Pod Insights Odd Lots Jim Millstein on the Massive Risks of Any 'Mar-a-Lago Accord' About this episode President Trump wants higher tariffs, and he also wants more industrial production in the United States. This we know. In the meantime, a coterie of economists and pundits have tried to assemble a larger intellectual architecture to explain that strategy in a coherent way. The story they tell is one where America gets paid by its allies for national security and access to American markets, while the US brings down its debt and deficits, and weakens the dollar, so as to make US manufacturing more globally competitive. Whether Trump sees things this way himself, and whether it will actually work is an entirely separate question. On this episode of the podcast, we speak with Jim Millstein, co-chair of Guggenheim Securities, about what he sees as the massive risks underway with this line of thinking. During his time in government, he was closely involved with the conservatorship arrangement of the GSEs, so we also talk about the possibility of re-privatizing Fannie Mae and Freddie Mac. Read more: Dalio Warns of US Debt Crisis ‘Heart Attack’ Within Three YearsWishful Thinking Won’t Solve the US Debt CrisisOnly Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox — now delivered every weekday — plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.
Transcript 10,151 words · 13 speakers
Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
0:00 Speaker 00 Finance is increasingly being built on digital rails. But as the adoption of virtual assets, tokenization and stable coins grows, can regulation not only keep pace but help accelerate it? Find out more later in the podcast.
0:16 Speaker 01 This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting and hiring practices.
0:59 Speaker 01 But according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.
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2:27 Joe Weisenthal? Hello and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.
2:32 Tracy Alloway? And I'm Tracy Alloway.
2:34 Joe Weisenthal? So Tracy, you know, there's obviously a lot of anxiety these days, really for a while, but going into the election post about the size of the US debt, the size of the US deficit, et cetera. And what I, the way I like to think of these things is that any discussion of federal spending is about a competition for resource allocation, right? So we know that a huge component of what drives persistent deficits is the social safety nets, social security, Medicare, Medicaid, et cetera. And when we talk about the debt or the deficit in the abstract, and when people talk about tackling the debt or the deficit, what they're really talking about is freeing up resources somewhere, freeing up consumption somewhere
3:19 Joe Weisenthal? and creating availability for consumption and resources elsewhere in the economy.
3:24 Tracy Alloway? Are they?
3:25 Joe Weisenthal? Well, maybe they're not saying-
3:26 Tracy Alloway? I mean-
3:27 Joe Weisenthal? Yeah, I think I would say so.
3:29 Tracy Alloway? It seems to me there's a desire to like pay down the debt and then not necessarily do anything else. Like what, what's the else here?
3:36 Joe Weisenthal? Well, so for example, Secretary Scott Besant in some of his recent interviews talked about, you know, we want to re-leverage the private sector. It's who we want to get rates down and therefore that makes investing more appealing for companies, et cetera. And so the idea of like, okay, we're going to like reduce demand, reduce consumption from various sectors of the economy that are perceived to be unproductive, such as retirees, et cetera.
4:04 Tracy Alloway? Okay, maybe.
4:06 Joe Weisenthal? And then open up expansion. So then there's less consumption and then that creates resource availability for other things which are perceived to be more productive, like re-industrialization.
4:16 Tracy Alloway? Okay, maybe. What I would say, you know how I like to think about this?
4:19 Joe Weisenthal? Sure.
4:20 Tracy Alloway? I like to ask like, think about the big picture in bonds. And I always say bonds are built on norms, right?
4:28 Joe Weisenthal? Yeah.
4:29 Tracy Alloway? Government spending is built on norms. So you lend money to me and I pay you back. It's basically a promise, which means it's a human construct.
4:39 Joe Weisenthal? Yes.
4:39 Tracy Alloway? And there are all these values and norms and narratives that are embedded in those constructs, in those promises. And that's what I find really fascinating, especially when those values start to change. And I think that's what's happening now.
4:53 Joe Weisenthal? Yeah. Well, you know, absolutely. And obviously, you know, we did that conversation with Jim Bianco about a, you know, either a literal or a metonymic Mar-a-Lago Accord. And then we talked to Ray Dalio and he slipped it in there. And I thought it was like, kind of, he's like, well, maybe they'll restructure the debt in some way or reterm it out. And to me, that screams default. You know, I mean, that's just a, you know, it's a polite way of saying default.
5:15 Tracy Alloway? But one man's default is another man's restructuring, Joe.
5:18 Joe Weisenthal? That's right. But I think if I were a treasury holder, I would be very upset if the thing that I considered to be the most liquid, safe asset of the entire world, that the entire finance system runs on, the one thing that's perceived to be genuinely risk-free from a credit standpoint, suddenly gets like, oh, it's, this is a five-year bond and a seven-year bond. And you're going to get the same money in the end. Like, I think that would be very disruptive in a way that is not disruptive, say, like, you know, when a hospital chain has to restructure its debt.
5:48 Tracy Alloway? It is definitely the risk-free rate upon which, like, all the other markets are basically built on. Should I do a reminder of what the Mar-a-Lago Accord maybe says about this point? So the way I think about it, it's an attempt to resolve some of the tensions embedded in the Trump administration's economic agenda. We spoke about it with Jim Bianco. And those tensions are primarily the desire to reshore manufacturing and shrink the deficit. And also, I guess, address the sort of emotional sense that the US isn't getting compensated enough for its role in the global economy or global security.
6:28 Joe Weisenthal? Excellent summary.
6:29 Tracy Alloway? All while paying down the debt, right? So having your cake and eating it too. And I should just emphasize, this isn't a hardcore plan. This is based on a paper that Stephen Moran put out last year that people started getting very interested in and talking about. And that's why we're talking about it.
6:48 Joe Weisenthal? Well, I want to get to our guest in a second, but there is something very funny, because there's all these academic papers that are going out. And it's like, oh, there's this big plan and, you know, the exorbitant Privilege of the dollar makes it so that, you know, it's hard to reshore manufacturing in the US. We need to weaken the dollar and decentralize its role. And it's like the sort of like intellectualizing 5D chess. Meanwhile, Trump is like, no, I just want more money from terrorists. Like, I don't know. He like, there's this intellectual infrastructure around it. I'm not sure that Trump himself buys into this. Anyway, we really do have the perfect guest because we're going to be speaking someone who knows about the intersection of finance and politics, someone who knows about debt and debt restructuring, someone who actually matters. We've had him on the show last year.
7:32 Tracy Alloway? Someone who actually matters.
7:35 Joe Weisenthal? So, sorry. Hope my wife says it. Someone whose opinion, someone whose opinion actually matters. All of our guests matter. All of our guests' opinion matters. We're going to be speaking with Jim Millstein, co-chair of Guggenheim Securities. Jim, thank you so much for coming back on Odd Lots.
7:51 Speaker 06 My pleasure.
7:52 Joe Weisenthal? We talked about your background when we had you on the show last year. What do you know about debt restructuring?
7:57 Speaker 06 Just a little.
7:59 Joe Weisenthal? What have you done in that role?
8:02 Tracy Alloway? You've dabbled a bit.
8:03 Speaker 06 Yeah, I dabble. Yeah, it's my métier. You know, so I had this awful job and a great title called Chief Restructuring Officer of the United States Department of the Treasury during the financial crisis.
8:14 Joe Weisenthal? There you go.
8:15 Tracy Alloway? That is quite a title.
8:16 Speaker 06 It is quite a title. It sounds like they would might have been hiring me to restructure the federal government, but in fact, I was there to help restructure the TARP investments we made during the financial crisis in AIG and Ally Financial and Citi and B of A and the rest of that crowd. But before that, you know, I worked on the restructuring of Argentina, the Republic of Argentina's, one of their many restructurings.
8:39 Joe Weisenthal? Yeah, you got to say it.
8:40 Speaker 06 In 2005, we did a big exchange offer for their international bond and debt. And so I worked on Puerto Rico's debt default and restructuring back in the aughts.
8:50 Tracy Alloway? Wait, were you on the hedge fund side of Argentina or the country?
8:54 Speaker 06 I was on the Republic side.
8:54 Tracy Alloway? Oh, okay.
8:55 Speaker 06 Yeah. And then when I was a lawyer back in the 80s, my firm, Clary Gottlieb, worked on all of the Brady bond restructurings across Latin America. So, you know, I've done a bunch of sovereign.
9:08 Joe Weisenthal? Okay, so you're the perfect guest.
9:09 Speaker 06 Yeah.
9:10 Tracy Alloway? Okay, shall I just jump into it and ask the obvious question or one of the obvious questions, but where is this suggestion coming from? A debt restructuring is part of a potential Mar-a-Lago accord and what is the problem we're trying to solve?
9:26 Speaker 06 So I, I think there's a clear, I mean, I don't want to engage in sane washing, which Yes. You know, we, there's clearly an impetus by the president to impose tariffs. He's tariff man and around him through Besant and Moran, there is some intellectual architecture that suggests that's just a tactic towards an end. And the end is to bring manufacturing back to the United States. Yeah. Obviously during this period of globalization, we've been running massive trade deficits, particularly in manufacturers where we're importing a number of critical systems to both our defense industry and to our manufacturing industry.
10:08 Speaker 06 You know, we once dominated the semiconductor trade. We actually created that industry in the 1960s through a series of government policies, research and development grants to IBM and AT&T that created the semiconductor technology, then a series of procurement policies at NASA and the Defense Department to commercialize that industry. And eventually we created the calculator industry and the computer industry and the TV industry and all of that. But that was all a byproduct of a coordinated set of federal policies. Fast forward 40 years, 50 years later, and you know, semiconductor manufacturing is
10:48 Speaker 06 mostly being done, particularly at the high end, in a strategically vulnerable country across the straits of China from China in Taiwan. And that has created a sense, you know, now going back in the 10 years in the defense establishment, that we have a problem. And not just in semiconductors, but in a number of advanced industries where we're really reliant as a country on the importation of critical technologies and critical intermediate inputs. Again, you know, if you piece together what's some of the things that Besant has said and some of the things that Moran has said, the goal of the tariff play, which is really
11:31 Speaker 06 just a tactic, is to bring manufacturing back to the United States to hollow in or build out the communities that were hollowed out by the wave of globalization that occurred after China's admission to the WTO in the early 2000s. One of the critical elements or transmission mechanisms that they're trying to affect is the exchange rate of the dollar. A high dollar means that our exports are more expensive and our imports are less expensive. So we have been the beneficiary with a strong dollar of very cheap imports, you know, moderating the inflation that might otherwise occur from domestic manufacturing.
12:16 Speaker 06 But that said, we've lost manufacturing. We used 40 years ago, we represented 25% of the manufacturing industry. Now we're a mere 15% of global manufacturing. China was nowhere to be seen. Now they're 35% of global manufacturing. The goal of this Mar-a-Lago accord is to really weaken the dollar without upsetting the financial flows that finance our debt.
12:44 Tracy Alloway? And crucially, the manufacturing build out is supposed to be done by private capital. To Joe's point earlier, it's not, you know, we've had efforts from the Biden administration, the CHIPS Act, to try to boost some of those industries, but the emphasis under Trump is really, we want to create. A beneficial market environment so that private capital moves in.
13:05 Speaker 06 Yes, there's obviously a kind of, you know, traditionally Republican bias in favor of private capital and scaling back the use of public investment to promote industrial development. But, you know, raising a tariff wall, a high tariff wall, is a bet that private capital will invest behind it. Biden administration, you know, started something that I actually worked on as a graduate student back in the 70s called industrial policy. That is to use not only tariff barriers, but investment policy, tax policy, procurement policy, and R and D policy to promote domestic industry.
13:50 Speaker 06 So, you know, Trump has inherited the CHIPS Act, and it is making progress. It has spurred-
13:57 Tracy Alloway? He says it's terrible.
13:58 Speaker 06 Yeah, I know he said it's terrible, but the reality is that there's all sorts of activity now, both in the, under the CHIPS Act subsidies and through the Inflation Reduction Act, which was another one of the Biden administration's policies to promote investment in the United States. The reality is, is that those investments have been made and are continuing to be made around the 50 states, most particularly in the red states.
14:25 Tracy Alloway? Right.
14:26 Speaker 06 And so there will be political pushback on the Trump administration to just, you know, zero those out going forward. So going back, though, you know, if we really want to restore American manufacturing dominance, particularly in critical industries, critical to our defense establishment, we're going to have to use a mix not only of high tariff barriers, but of R and D subsidies, of investment subsidies, and use procurement as a way to create demand pull for these new industries.
15:18 Speaker 00 What's next for virtual assets? I'm Jacob Rees, host of Economy Scale, a series exploring growth in key global sectors. And in this episode, we're diving into the digital forces shaping finance. Sean McHugh from Dubai-based Virtual Assets Regulatory Authority has this to say.
15:34 Speaker 07 We're seeing a lot of institutional players come in, digital asset dedicated hedge funds, high-frequency traders and that sort of thing, and folks who service institutional clients.
15:43 Speaker 00 As more capital enters the market, adaptive regulation is likely to become increasingly key. Reese Merrick of Ripple says.
15:50 Speaker 08 A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80-year-old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.
16:10 Speaker 00 Listen to the full episode wherever you get your podcasts. This series is brought to you by Bloomberg Media Studios and the Dubai Department of Economy and Tourism.
16:20 Speaker 01 This is the Bloomberg Tech Minute, brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting
17:02 Speaker 01 and hiring practices, but according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.
17:43 Joe Weisenthal? You use the word "seanwashing," which is a good word because there are, there's the sort of intellectual, as you said, "architecture" around Trump. It's not clear that Trump himself sees it this way, that this is, that this works, that you can sort of like re-accelerate US manufacturing simply via some sort of weakening of the dollar in a coordinated way or tariffs. What is the gap between what you see is actually going on and the sort of like the white papers that people put out on this?
18:16 Speaker 06 Okay, so, so, and this is all coming out of Moran's paper, as Tracy indicated at the beginning. I mean, he's put together the most kind of comprehensive strategy. And he acknowledges that there's a very narrow corridor within which this might work. And in some sense, the president has already gotten out ahead with his tariff tactics and also his threatening to withdraw the security umbrella from NATO. Because those are the two critical sticks that Moran advocated we use to induce foreign
18:55 Speaker 06 central banks and foreign investors to continue to buy treasuries at favorable rates so as to continue to finance what is really a growing and potential, as Dalio said in your podcast, debt crisis. And just let me say, maybe to frame that problem. Today, federal debt to GDP is one to one. Federal debt is equal to GDP. We're running deficits at 7% of GDP. And the economy has kind of grown at 1, 2, little north of 2%. So the debt is growing faster as a result of the imbalance in the federal budget,
19:39 Speaker 06 where deficits are growing at the rate of 7% of GDP, which means the debt's growing at the rate of 7% of GDP. Where our debt is growing now faster than GDP and is becoming an increasing overhang, to the extent that, when you look at the federal budget, interest expense has become the second-largest category of federal spending.
20:01 Tracy Alloway? Issuing bonds to pay off bonds.
20:03 Speaker 06 That's right. So we're now issuing bonds to pay the interest on our bonds. This is a classic recipe for disaster. We're not even treading water. We're now slowly sinking behind a huge, under a huge pile of debt. So we have to get that fiscal imbalance corrected. And as you were saying at the beginning of the podcast, Joe, you know, now some very tough allocation decisions need to be made with regard to federal spending. Because someone joked that the federal government, when you look at the federal government, it's really a retirement program attached to an army.
20:42 Joe Weisenthal? Yeah.
20:42 Speaker 06 Right? I mean, the largest category-
20:44 Joe Weisenthal? I've heard it called an insurance program.
20:46 Speaker 06 Yeah.
20:46 Joe Weisenthal? It's the same thing.
20:47 Speaker 06 Yeah, exactly. You have, you know, income security in the form of social security for retirement, and you have medical security in the form of Medicare for retirement. But when you add it all up, the parts of the budget that, you know, Elon Musk is and his merry band of pranksters are off trying to slash is a relatively small part of federal spending. But it is the stuff that actually, you know, supports education, transportation, housing, infrastructure, right?
21:22 Tracy Alloway? The wider economy, some people would argue.
21:23 Speaker 06 Yeah, that sort of stuff that, you know, is building human capital, building physical public capital, building housing structure. That part of the budget is a mere 700 billion out of a total spending of 6.75 trillion. The rest of it is interest on the debt.
21:44 Speaker 06 Retirement security, defense and healthcare support. And so we're really, we're really in a pickle. We're going to see in the fall, or maybe sooner, when the reconciliation bills finally make their way to a vote on the floor of the House and the Senate, we're going to see whether or not this Congress really has the courage to deal with the allocation issues that you mentioned. Because in the House, in the framework for the House reconciliation bill, they call for 880 billion, that's over 10 years. So it's really not a lot. It's really like about 100 billion of spending cuts annually in Medicaid, transportation, housing and education.
22:28 Speaker 06 You know, out of that Medicaid is about 600 billion a year and the housing, transportation, education, that part of the budget is about 700 billion. So there's a, they're calling for a reduction of 100 billion a year against that 1.3 billion of Medicaid and social, the other social spending. So it's not, it's not a big ticket and it's not going to make a massive change in the deficit, particularly if they add incremental tax cuts on tips, on overtime, on social security, as they've talked about. You know, they're not really attacking the deficit.
23:12 Speaker 06 So we're going to continue to need to sell a lot of debt.
23:17 Tracy Alloway? So you've laid out the pickle problem very well, perfectly. Laid out the pickle problem perfectly. Say that three times fast. The idea here embedded in the Mar-a-Lago accord is that the US could bring down its debt costs by getting foreign investors to swap some of their current treasuries into century bonds that would be less expensive for the US to actually pay back.
23:47 Speaker 06 That's right. And so how do we, how do we induce them to engage in that exchange? So the two primary tactics that Moran lays out in his paper.
23:59 Speaker 06 Are sort of, you know, the way you do exchange offers in the private markets that I traffic in, the way you do an exchange offer is with carrots and sticks. You offer a sweetener and you threaten, you know, doom and gloom. So the two primary tactics here are that you foreign country are going to face, on the one hand, a high tariff wall unless you play ball, and on the other hand, the withdrawal of our security umbrella. So if you want the protection of the largest and most powerful military in the world
24:38 Speaker 06 to protect your borders against a Russian invasion, you're going to have to swap your debt that you currently hold, which is generally short-term bills, into what they're calling century bonds, a, you know, 100-year bond at a low interest rate, which takes the refinancing risk of an indebted country away from it, because we don't have to touch that debt for 100 years.
25:05 Tracy Alloway? Termining out duration.
25:06 Speaker 06 Termining out duration, on the one hand, and reducing the interest burden of servicing that debt over time. So there are a couple of problems with this. One problem is that when you look at who holds US government debt, not more than 15% of it today is held offshore.
25:30 Tracy Alloway? Yeah. It's come down a lot.
25:31 Speaker 06 Yeah, it's come down a lot, and much of that 15% is not in the hands of, you know, government instrumentalities, but rather in foreign private investors. So inducing that crowd to come in to this exchange offer, even if you could succeed, you're touching a very small part of the debt. So where's the rest of it? Where's the other 85% of our $36 trillion of outstanding debt? It's basically owned by us.
25:58 Tracy Alloway? Yep.
25:59 Speaker 06 Some of it's owned in government accounts in the Social Security and Medicare trust funds, but some of it is owned by banks and insurance companies, some of it's owned by endowments and wealthy individuals, some of it's in the bond in the mutual fund market, you know, underwriting our money market funds. So the reality is, to get this done, we're really doing it with ourselves. But what we really need to do is term out our debt. And the problem we're facing right now is that, you know, the debt, the cost of debt, the interest cost of our debt is relatively high. You know, the 10 year is at 4.3, the 30 year, put aside what you'd pay for a century bond,
26:43 Speaker 06 30 year is even higher. And the current average interest rate on our outstanding $36 trillion of debt is 3.3%. So to term it out in this market would take that $1.1 trillion of annual interest expense up, you know, if we had to term it out at 4.3 or 4.6, we'd be talking about increasing the interest expense we're facing. So there, you know, so this intellectual architecture around the so-called Mar-a-Lago Accord has many flaws, not least among which is we're in targeting foreign holders of
27:26 Speaker 06 our debt, we're targeting a relatively small part of it. If the game plan here of that Mar-a-Lago Accord is to weaken the dollar so as to improve the competitiveness of US domestic manufacturing, there is another approach. And that you've also heard rumor of from the Trump administration, and that is the creation of a sovereign wealth fund to take assets that the US government currently owns, dump them in a central fund managed by the Treasury Department, and allowing the Treasury Department then to intervene directly into the current, the foreign exchange markets to try and push the dollar down.
28:09 Joe Weisenthal? I see. It's interesting because so, you know, historically, right, like sovereign wealth funds in resource-rich countries are often about stable, keeping the currency strong, et cetera, especially for counter cyclical elements. And so the idea that we would use it to intervene in foreign exchanges, interesting twist. You know, you said something about restructuring, and you said there's carrots and sticks in a typical restructuring. And imagine the sticks are, look, if you don't want to go along with this restructuring plan, then you're going to end up with like some sort of asset in a bankrupt company, and it's going to be pretty bad for you, and you're going to get less money, and it's going to take a long time, and so come on, go with the deal. It seems to me part of the problem, like just conceptually with the carrot and sticks approach is like, you can't really threaten a stick.
28:55 Joe Weisenthal? If you're the US government without immolating yourself.
28:58 Speaker 06 Yeah, I mean, the the la you really want to see rates blow out, have the federal government threaten to not pay its debts. That would be that would be an event from which the financial markets might not recover.
29:17 Tracy Alloway? Does the does the carrot hold any water here either? Because I the carrot's supposed to be like, OK, maybe you don't get tariffs, maybe you get US security. But that maybe is really important because what we've seen so far, it's only been two months, but we've seen Trump go back and forth, back and forth, back and forth. I think a lot of trust has been lost.
29:39 Speaker 06 Yeah, well, and and, you know, if you were going to use tariffs or the threat of tariffs and the threat of the loss of the security umbrella as the inducement to the exchange, he's already gotten out ahead of himself, right? I mean, he's he's on again, off again with the tariffs. So the threat isn't isn't imminent, it's extant. And as you say, the trust that he might change his mind the day after the exchange is consummated is real. And similarly, with regard to NATO, you know, it's not obvious if I were a NATO
30:22 Speaker 06 country that I can rely on the United States any longer. You saw what happened in Germany. You know, they've gotten rid of their debt limit and are now going to massively increase defense spending in order to, you know, potentially defend themselves without the benefit of the United States security umbrella. Poland's already done this, their way their increased their defense spending, basically, the countries on the border of the of Russia, the Baltics, Poland, have all increased their defense spending, recognizing that they may not be able to rely on us any longer. So. As you say, Tracy, he may have gotten out ahead of this to the point where this really
31:05 Speaker 06 can't be used as an inducement for an exchange of short-term to long-term debt.
31:10 Tracy Alloway? Joe, you know what I was just thinking?
31:12 Joe Weisenthal? Say more.
31:12 Tracy Alloway? What if China exchanged its bills and treasuries for century bonds in exchange for NATO protection?
31:20 Joe Weisenthal? First of all, you know, there's obviously that history of the fact that at one point in time, China perceived its main adversary as the Soviet Union and did, you know, try to have that protection with the United States. So there is not zero history for that. Maybe a slightly realistic version of that is swap out your debt and we'll let you build BYD plants. Then you get that technology transfer and you sort of do the whole classic thing where the high-tech country brings in their manufacturing and teaches you how to build giggle plants and stuff. I would be into that. Jim, say more, though, about an event from which the markets may never recover. That's not a term you hear, always recover. But, you know, like, when you get into existential questions about the sort of safety and risk
32:04 Joe Weisenthal? freeness of US debt, what do we talk about here?
32:07 Speaker 06 Yeah, I mean, the, the, when you think, once we went off the gold standard, once, you know, our currency and our debt was not convertible into gold, into a hard commodity, the reliability of the US government debt is really a bet on the US government economy, that the economy is going to be so strong and generate the capacity to pay taxes to support the repayment of the debt. And so these two things now, it's a confidence game, and they're intricately linked.
32:50 Speaker 06 You know, the dynamism of the US economy is ultimately what supports the creditworthiness of the debt. But, you know, as your debt, and this is what Dahlia was talking about, you know, as your, as your debt levels increase to the point where your ability to service the debt is called into question, or your ability to service the debt is squeezing out the role that the government plays in buttressing, undergirding the dynamism of the economy.
33:27 Speaker 06 You get to a point where, you know, investors start to worry about the durability of the debt, the ability of the government to pay the debt. And so the debt overhang itself becomes a retardant to economic growth. So if if the dynamism of the economy is what undergirds people's confidence in our ability to repay our debts when due, we're in a world of hurt. I mean, I went to the speech of Besen gave at the Economic Club of New York, and he talked a lot about, you know, unleashing the private sector, reducing regulation,
34:07 Speaker 06 freeing the banks to once again lend to the private sector, and withdrawing the Biden stimulus to, you know, the various subsidies and procurement policies that were his attempt at reshoring, to withdraw the heavy hand of government from overriding the economy, the private sector. You know, that's all fine and well, but the reality is that, you know, governments play an important part in promoting the growth of their domestic economies, as from as simple as, you know, connecting people and markets through roads
34:44 Speaker 06 and airports and railroads, to ensuring that there is a healthy and educated workforce for private employers to be able to hire. You know, these are really essential functions of government, not least in and including the development, their investment in research and development in novel technologies that the private sector won't invest in because the commercial potential of them is inobvious, right? So the basic research that we do through NIH and the National Academy of Sciences.
35:21 Tracy Alloway? We've done an episode on this.
35:22 Speaker 06 Yeah, this is a really essential function. So There's a balance, right? I mean, and the success of the United States is a demonstration of the balance between private and public investment. The risk that we are in now, given the massive amount of debt we've accumulated, and more importantly, the continuous reliance on deficits, on debt to fund our spending, is putting us in a place where we really do need a fiscal consolidation plan. We have to balance revenues and spending.
36:03 Speaker 06 It doesn't have to be one to one, but the deficit can't be growing faster than the economy, or we're just, you know, piling up debt that will become increasingly more difficult to sustain.
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38:54 Tracy Alloway? I want to go back to the sovereign wealth fund idea because when I hear that, it sounds like basically a shift from the US issuing unsecured treasuries to secured debt. And when I hear that, I think back to a term that I used to encounter a lot when I was covering European covered bonds: encumbrance. Like, there's a limited amount of collateral that you can put up into a bond, and at some point, you start to run out of it. How much collateral? I get that the US is the biggest economy in the world, and probably if anyone's going to collateralize their debt, maybe it's the US.
39:36 Tracy Alloway? But what exactly would they use to secure these things?
39:41 Speaker 06 Okay, so, you know, there's loan-to-value, and then there's cash flow coverage, right?
39:47 Speaker 06 So we, the balance sheet of the United States has a variety of hidden assets that have, are not really marked to market. You've heard a lot of talk recently about our gold stocks, right, that are, I think, at $42 an ounce when the price of gold is, you know, north of 3,000. If you remarked the tons of gold at Fort Knox that we own to market, it's probably 800, 900 billion dollars. That's against a $36 trillion debt balance. That's a drop in the bucket.
40:22 Speaker 09 But then nothing.
40:23 Speaker 06 But it's not nothing. It's not nothing. We own probably a third of the land west of the Mississippi. You know, the western states complain about this all the time, that the federal government and the Bureau of Land Management is an absent landlord.
40:39 Tracy Alloway? National park-backed bonds? Is that where we're heading?
40:42 Speaker 06 Yeah, God forbid that Teddy Roosevelt's legacy, great legacy, would be somehow undone. But put aside the national parks.
40:49 Joe Weisenthal? Because all of Utah, Nevada.
40:50 Speaker 06 Yeah, I mean, Utah, Nevada, Wyoming, right? And then there's the vast expanse of Alaska, most of which is owned by the federal government. So there are those kinds of resources. Now, they don't cash flow today, but there are mineral rights on these lands that could be like, you know, the many other countries in the world do with their mineral rights, that they, you know, give private developers the right to extract and they create cash flows for the government on whose lands they're doing the extraction. We have, you know, a variety of enterprises, commercial enterprises, that we own equity in or own
41:34 Speaker 06 outright. You know, the Tennessee Valley Authority is a huge electrical generation and distribution system in Appalachia. Fannie and Freddie take over during the financial crisis where the government owns, notwithstanding what Bill Ackman is asserting, where the government fundamentally owns, you know, 90 to 95% of the equity value in them. You know, there are those sorts of things that the government could try to monetize and capitalize a sovereign wealth fund with. Now, having done that, let's, let's say there's a
42:17 Speaker 06 Two trillion dollars of land values, mineral rights, ownership in commercial enterprises that could be, that could capitalize a sovereign wealth fund. And some of those things, cash flow, where you could design them to cash flow. So the sovereign wealth fund would actually have income. And some of those assets could actually be monetized, like the equity in Fannie and Freddie and the equity in the TVA. You could actually privatize them, sell them into the public markets and create actual cash in the sovereign wealth fund as opposed to just asset value. So there you would have, you know, two trillion dollar fund that could intervene in the foreign
43:00 Speaker 06 exchange markets to try to intentionally weaken the dollar without having to engage in this exchange offer and term out our debt and try to, you know, browbeat with security umbrellas and tariff walls, foreign countries to help us in that endeavor.
43:19 Tracy Alloway? It's still a big bet on economic growth though, right? Because the US has to grow enough to pay off what it owes. And if it doesn't, then at some point you have to hand back the collateral. And I think people would be sad slash annoyed if they were handing over all the gold or national parks, probably not national parks, but land and things like that.
43:43 Speaker 06 Yeah, no, I, you know, first of all, we never pay off the debt, right? We just outgrow it. That's the key here. The stock of debt is just refinanced and rolled over continuously. You know, it'd be great to pay it down one day, but we actually don't have to do it. We just have to outgrow it. And there are a couple of different ways that countries have done this, some of which are more dangerous than others, right? You can inflate your way out of the debt. You just, you know, devalue your currency over time and the debt stock shrinks relative to the, the then current value of your productive enterprises because you've devalued your
44:23 Speaker 06 currency and so the debt stock, which is fixed in amount, shrinks as relative to the size of the economy now denominated in much weaker currencies. You can try this kind of Mar-a-Lago, you know, exchange offer. And then, of course, the worst of all outcomes is an outright default, where you restructure the debt.
44:45 Joe Weisenthal? You know, it seems to me, and I said in the beginning, I sort of conceptualize these things in terms of resource allocation and who gets what. And it seems to me, you know, yeah, you could revalue the gold in Fort Knox and probably people are sitting here thinking like, why wouldn't you do that if it's, you know, it's $3,000 and we have it at 40 or whatever? Of course, no, just do it. But that doesn't produce more doctors. It doesn't produce more beds for hospitals. It doesn't produce more food for senior citizens. You know, like when we're talking about these resource constraints, which is how I sort of think about it, it's an accounting trick, right? Because it doesn't ultimately, it doesn't create any new factories. It does not do any of that. Anyway, let's talk a little bit more. You know a lot about Fannie and Freddie, and you've made a reference there to Bill Ackman. And the thing that I'm
45:30 Joe Weisenthal? trying, you know, there's obviously big profits being generated by these government-owned enterprises, and private investors would like access to those profits so that they don't just get to the treasury. But then, to me, there's the question of like, can you do that in a way to avoid the problem, which is that investors get access to those cash flows or access to those profits without the implicit guarantee of the government? Because, you know, obviously, like, you'd love to keep both, right? You'd love to privatize the profit and keep that backstop. Is there any conceivable way to privatize them and actually not have that backstop in place anymore?
46:09 Tracy Alloway? I think the expectation is they would implicitly keep the backstop. Like, that's what investors want.
46:15 Joe Weisenthal? How is that fair?
46:16 Tracy Alloway? Well, this begs the question, why bother doing it at all, right?
46:19 Joe Weisenthal? Is there a way to do it that's not just a giveaway?
46:23 Speaker 06 Yes, there is.
46:23 Joe Weisenthal? Okay.
46:24 Speaker 06 So.
46:27 Speaker 06 There's a lot of history here.
46:28 Joe Weisenthal? Yeah.
46:29 Speaker 06 So before the financial crisis, these government-sponsored, government-chartered entities had a special charter that enabled them to borrow from the Treasury Department. And that was the source of their being viewed as ultimately backed by the Treasury Department, even though what they could get from Treasury Department was a mere fraction of their balance sheet size. But the fact that they had that entitlement gave investors the confidence that in a pinch, the government would step in and take them over. And we had a pinch in 2008, and the government did, in fact, step in and put them into a conservatorship.
47:13 Speaker 06 The conservatorship was structured to make that implicit backstop explicit. And the Treasury Department entered into a preferred stock purchase agreement with each of the entities under conservatorship, pursuant to which the government actually purchased $192 billion of preferred stock in the two entities, infusing $192 billion worth of cash of Treasury Department cash authorized by Congress under the Housing and Economic Recovery Act of 2008 into the enterprises.
47:48 Tracy Alloway? In exchange for equity as well, right?
47:50 Speaker 06 They got preferred stock back, right? A senior preferred stock. That senior preferred stock carried a fixed dividend, which was converted into a variable dividend in 2012 in order to keep them from having just to borrow more preferred to pay off the dividend. And so they were only then required to pay a dividend to the extent that they were profitable out of their net profits. And were they profitable? They have paid the Treasury Department back now $302 billion on that, characterized as dividends, on that $192 billion par investment.
48:31 Tracy Alloway? Yet not only are they profitable, they've also, as I understand it, kind of restructured their business and increased their capital, basically like gotten ready for a sale while generating a profit, which is pretty impressive.
48:46 Speaker 06 Yeah. So the dividend stream to Treasury, which generated $302 billion, was turned off.
48:54 Speaker 06 In 2018 to allow them to build capital in anticipation in Trump administration one that they would be privatized. And so they allowed them to build capital. And so the Treasury Department hasn't received any dividends since 2018, so seven years ago. And during that seven year period, Fannie and Freddie have built, between the two of them, almost $200 billion of capital. That's still short of the capital rule, the capital regulation that was created for them during the conservatorship, but they're pretty damn close, probably two years away from
49:35 Speaker 06 being, meeting their minimum capital, their so-called CET1 capital levels. You know, there are many of us who think that the capital rule that was created for them grossly oversolved for their, how much capital they should carry.
49:49 Tracy Alloway? Right after the financial crisis, everyone's nervous.
49:52 Speaker 06 Exactly. And so, you know, the, as with the big banks, the so-called SIFs, Fannie and Freddie have been subject to so-called stress tests to see how they would fare in a severely adverse scenario where, you know, the financial markets declined by 20%, the interest rates go up by 10%, unemployment skyrockets, housing prices collapse, blah, blah, blah. They've been subjected to stress tests over the last couple of years, and those stress tests show that basically their losses would be less than like $10 billion.
50:32 Speaker 06 And so to have them carrying around, in Fannie's case, 156 billion of capital, and in Freddie's case, 120 billion of capital against what the stress tests show would be negligible losses, seems like a pretty, a waste of that, of that capital, just grossly oversolving them. I'll get off my high horse on that question, on that. Leave them with those capital levels, 156 and 120 billion respectively. They will be, they would need another four years of retained earnings to reach that. So if you were really, if you weren't prepared to let them out of conservatorship,
51:14 Speaker 06 until they were fully capitalized, you'd wait four years. And then they'd be fully capitalized under that rule. And then the question goes to the backstop. You know, why privatize them and can they be privatized without an explicit government guarantee? Well, there's no reason in law or fact that would prohibit them from carrying that preferred stock purchase agreement, that equity backstop, out of conservatorship and having the Treasury stand behind this $270 billion worth of capital with a commitment to buy 250 billion of capital should the need arise.
51:55 Speaker 06 So, you know, if, if in my view, Fannie carrying 160 and Freddie carrying 120 billion is already overcapitalized, well, we're going to almost double that with the Treasury backstop. And Treasury should be paid for the privilege of standing behind them, a commitment fee, and could the earnings would support a commitment fee. But that would give comfort to the markets that, you know, there's enough capital behind them to ensure the prompt payment of principal and interest on the underlying mortgages that they guarantee. The benefit to the government of doing this, of instead of leaving them in conservatorship
52:38 Speaker 06 in perpetuity, is that the government owns 90-odd percent of the equity. They own the senior preferred stock, they have a warrant to purchase 80% of the stock for a penny. You do a, you know, a classic recapitalization, turn the preferred stock into common, diluting the existing common and the Treasury Department's warrant and Fannie, the Treasury Department will end up owning 90 to 94% of the total common stock of cleanly capitalized companies. What's that worth? The CBO did a recent analysis and said, well, this is the Congressional Budget Office, did a recent analysis and it's, you know, filled with lots of assumptions and you could
53:23 Speaker 06 quibble with some of them, but it's a dividend discount model, which isn't, you know, unheard of in the valuation of financial institutions. And, you know, they suggested the equity, the total equity of which I think the government ends up with at least 90% when you recapitalize. And the total equity is worth somewhere between 300 and 500 billion dollars.
53:46 Tracy Alloway? That's a decent number.
53:47 Speaker 06 That's a decent number to put in your sovereign wealth fund or to pay down some of the deficit.
53:53 Tracy Alloway? The one question I have is, okay, if the GSEs are privatized, the government gets a payout of an unknown amount, but it could be pretty decent, as we said. Is there anything that Fannie and Freddie actually start doing differently once they're privatized? So they get an influx of private capital. What do they do with it?
54:14 Speaker 06 Okay. So this is, this is a critical question of whether they're going to be allowed to go back and do the kinds of crazy things they did prior to the financial crisis that got them into hot water. The, one of the great innovations, along with Dodd-Frank, coming out of the financial crisis was a new statute governing both the federal home loan banks, Fan and Fannie and Freddie. It's this Housing and Economic Recovery Act of 2008, which created a new, stronger regulator called the Federal Housing Finance Agency. This is the agency to which Bill Pulte has just been confirmed as the director. But
54:58 Speaker 06 that agency has significant supervisory and regulatory powers to constrain the business model that Fannie and Freddie can pursue. So, I mean, just to do, just a touch, little more history. If you look back to 2003 through 2008, you know, what really got Fannie and Freddie into trouble is they were running hedge funds. They were a government-sponsored hedge fund beyond the basic business of securitizing so-called conforming mortgages, you know, ADLTV or less, safe mortgages, besides packaging them and securitizing them and guaranteeing the prompt payment of principal and interest
55:42 Speaker 06 on those mortgage-backed securities, of which there are now seven and a half trillion outstanding. So they are the big factor in that conventional mortgage market. In the run-up to the crisis, they also expanded their balance sheets. They borrowed money at near-government rates, levered themselves up and bought all-day, subprime, no-doc, private-label securities in order to goose their earnings. And they did it on a highly-levered basis. One of the great reforms that has occurred during the conservatorships is those portfolios have been completely wound down. And so today, the only balance sheet that they have is
56:22 Speaker 06 to facilitate a securitization business they're in. So they buy mortgages that have been originated by someone else, they pool them, and then they securitize them. And with the proceeds of the securitization, they repay the debt that they incurred to buy the mortgages in the first place. And similarly, when mortgages go bad in the MBS and the securitizations, in order to fulfill their guarantee of prompt payment of principal and interest on those securities, they buy the mortgages out of the pools, restructure them, and modify them.
57:02 Tracy Alloway? Which is why Agency MBS is treated as a very safe and liquid asset for bank capital purposes.
57:10 Speaker 06 Exactly. Because Fannie and Freddie are there to guarantee the prompt payment of principal and interest. And now, if we go back to the privatization, right, what will back that guarantee is both the 280 billion of capital directly on their balance sheets, as well as the preferred stock purchase agreement with 250 billion of unused capacity. So behind that guarantee will stand more than half a trillion dollars of capital.
57:42 Speaker 06 And so that this is, you know, when I get into debates with people about people who are opposed to the privatizations, about whether or not this, the privatization would create instability in the MBS market. Because would they suffer a ratings decline and therefore attract higher capital for anyone who owned them and therefore higher rates on the mortgage backed securities, which translate into higher rates on the mortgages themselves. You know, the, that is the big question is half a trillion dollars of capital standing
58:21 Speaker 06 behind the guarantees enough to keep the credit ratings on the MBS stable and in place. I think it is, but you know, at the end of the day, there'll be a conversation with Moody's and S and P and Fitch and they'll have to decide whether they remain near sovereign credit.
58:42 Tracy Alloway? Oh, it's kind of funny that the credit rating agencies are like
58:45 Speaker 06 Still in control.
58:46 Tracy Alloway? Yeah, exactly.
58:50 Tracy Alloway? Okay, so we've talked a lot about creative ways for the US government to raise money and pay off its debt. There's one we haven't talked about, which is one of my favorite financial topics of all time.
59:05 Speaker 06 Oh, no.
59:05 Tracy Alloway? And that is the bonds owned by the US issued by other countries, really old ones.
59:12 Speaker 06 Oh.
59:13 Tracy Alloway? Like Chinese imperial debt. Or did you know the UK owes the US a lot of money from like World War II loans?
59:21 Speaker 06 Oh, still. I didn't know that. I didn't know that, no.
59:23 Tracy Alloway? And as an intellectual curiosity, I find it really interesting to think about the question of what would happen if Trump decided to go after those as a way of raising money. And this actually came up in the first Trump administration. The Treasury was looking at ways to get a payout on the Chinese bonds. And funnily enough, it was doing that at the same time that the SEC was prosecuting someone for selling those bonds to investors and promising a payout. That's fun. That could be fun.
59:54 Speaker 06 So, so these are, I don't know anything about this. So these are bonds issued by predecessor governments in China.
1:00:01 Tracy Alloway? Yeah.
1:00:02 Speaker 06 You know, there is some history of
1:00:06 Speaker 06 I'm aware of some czarist Russia bonds.
1:00:12 Tracy Alloway? Yeah, those are the famous ones.
1:00:13 Speaker 06 Yeah, that are out there. Shortly after the collapse of the Soviet Union, the French government and the British government, representing French and British bondholders, got the Russian Federation to acknowledge those bonds and make a payout on them because the Russian Federation was desirous of having access to the capital markets in Europe. And the quid pro quo was to pay off the debts of czarist Russia.
1:00:47 Joe Weisenthal? Well, we are in uncharted territory.
1:00:49 Speaker 06 We surely are.
1:00:50 Joe Weisenthal? So even this little intellectual exercise at the end of the conversation may one day not just be an intellectual curiosity. Jim Millstein, so great to have you back.
1:01:00 Speaker 06 Thanks, guys.
1:01:00 Joe Weisenthal? We could just talk to you for hours and hours.
1:01:02 Tracy Alloway? Thank you so much, yeah.
1:01:03 Joe Weisenthal? But that was a fantastic sort of conversation. I appreciate you coming back on up.
1:01:08 Speaker 06 Enjoyed it, buddy.
1:01:08 Joe Weisenthal? That's great.
1:01:25 Joe Weisenthal? Tracy, I love talking to Jim. He's so good.
1:01:27 Tracy Alloway? He's great. And he lays everything out so clearly, which is very useful when we're talking about a hypothetical like this. The one thing, well, there are a lot of things that I think are funny or ironic in some of this discussion. But one of the big ironies I think about is treasuries are kind of the US's biggest export.
1:01:49 Joe Weisenthal? Yeah, I know.
1:01:49 Tracy Alloway? And Trump is obsessed with exports.
1:01:51 Joe Weisenthal? I know, I know.
1:01:52 Tracy Alloway? But he doesn't want to export those particular things, even though you could make an argument that debt helps to grow the private economy, as Jim was discussing.
1:02:03 Joe Weisenthal? It is funny. I mean, look, I guess I'd rather us export real things that employ people than
1:02:09 Tracy Alloway? He could just take the win, right?
1:02:11 Joe Weisenthal? Take the win. Yeah, we're a big exporter of these pieces of paper, not even pieces of paper anymore. No, I thought there was like a great conversation. And look, the way I see it is some of this stuff could be playing with fire. Like, we really don't know how some of the, you know, some of these goals is like, we're going like, you know, we're the fact that Germany itself is rearming and that for decades and decades and decades, this sort of entire premise of sort of Western geopolitics was preventing Germany from rearming. That was in itself, this sort of is sort of like this, like massive pivot in world history feels like for me. And, you know, who knows, decades from now, you know, we don't, we might not know how the consequences of the ways geopolitics have
1:02:56 Joe Weisenthal? been reshaped by that decision.
1:02:57 Tracy Alloway? Well, this is the norms point, right?
1:03:00 Joe Weisenthal? Yes.
1:03:00 Tracy Alloway? Like, norms, it turns out, are actually pretty important. And there's a risk of what happens once they're gone, or they start to change.
1:03:10 Joe Weisenthal? Yeah, I would say two points. I mean, one is, yes, norms themselves, I think, are pretty important. And then you get into things that are sort of beyond norms questions, like, once you bring in the conversation about, and again, I don't know how serious it, but like restructuring debt, or etc., you're like, go beyond norms, and you actually, like, you could trigger, trigger formal things.
1:03:31 Tracy Alloway? No, that's still a norm, though.
1:03:33 Joe Weisenthal? I guess.
1:03:33 Tracy Alloway? Because the US, like, historically, has not defaulted on its debt.
1:03:36 Joe Weisenthal? No, but it's like, there are things and pieces of paper, right, that like, when you don't, when you like, try to change.
1:03:41 Tracy Alloway? There are legalities, but frankly, legalities are being treated as norms now, right?
1:03:48 Joe Weisenthal? I suppose so. Yes, I suppose so.
1:03:51 Tracy Alloway? Shall we leave it there?
1:03:53 Joe Weisenthal? Let's leave it there.
1:03:53 Tracy Alloway? This has been another episode of the Odd Lots Podcast. I'm Tracy Alockway. You can follow me at Tracy Alockway.
1:04:00 Joe Weisenthal? And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers, Carmen Rodriguez, at Carmen Armand, Dashil Bennett, at Dashbot, and Cale Brooks, at Cale Brooks. For more Odd Lots content, go to Bloomberg.com/oddlots. We have all of our episodes in a daily newsletter, and you can chat about all of these things 24/7 in our Discord with fellow listeners at discord.gg/oddlots.
1:04:23 Tracy Alloway? And if you enjoy Odd Lots, if you like it when we talk about US debt restructuring, potential US debt restructuring, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.
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