How Supposed Free-Market Theorists Destroyed Free-Market Theory

This guest post was contributed by Dan Geldon, a fellow at the Roosevelt Institute.  He is a former counsel at the Congressional Oversight Panel and a graduate of Harvard Law School.

Over the past year, there has been much discussion about how the financial crisis exposed weaknesses in free-market theory.  What has attracted less discussion is the extent to which the high priests of free-market theory themselves destroyed meaningful contracts and other bedrocks of functioning markets and, in the process, created the conditions for the theory’s weaknesses to emerge.

The story begins before Wall Street’s capture of Washington in the 1980s and 1990s and the deregulatory push that began around the same time.  In many ways, it started in 1944.

In that year, Frederich von Hayek published The Road to Serfdom, putting forward many of the ideas behind the pro-market, anti-regulatory economic view that swept through America and the rest of the world in the decades that followed.  Von Hayek’s basic argument was that freedom to contract and to conduct business without government meddling allowed for free choice, allocated resources efficiently, facilitated economic growth, and made us all a little richer.  Milton Friedman built on Hayek, creating an ideology that resonated with conservatives and ultimately became the prevailing economic view in Washington.

While many have noted how information asymmetry, moral hazard, and agency costs reveal glaring holes in free-market theory and contributed to the current crisis, few have focused on the extent to which the supposed heirs to von Hayek and Friedman directly and purposefully created market distortions and, in the process, destroyed the assumptions of free-market theory.

In other words, the same interests that claim the mantle of von Hayek and Friedman pulled the threads from the free-market system and exposed the theory’s greatest weaknesses.

In the years leading up to the crisis, the proliferation of fine print, complex products, and hidden costs and dangers – and the push against government regulations over them – exemplified the larger pattern.  While touting complexity as a form of innovation and railing against every attempt at government interference, supposedly pro-market forces used that complexity to clog the gears of free market machinery and to reduce competition and maximize profit.

When consumer credit contracts are buried in so much legalese that even experts can’t understand all the terms –­ I heard one former CEO of a top financial company admit privately that his lawyers couldn’t explain various mortgage terms and conditions — how can anyone believe the mortgage contract represents meaningful free choice?  What consumer is able to weigh the benefits and costs of individual financial product features buried in the fine print and decide what to take and what to leave?

The corporate assault on comprehensible contracts is important because contract law has been the bedrock of capitalism for a long as there has been capitalism.  By enabling free choice, meaningful contracts maximize economic efficiency.  The assumption behind von Hayek and other theorists is that robust contract law facilitates a vibrant economic system and minimizes the need for government intervention in the economy.  But that went out the window when von Hayek’s theory itself was used to manipulate contracts.  Now that products and fine print have become so perverted and incomprehensible, how can anyone expect contracts to steer the market in economically efficient ways?

We now know that the problem of complex contracts did not just harm consumers.  Municipalities across the country were lured into buying toxic derivatives and institutional investors were routinely abused at the hands of complex products.  Stories about Wall Street’s math wizards purposefully cramming dangerous and confusing products down the throats of the unsuspecting are commonplace and legendary.

The world has changed in fundamental ways thanks to computers and complexity can have value, but the world as we now know it has made traditional economic assumptions that assume real choice and real contracts irrelevant.  All that’s left is the hollow façade of choice when your broker shows you where to sign or when you click “accept” after quickly scrolling through incoherent legalese.  And we all are forced to accept this even though we know that the large majority of these products –­ and the actual deals around them — just aren’t that complicated.  The only thing that’s complicated are the fine print and the economically valueless tricks and traps hidden in the legalese.

Some conservatives are quick to blame the fine print on litigation and trial lawyers.  But that just doesn’t explain all the complexity that has come to define Wall Street.  Talk to a CEO of a major credit card issuer privately, and they will admit that “stealth pricing” was purposefully innovated to maximize profit by making contracts difficult to understand and compare.  The proliferation of opacity and the lack of competition in the industry are not an accident.

The industry has not only manipulated contract language to prevent real agreement (or what contract lawyers call “meetings of the mind”), but it also massively increased its negotiating leverage with counterparties by making it so onerous to walk away from boilerplate and incomprehensible terms and conditions.  It’s not easy to negotiate with the other side of a 1-800 number, nor is it easy to go toe-to-toe with an industry that can and does get away with tricking and trapping even supposedly sophisticated investors.

And if you think all that were enough, many of the same conservative economists and lobbyists have fought tooth and nail behind the scenes to preserve implicit government guarantees created by the bailouts – guarantees that allow large banks to access capital more cheaply than the smaller banks left struggling to compete.  While touting pro-market values and railing against “big government” attempts to break up the big banks, they are directly and purposefully allowing for market distortions.  And those distortions help explain the massive consolidation we’re seeing in the industry, the dwindling of real competition, and the proliferation of faceless conglomerates with infinite leverage over the drafting of terms and conditions.

What’s really galling though isn’t that supposed free-market advocates are so hell-bent on distorting the market wherever necessary to inflate profit.  What’s worse is the extent to which the same interests successfully advocated the rules that allowed this to happen under the well-worn guise of–you guessed it–freedom to contract and freedom to choose.  That is, through their well-financed and well-oiled lobbyist teams, they facilitated the destruction of the freedom to contract and free choice while pretending to do the opposite.  They killed the free market in the name of saving it.

The greatest lesson from the crisis that we haven’t yet learned is that “industry interests” and “free-market interests” are not the same.  In fact, they are more like oil and water, as the industry profits most in the absence of true market competition.  And so it should be no surprise that Wall Street has devoted itself to making contracts indecipherable, building boundless negotiating leverage and fighting for favorable breaks and regulation at every turn.  What should be a surprise is that the same scoundrels that killed our markets (and also, mind you, wrecked the global economy and demanded taxpayer bailouts) have so ably sold themselves as natural heirs to von Hayek ­and Friedman — and that so many of us have let them.

By Dan geldon

76 thoughts on “How Supposed Free-Market Theorists Destroyed Free-Market Theory

  1. I agree with the point that ‘industry’ interests and ‘free market interests’ are not one and the same. I have yet to meet a CEO who truly believes in free markets: the extent with which they go to avoid the spread of information is a simple example of their opposition.
    Yet this does not suddenly exonerate the free market crowd. Their model is flawed for exactly the reasons that CEO’s oppose it: Friedman and Hayek’s concept cannot exist. The real world is riven through with asymmetries, uncertainties, and inequalities that will always prevent its realization.
    The free market is an unattainable dream, an ideal, and not a representation of the real world. It belongs in academia.
    Meanwhile: out here in the jungle, Hayek’s ideal is simply a weapon used by those who ‘have’ to tilt the game against those who ‘have not’. It is like communism: an idea perverted into an ideology.
    So blame the CEO’s all you want. But blame the ideologues too.

  2. The real problem is government and monopoly capitalism conspiring together. Hayek warned against this. Those blaming him should read his book more carefully. Friedman is another case entirely, pretty much a charlatan.

  3. While Hayek’s name on his birth certificate had the aristocratic participle ‘von’ it became illegal to use this in his native Austria in 1919 – and as a classical liberal with little affection for ancien regime fripperies he never used it himself when he published his books or made public appearances.

    However ‘his’ wikipedia entry has the von so unless I obsessive-compulsively devote myself to removing them I suppose he is now going to be for ever posthumously re-ennobled.

  4. This post is an unsurprisingly accurate overview of the financial jungle. Can we now see a fix for the situation?

    Enough is enough! Why can’t we see our country’s government protecting we citizens from these super carpet-baggers? Freedom is for all people, not freedom to exploit financial trickery.

    May I assume Dan also has a fix in mind? Let us see it. I am familiar with the problem, what I want is the solution.

  5. If you take the number of people who read this blog in a year, and compare it to how many people listen to and watch Glen Beck in a month, the problem of the typical voter’s comprehension and cognizance of reality becomes agonizingly clear. Most people do not even know, or could define what the problem (the problem as Mr. Geldon defines above) is. A large percentage of them aren’t even literate enough to read the average post on this site, much less explain it to you. All they know is taxes. “My taxes went up, my taxes went down”.

    Coakley ran her campaign like a brain dead 5th grader, with campaign management like a brain dead 5th grader on weed. But she probably would have voted better on the issues than Brown will. Instead people voted for the person who could quote nonsense slogans and brag that he had a pick-up truck. George Bush might drive around a pick-up truck also, it doesn’t mean you should vote for him.

  6. I believe that this tyranny of racketeers was always the intention right from the start, and that no one has abused the original “ideals” of the likes of Hayek and Friedman.

    If there was any doubt about their original evil, Friedman’s willful complicity in mass murder in Chile puts it to rest once and for all. Indeed, he thought Pinochet was too cautious.

    Hernando de Soto is good on the destruction of markets and the rule of law itself through the systematic disintegration of anything which could legitmately be called a contract.

    We currently live under Hobbesian conditions, and everyone outside the power structure is free to defend himself.

  7. As someone whose ideological journey has taken him through both libertarianism and most of the major varieties of socialism I can state that the only time I was truly a starry-eyed utopian was when I was a free-marketeer.

    When they are not contaminated by the cult of Ayn Rand (whose whole life and work represents a spookily inverted mirror image of the Stalinism she fled Russia from) you do occasionally find libertarians who’ll admit this – I remember hearing David (son of Milton) Friedman describing his own anarcho-capitalism as really best suited to a society of omniscient immortals.

    Having said this I would put Hayek in a rather different league to Friedman and his Chicago-school acolytes – as a mitteleuropean refugee he had a far sounder view of the limits of all political activity than the jeunesse doree who came to dominate the American right.

    For this reason Road to Serfdom is a bad example as it is primarily a negative work analysing why it is that socialism makes us less wealthy and less free rather than a utopian capitalist manifesto like Friedman’s Free to Choose.

    Even in his more positive works Hayek doesn’t vulgarly celebrate the liberating powers of capitalism like Friedman (or for that matter Marx) does – rather all things considered he finds it the least bad way for imperfect human beings to organise their economies.

    I’ve moved on a long way left since I last read Hayek but I still feel I could profit from a re-reading of some of his works – not sure I’d say the same about Friedman, Nozick, Rothbard et al.

  8. “In the years leading up to the crisis, the proliferation of fine print, complex products, and hidden costs and dangers – and the push against government regulations over them – exemplified the larger pattern.”

    The irony here is the volume of regulation to enforce contractual obligations under cover of government enforcement of “deregulation.”

    I can’t think of an organisation (for example social units or the botanical world) without an underlying order or regulation.

    Deregulation is unnatural. Put another way, it is natural for living things to have ordering principles.

  9. Thanks to massachussets may be the Dems in congress can wake up and do something about financial regulation before they are booted out. They have more pride in their majority than introducing real reform. As for the GOP in congress, they are devoted to stopping everything from happening even when it is in their constituents’ interest. Now that the majority is gone, even the modest taxes that Obama proposed on large financial institutions could be in jeopardy. Back to square one.

  10. I know very little about the Austrian school of economists. But it seems to me they were reacting against the excesses of Communism in Europe with their own form of excess. One can only wonder what is happening in Eastern Europe (countries like Estonia) that adopted Milton Friedman’s ideology and are facing a similar fate to Iceland.

  11. We need more simplicity in the system. I had to agree to the following before I could post a comment to the American Express Open Forum. I decided not to comment.

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  12. The persistence of the free-market myth in the face of market failures everywhere in real life has to be one of the more striking oddities of modern America.

    I understand the love that professional economists have for the beautiful and elaborate intellectual edifices they have built on it. I understand the myth’s appeal as a coherent rationale for the existing distribution of wealth and power. I even understand the naive hypocrisy of those who sing hymns to the free market while doing everything they can to rig it to their advantage.

    What I don’t understand is how so many of the rest of us, who aren’t priests of this cult and gain little from it, prefer a deceitful phantom in our heads to the blatant evidence of our senses. Weren’t we Americans once considered a practical, pragmatic people? We seem now to have fallen into a crater of ideology and dogmatism.

  13. The financial meltdown is not evidence of deregulation run amok. Where’s the evidence of any deregulation? Sure there’s a PBS special on OTC derivative regulation attempts and Glass Stegal repeal, but how about hard evidence of rules repealed or less spending on government agencies that regulate financial services. Are any of the main agencies smaller than 30 years ago, FDIC, SEC, Treasury, FED, OFHEO, Consumer Protection Agency? Are their budgets lower? Do they have fewer employees? Of course not!!! So we just needed more and smarter regulation to counter the rascally bankers. It’s incredibly naive to think altruistic government employees will march into battle and slay the evil bankers.

    The problem is regulatory capture which leads to privatized profit and socialized losses. True free market believers predict this outcome as an inevitable result of growing regulation and government power. Everyone wants their business to grow. The employees at the FDIC and FED are no different. However, they are dependent on the financial institutions they regulate for growth. Consequently, its in the regulators self interest to see banks build balance sheets and enter new areas. Increasing complexity requires more regulators and higher budgets. The regulators build their business and the bankers get job security with the FED behind them. Is it good for customers, creditors and equity holders in those banks? I’m not so sure.

    However, the process certainly isn’t the result of less regulation and free market policies run amok.

  14. I think it’s hard to argue against the proposition that being pro-market is not the same as being pro-business. Competitive markets are by definition brutal places for companies to be- they are markets in which any firms generating returns on capital greater than costs of capital cause new entrants who then compete down their excess returns, and where, when returns fall, businesses must leave the market until returns rise again. Even if markets aren’t perfectly competitive and some firms have some means of making an enduring return above the cost of capital, they are just one innovation or regulatory change away from losing it.

    Given how brutal competitive markets actually are, it’s not surprising that business interest groups would try to subvert the ‘pro-market’ ideology in order to achieve objectives that are pro-business and actually anti-market. For established firms, the less competition the better. All they have to do is to solve the problem of those darned foreign firms not getting the message and still competing with them anyway. And subverting trade policy is pretty easy for these guys too.

  15. you seem to forget that you are “free” to hire a lawyer to advise you on signing that credit card agreement. Or you are free to spend even more money hiring an attorney to negotiate the terms of that agreement. If you don’t, then that’s not their problem. It’s the free market.

  16. “In other words, the same interests that claim the mantle of von Hayek and Friedman pulled the threads from the free-market system and exposed the theory’s greatest weaknesses.” I don’t think this is remotely true. As pointed out Hayek took aim at State Planning Communists – frequently held up as a great example both pre and post WWII (as well meddlesome Western Governments) who spent years trying to micro-manage the economy resulting in continuing suboptimal economic performance. Blaming economic theorists is another attempt to throw sand in the face of measured and sensible reforms, much of which has been posted on this very site. Whatever did happen to US anti-trust law – why is their no proper bakruptcy arrangements for bank holding companies would be a better starting point. Isn’t this what lawyers are supposed to advise on? Where was Dr. Geldon and his felolow Overseers? Underwritingsolutionsllc wonderfully ludicrous example of protective overkill from Amex has been mirrored by the investment and finance communities abetted by an equally out of control legal system, less comncerned with common justice than in milking the system. It is not free markets or their advocates that are at fault but rather the complete inability of Governments to control the finance behemoth nor the insousiance of the general public who have foregotten so-called “old style values” of thrift and balance in a get rich quick and to hell with the rest kind of society. This is/was always unsustainable and has little to do with dead economists, whether of right or left

  17. “Talk to a CEO of a major credit card issuer privately, and they will admit that ‘stealth pricing’ was purposefully innovated to maximize profit by making contracts difficult to understand and compare.”

    Or, if you don’t happen to know personally the CEO of a major credit card issuer, watch PBS “Frontline”:

  18. Obama had the chance to do real damage to the looters a year ago by having the Treasury become the major or majority share holder in banks that caused the crisis, and then by exerting power.

    From there, he could have replaced the upper management, fired and defunded the lobbyists, gained access to files and personel to get information that could be exposed, and gotten some real reforms in place both from the outside and inside.

    He didn’t do it. I think he didn’t do it partly because to do so would have disrupted campaign donations and would have been “disloyal” to people who helped get him elected.

    Insights about economic theory are interesting but don’t amount to much in the face of the political money mechanisms that have remained in place even in the face of a really big debacle, brought on by the donors.

  19. The description of Milton Friedman’s and Hayek’s views is so poor that it beggars belief. If you take the time to actually read these authors, you would know that they laid out various positions in their lives, some more on the Pragmatic Side and some more on the Political Philosophy side.

    For example, people might try reading Friedman’s “A monetary and fiscal framework for economic stability”. In this essay, which I still basically argue for, he advocated Narrow Banking, a Guaranteed Income, and a Progressive Income Tax. I find it hard to fathom a less risky proposal than Narrow Banking, upon which he wrote an entire book called “Program for Monetary Stability”.

    On health care, he advocated a plan that guaranteed universal coverage, another plan I basically agree with:

    Finally, on the so-called Shock Doctrine, which is a complete fabrication, he did believe that changes could be made to the financial system during a crisis. That’s true. And what did he give as the paradigmatic plan that was introduced which he offered in support of this belief? It was Deposit Insurance. See “The Essence of Friedman” p. 424. Indeed, if you read the essay, you’ll discover that the whole point of it is to avoid financial crises.

    There is no way to argue that the current system we have, a Cronyist/ Interest Group Driven Welfare State, is a Free Market in any ideal sense.

    As for Hayek, he too held different views at different times. He did, however, at one point, at least, argue for Universal Health Care and a Guaranteed Income.

    I don’t expect everyone to agree with my views. But I don’t think it too much to ask that people actually read the people they’re attacking and present different opinions than the ones they hold accurately and fairly.

  20. It’s true that Hayek is best known for forseeing the collapse of Soviet communism and warning that the Western world was heading in the same direction. I’d suggest reading the Road to Serfdom and the Constitution of Liberty – you’ll get a ton out of them and I don’t think you’ll find them excessive.

    Friedman is a whole other story. Basically he, like Alan Greenspan, started from free-market principles and then realized it was far more profitable to sell out to the State. His big “contribution” here was suggesting that the Federal Reserve caused the Great Depression by not creating enough credit after the Crash of 1929, when in reality the cause was creating *too much* credit *before* 1929, after which the Depression was baked in. You can’t cure a hangover with more drinking. Of course, the State loved Friedman’s version since he, like Keynes, provided intellectual cover for more inflation. Bernanke built his career on this fundamental untruth and the result will be far more economic pain, of which 2008 was merely a foretaste.

  21. The ideas of Dan Geldon’s “How Supposed Free-Market Theorists Destroyed Free-Market Theory” is pointing to a very important legal requirement for ‘capitalsm’ and ‘free markets’ to work properly: property rights need to be clearly defined (the so-called Coase’ theorem) and costlessly enforcable (they need not be ‘just’ according to any princple, but simply neeed to be clear and easily enforcable). And as Dan points out that must include: understandable contract terms, so that ‘minds can meet’. His most profound insight is that ‘opaque and complicated rules imposed by one contract side’ tend to favor the better endowed party who understands how to play the ‘legal game’.

    I agree that the ‘free market’ ideology has been misused to justify a whole host of one-sided arrangements that tend to benefit the better endowed, which in capitalistic terms often means the recently succesfull economic agents, and Dan is adding the insight that opaque rules often serve that purpose. A recent book by two Chicago economists called “Saving Capitalism from the Capitalists” by Raghu Rajan and Luigi Zingales has been highlighting a more general threat to the working of a free market system by ‘identifying the most dangerous enemy to capitalism’ – the recently succesful capitalist, whom they call the ‘incumbent’. In their concluding chapter 13 they state “The main point of the book is that free markets, perhaps the most beneficial economic institution known to humankind, rest on fragile political foundations.” After praising the coordinating features of markets they go on: “The invisible hand of the market substitutes for bureaucrats and politicians in all these decisions. This has engendered the misperception that markets do not need governments. But markets cannot flourish without the very visible hand of the government, which is needed to set up and maintain the infrastructure that enables participants to trade freely and with confidence.
    Here is where the political tension arises: The very same difficulties of organizing collective action that necessitate the intervention of the government also make it hard for the public to ensure that the government acts in the public interest. Organized private interests can thus have their way against the larger interest of the public. The nightmare scenario, which has played out before, is that under the cover of obtaining security for the distressed, the incumbents also obtain security for themselves by repressing the market. The victim is the free market and all those who look to it for opportunity.”
    End of quote from the Rajan-Zingales 2003 (paperback: 2004) book. They go on to outline some measures that can help to preserve free markets in their desirable form; i.e. they justify the “INHERITANCE TAX” as a viable way to prevent incumbents from exercising undue influence over the political and legal process into the future.
    Thus, there are first signs from within the nerve center of the free market ideology that the distinction between “industry interests” and “free market interests” has been noted and is being taken more seriously.

    The conservative interpretation of the “free market” ideology attributed by Dan to Hayek and Friedman indeed has been misused to argue for deregulating the financial sector and economic activity in general. Even the term ‘deregulation’ in the sense of reduced bureaucracy may also be a misnomer, since indeed all that is needed for the incumbent capitalist to be entrenched is a dysfunctional bureaucracy – four different agencies monitoring bank-like institutions which over time were allowed to be held by holding companies, which in turn had the choice to pick their regulator from the menu of available options (AIG’s holding company was able to pick the ‘weak’ S&L regulator simply by acquiring a tiny Savings & Loan institution to its corporate structure).

    In fact, the disrespect for government by free market economists originates from another aspect of the “free market” school championed by Friedman’s colleague George Stigler, who highlighted the capture of regulators by the very industry they are supposed to regulate. The broader point made by Buchanan & Tullock is that the legislature (Congress and thus the government) is easily captured by narrow well-organized private interest groups.
    Hayek was well aware of these issues, and thus worked on various ways on how to insulate legislators from well-organized interest groups in a series of treatises in the 70’s on “Law, Legislation and Liberty”. One could argue that he failed to get attention for those ideas, but I agree with Roger’s statement that Hayek was not a blind free market advocate, although his efforts to the contrary have not gotten much attention.

    Milton Friedman deserves to be criticized on some of the free-market policies he favored, but even his contributions included the recognition that the best monopolist is the one who can enlist the government to maintain that monopoly famously citing the example of the Texas Railroad Commission which enabled Rockefeller, the founder of the University of Chicago, to enrich himself fantastically. As a true liberitarian, Milton Friedman remained rigorous in his analysis of the ‘war on drugs’ as a wasteful government undertaking (just as alcohol prohibition was) and he therefore advocated legalising drug use in several editorials.

    It therefore would be premature to totally discard the tools used by Hayek, Friedman, Stigler and Buchanan/Tullock when analyzing the current financial crises, because the advocated solution needs to take into account the organized concentrated interests which will dilute any effort to ‘reregulate’ the financial sector and to reduce the set of permissible contract types that would allow and enhance a “meeting of minds” in financial contracting between private households and the much better equipped army of financial service providers with an inherent interest in the complexity of financial contracts.
    The only expert in this area I have seen is Harvard’s Elizabeth Warren, and I hope to see more legally trained scholars like Dan Geldon to push and advance this point.
    Ironically, such an agenda is also one of the few ways to actually preserve free markets as a coordinating device that serves to enhance economic opportunities for the general population rather than for a few well-organized ‘incumbents’ in the economic and political arena.

    The trick is to find a legal and institutional mechanism to protect financial consumers that somehow will escape the almost certain backlash from financial service provider conglomerates and professional organisations (including the Chamber of Commerce) to capture the protector of the consumer of financial products.

    It is not necessary to invoke anti ‘capitalistic’ or anti ‘free-market’ rethoric to advocate this point. In fact, we need to point out the contradiction that enhancing consumer protection is somehow not “free-market” or destroying the foundation of our economic order – nothing could be further from the truth.

  22. I’m not sure Hayek’s argument was exactly what this post outlined. Is book was an argument against keeping or expanding welfare states after the Second World War. He wrote the book as a warning that the totalitarian regimes nearing defeat in the war were rooted in welfare-state paternalism and that the West would go down the same road (to serfdom) if it did not pare back the state and allow markets to operate freely. It was a “slippery slope” argument – one that has been conclusively disproved now that, after more than sixty years, Western Europe has maintained large welfare states but not traveled the “road to serfdom.” Since we now know that you can have universal health care and labor unions and minimum wages WITHOUT having concentration camps, it is not clear to me why anyone would pay attention to Hayek at all anymore.

    The truth is that there is a fundamental hostility to democracy underlying the Hayeks, Friedmans, and Greenspans of this world. They want elites to dominate social and economic life, without interference from non-elites, who, unfortunately for the aforementioned anti-democrats, are allowed to vote. Limiting the state – the one site where the non-elite could control the elite – is simply a means of ensuring that the wealthy will run things, more or less undisturbed.

    At the root of our problems is the fact that we’ve lost ideas about thrift, balance, prudence, moderation, and fairness. Instead, we’ve adopted all over society the motto of the ambitious in every time and place: take as much as you can get. The internalization of this motto in all our hearts and minds has made it impossible for us to even conceive of what is wrong with our country. Consequently, the middle class cannot play the role it was supposed to play in the political thought of men from Aristotle to Jefferson to Dewey, namely that of a check on the ambitious. Instead, we’ve all agreed that everyone should take whatever he can get. Why are we surprised that certain people and institutions do so much better in this game than others?

  23. I don’t know that Geldon is arguing against Hayek/Friedman. I think he’s arguing that the current champions of the ‘free market’, who claim lineage to Hayek and Friedman, are not in fact their true heirs at all.

  24. Free market arguments serve a utilitarian function; they are trotted out whenever an industry wishes to kill a particular piece of legislation, but put aside when industry wants a privilege or a subsidy. The plain truth of the matter is that no one has seen a “free market” since 1929. Before that date, Federal expenditures were in the range of 3-4%/GDP, since 1933, they have been in the 18-24% range, and sometimes as high as 42%.

    But it should be noted that the pre-war economy (1853-1941) was in recession/depression an astounding 41% of the time. Since the war, the economy has been in recession only 15% of the time, including the current meltdown.

    Which system do you prefer?

  25. Another consideration is that to have replaced bank managers, etc would have disrupted business exchange practices to the point of destabilizing the economy.

  26. I agree, Hayek has been completely bastardized by Rand, and to a lesser extent Friedman, just like Keynes was bastardized by Samuelson.

    Serfdom was mostly about communist regimes, and communism bears absolutely no relationship to the US situation today. That book is not a valid critique of the majority of the post-Cold War world.

    Not only that, he supported gov’t provided universal health coverage:

    “Nor is there any reason why the state should not assist the individuals in providing for those common hazards of life against which, because of their uncertainty, few individuals can make adequate provision.

    Where, as in the case of sickness and accident, neither the desire to avoid such calamities nor the efforts to overcome their consequences are as a rule weakened by the provision of assistance – where, in short, we deal with genuinely insurable risks – the case for the state’s helping to organize a comprehensive system of social insurance is very strong…”

    Friedrich Hayek, The Road To Serfdom (Chapter 9)

    None of these teabagging “free marketeers” have any idea as to what in the hell they are talking about.

  27. “At the root of our problems is the fact that we’ve lost ideas about thrift, balance, prudence, moderation, and fairness. Instead, we’ve adopted all over society the motto of the ambitious in every time and place: take as much as you can get. The internalization of this motto in all our hearts and minds has made it impossible for us to even conceive of what is wrong with our country”

    I completely agree with this. I’ve always maintained that our core problem has to do with our culture, and standards of acceptability.

    The mentality you described above is common in many emerging nations that have never “emerged.” I know, because I am from such a country.

    It is a potent recipe for perpetual regression, or at best, perpetual stagnation.

  28. “Free markets” imply that all participants are more or less equal. They all have access to the same information — no one is more or better informed. They are more or less the same size — no one has significant market power. There are a large number of competitors in every aspect of the market and their is no collusion among them. There are no monopolies, duopolies, oligopolies, etc.

    Clearly what we have today is nothing like this. Many industries are dominated by a few behemoths. And every merger and acquisition gets us further and further away from anything that even slightly resembles a true free market. So what is it that “free marketers” REALLY mean?

    If they were true to Adam Smith — whom they love to invoke — they should be screaming for extreme anti-trust regulation. They should be demanding that all large corporations be chopped up into small, rigorously competing entities. But that’s the opposite of what they advocate. In their free markets the titans of industry are free to merge and acquire and get bigger and bigger.

  29. Ted, I suggest that the problem is not with those who listen to Glen Beck; that is merely a symptom. The problem is with those who teach economics. 90% of them missed the warning signs of this crises, and those who didn’t were marginalized as “Dr. Doom’s” and “Cassandra’s”. Which is not surprising when you consider that 90% missed the last crises, and the one before that, and the one before that…ad nauseum.

    Any doctor who failed in his prognosis as much as these would be sued for malpractice.

  30. Very interesting article and discussion.

    A good part of the article discusses how excessive legalism undermines the free market. That is not quite the same thing as free-market theorists destroying free-market theory.

    You’re definitely on to something labelling them as “supposed”. Their rent-seeking and subsidy-cultivating means that in reality they are not free-market oriented at all.

    Dave Smith from

  31. Are you saying that taking complete managerial control of publicly traded banks would not have been seriously disruptive? I’ll take that “destabilizing” was a little over the top. I don’t see how the administration would have received any political cover after taking that route.

  32. Aristotle observed that the problem with markets is fraud. In recent years we seem to have stopped trying to prevent it.

  33. This post is right on, this system is unsustainable and was rigged from the start, regardless of the theories of dead economists.

  34. This is a very important insight. Free, highly competitive markets are mostly a benefit to those people with means enough to buy the products offered by those markets. Don’s post assumes that free markets are an unalloyed good for everyone.

    In a highly competitive market, the producers and their employees are constantly being squeezed, which is brutal process where, in theory, no one can organize their business or work with any deliberate focus on the object of their work, without scanning the horizon for moves by their competitors.

    One key problem with our current system is that protections are offered to the very wealthy and the corporate leadership and not to workers. Don seems to be saying “we should try to make all markets highly competitive” and not looking at the consequences for those producing goods and services.

    It is MUCH easier in our current ideological climate to stand up for consumers rather than producers, and easier to claim the mantle of free markets rather than for, for instance, social democratic social policy and industrial policy. However we are desperately in need of economic policy that helps us preserve and build upon our productive capacity rather than hold onto the myth of markets, which have tended to favor consumption over production.

  35. The SEC/FDIC people I know actually do see themselves as marching into battle to slay the megabank monsters. They love prosecuting bad guys and shutting down banks on Fridays. The problem is that my sample is tiny. But I don’t think it naive based on my own observation to expect at least some of them to be immune to capture.

    As it has been explained to me, regulatory agencies such as the SEC have a limited budget compared to the banksters. If the goal is to prosecute the big fish in the pond, the regulators need to have a technically perfect case before they can bring it to a jury because the banksters will bankrupt the prosecution by endlessly nitpicking the technicalities until the (politically appointed) manager decides to go after small fry that might bring a conviction for less of a budget hit.

  36. Though there is a lot of truth in what Dan writes about the false free-marketers I must disagree when it is said “Municipalities across the country were lured into buying toxic derivatives and institutional investors were routinely abused at the hands of complex products.”

    No one was lured by any complexity in financial products, they did not even try to understand them, they were lured by the credit ratings they followed and by believing there was a regulator out there doing his job. Let me take it one step further, without bank regulators, some other bad things might have happened, but not this crisis.

    There are of course different risks when being invested in products perceived as high risk or low risk, but there is a completely different set of risk involved when you are deciding on investing… in which case a product that is perceived as low risk is treated in a much more nonchalant way than a product that is perceived as more risky and is therefore handled with more care. Water and nitro-glycerine are not handled the same way! And so perhaps the capital requirements for banks should be higher when they lend to someone with a good credit rating and lower when they lend to a risky client… and this is the part of the free-market reality that those naive and gullible regulators in Basel still do not understand.

  37. Right on! Do not believe for an instance that the current crisis had anything to do with free-markets, it was just the opposite. Never ever before have the regulators interfered so much in the market as when they set different capital requirements for banks depending on what the regulators and the credit rating agencies perceived as the relevant risks.

    Still today when your small community banks lends to one of the citizens it is required to have 8 percent in capital but when lending to government it can do so with zero capital… free markets? you´ve got to be kidding.

  38. Why are things so complicated? Don’t blame the free markets.

    1. The Mortgage Interest Tax Deduction resulted in the abomination known as the ’30 year mortgage’. Without the tax deduction, this toxic time bomb (in the form of MBS) would not exist. (Thank you government.)

    2. The industry-captured ratings agency cartel that *by law* controls access to the credit markets and therefore is not accountable to investors; and issues compromised ratings that municipalities must accept. (Thank you government.)

    3. Government-sponsored enterprises (GSEs) that, by eliminating risk, inflated house prices to nearly double market levels, corrupted the mortgage industry, and encourages speculation. Together, Fannie, Freddie, Sallie, FHA, and FHLB guarantee 70% of the mortgage market. (Thank you government

    4. $1 trillion price tag (or more if the housing market falls further), because GSEs guarantee inflated mortgages at the taxpayer’s expense. (Thank you government.)

    5. An elite that would rather rail against conservatives than publicize outrageous bank and credit card fees. (Thank you Harvard.)

    It’s pretty simply really. The free markets work fine. It’s the government that makes things so complicated. (Of course it’s our fault for letting them.)

  39. Thank you for this comment. Well put. I can’t help but think that what most miss is that we do not have a free market in money. We have a government sponsored monopoly on money. As such, the whole talk of free market or deregulation breaks when it comes to influences based on our current money system.

    Until we go for the root of the problem (get gov’t out of the business of money), I suggest we stop arguing the other points. Non-free-market believers are able to turn thinking against the free-market thinkers because of this fundamental weakness in our economic / monetary system.

  40. “True free market believers predict this outcome as an inevitable result of growing regulation and government power.”

    Free market believers predict that all problems in the economy are results of regulation and government power. That’s an article of faith for them.

    Astrologists predict that your life is influenced by rocks floating in the void millions of miles away. Do you believe them too?

  41. I spent many years in real estate transactional law. I am used to the “fine print” and can vouch for the idea the it can be overwhelming. In commercial real estate the largest contract document that I was involved with was more than 2000 pages, and, needless to say, all parties were represented by counsel who were earning at least $200 per hour to assist them. When it comes to financial reform, since consumers can’t afford and, moreover, shouldn’t need, attorney representation, the focus should be on limiting the markets to products which involve only simple, easy to understand terms and conditions, with no tricks or traps or smoking mirrors of imbedded legalese. That should be the first requirement on all products offered by any business to any individual, whether a bank, credit card company, auto dealer, appliance seller, etc.

    Who was it who said (a Shakespearian character): “kill all the lawyers!!” I wouldn’t go that far, and they do serve an important purpose, but they should not serve to create bogus commerce and break our economic system by doing so.

  42. “If language is not correct, then what is said is not what is meant; if what is said is not what is meant, then what must be done remains undone; if this remains undone, morals and art will deteriorate; if justice goes astray, the people will stand about in helpless confusion. Hence there must be no arbitrariness in what is said. This matters above everything.”

    From The Analects of Confucius, Book 13, Verse 3 (James R. Ware, translated in 1980.)

    This is one of the oldest problems of governance in complex rule-bound societies. It’s always nice when individuals can manage to live up to this standard themselves, but when they stop doing so the only observed / predictable responses are external regulation, or inevitable, progressive degeneration.


  43. I think there are really useful points in this post and the discussion for people of a more liberal/progressive/pro-regulation tendency, and that is that there are really two “free market” discourses:

    “The myth,” ie., these obfuscatory uses noted here, and the effectively critical discourse that emerged in particular historical contexts. It seems to me that “the myth” is a product of lifting the critical strain of discourse out of it’s historical contexts, rendering it an abstration and raising it to the level of unquestionable principle, and applying that in very different contexts that may require different responses.

    I don’t think it’s really productive to be so dismissive of this body of thought. Over time, things fall apart and lose their intellectual rigor. Take the “other side” of the argument. Today’s pro-government “liberals” are not exactly the people friendly party of FDR. Just look at their healthcare monstrosity–their individual mandate made funding your own health care out of pocket look like a life long bargain, with more personal control to potentially better outcomes in both health and one’s personal bottom line.

    I always think these people can’t possibly be worse–until they are.

  44. “Don seems to be saying “we should try to make all markets highly competitive” and not looking at the consequences for those producing goods and services.”

    That’s more the opposite of what he said. What he said was “the principle of free contract demands that all parties understand the contract. The financial services industry just gamed that relationship by holding a monopoly on financial services and then writing sleazy legal contracts that would enable them to take the other party to the cleaners and get of scott-free.”

    He didn’t delineate how to force them to clean up their act, but he did say it had negative consequences in addition to being contrary to the principle of free contracts. A pro-regulation person would suggest intervention. A free market person would suggest a boycott.

    Why a penions fund would continue to do business with GS, *is* a bit of a puzzle.

  45. Geldon makes some good points but he doesn’t connect the dots. Of course the major interests are complicating contracts to screw the little guy, thats well known. What he doesn’t understand is that “free markets” always lead to an accumulation of capital and power at the top. Naked power grabs are part of capitalism and cannot be separated claiming that a real free market wouldnt do the same. For anyone who wants to read up more, try David Harvey’s “A Brief History of Neoliberalism”. Also, for all those Hayek believers, i’d highly recommend “The Great Transformation” by Karl Polanyi, its a strangely prophetic book, written the same year as road to serfdom in 1944.

  46. I must say that this is the first time I’ve read or commented on this blog, and both the posts and the discussions are superior to most blogs of this type.

    To those who lay the blame solely with the gov’t, this turns out to be a self-proving hypothesis, since there is always a gov’t to blame, and gov’ts are certainly capable of acting in ways detrimental to the market. Thus there is always a ready-made excuse for the failures. But the thesis is not falsifiable. Nor verifiable. And it allows one to escape any real analysis. Even if the gov’t is a contributing factor, does that mean we should not ask whether the market is sufficient? Whether deregulation, such as the Glass-Stegal Act, had some influence on events? The thesis provides an ideological cop-out which avoids any real analysis.

    The real answer would be to find an anarchic market and show that it is better. But such examples do not, and cannot, exist, since markets are made by rules, and rules require a ruling authority. Thus the Austrian must deny, but never affirm, because there is no reality for him to point to; just a theoretical construct that cannot be tested by practice.

  47. “The greatest lesson from the crisis that we haven’t yet learned is that “industry interests” and “free-market interests” are not the same. In fact, they are more like oil and water, as the industry profits most in the absence of true market competition.”

    Didn’t we learn this in the 19th century? They didn’t call them Robber Barons for nothing, you know.

  48. Superbly written analysis of the consequences of legalese used as a financial weapon to gain economic advantage.

    Thank you.

  49. Apple Pie Land empirePie January 21st, 2010

    Come see the latest slate creation
    an arty artifact without the law
    a conscience ‘like a rock’
    iDove without a flock

    missing bits and fig leaves,
    it silhouettes a logo of empty space
    a missing apple with colored splatter
    the bitten bit doesn’t matter
    it’s just from the garden but with extra blather

    iFigure, iPhone, iNest, iPod
    iSlate ..
    like any reborn non-entity
    or lawless newbie in
    Logo… la la land
    it creeps up on culture
    plasma colored, brighter than real
    with the extreme agility
    of the virtual feel,
    defined by what’s missing

    the O bomb o brand
    with due diligence dithering
    a brand that is slithering
    like a sticker tagged apple
    on a ‘Tipping Point’,… a slide
    a blank ‘Blink’
    too glad to fall from the tree
    for an empty pie
    for splattered apples without a granny
    applause without a grammy
    a pause without a cause

    Logo land,…Apple pie land
    la la lawless land
    for the corporatocracy band
    like the Blackwater mercenary stand
    above the law
    a slate less empty brand

    clerofascism redux

    add the clergy baked with profit pie
    a mark chilled out for market whys
    to ‘hail a Mary, ..and please pass the buck..

    for you to can be
    proud to be… rogue and sated

    In apple pie land

  50. No, In his last two paragraphs he SEEMS to be saying that the “ultimate ground” or where the economy should be heading is towards the ideals of the free market, undistorted by unclear contractual terms. I am entirely in agreement with his proposals to clear up and make transparent contractual language. However, I am not so sure that the purpose of this maneuver is to make markets more competitive. I believe instead that this should serve as a standard for ethical protection of contractual parties no matter the competitiveness of the market in which they find themselves

    The American Apologists


    It is unusually difficult to work through the barriers of entry (so to speak) that make up the departmentalized and class lineages of Academic Economics in Modern to Contemporary thought. To say that it is concerted and delineated is a gross understatement. Economic theory has been closely intertwined with the working process of facilitating domestic social status and international political order coordinated around what has been termed the power elite. A cold war mandate formally initiated after WWII but articulated after 1950 established a political utilization process of bankruptcy as a kind of warfare imperative. A global shift from cold war towards a realignment of “hegemonic” confederations has changed the groupings and dynamics of extensive global interreciprocity (as well as various intensities of “war by other means.” Domestically, however, post cold war political economy has returned to an insidious schism of neo-class power based upon monetary domination. Theories serve this purpose and will not be surrendered as long as they legitimate the “necessity” of grand scale market forces that service the expansion and intensification of the so called Financial Service System which becomes the ultimate regulator of all social and political forces.
    Read the links above from archives concerning the social and cultural context of political economic ideation. Judge for yourself. Economics services business and the Economy is perceived as one universal industrial machine. Owning the machine has become the Prize. And I suppose you can say that those that are allowed through the barriers get to do real time “Enter-Prize” (but please don’t call it “Free” market. Freedom was never truly a part of it…but it sounds real good and usually gets the common foot soldier out to fight for the ideal behind the term.

  52. 1. Make the Fed a Federal agency.

    2. Govt. to print legal tender (i.e. create money). NOT the private banks. That is, create debt-free money. Ensure money is printed for purposes of providing goods and services in demand. For instance, 10% unemployment; idle factories, etc; raw materials obtainable; people need housing, schooling, training and skill development for their kids and re of these things for themselves —- new energy systems, transportation systems, etc. Money printed under these conditions will NOT produce inflation. It will jump start economic activity and create jobs. Yes, mucho debt to the banks which they want to ensure they get back, which requires moves by the politicians and Fed which will devalue the dollar to produce their (the banks) dollars for repayment WILL cause inflation since the real economy produces nothing in this/these transactions.

    3. ALL political campaigns 100% publicly financed, constrained as to duration, with media providing gratis time.

    4. Input to pending legislation needs to be ideas and clauses NOT campaign contributions and other uses of funds which have no direct input to improved and/or effective legislation.

    5. Too big to fail is too big to exist, particularly unregulated. The financial “industry” extracts far too much of the productivity gains of the overall economy. When one thinks make, mine, grow and provide productive services, the finance sector to the overall economy is as the tail wagging the dog, as things are currently working.

  53. Complexity, lack of information, failure of the medias to provide it, failure of keeping real and material track of corporate power, degradation of political thought since the 80’s, accumulation of capital and power by certain elites, slow destruction , at least in western Europe where they still meant something, of regulatory safeguards and protection of the underclasses, all lead to 21st century mesmerized minds trying to understand what went wrong when 2008 hit, the way they did after 9/11 : there must be a flaw in the ideological premises, be it our relationship with islam, or the belief in “free market” and “free enterprise”. One of the consequences is people waisting time on arguing if there is such a thing as a free market, which is a contradiction in terms, and calling up Hayek’s and Friedmann’s ghosts. Another is watching Greenspan making late amends for his belief in such a concept, which raises the real question : if Greenspan , the whole Wall Street gang and the political body have acted out of ideological conviction, how could these poor and naïve fellows be held accountable for the catastrophy, much less the huge profits some have made under the disguise of free market laissez-faire ?

  54. yeah-

    i read ‘the road to serfdom’ about a year ago in my ongoing study of the history of economics (or, classically, political economy) and while their were many interesting insights hayek failed glaringly in omitting a factor of production in his analysis. and so thus he has been apropriately lionized by the powers that be…. specifically– land values, and the failure to statistically differentiate them in economic analysis has led to where we are at now. and this goes back ages… the enclosures, highland clearances, etc. from a purely analytical standpoint, to not include land (natural resources- or classically meaning, anything not born by the labor of humans) in determining a method of public finance is where economics as a social science lost its credulity…

    and so the joke is on us all for the answer lay right beneath us…

  55. Kirk, you are correct about the disappearance of land as a factor of production in economic thought, although it is unfair to blame Hayek; it happened half a century earlier with J. B. Clark, who just subsumed land into the capital fund. Totally irrational, of course, since land and capital are completely different things. Elimintating rents simplified the equations greatly, but at a great cost.

    Since land always connects an economic rent, and such rent is the very epitome of economic inefficiency, neo-classical economics lost the ability to adequately describe the economic. They have very neat formulas, but the math no longer describes any actual economy.

  56. David’s point rings truest: [“free markets” always lead to an accumulation of capital and power at the top.]

    It’s a liberal fantasy that you can regulate a system founded upon greed and privitization of the means of production.

    Business Ethics is an oxymoron yet college courses go by this name.

    Technology is the collective wisdom of humankind yet it’s privatized to enrich a tiny minority.

    Ultimately capitalism is unsustainable: that’s what Marx concluded after decades of scrutiny.

    Thus I agree with Marx that in the last analysis a sustainable sociey is impossible without expropriating the expropriators.

  57. is this a f#ckin joke article that was pulled from

    the arguments presented in this joke of an essay do not represent anything that Mises/Rothbard/Rockwell/Woods has ever talked or written about… Friedman was a monetarist not an Austrian economist…. to everyone who reads this crap, go read Thomas Woods book Meltdown… baseline scenario doesnt know what the f#ck they are talking about.

  58. To the Person who calls himself “is this a joke,” I think you have brilliantly represented the intellectual level of the average Austrian economist. Thanks for reminding us of what we are fighting.

  59. Jest,
    What did you mean that Rand bastardized Hayek? Misrepresented him?
    Are you aware that she did NOT like to recommend him because of his inconsistencies and somewhat statist leanings?
    As you are probably well aware, she admired von Mises and recommended his work; although she rejected his starting point (human action) in economics as being incorrect.
    Where as Mises philosophically was somewhat of a Kantian and admired him, she – needless to say – rejected and despised that.
    Her position was that human action was derivative, rather than an axiomatic starting point. She said you have to start in economics (not philosophy) w/a proper definition of values.
    Rand’s position was that economics can NOT be value free (a further disagreement w/Mises).
    Which, in the history of economics was quite radical.
    For her, the concept of a “value free” or “neutral” science of economics was not tenable; precisely because it deals with human action. Further, this whole “value free” approach was another product of the Kantian mind/body split: also not tenable philosophically nor practically.
    Also, I think Pacr provides a sophisticated analysis of the fallacies inherent in most “free-market” advocates: along with the absurd and impossible premise of “efficient markets.”

  60. it’s not difficult to understand how free-market principles of freedom to choose, and freedom to contract, contradicted two other essential principles of free markets – competition and transparency

    as Greenspan stated in testimony before Congress, the critical flaw lay in the failure of the self-interest of bankers to represent their stockholders, effectively an admission that competition within the financial sector failed, due primarily to a breakdown in transparency which itself was driven by the freedom to choose and the freedom to contract

    the culpability of the credit rating agencies closed the circle of deception, enough to sustain the lack of transparency necessary to conceal the overleveraged credit, and shut off the possibility of entry and competition from more legitimate players who could have reduced the leverage by exposing the absurd level of risks

    the excess leverage was the driving, mechanical factor that brought down the financial sector, magnifying greatly the effect of each dollar of default at the homeowner level as housing prices fell, a process that could not have continued and sustained the bubble to the point it did, had there been transparency and the concurrent competition enabled by transparency

    Geldon correctly demonstrates that two principles of free markets undermined two other principles of free markets, in the absence of offsetting changes in regulation that were specifically, intentionally prevented in order to block transparency and competition, and sustain the housing bubble

  61. And someone had to resurrect the old lie that Friedman was complicit in Pinochet’s murders. In fact he condemned him right from the start and specifically refused honorary degrees from universities the Chilean government funded. His “complicity” with Pinochet extended to advising him, 2 years after the coup, to change almost all his economic policies in one letter and a 45 minute meeting. Any actual checking of the facts would reveal this, such as checking what the monetary policy of Pinochet was, but you’re not interested in the facts are you?

  62. Ordering principles are not the same as government regulation. There is nothing unnatural about real deregulation, which has not occurred. I always like to tell people who talk about financial deregulation to read the actual regulations. Not so as to show them anything, just to shut them up for the year or so it will take. The market is a far better regulator than government ever was. Note how short-sellers detected almost every big case of financial malfeasance. Other private individuals detected most of the others (e.g. Madoff).

  63. Michael, there is some truth in what you say about Friedman and Pinochet; the activities of Hayek (who kept going back) get blamed on Uncle Miltie. However, the “Chicago School Boys” (as they were known) had a big hand in the fiasco. Apparently, Monetarism is no proof against dictatorship.

    As far as the market being the best regulator, that just doesn’t seem to be true.

  64. Well considering that from 1851-1941 included “the Long Depression” where real production actually went up I’d prefer the former. The idea that recessions are bad is based on the absurd idea that growth has to be constant. If you measure the growth in things people actual buy it’s far greater before government thought it could handle everything.

  65. Hmm. The trouble with your “defense” of capitialism is that is sounds very much like the attacks: capitalism can’t balance itself, and needs periodic misery–41% misery in the pre-keynesian economy–to exist. What, precisely, distinguishes your defense from Marx’s attack?

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