Archive for the ‘Blogs to Read’ Category

Free Riding in Finance: A Primer

December 19, 2017

Nice post on money and banking blog:

“The problem of the ‘stability commons’ is that anybody who could deplete the [financial] system’s resilience needs to be within the broad scope of the regime for stability.” Paul Tucker, October 2015.

Many features of our financial system—institutions like banks and insurance companies, as well as the configuration of securities markets—are a consequence of legal conventions (the rules about property rights and taxes) and the costs associated with obtaining and verifying information. When we teach money and banking, three concepts are key to understanding the structure of finance: adverse selection, moral hazard, and free riding. The first two arise from asymmetric information, either before (adverse selection) or after (moral hazard) making a financial arrangement (see our earlier primers here and here).

This primer is about the third concept: free riding. Free riding is tied to the concept of a public good, so we start there. Then, we offer three examples where free riding plays a key role in the organization of finance: credit ratings; schemes like the Madoff scandal; and efforts to secure financial stability more broadly.


Like adverse selection and moral hazard that arise from information asymmetry, free riding poses serious problems both for providers of financial services and for governments wishing to secure financial resilience. Rules and practices—such as the role of independent custodians in asset management—continue to evolve to limit the impact of free riding. In theory, technological progress that lowers information costs helps overcome information asymmetries. However, the distortions arising from free riding likely will persist so long as there are fixed costs to producing financial information, and the resulting information is not excludable.

The tragedy of the financial stability commons poses a particularly important challenge that, in a globally integrated financial system, requires an internationally coordinated response.

Getting to basics of finance…


Discussions on issuing e-New Zealand Dollar…

December 14, 2017

After Sweden, Australia, we now have some bit from New Zealand as well. Though, unlike the Sweden and Australia posts which were based on speeches of their central bank chiefs, the NZ one is from Michael Rendell, former  central banker from NZ.

He reflects on this report from the NZ central bank:


Hayek on the Creation of Moral Hazard by Central Banks

December 8, 2017

Prof Larry White discovers an older paper by Hayek where Hayek questions role of central banks:

In section 8 of the article (pp. 145-47 in the 1999 translation), Hayek gives a favorable evaluation of free banking as against central banking. Having overlooked this passage, I had previously thought that Hayek first addressed free banking in his 1937 book Monetary Nationalism and International Stability. Hayek does not embrace free banking as an ideal, first-best system, because he thought it prone to over-issue (as I discussed in my 1999 article based on Hayek’s other writings). But he criticizes the Federal Reserve Act for relaxing rather than strengthening the prior system’s constraints against excess credit expansion by American commercial banks.

Hayek begins the passage with a caution that the intended result of creating a central bank, when the intention is to avoid or mitigate financial crises, need not be the actual result:


Are Bank Holding Company Structures Still Beneficial?

December 6, 2017

Julie Stackhouse, Executive Vice President of St Louis Fed posts about structure of Bank Holding Company. They were popular till Dodd Frank Act was enacted:


A primer on the rise of populism and a way forward

November 30, 2017

Gulzar posts about why rise of populism is closely linked to inequality and gulf between 1% and 99%.

Why is it happening? But this consensus was accompanied by a less benign bipartisan elite convergence (more of it latter) which effectively ended up capturing the economic and political establishment. 
The rapid and fairly inclusive economic progress achieved in the period helped underpin this consensus and paper over fissures that were developing due to forces like trade liberalisation, globalisation, de-unionisation, and skill-biased technological changes. But once growth started slowing, for a variety of factors, these fissures started to show up.
But mainstream political parties, captives as they had become of elite interests, failed to see the breakdown in social consensus. The liberal elites too became caught up in their rhetoric.    
Nothing has been more emblematic of this isolation of elites from the electorate than the staggering levels of economic inequality, which has been widening at a rapid pace since the millennium. As the graphic below shows, in the US, the share of national income going to the top 1% has nearly doubled from 11% in 1980 to 20% in 2014. 
Fair amount of graphs etc to emphasise his point.
What is the way out? Gulzar quoting Prof. Rodrik says “the most promising solution may be to let the house burn down completely!”…




If central banks cannot provide anonymous payments in digital currency world, they should give up their monopoly

November 28, 2017

Tyler Cowen recently started this debate recently where he said central banks should mint their own cryptocurrency or not. Cowen said central banks should keep away from the cryptocurrency space as they are conservative bureaucracies which shall kill all innovation.

There was a response from David Andolfatto disagreeing with Cowen and says currency is a central bank game and they will have to eventually play it.

And then there is this post by JP Koning who manages to sum up issues on monetary economics really well. In this new post, he says central banks have been focusing all this while on monetary stability which is obvious. But they came into being monpolising currency function and anonymity was central feature of their issued currency. But this was long ago and central banks neither more remember nor care much for this function as they take it for granted.

Now for the first time in many years they have to rethink on this currency function as cryptocurrencies are providing competition:


Research on cash usage…

November 27, 2017

There are three research pieces looking at cash and other means to make payments.

First is this blogpost by  John Williams (President of San Francisco Fed) and Claire Wang. Second is this paper by ECN economists Henk Esselink and Lola Hernández on cash usage in Euroarea. Third is RBI Memo which looks at how non-cash transactions are rising across the country.

First the San Francisco Fed Blog says cash usage remains high and its death is widely exaggerated:


Why study and research numismatics?

November 14, 2017

Nice post by Hillery York, Jennifer Gloede, and Emily Pearce Seigerman:

Whenever we tell friends and family where we work, their first response is typically, “What is Numismatics?” Of course, they pronounce it anywhere from “numismatic” to “gnomimatic!” The National Numismatic Collection (NNC) is the Smithsonian’s collection of monetary and transactional objects. It houses approximately 1.6 million objects spanning thousands of years and a great variety of materials. One of the best parts of our jobs is getting to share the collection with the world! Numismatics is a far-reaching field, and we’ve found connections to military history, facial hair, woman suffrage, and even Game of Thrones! We often share things about our favorite objects, but here are a few large, notable collections that you may not know are housed within the NNC. We’re making these available online, and researchers are welcome to contact us regarding their research in these areas.

Greco-Roman Collection

Ancient coins have long been collected because of their beauty, age, history, and sometimes rarity. Even dating back to the Renaissance, aristocrats and royals sought to add ancient coins to their collections. It makes sense then that the NNC would also have an extensive collection of these fascinating coins donated by various collectors over the years. Scholars recently dove into the collection to assess its strengths as compared to other notable museum collections. In doing so, they created a detailed listingof the holdings and discovered the collection contains approximately 26,900 Greek and Roman coins! These coins offer a great opportunity to study economics, art history, ancient coin production, classics, and more.

Numismatics is simply fascinating . It should be part of teaching monetary economics as it tells you so much about the monetary history and even politics around it…

We should move beyond just assembling these coins and put them in a museum. The idea should be to research and figure why certain coins were changed/modified, introduction of new coins and so on. Central banks should sponsor research on numismatics as there is much more to research than the usual “download data and run models”…

How Newton learned about financial gravity the hard way…

November 13, 2017

Interesting post by Jason Zweig (HT. V. A. Nageshwaran).

Zweig picks this paper by Andrew Odlyzko of  University of Minnesota which looks at Newton’s investments and eventual losses in South Sea Bubble :


Global real interest rates since 1311: Renaissance roots and rapid reversals

November 6, 2017

Superb insights by Paul Schmelzing in Bankundergound blog.

With core inflation rates remaining low in many advanced economies, proponents of the “secular stagnation” narrative –that markets are trapped in a period of permanently lower equilibrium real rates- have recently doubled downon their pessimistic outlook. Building on an earlier post on nominal rates this post takes a much longer-term view on real rates using a dataset going back over the past 7 centuries, and finds evidence that the trend decline in real rates since the 1980s fits into a pattern of a much deeper trend stretching back 5 centuries. Looking at cyclical dynamics, however, the evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable.

Despite much research into the causes of real rate distortions in recent years, the discussion has arguably suffered from a lack of long-term context. Key additions – such as the  influential BoE staff working paper confirming the role of excess savings and lower investment preferences – typically trace back their observations to the late Bretton Woods period, or at best to Alvin Hansen’s time in the interwar period. Hamilton et al. and Eichengreen are rare exceptions in their inclusion of 19th century data.

Therefore, the majority of work on secular stagnation– and with it the debate regarding bond market valuations  – fails to consider the deeper historical rate trends. In contrast, a  multi-century dataset  offers the opportunity to look at cyclical behavior and the dynamics of reversals from earlier real rate depressions.

Quite a few charts and details there…Conclusion:

On aggregate, then, the past 30-odd years more than hold their own in the ranks of historically significant rate depressions. But the trend fall seen over this period is a but a part of a much longer ”millennial trend”. It is thus unlikely that current dynamics can be fully rationalized in a “secular stagnation framework”. Meanwhile, looking at past cyclical patterns, the evidence suggests that when rate cycles turn, real rates can relatively swiftly accelerate.


Is the so called new economic thinking, same old stale stuff?

October 25, 2017

Frances Coppola writes a scathing critique of recently held Festival for New Economic Thinking in Edinburgh by Institute for New Economic Thinking.

I’m sitting in a coffee shop opposite Haymarket Station in Edinburgh. Just up the road, the Institute for New Economic Thinking (INET) is holding its conference. I’m supposed to be there, as I was yesterday and the day before. But I am not at all sure I want to go. The last two days have left a very bitter taste.

This conference, grandly entitled “Reawakening”, is supposed to be a showcase for the “new economic thinking” of INET’s name. I hoped to hear new voices and exciting ideas. At the very least, I expected serious discussion of, inter alia, radical reform of the financial system, digital ledger technology and cryptocurrencies, universal basic income (recently cautiously endorsed by the IMF), wealth taxation (also recently endorsed by the IMF), robots and the future of work. And I looked forward to the contributions not only from the speakers, but from the young, intelligent and highly educated attendees.

Not a bit of it. In the last two days we have had panel after panel of old white men discussing economic theories developed by old white men, many of them dead. Economic beliefs that I thought had been comprehensively debunked have reappeared, dressed up as “new thinking”.

She revisits all the panels and in unimpressed by most.

In the end:

For me, the ultimate insult came in the form of an announcement yesterday. INET is creating an Independent Commission on Global Economic Transformation. “Call for New Thinking and New Rules for the New World Economy; Final Report will Outline Solutions for Emerging and Developed Countries”, says the announcement. Here’s the remit of the new commission:

And here are the members of the Commission, so far:

  • Robert Johnson, President of INET and Former Chief Economist of the U.S. Senate Banking Committee;
  • Lord Adair Turner, Chairman of INET and former chairman of the UK Financial Services Authority;
  • Kaushik Basu, Professor of Economics at Cornell University and former Senior Vice-President and Chief Economist of the World Bank;
  • Peter Bofinger, Professor of Monetary and International Economics at Würzburg University and a member of the German Council of Economic Experts;
  • Winnie Byanyima, Oxfam International executive director; former member of the Ugandan Parliament, African Commission and Director of Gender and Development at the United Nations Development Program;
  • Mohamed El-Erian, Chief Economic Advisor, Allianz, and former chair of U.S. President Obama’s Global Development Council;
  • Dr Gaël Giraud, Economist and senior researcher at C.N.R.S. (French national center for scientific research); 
  • James Manyika, Director of the McKinsey Global Institute;
  • Rohinton Medhora, President of the Centre for International Governance Innovation (CIGI);
  • Danny Quah, Professor of Economics at the Lee Kuan Yew School of Public Policy, National University of Singapore;
  • Dani Rodrik, Professor of International Political Economy at Harvard’s John F. Kennedy School of Government, and President-Elect of the International Economic Association;
  • Eisuke Sakakibara, Professor of Economics at Keio University and former Japanese Vice Minister of Finance for International Affairs;
  • Beatrice Weder di Mauro, Professor of Economics, Chair of Economic Policy and International Macroeconomics at the University of Mainz, Germany and former member of the German Council of Economic Experts;
  • Yu Yongding, former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences; former member of the Monetary Policy Committee of the People’s Bank of China.

Now, there are some wonderful people on this list. But collectively, they represent the elite establishment that I mentioned before: senior academics, rich businessmen, former and current public servants and policymakers. There are no new voices here, no-one from the heterodox economic community, no-one who has their feet in the real world. Everyone is at the top of an establishment hierarchy. How dare these people presume to take to themselves the responsibility for creating a radically new economic paradigm, when they have benefited so enormously from the existing one?

This is not “new economic thinking”. This is the establishment, reasserting itself at the behest of the elite, which fears the loss of its status and its privileges as the threat of populist revolt rises. The young crowd round the elite, hoping to be picked as their proteges: and the old scan the young to pick out the ones most like them. So the system perpetuates itself.  
And I, like the rest of the creatures outside, look “from pig to man, and from man to pig, and from pig to man again.” But already it is hard to say which is which. 

I had similar reactions on seeing the panel members. It looked quite similar to the Growth Commission floated a decade ago.

How perverse incentives led to a soccer match teams scored self-goals in order to qualify!

October 24, 2017

Superb post in Managerial Econ blog:

Presumably, the primary goal of any sport governing body is to provide adequate incentive for competitors to do battle on the field (court, pitch, etc.), each striving for victory. Things don’t always turn out that way. 

My all time favorite example of the strangest (incentive-driven) spectacle in sport is from the 1994 Shell Caribbean Cup involving a match between Barbados and Grenada. 

A very poorly-conceived (though well-intentioned) tournament rule stipulated that any goals scored in overtime (and, by virtue of a sudden-death rule, there could only be one) would count double, as if the team scored two goals. The idea was to reward teams in close matches. This simple rule led to a very strange match.

Read the post in details…

Happy Diwali wishes to all Mostly Economics visitors.

October 19, 2017

Wishing all Mostly Economics visitors a very Happy Diwali. Celebrate and have a great year!

The ubiquitous Spanish dollar—a photo essay

October 13, 2017

Superb post by JPK. How he keeps coming up with these gems is a mystery.

Fascinating to learn how Spanish Dollar was used across so many countries in really interesting ways…


Reforming the central bank boards: Case of New Zealand…

October 3, 2017

Central banks and their followers focus a lot on monetary policy, financial stability and so on (rightly so given all the noise). What is not understood is how little attention is paid towards governance  of these central banks. How these central banks are organised and how they make decisions under a Board and so on are as important. Central bank reforms have been limited to whether they target inflation or not but not towards whether they are governed properly or not.

Michael Reddell writes on reforming RBNZ Board:

Last Friday, the Reserve Bank’s Annual Reports were published.  There were two of them, both required by law.   But most people wouldn’t know that.

There was the outgoing Governor’s own report on the Bank’s performance, the annual accounts etc.  That warranted a press release, and some modest media coverage.  But buried inside the Bank’s annual report was the, quite separate, statutory Annual Report of the Reserve Bank’s Board.    It has no separate place on the Bank’s website, it wasn’t accompanied by a press release from the chairman, although this year it did actually get passing mention in the “acting Governor”‘s press release.

The Reserve Bank Board isn’t a real board, in the sense known either in the private business sector, or in the government sector.  As the Board itself notes “the Board is a unique governance body in the public sector”.  The Board largely controls the appointment of the Governor, and has some say over the recommended dividend.  But otherwise, its powers are all supposed to be about providing a level of scrutiny and monitoring of the Bank –  and in particular the Governor personally – on behalf of the Minister of Finance and the public.  In practice, at least with a public face on, the Board tends to be emollience personified –  nothing to worry about here chaps –  that has very effectively served the interests of successive Governors.


 I’ve written previously about the role of the Bank’s (now) deputy chief executive –  who attends all Board meetings –  in these matters.   But the Board’s Annual Report simply records the heart-warming fact that the new superannuation fund chair “kept the Board informed of the work associated with the development of a new Deed for the Trust”.  On the principle that when you things you know about are wrong, it leaves one worried about the other material that one doesn’t know in detail.  On this occasion, there was no “new deed”, but some amendments to the rules (largely) to allow the superannuation fund to comply with the new Financial Markets Conduct Act.   As part of those changes, trustees were about to left in the lurch by the Bank –  unremunerated and yet with no liability insurance.    Only threats that the new rules would not be executed (requires all trustees to sign) and a written protest to the Board helped secure a backdown.  And the more serious issues, of past rules breaches, and mistakes in past rule changes, still look set to head to the courts next year.  Millions of dollars are potentially in dispute.

As I’ve written (repeatedly) before, the Reserve Bank’s Board doesn’t really serve much of a useful function.  A thoroughgoing reform of the goverance of the Reserve Bank (including the role of the Board) is well overdue, and there are signs now that whoever forms the next government it may well happen (although I am less optimstic of that if National leads the next government as even if they favour some change, they may not favour changes New Zealand First –  or the Greens if you must –  would support).   If the Board is to retain a role as an accountability and monitoring body, it too will need a shake-up.  Independent resourcing would help, but much of what is really needed is a different mindset, in which the Board finally serves the public, not acting as guardians of the Governor.  My own preference would be for the monitoring and accoutability functions to be undertaken by a Macroeconomic Advisory Council, established formally at arms-length from the Bank, the Treasury and the Minister of Finance.


We need similar assessment for RBI Board too..

Did Reserve Bank of New Zealand outgoing chief give himself a big pay rise? On what grounds?

September 29, 2017

Michael Reddell, the ever alert commenetator on NZ economy and their revered central bank has a startling piece:

….someone emailed me suggesting that the Reserve Bank Annual Report implied that the (now former) Governor, Graeme Wheeler had had a big pay rise.  And that did interest me, because outside the halls of the Reserve Bank Board it isn’t clear who would have thought that Wheeler had done something even approaching a stellar job as Governor.

Wheeler started at the Bank in September 2012, so we can’t get a read on his initial salary in the (June year) 2012/13 accounts.   But there are four years of annual reports when he will clearly have been the top earner in the Bank.    The relevant tables show the top earner received as follows during these financial years:


Bitcoin vs Dollars: Which One is a Fraud? Which One is a Ponzi Scheme?

September 29, 2017

Mistalk blog reflects on Jamie Dimon calling Bitcoin a fraud:

Dimon’s statement on Bitcoin represents the irony of the year. Euros, dollars, etc. are precisely fabricated out of thin air.

That was not always the case for dollars. They were once exchangeable for gold. But euros right from the start were a complete fabrication.

The Eurozone problems we see today are a direct result of the fraudulent nature of Target2 guarantees on top of the fraudulent nature of the euro itself.

🙂 Even if thin air is not fully right, all these currencies are just based on government order. One can increase and decrease the currency at govt will and create mega monetary theories to justiify whatever they do: inflation target, Taylor rules and so on.

He says things like modern finance are a bigger fraud:

In an article that I wish I had written myself, Viktor Shvets, head of Macquarie’s AsiaPac equity strategy, accurately explains “Modern Finance”, Not Bitcoin, Is The Real Fraud.

If one describes Bitcoin as a fraud, how would one describe a ‘financial cloud’ that is at least 4x-5x larger than the underlying economies? It is unlikely that US$400 trillion+ of financial instruments circulating around the world would ever be repaid and most are now backed by assets that are already either worthless or are diminishing in value. How does one describe rates and the yield curve that are either directly determined by Central Banks (BoJ or PBoC) or heavily influenced by them (Fed or ECB)?

While we maintain that despite the presence of US$7.5 trillion of excess reserves (amongst G4+Swiss central banks), global deflationary pressures are so strong that break-out of inflationary pressures is unlikely. However, if public sectors continue to insist on suppressing business/capital market cycles, then some form of full credit market nationalization and/or currency debasement becomes inevitable.

Even fractional reserve lending:

If someone had a Yap Island stone and wanted to lend out three of them, that would not be possible. Nor can one have $100,000 worth of gold or Bitcoin and legally lend out $1,000,000 of it.

If someone tried to do so they would be convicted of fraud. Yet, via fractional reserve lending, banks can lend out money they do not have, and few think anything of it.

There are two distinct problems with fractional reserve lending as it exists today.

  1. Duration Mismatches
  2. Money Creation Out of Thin Air

CDs provide an easy to understand example duration mismatches. A person buying a 5-year CD gives up the right to use his money for 5-years in return for an agreed upon interest rate. Bank can and do lend out such money for 20 years.

Historically, borrowing short and lending long caused numerous bank runs and financial crises. Note that there are no reserves on savings accounts. Banks can lend that money out while guaranteeing you availability. If everyone tried to get their money at once, the system would implode. We have seen numerous examples in Europe recently.

It is a pity that much of this so called modern finance tools have become so ingrained in our textbooks and thinking, that we hardly question them. Infact these are the most admired jobs and calling anything which challenges the status quo is called as fraud. But then those whose houses are made of glass should not throw stones at others..


Given the technology at hand, why don’t the equity markets move to a T+0 settlement cycle?

September 28, 2017

This blog pointed earlier to how US is moving to a T+2 settlement in equity markets whereas India had it more than a decade ago.

JP Koning asks why don’t we move to a T+0 settlement cycle given we have the technology now? He says there is a reason why these systems are slower. The idea is to settle and net transactions at the end of the day rather than immediate to avoid repitition:


The truth about the Indian economy…

September 19, 2017

The GoldStandard blog by Anantha Nageshwaran has 4 posts on truth/state of Indian economy. In the process, he links to several articles/pieces on Indian economy (which is also the trademark of his blog).


What is also interesting to note is how quickly the narrative changes. All this while, we were saying things are stable in Indian economy and so on. Demon is a blip. GST is a blip etc etc.

Now, one is reading quite a few pieces on the need to pass fiscal stimulus to shore Indian economy! For instance see this, this and this. Once the government bites the fiscal bullet and things go haywire (as they usually do with most governments), the same articles will start criticising the Government! Some will say eased too much, some will say too soon and some will suggest that instead of easing this component, that component should have eased..

So much so for all the macro analysis which keeps going in circles….

Did Free Banking Stabilize Canadian NGDP?

September 15, 2017

Interesting post by Prof George Selgin. Selgin counters view of a blogger who says that Free banking between 1867-1935 in Canada did not stabilize its GDP.

About a month ago, a Facebook post drew my attention to an attempt, by Casey Pender of Prague’s CEVRO Institute, to test my thesis that free banking contributes to NGDP stability using statistical evidence from Canada, which had a relatively free banking system between 1867, the year of Canada’s confederation, and 1935, when the Bank of Canada was established.

In “Some Odd Data on Free Banking in Canada,” a blog post discussing his preliminary findings, Pender reports that he had hoped to

be able to show that Canada, from 1867-1935, had a more stable NGDP percent change from year to year than the U.S. And I thought this would be an easy and quick historical example that I could use to bolster my underlying theory. But things seem like they just ain’t so.

Instead, in comparing the fluctuations of Canadian and U.S. NGDP using data from the Macrohistory database, Pender found that Canadian NGDP was not less but more volatile. Moreover that conclusion held not just for the full 1870-1935 sample period, but also for the sub-period 1870-1914, which omits various extraordinary Canadian government interventions during WWI and the Great Depression.

Here is Pender’s chart showing his results from the full sample period:









Having now been made privy to these findings, I suppose that you are looking forward to seeing ol’ Doc Selgin eat humble pie. Well, you can quit holding your breath ’cause that won’t be happening anytime soon. In fact, for the moment at least, I remain thoroughly impenitent.

He says one must not just look at changes in NGDP but look at the relationship between those fluctuations and underlying changes in Canada’s monetary base. He shows that this relationship is much stronger in Canada than US…

In the end:

In brief, both our Canadian regression results themselves, and a comparison of those results with results using U.S. data, seem fully consistent with the theory that free banking helps to stabilize the relationship between NGDP and the monetary base.

Does that mean they confirm the theory? Alas, it doesn’t. Freedom in banking is but one of many differences between the pre-WWI Canadian system and its U.S. counterpart. Furthermore, even if Canada’s more stable NGDP-M0 relationship were in fact due to its having had a relatively free banking system, it wouldn’t follow that my theory is correct. Free banking could well have contributed to the stable relationship in question for reasons apart from the one my theory points to. We know, for example, that branch banking — itself an element of free banking — made Canada’s system less fragile, and therefore less vulnerable to financial crises, than the U.S. system. We also know that financial crises tend to involve a collapse in bank credit and spending. So the relative stability of the Canadian NGDP-M0 relationship, instead of reflecting a tendency for changes in M to offset opposite changes in V, may instead simply have reflected a relative lack of banking crises and associated increases in the ratio of bank reserves to bank credit.  Although all this is still good news for fans of free banking, it leaves my particular hypothesis unproven.

In short, while my theory has yet to be discredited, it also has yet to be confirmed. I hope that either Mr. Pender or some other enterprising econometrician will eventually settle the matter, one way or the other.


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