It's Not the Shorts

Posted by: Matthew Goldstein on September 19, 2008

Let’s be honest, short sellers will never win any popularity contests on Wall Street. It’s hard to warm-up to traders who make a killing when stock prices tumble. So that’s why short sellers have become such an easy and inviting target for regulators in the current financial crisis.

But the Securities and Exchange’s Commission move to bank all short selling in some 800 financial stocks for the next 10 business day smacks of overill. That’s because the short interest—shares sold short in anticipation of a stock decline—in big financial stocks is really rather paltry compared to the number of outstanding shares in those securities. At the close of trading on Sept. 17, short interest as a percentage of shares outstanding was 2.5% in Goldman Sachs; 2.6% in Morgan Stanley and 1.3% in Citigroup, according to Bloomberg.

Indeed, statistics taken from Bloomberg reveal that one bank with the highest percentage of shares sold short was credit card firm Capital One—a company that hasn’t been a target of much recent criticism from short sellers. The short interest on Capital One accounted for a whopping 21% of the bank’s outstanding shares. That’s nearly twice as much as the percentage of shares sold short on Wachovia, a big bank that has in the firing squad for quite some time.

Now there’s nothing wrong with regulators targeting abusive short selling, such as so-called naked shorting. In a typical short sale, a trader must borrow the shares from a broker so he can return them to the broker when the stock actually drops in price. In a naked short sale, a trader bets against a stock without actually arranging to take possession of the necessary borrowed shares.

It probably wouldn’t have hurt if the SEC immediately reinstituted the so-called up tick rule, which says traders can only short a stock when the price is moving up. A little over a year ago, the SEC discarded the uptick rule after determining that it had no bearing on the direction of stock prices.

Needless to say, short sellers are hoping mad about the SEC’s emergency ban. But don’t look for many hedge fund managers to go public with their discontent. The sentiment on Wall Street is that challening the ban won’t do any good and may draw unwanted attention from regulators.

Another idea the SEC could have pursed, instead of focusing all its attention on the shorts, is demanding that Wall Street banks come clean on holdings of toxic investments. Even now, 13 months into the financial crisis, Wall Street firms are still reluctant to tell investors just what troubled securities they have sitting in their balance sheets. That’s a big reason why investors harbor so much distrust of Wall Street banks.

So if it’s not short sellers who are driving a bear raid in financial stocks, who is? Well, it’s probably plain vanilla money managers, looking to get out of positions. Fear is a powerful emotion on Wall Street—almost as powerful as greed. What we’ve probably seen the past few weeks is simply a situation in which money managers decided to sell first, and ask questions later.

Counting Up the Shorts
Bank/Broker Short Interest as % of Outstanding Shares
(Sept. 17) (Aug. 29)

Bank of America 1.7% 2.6%
JPMorganChase 1.0% 1.4%
Citigroup 1.3% 2.8%
Goldman Sachs 2.5% 3.1%
Merrill Lynch 3.7% 2.9%
Wachovia 11.5% 12.5%
Morgan Stanley 2.6% 4.1%
Blackstone Group 6.5% 12.5%
Capital One 21.2% 19.6%

Source: Bloomberg

Reader Comments

sam

September 19, 2008 3:39 PM

The naked shorts didn't cause this. They are always blamed, but the real reason is always that someone has screwed up and created a situation that obviously can't hold up. The Empire is over. Even without California leaving the Union, Washington will be weak for decades.

MARK

September 19, 2008 4:30 PM

Take too many risks with your money and you will pay. It's the firms not taking responsibilty for the failures that gets me. Short sellers were making good decisions based on the knowledge they had. SEC didnt seem to mind the over buying of the mortgage money. Thats when they should have stepped in, too late now.

JohnB

September 19, 2008 4:49 PM

Errr... how about picking a period when the stock prices of the companies in question was being driven down 50-80% instead when it was all over??? You'll see an entirely different pattern. The issue is, that EVERYONE was short selling, because IN THE SHORT RUN that was the only way to make any money on trades in this environment. It became a feeding frenzy, a downward spiral, negative feedback. Something significant had to happen to stop it, and it now has. The short selling didn't START the problem, but it damn near finished off the whole of the financial sector because no-one could bring it back under control. Learn the bloody difference. Also, you don't think there's any chance some in the banking industry saw an opportunity to take down a number of rivals or gobble them up? The CEOs of companies like Barclays wouldn't agree to a deal on Lehman last weekend, but lo and behold, they pick up the assets for pennies on the dollar 2 days after they've allowed them to fold? Come on, you can't be that dumb. The Fed and Paulson got played.

JD

September 19, 2008 6:31 PM

Why are all these articles written in defense of the shorts? They have cost people millions of dollars and jobs as well. Isn't there another way of making money instead of running a company into the ground. If you don't like a company stay away from it period.

Bob

September 19, 2008 7:17 PM

I agree with Matthew. It is very easy for the regulators to blame on low-voice group, short-sellers. The problem remains with the bad companies or banks or organizations with or without the help of short-sellers. Short-sellers got penalized or blamed for acting on right(by regulators) or wrong(by markets)rumors.

Midwest

September 19, 2008 9:22 PM

Naked shorting begs for dishonesty or unethical behavior. Betting against something you don't even own or have permission to borrow is a recipe for problems. This is similar, in a way, to oil speculation. All it took was as little as 6% percent of the entire contract amount and never taking physical ownership of the oil and suddenly, you're a speculator. Go over to Europe and bid up oil futures there and suddenly your futures in America go up.

Naked short some big name stocks combined with a focused whisper attack and you risk next to nothing while taking down an entire company. There is a great deal of suspicion about just this type of activity surrounding Bear Stearns. I would put good money that plenty of collusion occurred once Lehman start tanking, too. "Nobody help them out and we'll pick those dirt poor bones clean for next to nothing".

Ahh, capitalism. It's fast becoming a joke at the hands of those that claim market forces are the only way to run an economy.

Right.

I've seen enough. I switched parties last year (along with my wife) after being a Reagan Republican. No more Republican hands off approach to governing. It only took 12 years of total Republican control of the Congress to completely tank our economy.

Thanks for nothing.

tiger

September 19, 2008 10:29 PM

They need to ban the short sellers in order to fully control the market and the naked shorts are just a convenient victim as a reason for them to turn around their so called "Free Market Policy". Do what I tell to do but don't do I do ok. Especially to all the other Governments.

TomV

September 19, 2008 11:58 PM

I've made the same comment in other BW articles on the current mess, and I'll make it again, also as a response to MARK above. From what I understand, the SEC did not do anything because it could not. Why? Because the laws on the books and it's authority did not extend into the dealing of independant banks like Lehmans. Now, who rights and approves the laws of this land? Yep, you guessed it, our lovely do-nothing Congress. As for the response of Midwest, be careful. Do some research on the core issue that started all of this, namely the huge numbers of bad mortgages from Fannie/Freddie that acted as the fuel for this entire sub-prime fiasco. In 2005, McCain submitted a bill AS A REPUBLICAN that was quashed by the Democrats. Fannie/Freddie were govt sponsored agencies, so why did they give large contributions to Barack Obama and Christopher Dodd (Dem, Chairman Senate BANKING Committee) around that time? When attempts have been made to reform Fannie/Freddie, Democrats have repeatedly quashed such efforts under the guise of "helping the common man". "Helping the common man" = vote buying and with Midwest comment above, sounds like they just made another purchase. Won't go into how Clintons used Fannie/Freddie positions to help freinds make millions, but I will tell you where those folks are now, on the Democratic presidential nominee's, Barack Obama himself, staff. Again, all this is a matter of record, just do enough Goggle searches.

williambanzai7

September 20, 2008 12:11 AM

From The Soundtrack : Ghostbusters (1984)


SHORT Busters…


If there's somethin' strange on your balance sheet
Who ya gonna call (shorttbusters)
If it's somethin' weird an it don't look good
Who ya gonna call (shortbusters)

(Lehman) I ain't afraid a no shorts
(AIG) I ain't afraid a no shorts
If you're seein' CDO's ruinin' your networth
Who can you call (shortbusters)
An' invisible trade dragging down your spreads
Oh who ya gonna call (shortbusters)
(Merrill) I ain't afraid a no shorts
(Bear) I ain't afraid a no shorts
Who ya gonna call (shortbusters)
Morgan Stanley: If you're all alone pick up the phone
An call (shortbusters)

(Paulsen) I ain't afraid a no short
I hear it likes Goldman
(Goldman) I ain't afraid a no shorts
Who you gonna call (short busters)
Mm…if you've had a dose
Of a naked short baby
You better call short busters
(SEC Cox) Bustin' makes me feel good
(Bernanke) I ain't afraid a no shorts

ahmad salman

September 20, 2008 12:46 AM

anybody somehave problem.how growth bussines in electronic and foodcourt with unless money?

GIS Utilities

September 20, 2008 1:17 AM

Leo

September 20, 2008 3:13 AM


Rubbing it in ....

USA Today 12/20 2006 : ….
All told, this year’s bonus pool for Wall Street executives hit $23.9 billion, the New York State Comptroller’s office estimates. That’s a 17% jump from last year’s bonus pool of $20.5 billion, and it works out to an average bonus of $137,580 for every person employed in the financial services industry.

Bloomberg 11/18 *2007*
Shareholders in the securities industry are having their worst year since 2002, losing $74 billion of their equity. That won’t prevent Wall Street from paying record bonuses, totaling almost $38 billion. That money, split among about 186,000 workers at Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos., equates to an average of $201,500 per person, according to data compiled by Bloomberg. The five biggest U.S. securities firms paid $36 billion to employees last year. …..

m.r.

September 20, 2008 5:17 AM

what brought the financial system to its knees was that "bad meat" was wrapped in "good meat" so that it would not smell and was sold at a good price(and gave a high returns to excite portfolio holders). eventually the smell leaked out and the buyers realized what a rotten piece of "meat" they actually bought! too many participants are claiming that they did not know what they were buying...hard to believe!
too many solutions to solve a simple problem...honesty..and you will pay dearly if you dont! and ...politicians,
regulators, and finacial institutions
that did not live up to their responsibilities. add...a stupid and indifferent consumer. hey.. the Emporer realy had no clothes!
p.s. they should invent a special Xray
to look into financial entities!

CMB

September 20, 2008 6:45 AM

The shorts were right about many of these stocks and the government AND MOST ANALYSTS avoided the problem. The shorts have been targeting these accounts for a long time. The issues were really a total lack of transparency in regard to balance sheet issues as well as a massive failure of leadership to address the issue, preferring instead to band-aid problems. I fault both parties in this as this is not just a GOP problem. However, much of the blame in the history books needs to go to the cause of the bubble not the unwinding of it. We must learn how to avoid bubbles because the cleanup is much worse than the profits made during the bubble. In this case, I suspect that the fed and especially Alan Greenspan will be quite harshly judged in history for the overabundance of cheap money, essentially bowing to Democratic and Republican pressures.

munidas pereira M.B.A (McGill)

September 20, 2008 7:40 AM

Unless the short sellers did something illegal such as spreading false stories they cannot be blamed for the fall in financial stocks. If companies took undue risks which makes their share prices excessive, blame the management. Now that short selling has been stopped in some companies, will their shares immediately rebound to where they were prior to the shorts stepping in. No !
The shares were overvalued.

Dana Wallace

September 20, 2008 7:56 AM

Do you think that we’ll only have a 10-Day moratorium on shorts? I think this could be an example of government instrumentalism. The Federals could continue to extend this moratorium for as long as they want. Perhaps this is necessary - scapegoat or not. I'm glad that I didn't short the financial stocks as I was planning.
Some people blame political parties for the financial fallout. Both Republicans and Democrats are guilty. I agree that deregulation has been a problem. My irritation is not that deregulation happened, but rather that reregulation didn’t occur earlier when it was obvious that the bubble wasn’t sustainable. Whom are we kidding? We foresaw that the bubble would pop. Like the Tech stocks in the early 90s, derivatives and securitized debts were little more than paper, pen, and air sustained by momentum. We are all to blame. We let this happened while we enjoyed the illusion of wealth on a cushion of air. We didn’t complain while we enjoyed our ride. Why don’t we take responsibility and blame ourselves now? Once we take personal responsibility, then we can change our society so that we won’t repeat the same mistakes over and again.

Phil

September 20, 2008 9:46 AM

If the shorts are all so deadly and such a problem, then why do we have to have the Feds come in and take all this toxic paper off the financial firms hands? The real issue is, these firms have not been honest with the public so no one really knows how much of this toxic paper is on the books. Where is the transparency?

Phil

September 20, 2008 9:50 AM

Tommy V: There is plenty of blame to go around on both sides of the aisle. Anyone with half a brain could have told you this was going to end badly 5 years prior. Of course, since Bush doesn't have half a brain, I guess this was a moot point. In general, we all know that Republicans mantra is less regulation, not more.

When you "google" stuff on the Clintons, how do you verify the accuracy of its sources?

pm69

September 20, 2008 10:44 AM

Goldman Sachs was next to go... so they called buddy Hank to the rescue. It's as simple as this.

Yasser Shah

September 20, 2008 11:15 AM

Short interest as % of outstanding stock is probably not a good measure of the insignifiance of short selling in perpetuating the wall street collapse.The market is a collective entity and a few rumors in an already uncertain envionment can lead to disaster. It is like being on a cruise ship with few people chattering that the ship is going to sink. When the sea is stormy, the chance that it would spread from a small point is not that huge.

Yasser Shah
(pakistan)

PNW Trojan

September 20, 2008 1:05 PM

You see? It IS the Wall Street crowd, EATING THEIR OWN! Some knucklehead wrote that 'this is not possible as Wall Street is -get THIS! - 'REGULATED!'!!! And I'm sure this knucklehead is a loyal Party toady. I remember either Dodd or Lie-berman proclaiming "My FIRST LOYALTY is to the Party!" Nice to know his constituents don't consider themselves AMERICANS, FIRST AND FOREMOST.

dw

September 20, 2008 1:13 PM

I think the real reason they did the short selling rule was make the market jump. mission accomplished! it worked the first time they did it, and the second time too! now the market will settle down as nobody buys stocks. since they are stuck for 10 business days. on the 11th, watch out. those stocks will collapse!

showmethemoney

September 20, 2008 2:37 PM

Imagine: a bank gets robbed; what happens:
1. We immediately pass laws to build a stronger door on the bank lobby.
2. We call for the firing of the bank auditor and the bank commissioner.
3. We call congress to pay back the money to the bank that the robbers stole.
4. We shut down all the other banks in the country who could be robbed as well.
5. We create a new bank law that required stronger doors on the bank buildings.
6. We allow the us govt to take over all the bank's cash and loans that could be stolen as well; and actually, we let a private bank consortium do this, with the taxpayers on the hook if it goes bad.
7. We pass new laws that make it more difficult for people to come in or out of the bank, and for them to write checks and make deposits.

What's missing?.......

How about:
1. Who robbed the bank?
2. Where are they?
3. Where did they stash the money?
4. Who wants to saddle up and ride to find them.
5. Which tree will we use to string them up?
6. Who inside the bank colluded with the robbers, and when are we going to have the courage to put them to death, as they deserve after a fair trial?
7. Who wants to go get the money back?

It is very obvious that just as in the S&L crisis, and the debacle that became the BCCI scandal, we are ignoring the most important questions....what are we going to do to recover the money stolen through fraud, and when are we going to wake up and connect the dots?
What we really need are wanted posters with rewards for common citizens, and finders fees for anybody who can help recover the loot.
Until we get serious about (forget a "perp walk") the DEATH PENALTY for organized criminals who steal billions, we will continue to accelerate down the path to becoming a footnote in history. Desperate times call for desperate measures.

http://deadlinenewsroom.blogspot.com/2008/04/mortgage-fraud-now-organized-crime.html

Jim L, San Diego

September 20, 2008 3:25 PM

Financial expert John Mauldin writes in his newletter:

Want to get really mad? Up until 2003, all investment banks were allowed only 12 to 1 leverage. Then in 2004, the SEC basically gave five banks (and only five banks) the ability to lever up 30 or even 40 to 1. Bet you can guess the five banks. Bear, Lehman, Merrill, Morgan and Goldman. Three down.

As Barry Ritholtz wrote: "So while the SEC runs around reinstating short selling rules, and clueless pension fund managers mindlessly point to the wrong issue, we learn that it was the SEC who was in large part responsible for the reckless leverage that led to the current crisis." (Don't get me started on blaming the short sellers. Let's not blame the people who leveraged up their companies 40 to 1 with bad investments.)

Amanda

September 20, 2008 8:37 PM

Exactly: While the SEC runs around reinstating short selling rules, and clueless pension fund managers mindlessly point to the wrong issue, we learn that it was the SEC who was in large part responsible for the reckless leverage that led to the current crisis.

Who is regulating (examining) the asset quality of those publicly traded companies that failed? SEC, OTS etc. They failed miserably, and guess what? They will blame it on fair value accounting principles.

jay

September 20, 2008 8:57 PM

Who directed or who influenced that decision of SEC to leverage 30 or 40 to 1?

Midwest

September 20, 2008 9:50 PM

To TomV:
I know very well what the main problem is in this mess. NINJA loans made to people who should have never gotten them. That is at the core of the real estate bubble market and there isn't one iota of an underlying fundamental that should have caused the extreme run up in home values.

The financial institutions were caught up in their own hype and they massed the kindling around their feet, doused it with gas and loudly told everybody that they were smarter than everybody else and that they could never lose. That is where the flame came in- via greed. Had they just slowed down a little, the kindling wouldn't have been lit.

As to Democrat versus Republican in this mess- The Republicans held the Congress for 12 straight years and 6 of those included holding the White House. There was NOTHING done to prevent this mess and trying to blame the Democrats is just another feeble attempt to move the spotlight away from 12 YEARS of inaction on the part of a Republican controlled Congress.

The Republicans are responsible because they held power for so long and did so little. Now the problem is expected to cost more than ONE TRILLION TAXPAYER DOLLARS.

Oh wait...I think Bill Clinton had something to do with this... It must be connected to his extramarital affairs...

Sorry, the Republicans sat on this mess for 12 years. It's their fault and the number of Republican to Democrat converts in the last 18 months is clearly tilted to the Dems favor. How the pendulum swings. Republicans can't wiggle out of this one no matter how much spin they put on it.

As for a little research- Please note that real estate in Japan dropped by as much as 2/3 before bottoming out 2 years ago. We could easily be facing a 50% drop in the white hot U.S. markets before this is all over.

I have no sympathy for those that speculated in the real estate market or those that knowingly invested in a mortgage industry that swam in fraudulent behavior. If the investment banks go under, so be it. They deserve it and they should not be getting a single cent of taxpayer money to bail them out. So much for the SMALLER government Republicans can't shout enough about. Now, under a Republican president and his cohorts, government will step in and become bigger than ever.

Show me where it says in the Constitution that the Feds are supposed to help out an industry that self immolated due to greed. Or that they even have the right to.

Strict constructionists? Nah, bailing out their voter base is more like it.

gambler

September 20, 2008 10:40 PM

I don't understand this...blaming short sellers. Wall street and all the stock exchanges around the world are big casinos. What can we expect from gamblers? The gambling itself is to make others fools using loopholes and get out. That's what's happening. If that is true, why do we have to finger short sellers. He just played his game. When your stocks went up and gained millions, you were happy. Now somebody brought you down and you are crying. And also, why we need to worry about stock markets going up and down. Really, they are not the real reflections of economies of nations.

Bignumone

September 21, 2008 1:40 AM

A lot of things went wrong in subsequent order. Short selling was one of them, but not the first or last. It was in there.
This is like listening to a fat person talk about a fad diet. "If I just don't eat fat", "If I just don't eat carbs", "NO PROTEIN", or starvation! What is ignored is the obvious, exercise and eat less.
There is much that went wrong that is obvious that can be corrected (I think showmethemoney has it mostly right). The hidden stuff can be worked out as it is found.
BTW, what the heck is "Sam" talking about Cal leaving the union? That is just crazy talking!

It's the short sellers

September 21, 2008 3:02 AM

... who brought down terminally sick banks! So they should be brought down to jail for participating socially destructive activities with brutal greedyness. DON'T YOU AGREE?

Ajoy

September 21, 2008 8:37 AM

In my view, blaming it on naked shorting is incorrect. Have a look at the current account deficit chart. USA sits at bottom with around 700 billion dollar deficit. it's a steady decline since 2001. Add to it burden of another 750 billion bailout package to save the great (?) institutions. The picture is quite clear. All those dependent on US economy will suffer in pain in coming years, till USA corrects its rich lifestyle.

TOObad

September 21, 2008 1:07 PM

Actually it is the shorts-- and the worthless SEC to allow the naked short that is !!!!!!!!
Any one who does not understand what they have done
to our market- economy etc - well too bad.
And NINJA loans - bad business how did you think it would end.

David

September 21, 2008 3:12 PM

Short selling is a practise necessary to all markets and it should not be blamed for the current crisis. Regulators knew what was going to happen and let speculators massively go short. I agree this is a shame, but the practise in itself isn't.

Alok

September 21, 2008 4:07 PM

In my opinion, this article is misleading the effect of % short oustanding as a yardstick to understand the effect of short selling. The volume of shares being traded should also be mentioned of all the stocks. This is truly reflect that if the 2% is the shorts oustanding and 3% is the daily average volume, then short sellers can manipulate the price and bring it down quickly.

armedhippie

September 21, 2008 5:27 PM

short selling isn't the problem, irresponsible management is the problem. and now irresponsible management is being rewarded. How are they going to learn if there are no consequences?

S P

September 21, 2008 6:31 PM

In America there is a tendency to look for the one and only big bad wolf. But reality is that there is a pack of wolves. Lets not try to find the one and only reason and exclude short-selling by providing evidence that minimizes its role. Short-selling is also responsible. The article should be rewritten to say "Its not just the short-sellers".

Joe 2

September 21, 2008 7:10 PM

The bailout is absolutely necessary. From past history, in the Depression and the Real Estate crash in the 1980's, the government has set up a system to stop financial disasters. The Panic selling of stocks is not helping the situation. Some companies are continuing to grow even in this financial crisis but their stocks are being sold. The law to stop selling stocks will have to continue until the end of the year when everything calms down. The results of the bailout will not be known until at least 3 months. If the banks go bankrupt, the whole country will be in trouble. Companies will not be able to pay employees. Consumers will not be able to write checks.

BIGWEEDS

September 21, 2008 10:20 PM

TO BAD THAT THE AUTHOR CAN NOT SPELL "OVERKILL".
REGARDS

BIGWEEDS

September 21, 2008 10:24 PM

WHY DOES BUSINESS WEEK HAVE THE LAST COMMENT AT THE TOP FOR SOME ARTICLES AND AT THE BOTTOM FOR OTHERS? DOES THE LEFT HAND NOT KNOW WHAT THE RIGHT HAND IS DOING? I BET ONE THINKS THAT THE GLASS IS HALF FULL AND THE OTHER THINKS THAT IT IS HALF EMPTY. REMEMBER WHAT GOES DOWN WILL GO UP....AT SOME POINT.
DO NOT SELL LOW AND THEN BUY HIGH.
REGARDS

BIGWEEDS

September 21, 2008 10:27 PM

HEY ARMEDHIPPIE,
THEY HAVE LEARNED THAT THEY CAN DO WHAT EVER THEY WANT AND STILL MAKE BIG BUCKS. AMERICA IS GREAT!!
REGARDS

Queennabber

September 21, 2008 11:02 PM

No party lines in this arena. All these lawmakers do the same when enormous amounts of money are involved.

That means, you are seeing the 'Good ol Boy' system working full tilt.

Sad way to view the country's leaders but facts are facts.

Proverbs 29:2

Amit

September 21, 2008 11:57 PM

Why are the Feds protecting the very banks that created this problem in the first place? Banks were labeled "financial innovators" with new (structured) products that transferred risk "efficiently." Now the same banks that provided these loans and then repacked them (after splitting them into pieces based on risk), are asking the taxpayers to bail them out? And then they have the nerve to single out short sellers?

If you have the intelligence to identify a poor company and can legally short that stock, what is the issue?

Every 10 years or so, these banks create a problem using the derivatives market. They haven't learned their lesson. Bailing them out now will only cause a bigger problem down the road.

I don't mean to sound like a cynic but the gov really does protect the rich - it's always the taxpayer who gets screwed.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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