October 21, 2007

Crashing property market begins to reveal its casualties

Posted in Banks · 36 comments ·

Given that house prices are now falling across the board, it means that every valuation made last year was wrong.

In May 1720,William King, the Protestant Archbishop of Dublin, writing about the speculative mania for shares in a company called the South Sea Scheme that had overtaken the city, warned: ‘‘Most who go into this matter are well aware that it will not succeed but hope to sell before the price fall.”

Meanwhile, Richard Cantillon, the great Irish economist, warned about the South Sea speculation frenzy, pointing out that while prices can be kept up ‘‘for months, maybe years . . . a melancholy prospect awaits those who stay in the market last’’.

These warnings were triggered by the announcement in April 1720 that the South Sea Company, the entity issuing shares, would lend against it own stock. This would only mean that before the collapse, prices would rocket higher as people got into debt to the company to buy shares that the company had issued in the first place.

The so-called ‘South Sea Bubble’, which left thousands of Irish investors broke was simply an example of the speculation that has characterised financial markets over the years. (After losing a fortune speculating in the South Sea Company, Isaac Newton mused that he could ‘‘calculate the motions of heavenly bodies but not the madness of the people’’.)

The Irish have been involved in plenty of great frenzies down the years. Amazing as it sounds, in the winter of 1847, when half the country was starving, many Dubliners were up to their necks in debts speculating on Irish shares in the railway companies that were vying to roll out a rail network to a famished country.

In the preceding years, a railway boom across the water had led to mass migration from Ireland to England. An estimated 200,000 Irishmen worked on the British railways. Those ‘navvies’ (which stems from the nickname the ‘navigators’, which was what Irish workers who built the British canals in the 18th century were called) served exactly the same purpose as the Polish labourers on the sites in Ireland now.

Ironically, in 1847 the British parliament suggested that more and more workers would be needed, as there seemed to be no end in sight to railway building. Apparently, the ‘fundamentals’ at the time guaranteed this optimism. But, like all booms, the railway boom came to an abrupt halt when it was least expected. By 1848, railway shares were in freefall, exposing all sorts of malfeasance and skulduggery.

Again, the Irish were so prominent in this carry-on that Charles Dickens based his swindling banker, Mr Merdle, in Little Dorriton an Irish MP, John Sadleir. Little Dorrit was a serialised book published in the late 1850s.

Sadleir, the MP for Carlow, founded the Catholic Defence Association and was a leading figure in the Irish Independence Party. He was found poisoned on Hampstead Heath in 1856, having committed suicide.

Behind the respectability of his political career, Sadleir was a monumental fraudster. He had speculated wildly on railway stocks, defrauding hundreds of small investors as he forged shares in a railway company of which he was chairman.

He also misappropriated €400,000 from a consortium of Irish banks to cover his losses on railway shares. According to Dickens, Sadleir epitomised the greed of the boom, where no deal was too big to be financed and where other people’s money was there to be used and abused at will.

This is the lesson of all financial frenzies: when things are going well, no one asks any questions, but when the market turns, people get hurt, dodgy practices are exposed and reputations are tarnished.

What the boom hides, the slump exposes and former pin-up boys are often revealed as tricksters. This ebb and flow process was evocatively summed up by Warren Buffett when he said: ‘‘It is only when the tide goes out do you really see who is swimming in the nude.”

A similar development is occurring here as our property frenzy succumbs to the logic of financial gravity. This week we saw a solicitor being hauled into court over claims of questionable mortgage practices and claims that he misused client funds. This will not be the last of these types of stories.

The reason is fairly simple. During the great Irish housing boom, like the South Sea Bubble, the railway mania of the Famine years or the likes of Enron more recently, investors became carried away on the effervescence of easy money. As JP Morgan, the legendary American banker, observed: ‘‘Nothing undermines your financial judgment as much as the sight of your neighbour getting rich.”

This procedure – half virus, half envy – certainly applied here in the past few years as thousands of us joined the great property frenzy. Last year, 59 per cent of all houses bought were purchased either as investments or holiday homes.

More astonishingly, €8 billion was invested by Irish people in overseas property. At times, it seems as if most of the country is involved.

With so much cash sloshing around, there are bound to be some casualties and bad eggs. But what if, like all previous financial frenzies, there is a systemic failure which almost guarantees fraud?

Think about how money is raised from Irish banks to buy property. The most crucial number is the valuation that the potential investor gets on the relevant property. Given that house prices are now falling across the board, it means that every valuation made last year was wrong.

By definition, every valuation, therefore, overvalued the asset. When the market is rising, everyone has an incentive to overvalue the price of the asset: the valuer because he is often the same estate agent who is selling; the broker because he gets a commission; and the bank because it makes money lending cash. Systemically, the entire edifice is geared to making the upswing more dramatic and downturn more precipitous.

Anyone trying to sell a property bought last year will realise the valuation was wrong. Can they sue the valuer now? No: they were fully aware of the game and, in so many cases, the buyer was aware that the valuer was trying to get the value ‘up’, so that the buyer could get as much leverage as possible. Expect more questionable dealing to be revealed in the next few months.

The Archbishop of Dublin was right: the people who will get really burned are those who hang on longest. Very often, they are the ones who were last in and can least afford it.

  1. Ian


    The property boom has simply been an outworking of the ‘Bigger Fool’ theory of economics. Everyone knows property has been overvalued – I could buy a cottage in Windsor, Berkshire, close to the castle, for the price of a semi in plain parts of Dublin – but everyone has continued in the belief that they could sell at a higher price to a bigger fool. Market forces dictate that as bigger fools become scarcer their price goes higher, sellers having to sacrifice more and more of their property price to pay for a buyer.

    The people who, of course, get hurt are the weakest and most vulnerable who were put to the pin of their collar to buy a townhouse in Dublin 29 and now find that the price fall is already equivalent to one partner’s annual take home pay.

  2. Now, if only I’d the nerve to sell my house at the top of the boom and rent for a while :-)

    BTW, Think if any of these 10 predictions for Post Tiger Ireland are wrong?


  3. David was recently talking about the irish diaspora returning to their native land,as a form of salvation for the distressed ship “SS.Ireland”, but a letter in todays Irish Independent starkly highlights the fact that no retired irishman living abroad in his right mind would want to come back the the nightmare that represents every facet of life there now.
    Where I live and retired to some 7 years past (Gran Canaria. Spain) we have nothing like the level of criminality reported in the irish newspapers daily-even in the larger cities such as las Palmas or Santa Cruz de Tenerife.A three bedroom house in a normal ( non tourist resort) town costs about 160,000 euros.Many Scandanavians are taking up residency here and paying taxes here on their world wide income (including their pensions). They therefore pay lower tax on say, a swedish pension-and enjoy a civilized way of life in an unsurpassable climate-as most irish know.
    Irish civil servants for example,retiring here, would live like kings on their Rolls Ryce government pensions.
    Motor cars, fuel,food etc at up to half the irish prices- and no heating oil bills- only air conditioning needed in July and August!!
    I believe that if the Canarian government do not impose restrictions in future years,(sometimes discussed here) on the volume of european pensioners coming here to live in happy retirement, we will see an emigration from Ireland and the rest of Europe to match the immigration now taking place in Ireland ,by economic refugees fleeing the poverty of the african continent.

  4. paddy cullen

    In my opinion the residential property market has burst, and we should expect a fall/crash in home values. Based on the large amount of articles I have read over the last year or so, I predict that the collapse in the residential property market will look similar to what I hope to explain now.

    Once a month, the Permanent TSB/ ESRI publishes its House Price Index report. In my opinion it is highly likely that the average person is not going to have an idea of how the price of his house is performing against the indices that are available. At the early stages on a decline, investors/home-owners will probably assume this decline does not effect there particular home, and will in all likely hood will probably pay little if any attention. As prices fall, the many who had intended to sell investment properties may be forced to withdraw from the market, preferring to rent them out in anticipation of a more buoyant market later on. A market for rented accommodation will then appear. This will exert downward pressure on an already faltering residential market. As the market for rented accommodation increases, there will be more competition and downward pressures on rents. This will mean that the gap between the interest on a mortgage and the rent from the property will widen. It will become far cheaper to rent property than to rent it out. This will further depress the values of residential property, add to the self-feeding downward spiral in prices.

    As residential property continues its long slide, there will be many minor ripples. Prices will certainly not fall in a straight line until we approach the end of the property crash. After a speculative bubble bursts, there are many upward moves that may trap the unwary. Initially people will see declining property values as a fleeting opportunity to buy at a slightly lower price. Estate agents will seize on this opportunity, selling the “get in now, last chance” concept i.e. get in now before the property prices start soaring again. Hope springs eternal at the early stages of a falling market, and each minor flip-up is considered to promise a reversal and the next massive rise. Each dip in property prices will be classified as a “healthy breathing spell” by most. Each rise will be hailed as the beginning of the next boom. Because of the enormous participation in the house-buying boom over the last two decades, thousands of Irish will be affected as they gradually become aware that property prices have been steadily falling. Eventually, I believe that many will begin to think that house prices may not start rising again for quite some time. Many will begin to doubt that property prices will “always go up” and will become deeply concerned. Lending institutions will then in turn place restrictions on lending. House builders may try to gold their stocks of unsold houses, but most will probably be forced to sell distressed prices to meet overdue construction loans. With professional property speculators adding to the supply of houses and lending institutions restricting demand, the fall in prices will increase with severity. This trend in my opinion my not be easily reversed. Minor recoveries will become brief and gains will be more modest. The declines will be sharper and longer.

    The sense of urgency to buy a home that exists to some extent at the moment among the youth of Ireland I expect will also virtually vanish from the residential property market. As the fall in prices become more pronounced, other necessities of life may take priority to owning a home. Rented accommodation because of what might happen in the buying market, I would envisage would become more plentiful. Investors in property will have no choice to rent, since buyers will may be less interested in buying given the current climate in the market. There will be a steady increase in the supply of houses, but sales will become scarce. Losses on property will be making the headlines and building and construction companies may stop trading. As we enter a stage of increased uncertainty (i.e. increases supply, the increase in borrowing costs, increased living costs and coupled with falling house values) within the Irish property market, we may be confronted with the forced sale of houses. House buying has been the main player in the bubble of our recent prosperity. When a bubble bursts, the fall could (based on past bubbles) be as much as 60%-70%.

    In the period immediately ahead, I can envisage that property prices will continue to fluctuate and the severity of the decline may go unnoticed. For the next six or seven months, prices may decline, they then might rise for a few months. On the back of this, investors/homebuyers will jump to the conclusion that the decline is over, they will then in turn invest. Then prices will begin falling again for another period of time, taking the published monthly index to new lows. As prices fall further, investors who where excluded from the market at the higher prices will enter the market and will rush to buy. Prices may then decline even further. At the terminal stage of the decline, perhaps after prices have fallen by 30 to 40 percent, there will be will be a complete flush out of the market.

  5. Nice to know that our domiciled retirees for the most part don’t have to rely on the labour market over in warmer climes: the “Costa’s”, the Med, Bulgaria, Florida, etc. Meanwhile back in the “auld sod” – workers (taxpayers) here can tolerate high prices as long as we have employment. Though I would happily swap Ireland’s weather and property prices for the likes of Spain’s, they can keep their paltry wages and constipated labour market which I would think is also not immune to immigration from low-skilled economic migrants.

    Generalising on the subject of immigration for a moment: we in Ireland seem to be blessed by the disporportionate amount of highly-educated immigrants (relative to those who are unskilled) that we are receiving from all over the world. They are helping to keep us to the forefront in Hi-tech and Pharma sectors to name but a few. These people are smart and will gravitate to where they can earn well and live well. Wages in the US might be better, but not a country you want to be sick in (where funnily enough, they don’t have a two tier system – alternative to the private system being no system at all apparently….).

    Factor in tradespeople from eastern europe who are providing much needed competition in inflated sectors of the economy…Filipino nurses who sacrifice their families to look after our childcare and health service and our quota of Asian students. They not only supply cheap labour in convenience stores, cleaning and fast food outlets, but also give employment to English teachers and pay rent. One begins to see an immigrant demographic which seems to give a lot more that it asks for. Just as well ‘cos we seem unable to give them the basics, sense of indentification with our police and public services, school places for their children just some that come to mind.

    Young workers who may be struggling with long commutes to raise families, hold down jobs and pay mortgages are for the most part, happy to invest in the future of Ireland Inc., and Lord knows it’s the only option open to most of us. Good luck to all our retirees who have presumably worked hard all their lives and now deserve to enjoy their golden years. We won’t be joining you on the deckchairs for a few decades yet but feel free to drop in on us now and again so we can admire your tan and golf handicap while we try to find time-rich millionaires among us who have the time and energy to train our next generation of soccer & rugby internationals, inter-county stars, chess masters, artists, etc. We’re not going to give up on S.S. Ireland.

    Although some might be reaching for the lifeboats thinking that she resembles the infamous vessel built on these shores early in the last century – most of us know that by working together with our new crew members we can find that all of us “navvies” together can find calmer waters in time – with hard work, patience, perseverance and above all teamwork with our new crew members. We would choose to “believe” in our futures and see the S.S.Ireland as being more “Chieftain” Rolex Fastnet winner than Titanic disaster.

  6. DD

    A very good and, as usual, honest article David. I am also very impressed with the comments here, especially those made by Paddy Cullen.

    At a company Christmas party a few years (but not too many) ago, I asked the, now retired, CEO of one of Ireland’s lending institutions if he would agree that there was a high posibility of an oncoming crash in the property market in the not too distant future (as I personally believed was the case.) He literally laughed at the idea and told me that it could never happen. About eighteen months later, I asked one of the most senior directors of the same institution the very same question. He looked at me with all sincerity and said not that he believed it would never happen, as interest rates would probably never go into double figures again (on the basis that this was the pre-requisite for a potential crash.) Some time later, I even laid this question at one of the senior mangers in the company and was given, yet again, the same answer. However, while this apparent ‘self-belief’, or whatever you may call it, seemed to throw cold water on the burning embers of a potential disaster in the property market, I realised that what I was possibly hearing in fact were two separate things, a) the Company line, and b) Denial. What has been interesting to note, is that in the last two to three years, the Chief Economist, not only of this same lending institution, but across the board of Irish lending institutions, have gradually been courting the slowest u-turn in economic history.

    While six years ago, it was insane to think there could be anything but a buoyant property market in Ireland for the next few decades, these same ‘economic prophets’ have since changed to being the harbingers of a ‘soft landing’ approach. Now it looks like they are running out of a proverbial runway to land on. And why does this happen? I hate to be cynical, but it’s all good business. For the consumer, you ask? No. For the lenders, perhaps? What do you think! Let’s face it, if the market crashes, will the banks lose out? Highly unlikely. Lending institutions are like Bookies. No offence (to bookies that is.) All the time property prices are high, then so are the relevant mortgages. Whatever the Interest Rates may be set at, the banks will make good returns from the interest on the amount borrowed once the mortgage passes the magical profit line (usually 2-3 years in at most.) If, perish the thought, Interest Rates should rise, then despite what the lenders may say about their having to buy money at a higher price to be in a position to lend to their customers at the higher interest rates, they then make even more money. Let’s not forget that the lenders are in business, they are not charitable organisations and as such are trying to make a decent profit to keep the shareholders happy and the stock value rising. And, should the market go pair-shaped, should the terrible thought of repossessions be on the increase, or should the market grind into first gear, or worse, reverse, then the banks are still covered. Every mortgage over 75% Loan to Value on set up, has to have Indemnity cover. This is to protect the lender in the event of non-payment of a mortgage. Of course this action is only undertaken once all possible efforts have been explored to retrieve the repayments due from the borrower (including legal fees if necessary.) They will simply tighten their belts, put a stranglehold on lending criteria and wait for the dust to settle.

    So, when we listen to, or read the opinions and views of the very institutions that we look to borrow money from, let’s remember that those very institutions have a vested interest in one thing, making money. Now they are hardly going to stand up and tell us that the market is in trouble are they. Once the market goes into the latter stages of phase seven of it’s cycle, the lenders will already have set new policies in motion to look after their own interests.

    While in the meantime people who saw this coming for the last four to five years may probably say, “I told you so!”

  7. Glen Quinn

    I’m still in denial and I don’t want house prices to drop. Turn those machines back on, turn those machines back on!!!. LOL

    Lets look at some straight logic:
    Buy a house in Dublin for 485,000 euros (average) on a salary of 45000 euros, yes thats really smart and therefore using Irish logic it makes sense to buy LOL

    It’s a disaster waiting to happen.

    Bertie says “we are talking the market down”
    Answer: The market has gone so much up that you can’t talk up any more

  8. Paddy Cullen seems not to factor in to his calculations the fact that a small number of very powerful developers (i.e. the well publicised Bailey brothers) control much of the availible building land in the Leinster area, so it is a chess board with a few powerful bishops and many pawns, open to more subtle manipulation than he envisages in his “free market” scenario.

  9. To Glen

    That’s the problem with these $1 dollar bets between friends

  10. MB

    Good story about Sadleir – interesting to hear that the brown envelope brigade have been around for a lot longer than we think and aren’t just a product of the post-Independence gombeen takeover. Still, it’s amazing how many of Sadler’s descedants seem to have ended up as FF politicians…

  11. Stephen

    They say that in crashes, first the stupid people lose their money, then the clever people, and then finally, the really clever people lose their money, before it’s over.

  12. Bobby

    Oh come on David! “every valuation made last year was wrong”! I think you are confusing value and worth. Worth is the true value of any item. A valuation is only ever “right” at a moment in time and to suggest that the valuations of property made last year were wrong is rubbish! At the end of the day, a property’s value is determined by the person who wants to acquire it. If I was prepared to pay €500k for a property last year and am only prepared to pay €450k for it now, its a reflection of the value I place on it. (Equally I might only consider it worth €400k, but I know I’ll be able to sell it to some other sucker for €450k at a later date!)

  13. Bobby

    Hey DD, what exactly is “pair-shaped”?

  14. DD

    ‘Pair-shaped.’ ‘Down the toilet.’ In the crapper!’ ‘or even ‘Tits up!” Basically, going horribly wrong. But then you knew that, right?

    Bobby, I dont agree wth your other comment. True value is not what somebody is prepared to pay for something, it’s what the market deems it’s correct value in relation to manufacturing costs, including purchase of materials, transportation, labour, marketing, etc. Then adding on profit margins for the manufacturer and/or distributor, so to speak. What an individual might be prepared to pay for something does not deem it’s true value and simply reflects that persons desire to purchase it. If you wanted to but a copy of the Herald and decided you wanted to pay five Euro for it, thats the worth you have placed on it yourself. But the goods value is no different than it was before and what you paid for it has not affected it’s true market value.

    For the last four years or so, valuers have been throwing silly figures at property. There are a lot of stories around of valuers commonly being asked to place inflated valuations on properties in order that a house owner may get bigger mortgage top-ups, or for vendors to get more for their property sale. Those figures have grossly distorted the true value of the property market. If someone is dumb enough to pay through the nose for a property, or any other goods for that matter, then that is their business. But while grossly inflated prices may have a knock-on affect (i.e. neighbours deciding to match a recent sale price in their own property sale price desires,) it’s not an accurate reflection of ‘true market worth’ or ‘true market value’, however one may wish to personally look at it. So, in answer to your comment, the truth is that David is correct in what he says and property in Ireland has been massively over-valued (by 50% or more) for the last 5-6 years, if not longer.

  15. This has happened in Spain too in recent years. Banks were accepting unrealistic valuations and allowing clients to borrow almost 100% of what they were actually paying for a property. By facilitating this subterfuge to facilitate the flow of business they contributed to house inflation and created a “sub prime” market of mortgage holders. Perhaps the American story is similiar.The spanish banks are getting nervious now following on the american experience and unreal valuations for loan applications are now longer in flavour here.

  16. Andrew

    Check your spelling there DD. Bit pedantic though Bobby. maybe you should correct all the comments.Anyhoo,I heard A.I.B say, that the economy is facing “strong headwinds” I had to laugh.It kills them to actually call a spade a shovel. John McDermott makes a good point about the likes of the Bailey brothers.They can manipulate the market.I am not a believer in conspiracy theories, however in Ireland we have the mother of all conspiracies to keep this ridiculous property boom going. Certain sections of the media, the banks, the builders,your neighbour the list goes on. They are all guilty. Shame is not a word in their vocabulary however.

  17. DD

    Ha! Good point Andrew. Or should that be points? I sit corrected and apologise to anyone who didn’t quite understand that I meant ‘Pear’-shaped. Pedantic indeed… or just plain dumb perhaps.

  18. SpinstaSista

    Has anybody heard anything about banks renting houses out to owners who can’t pay the mortgage as opposed to repossessing the houses? Apparently this is a means of keeping repossession figures down and preventing panic in the property market.

  19. Glen Quinn

    Hi SpinstaSista,

    No, I havn’t heard of banks doing what you outlined above, in any case it would not make sense for a bank to do that because the bank will be holding onto an asset thats decreasing in value each year and this value gets reflected in the banks loan book which in turn gets reflected in the Banks balance sheets that shareholders use to calculate the net asset value (NAV) of the bank. So if a bank did this with a lot of there properties, then as resposseions rise and on there next financial results they would announce a mark down on there assets (It whats happening at the moment with the American banks like CountryWide, Wells Fargo just to name a few).

    What banks need to do if someone defaults on there loan is too sell the property as fast as possible and if the bank sells the property for less than what is currently owed on the mortgage by the original owner of the house, he then pays the difference to the bank.

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  21. Stephen

    Of course it’s always possible that rather than property prices falling, the prices of other things, except labour, will rise.

  22. Lonely Expat


    high inflation, huge levels of personal debt, multinationals downsizing, crime wave on the increase, overdependency on construction sector, property market crash, acute lack of child care, rising stress levels, no more craic, etc. etc. etc.

    Seems Ireland has surpassed Germany in the art of talking down a nation – anything positive going on in Eire these days? Any chance at all of a ray of light emerging over the horizon? Or should resign myself to retiring to a Costa-del-nowhere.

  23. Andrew

    “Seems Ireland has surpassed Germany in the art of talking down a nation -” Oh God! That’s Bertie Aherne speak if I ever heard it. There is a difference between idle comment and reality! Aherne also said the same about the health service. There is no problem there either apparently. In fact all is fine and dandy here. Please can we all just look at the stae of this country. Despite apparent prosperity over the last 15 years our govt. which is mostly made up of school teachers have squandered the money. Health service is in a mess, our public transport is as crap as ever and corruption is alive and well.They are facts!

  24. Lonely Expat

    Thanks Andrew, that’s settled then. John McDermott, would appreciate tips on nice sunny beaches. Meanwhile, maybe someone at home could do the honours and shoot the criminal teaching government.

  25. Donal

    House prices aren’t the only thing that are going down in this country…. the moral practise of Ireland too.

    The National Identity is declining because of uncontrolled Immigration

    The Tax system is ridiculous where if you earn over E28,000 you are charged 42%

    The family is under threat because of children being born out of wedlock (33 – 39 %) and the greater unreasonable concessions for Homosexuals (They should just be protected from the basic rights of employment and housing)

    Also idiots trying to advertise illicit services on this site isn’t improving matters

  26. Andrew

    Donal, you should perhaps think of going back to the 18th century, where I’m sure your views would go down a treat. Children born out of wedlock? Concessions to homosexuals? Whatever next?

  27. Criostor


    I understand that things are different now but surely there are limits in society to what are acceptable?

    How would you feel if you learnt that your daughther was with child and unmarried or if your son wanted to marry his boyfriend.

    Unless you’re David Norris or someone who doesn’t recognise the sanctity of marriage, I would like to see your reaction.

    I hope you practise what you preach

  28. Dave

    Donal and Criostor, you guys are the epitomy of that sad little e,barrassing kip that ireland was under Dev, fortunatly that old ireland is long since dead and buried.

    lets all enjoy the ride to the bottom eh, and maybe we’ll pick up a nice semi-d on the way back up eh?

  29. Andrew

    Oh Dave, Donal and Criostor will be very annoyed with you. Using words such as “ride” and “bottom” in such close proximity is clearly a breach of moral standards!!!!
    Leave them to it Dave we all know what their problem really is. They aren’t worth replying to, bigots generally aren’t.You’re not going to change their minds.

  30. Chip on shoulder

    Dave, Andrew.

    Why don’t you just have a cup of “shut the hell up”?

    The only bigots that are really here are you, the two of you just seem to pick fights with people for no good reason without establishing the facts.

    A mature arguement means respecting the opposition and slandering them or calling them names and insinuating they are prejudiced when you don’t share their viewpoints?

    Andrew, didn’t you suggest that ireland doesn’t have a naturally talented workforce? That’s sounds very ignorant to me and bigoted! Double standards don’t apply to anyone!

    Donal and Criostor at least know when to back down, they aren’t perfect individuals and have their flaws like everyone else.

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