract monetary policy in order to preserve “financial stability.”

Brad Delong says critiquing this idea is “PRIORITY #1 RED FLAG OMEGA,” while Nick Rowe argues that this idea “may be influential. And that idea is horribly wrong.”

Here’s one version of the argument, from a recent speech by Narayana Kocherlakota:

“On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.”

Tim Duy and Ryan Avent commented on this speech, which essentially argued that that raising rates would certainly cause a problem, but rates at their current value could cause even bigger problems.

Let’s be clear on the terms: should we risk another immediate recession (“lower employment and prices”) to preserve a thing called “financial stability?” Five immediate problems jump out from this argument. Nick Rowe emphasized tackling this on an abstract level; I’m going to focus on practical stuff.

1. This whole story seems predicated on the idea that expansionary monetary policy was behind the housing bubble and collapse. I think there’s very little hard evidence for that. Also, the basic stories surrounding interest rates, as JW Mason mentioned in a guest post here, being too low for too long have some serious contradictions. (For instance, if the problem is a “global savings glut,” expansionary monetary policy should push against that by reducing capital inflows.) So if the idea is to risk another recession in order to not repeat the 2000s, we should work with a clearer story about what went wrong in the housing bubble.

2. The term “reaching for yield” is often deployed in these arguments. Low rates means that traders have to take on bigger risks in order to earn a rate of return that is acceptable. (Is there a minimum level of profit that finance must make on lending? And should we throw people out of work to make sure they make it? I hadn’t heard of that, but sounds like a nice gig.)

But either way, it isn’t clear that low rates drive reaching for yield. Yields are the difference between lending and funding rates. And as JW Mason again writes in an important post, banks’ funding costs are also affected by the policy rate. “Looking at the most recent cycle, the decline in the Fed Funds rate from around 5 percent in 2006-2007 to the zero of today has been associated with a 2.5 point fall in bank funding costs but only a 1.5 point fall in bank lending rates -- in other words, a one point increase in spreads.” If anything, the story is the opposite of what people are arguing.

3. The best empirical evidence at understanding the “reach for yield” phenomenon I’ve seen comes from Bo Becker and Victoria Ivashina from Harvard University, “Reaching for Yield in the Bond Market.” Here’s a Voxeu summary, and here’s the research pdf. They look at holdings of insurance companies, and find that, “conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds...It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding.”

This comes across as portfolio managers juking and manipulating capital requirements and the ratings agencies. The authors note that this is a major agency problem for insurance agencies. It was the strongest at the peak of the cycle, but went away during the recession.

Now if I told you we should keep the economy in a permanent recession because senior managers at insurance companies aren’t good at their basic job of monitoring mid-level portfolio managers you’d probably think I was crazy. And I would be. Especially since it seems that “reach for yield” is tied less to monetary policy and more to gaming ratings-based capital requirements.

4. If this is a serious problem, people should be talking about more serious forms of financial regulation. As a starter platform, we can raise capital requirements. Much of this “reach for yield” looks to be a regulatory arbitrage on ratings-based capital requirements, so, say, tripling the leverage requirement should net out the importance of the ratings agencies in capital requirements.

This is why a more coherent story about what we are concerned about when we think about “financial stability” would help. If we need to make the financial system less complex and prone to abusive practices, requiring parties of a derivatives contract to hold a stake in the underlying asset would do a lot. Are we worried about contagion? In that case, force banks to hold more capital as well as convertible instruments. About bad debts holding back the economy? Then reform the bankruptcy code, dropping the 2005 “reforms.” Some people are demanding more jail sentences, not only for the benefit of the public but for boards and shareholders who can’t keep their workers in line.

5. Because imagine this argument in the context of any other industry. Right now the interest rate is above where it needs to be to guarantee full employment. People are arguing that we should raise rates because banks might make loans, even though that is what the financial sector is supposed to do. (As Daniel Davies notes, “If the Federal Reserve sets out on a policy of lowering interest rates in order to encourage banks to make loans to the real economy, it is a bit weird for someone's main critique of the policy to be that it is encouraging banks to make loans.”)

Now imagine the government was going to take some land it owns containing oil and sell it to an oil company. Could you imagine someone saying, “We shouldn’t do this, because we can’t assume that oil companies are capable of drilling, refining and selling that oil” as a valid concern? Not concerns about random spills or global warming? But instead expressing concerns about whether the industry is capable of executing its most basic function.

Or take immigration. Imagine if a common response to letting a large number of high-skilled immigrants into the country would be “but we can’t assume that the labor market is capable of matching people with skills who want to work with employers who are willing to pay to complete jobs.” It’s tantamount to saying, “we shouldn’t assume that the labor market can do its basic function.”

It’s hard not to read the financial stability arguments as saying “look, we can’t trust the financial sector to accomplish its most basic goals.” If true, that’s a very significant problem that should cause everyone a lot of concern. It should make us ask why we even have a financial system if we can’t expect it to function, or function only by putting the entire economy at risk.

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What Does the Leaked Brown-Vitter Bill on Too Big To Fail Do?

Apr 9, 2013Mike Konczal

Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) have been working on a bill to block the largest banks and financial firms from receiving federal subsidies for being deemed Too Big to Fail. On Friday, a draft version of that bill was leaked to Tim Fernholz of Quartz, much to Vitter’s chagrin. So, what does the bill do?

Let’s start with what it doesn’t do: It doesn’t break up the big banks. Rather, it focuses on how much capital they have to hold to protect themselves from disasters and would “prohibit any further implementation of” the international Basel III accords on financial regulation.

But let’s back up. Banks hold capital to protect against losses. The more capital they hold, the safer they are from crisis. As Alan Greenspan said after the financial meltdown, “[t]he reason I raise the capital issue so often, is that, in a sense, it solves every problem.” The “ratio” in question is the amount of capital against the amount of assets. So, if a bank has $10 in cash and $100 in assets, its capital ratio is 1:10.

Regulators set minimum capital ratios for banks. A capital ratio is like any other ratio, with a numerator and denominator. Some amount of capital held goes on top, and some value of the assets the bank holds goes on the bottom. The Brown-Vitter legislation would significantly change both parts of that ratio.

This is where things get a bit wonky: Common equity is viewed as the best form of capital because it can directly absorb losses. Basel III puts more emphasis on using common equity than previous versions. There’s a baseline 4.5 percent buffer, which is supplemented by a 2.5 percent “capital conservation buffer.” In addition, Basel III also has requirements for categories of less effective forms of capital, grouped under Tier 1 and Tier 2, or “total capital.”

As for the denominator, Basel III has risk-weighted the assets held by the firms. Firms use models and ratings to determine an asset’s risk. The riskier the asset, the more held capital needed in case of a loss. An asset rated as less risky requires less held capital. (You may remember the financial crisis involved both the ratings agencies and the financial sector getting these ratings very wrong for subprime mortgages.)

The Brown-Vitter proposal would not adopt Basel III. It would instead have a baseline of 10 percent equity in the numerator consisting solely of common equity. There are also surcharges for capital over $400 billion, which would cover all assets regardless of their risk-weighting. So there would be a significant increase in equity. The denominator would also increase, forcing banks to hold even more capital. This approach has much in common with the recent book “The Banker’s New Clothes,” by Anat Admati and Martin Hellwig, and should be seen as a win for those arguing along these lines.

Though it might seem like a technicality, risk-weighting assets is as significant in this proposal as a higher capital ratio. Risk-weighting was introduced by the first Basel in the late 1980s, using broad categories. It evolved to, among other goals, encourage firms to build out their risk management teams. However, those teams often acted as regulatory arbitrage teams instead. Many people view the system as encouraging race-to-the-bottom regulation dodging, backward-looking strategies that reduce capital held in a bubble and techniques that use derivatives and bad models to keep capital ratios low.

Regulators are growing more critical, both domestically and internationally, about Basel III. That regulation has several measures to address problems with risk-weighted assets, from adjusting the numbers used to requiring capital for derivative positions. But it is unclear how well these will work in practice.

Basel III has to be enacted by the banking regulators in the United States. The process began last summer (see a summary here). As Federal Reserve Governor Daniel Tarullo notes, regulators are expected to finish the Basel III capital rules this year and begin working on the rules for new liquidity requirements and other parts of Basel III.

It is interesting that the Brown-Vitter bill would replace, rather than supplement or modify, Basel III. Basel III has a leverage requirement that does similar work to the extra equity requirements Brown-Vitter recommends. That rule is only set at 4 percent, instead of 10 percent, but could be raised while keeping the rest of the Basel rules intact.

Because even those who want financial institutions to hold a lot more capital and less leverage may see a few downsides to abandoning Basel III. If firms go into Basel’s newly created capital conservation buffer, they can’t release dividends and are limited on bonuses. This, to use banking regulation jargon, is a way of requiring “prompt corrective action” on the part of both regulators and firms, who will normally drag their feet.

Basel III isn’t just capital ratios, though. Another important element is its new liquidity requirements. Liquidity here refers to the ability of banks to have enough funding to make payments in the short term, especially if there’s a crisis. Basel III includes a “liquidity coverage ratio,” which requires banks to keep enough liquid funding to survive a crisis.

Financial institutions have been lobbying against an aggressive implementation of Basel IIl’s liquidity requirements. They saw a small victory when some of the requirements were pulled back in the final rule in January. Brown-Vitter would remove them entirely — a remarkable win for the financial sector if the proposal passes.

(There are already some liquidity requirements made since the financial crisis, but they aren’t as extensive as Basel lll. And because they have evolved consciously alongside Basel III, it’s unclear what would happen to them.)

Note that this bill is explicit in not breaking up the big banks, either with a size cap or by reinstating Glass-Steagall. Two months ago in the House, Rep. John Campbell (R-Calif.) also introduced a bill designed to end Too Big To Fail, which called for banks to hold special convertible debt instruments while also repealing the Volcker Rule. There’s been a lot of talk about conservatives becoming aggressive on structural changes to the financial sector, but so far there’s no evidence of this in Congress.

During the drafting of Dodd-Frank, Treasury Secretary Timothy Geithner argued against Congress writing capital ratios into law, preferring to leave it to regulators at Basel to find an internationally agreed-upon solution. Basel’s endgame is now coming into focus, and there needs to be a debate on how well it addresses our outstanding problems in the financial sector when it comes to bank capital. This bill means reformers might start to rally around the idea that dramatically increasing capital, as well as removing the emphasis given to measuring risks, is an important part of ending Too Big To Fail. Even if that means going against the recent Basel accords.

 

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Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) have been working on a bill to block the largest banks and financial firms from receiving federal subsidies for being deemed Too Big to Fail. On Friday, a draft version of that bill was leaked to Tim Fernholz of Quartz, much to Vitter’s chagrin. So, what does the bill do?

Let’s start with what it doesn’t do: It doesn’t break up the big banks. Rather, it focuses on how much capital they have to hold to protect themselves from disasters and would “prohibit any further implementation of” the international Basel III accords on financial regulation.

But let’s back up. Banks hold capital to protect against losses. The more capital they hold, the safer they are from crisis. As Alan Greenspan said after the financial meltdown, “[t]he reason I raise the capital issue so often, is that, in a sense, it solves every problem.” The “ratio” in question is the amount of capital against the amount of assets. So, if a bank has $10 in cash and $100 in assets, its capital ratio is 1:10.

Regulators set minimum capital ratios for banks. A capital ratio is like any other ratio, with a numerator and denominator. Some amount of capital held goes on top, and some value of the assets the bank holds goes on the bottom. The Brown-Vitter legislation would significantly change both parts of that ratio.

This is where things get a bit wonky: Common equity is viewed as the best form of capital because it can directly absorb losses. Basel III puts more emphasis on using common equity than previous versions. There’s a baseline 4.5 percent buffer, which is supplemented by a 2.5 percent “capital conservation buffer.” In addition, Basel III also has requirements for categories of less effective forms of capital, grouped under Tier 1 and Tier 2, or “total capital.”

As for the denominator, Basel III has risk-weighted the assets held by the firms. Firms use models and ratings to determine an asset’s risk. The riskier the asset, the more held capital needed in case of a loss. An asset rated as less risky requires less held capital. (You may remember the financial crisis involved both the ratings agencies and the financial sector getting these ratings very wrong for subprime mortgages.)

The Brown-Vitter proposal would not adopt Basel III. It would instead have a baseline of 10 percent equity in the numerator consisting solely of common equity. There are also surcharges for capital over $400 billion, which would cover all assets regardless of their risk-weighting. So there would be a significant increase in equity. The denominator would also increase, forcing banks to hold even more capital. This approach has much in common with the recent book “The Banker’s New Clothes,” by Anat Admati and Martin Hellwig, and should be seen as a win for those arguing along these lines.

Though it might seem like a technicality, risk-weighting assets is as significant in this proposal as a higher capital ratio. Risk-weighting was introduced by the first Basel in the late 1980s, using broad categories. It evolved to, among other goals, encourage firms to build out their risk management teams. However, those teams often acted as regulatory arbitrage teams instead. Many people view the system as encouraging race-to-the-bottom regulation dodging, backward-looking strategies that reduce capital held in a bubble and techniques that use derivatives and bad models to keep capital ratios low.

Regulators are growing more critical, both domestically and internationally, about Basel III. That regulation has several measures to address problems with risk-weighted assets, from adjusting the numbers used to requiring capital for derivative positions. But it is unclear how well these will work in practice.

Basel III has to be enacted by the banking regulators in the United States. The process began last summer (see a summary here). As Federal Reserve Governor Daniel Tarullo notes, regulators are expected to finish the Basel III capital rules this year and begin working on the rules for new liquidity requirements and other parts of Basel III.

It is interesting that the Brown-Vitter bill would replace, rather than supplement or modify, Basel III. Basel III has a leverage requirement that does similar work to the extra equity requirements Brown-Vitter recommends. That rule is only set at 4 percent, instead of 10 percent, but could be raised while keeping the rest of the Basel rules intact.

Because even those who want financial institutions to hold a lot more capital and less leverage may see a few downsides to abandoning Basel III. If firms go into Basel’s newly created capital conservation buffer, they can’t release dividends and are limited on bonuses. This, to use banking regulation jargon, is a way of requiring “prompt corrective action” on the part of both regulators and firms, who will normally drag their feet.

Basel III isn’t just capital ratios, though. Another important element is its new liquidity requirements. Liquidity here refers to the ability of banks to have enough funding to make payments in the short term, especially if there’s a crisis. Basel III includes a “liquidity coverage ratio,” which requires banks to keep enough liquid funding to survive a crisis.

Financial institutions have been lobbying against an aggressive implementation of Basel IIl’s liquidity requirements. They saw a small victory when some of the requirements were pulled back in the final rule in January. Brown-Vitter would remove them entirely — a remarkable win for the financial sector if the proposal passes.

(There are already some liquidity requirements made since the financial crisis, but they aren’t as extensive as Basel lll. And because they have evolved consciously alongside Basel III, it’s unclear what would happen to them.)

Note that this bill is explicit in not breaking up the big banks, either with a size cap or by reinstating Glass-Steagall. Two months ago in the House, Rep. John Campbell (R-Calif.) also introduced a bill designed to end Too Big To Fail, which called for banks to hold special convertible debt instruments while also repealing the Volcker Rule. There’s been a lot of talk about conservatives becoming aggressive on structural changes to the financial sector, but so far there’s no evidence of this in Congress.

During the drafting of Dodd-Frank, Treasury Secretary Timothy Geithner argued against Congress writing capital ratios into law, preferring to leave it to regulators at Basel to find an internationally agreed-upon solution. Basel’s endgame is now coming into focus, and there needs to be a debate on how well it addresses our outstanding problems in the financial sector when it comes to bank capital. This bill means reformers might start to rally around the idea that dramatically increasing capital, as well as removing the emphasis given to measuring risks, is an important part of ending Too Big To Fail. Even if that means going against the recent Basel accords.

 

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How Congress and the Courts Are Closing in on Dodd-Frank

Apr 4, 2013Mike Konczal

What are the serious threats to Dodd-Frank? Last month, Haley Sweetland Edwards wrote "He Who Makes the Rules" at the Washington Monthly, which is the best single piece on Dodd-Frank implementation I've seen. In it, she identifies "three main areas on this gauntlet where a rule can be sliced, diced, gouged, or otherwise weakened beyond recognition." The first is "the agency itself, where industry lobbyists enjoy outsized influence in meetings and comment letters, on rule makers’ access to vital information, and on the interpretation of the law itself." The second is the courts, "where industry groups can sue an agency and have a rule killed on a variety of grounds." And the third is Congress, "where an entire law can be retroactively gutted or poked through with loopholes."

How important have those three areas been? Looking at the first two and a half years of Dodd-Frank, the courts turned out to be the unexpected danger for financial reform. I have a piece in Bloomberg View today arguing this, as well as the fact that the courts are structurally biased against reform in some very crucial ways.

That's not to say the lobbying battle is going well. But when the bill passed, people understood that rulewriting would be a difficult battle, and some groups like Americans for Financial Reform and Better Markets could at least help balance the lobbying efforts of financial industry groups. What was less understood was that the D.C. Circuit Court would have so many vacancies, and thus tilted to the far right and a radical agenda. I hope you check out the piece.

But what about Congress? Erika Eichelberger at Mother Jones has an excellent piece about the ongoing, now biparistan, efforts to roll back parts of Dodd-Frank's derivative regulations that are starting up in the House Agriculture Committee. (I wrote about this effort for Wonkblog here.) This third area Edwards identifies, Congress, is only now becoming a serious battlefield. But isn't the timing off? President Obama and the Democrats lost in 2010 but won in 2012. Yet while the threat of Congress rolling back Dodd-Frank, one of President Obama's major achievements, with new bills wasn't on the radar in 2011, it may be in 2013. Isn't that backwards?
 
Part of the answer is that the rules are becoming clearer, so financial industry lobbyists have more concrete targets to bring to Congress. But there's a political dimension as well. The general shutdown and polarization that dominated Congress after 2010 made a congressional threat to Dodd-Frank less likely. And ironically, the rise of the Tea Party within the conservative movement, even with its anti-Obama and anti-regulatory zeal, made bills to weaken Dodd-Frank less likely to pass. One reason is that the Tea Party wanted a full repeal of the bill or to gut entire sections, rather than more targeted interventions. Another is that the biggest losers in the 2010 shellacking were centrist “new Democrats,” those that would be more responsive to the needs of the financial industry than the progressive caucus that gained in relative strength afterwards.
 
It’s possible many more centrist Democrats could have moved a bill through Congress weakening Dodd-Frank as it was being implemented, especially if conservatives were looking to compromise. But remaining centrist Democrats were not going to remove the FDIC's new resolution authority to end Too Big To Fail, which is what the Ryan budget calls for, or knee-cap the CFPB out the door, which is what the Senate GOP wants in exchange for nominating a director, or vote to repeal the bill in its entirety, which was a litmus test for the 2012 GOP presidental candidates. Especially after they just took a lot of heat to pass the bill. Deficit hysteria was the only thing that got momentum, with both parties doing serious damage by cutting the budget of the CFTC.
 
(The unpopularity of the financial industry probably didn't help either. The congressional change that the financial industry most wanted, the delay of a rule designed to limit the interchange fees associated with debit cards, failed to clear 60 votes in the Senate.)
 
Now that the GOP is realizing that Dodd-Frank is here to stay, we might see more effort to reach across the aisle to dismantle smaller pieces of it in accordance with what the financial industry wants. Health care is facing a similar situation, where conservatives policy entrepreneurs are currently debating whether or not to work within the framework of Obamacare or continue trying to repeal it. Sadly, conservatives will probably do far more damage if they get to the point of accepting that Dodd-Frank is the law of the land and try to do more targeted repeals rather than wage all-out war.
 
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What are the serious threats to Dodd-Frank? Last month, Haley Sweetland Edwards wrote "He Who Makes the Rules" at the Washington Monthly, which is the best single piece on Dodd-Frank implementation I've seen. In it, she identifies "three main areas on this gauntlet where a rule can be sliced, diced, gouged, or otherwise weakened beyond recognition." The first is "the agency itself, where industry lobbyists enjoy outsized influence in meetings and comment letters, on rule makers’ access to vital information, and on the interpretation of the law itself." The second is the courts, "where industry groups can sue an agency and have a rule killed on a variety of grounds." And the third is Congress, "where an entire law can be retroactively gutted or poked through with loopholes."

How important have those three areas been? Looking at the first two and a half years of Dodd-Frank, the courts turned out to be the unexpected danger for financial reform. I have a piece in Bloomberg View today arguing this, as well as the fact that the courts are structurally biased against reform in some very crucial ways.

That's not to say the lobbying battle is going well. But when the bill passed, people understood that rulewriting would be a difficult battle, and some groups like Americans for Financial Reform and Better Markets could at least help balance the lobbying efforts of financial industry groups. What was less understood was that the D.C. Circuit Court would have so many vacancies, and thus tilted to the far right and a radical agenda. I hope you check out the piece.

But what about Congress? Erika Eichelberger at Mother Jones has an excellent piece about the ongoing, now biparistan, efforts to roll back parts of Dodd-Frank's derivative regulations that are starting up in the House Agriculture Committee. (I wrote about this effort for Wonkblog here.) This third area Edwards identifies, Congress, is only now becoming a serious battlefield. But isn't the timing off? President Obama and the Democrats lost in 2010 but won in 2012. Yet while the threat of Congress rolling back Dodd-Frank, one of President Obama's major achievements, with new bills wasn't on the radar in 2011, it may be in 2013. Isn't that backwards?
 
Part of the answer is that the rules are becoming clearer, so financial industry lobbyists have more concrete targets to bring to Congress. But there's a political dimension as well. The general shutdown and polarization that dominated Congress after 2010 made a congressional threat to Dodd-Frank less likely. And ironically, the rise of the Tea Party within the conservative movement, even with its anti-Obama and anti-regulatory zeal, made bills to weaken Dodd-Frank less likely to pass. One reason is that the Tea Party wanted a full repeal of the bill or to gut entire sections, rather than more targeted interventions. Another is that the biggest losers in the 2010 shellacking were centrist “new Democrats,” those that would be more responsive to the needs of the financial industry than the progressive caucus that gained in relative strength afterwards.
 
It’s possible many more centrist Democrats could have moved a bill through Congress weakening Dodd-Frank as it was being implemented, especially if conservatives were looking to compromise. But remaining centrist Democrats were not going to remove the FDIC's new resolution authority to end Too Big To Fail, which is what the Ryan budget calls for, or knee-cap the CFPB out the door, which is what the Senate GOP wants in exchange for nominating a director, or vote to repeal the bill in its entirety, which was a litmus test for the 2012 GOP presidental candidates. Especially after they just took a lot of heat to pass the bill. Deficit hysteria was the only thing that got momentum, with both parties doing serious damage by cutting the budget of the CFTC.
 
(The unpopularity of the financial industry probably didn't help either. The congressional change that the financial industry most wanted, the delay of a rule designed to limit the interchange fees associated with debit cards, failed to clear 60 votes in the Senate.)
 
Now that the GOP is realizing that Dodd-Frank is here to stay, we might see more effort to reach across the aisle to dismantle smaller pieces of it in accordance with what the financial industry wants. Health care is facing a similar situation, where conservatives policy entrepreneurs are currently debating whether or not to work within the framework of Obamacare or continue trying to repeal it. Sadly, conservatives will probably do far more damage if they get to the point of accepting that Dodd-Frank is the law of the land and try to do more targeted repeals rather than wage all-out war.
 
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Why the U.S. Could Use a Financial Transaction Tax

Feb 11, 2013Greg Noth

Taxing speculation would raise revenue and make markets safer for everyone.

Taxing speculation would raise revenue and make markets safer for everyone.

In January, 11 European countries implemented a Financial Transaction Tax (FTT), which places a small tax on stocks, bonds, and other products traded in financial markets. They expect to raise billions of dollars in revenue, and there are signs the idea for a similar tax may be gaining traction in the United States. Senator Tom Harkin and Rep. Peter DeFazio are reviving their Wall Street Trading and Speculators Tax Act, which includes an FTT but died in committee in 2011.

The purpose of a Financial Transaction Tax is to raise revenue by requiring buyers and sellers to pay a very small fee for each trade they make. The FTT proposed by Harkin and DeFazio, for example, places a three-basis-point charge on most stock, bond, and derivative trades. (In comparison, the European FTT taxes stock and bond trades at 0.1 percent of their value.) A basis point is one-hundredth of one percent, meaning a tax of just 3 cents would be paid for every $100 traded, $3 for every $10,000 traded, and so on. It would apply to any trade in the U.S. and by any U.S. individual or company, so corporations’ offshore subsidiaries would not be able to get around it.

The bipartisan Joint Committee on Taxation projects a three-basis-point FTT could raise as much as $352 billion over the course of 10 years – an average of $43 billion a year. This is a significant amount of money. With it, many of the harsh across-the-board cuts put in place by the 2011 Budget Control Act (BCA) (also known as sequestration) could be alleviated. For example, the $38 billion scheduled to be cut from non-defense discretionary spending – for things like housing assistance and community development – could be avoided entirely.

The FTT is a very low-risk bet, and, as mentioned, the returns could be huge. Most Americans are not trading derivatives or credit-default swaps, and thus would have nothing to worry about. The International Monetary Fund (IMF) examined Europe’s FTT and said it was “quite progressive.” According to the European Tax Commissioner, banks and other financial institutions, such as hedge funds, carry out as much as 85 percent of taxable transactions. In practice, the FTT would function in a similar way to the capital gains tax, which affects a very small number of people, most of whom are already wealthy. It would not be like the sales tax, which is regressive and falls disproportionately on the poor.

A Financial Transaction Tax would create a less volatile and speculative stock market, something few Americans would have a problem with. Because trades would be taxed (albeit at a very low rate), investors and financial managers would have an incentive to think long-term when making investments. This would discourage high-frequency trading (HFT), which offers very little to normal investors and has exploded in recent years, making the market more volatile  and dangerous. If HFT did not decline, however, it would simply result in more revenue.

Opponents of the FTT say it would harm financial markets and companies looking to raise money. However, smart legislation can avoid that problem rather easily. For example, the Harkin-DeFazio FTT would exempt the initial issuance of stocks, bonds, and other debts. Loans from financial institutions, companies’ initial public offerings (IPOs), and a city’s sale of municipal bonds, for example, would all be exempt from the FTT the first time they are sold. If a financial institution decided to trade a company’s debt after issuing it a loan, however, the FTT would come into effect.

Those arguing against the FTT also say the costs incurred by the tax would be passed on to retail investors -- through increased ATM fees, for example. But this is entirely avoidable with the right legislative language. The law could simply ban the practice, but even without an explicit ban, it is unlikely banks would take that course. Since some banks’ activities would fall under the FTT more than others’, not every bank would have the same incentives to raise fees on customers. As a result, if only a select few banks did so while others did not, marketplace competition would drive consumers to institutions without FTT-related fees.

In the wake of the 2008 financial disaster, which banks and financial institutions played a large role in creating, it makes sense to have policies designed to incentivize responsible trading practices and reign in reckless behavior. A Financial Transaction Tax would result in a more stable and less volatile stock market. It would also raise billions of dollars that could help avoid the harsh cuts set to begin March 1 – and it would do it all without touching the vast majority of Americans’ wallets.

Greg Noth is an intern in the House of Representatives and has formerly worked with the Center for American Progress and Iowa Senate Democrats. He is a graduate of Knox College in Galesburg, IL.

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