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Tuesday, March 27, 2007


consumer confidence wire is tripped

the conference board reported a sharp fall in its overall confidence reading.

The Present Situation Index, which measures how shoppers feel now about economic conditions, increased slightly to 137.6 from 137.1 in February. The Expectations Index, which measures consumers' outlook in the next six months, declined to 86.9 from 93.8.

this places the future-less-present figure at a new low of (-50.7). the history of the indicator is that recessions are preceded by readings under (-20), with more severe and considerable instances being preceded by (-50).

this page has been tracking this figure informally since march 2005 with the fearful expectation that it might eventually dip below (-50) -- and now that day has arrived. subsequent posts followed in september 2005, early february 2007 and again late.

with the housing market in a full-fledged rout, manufacturing in a recession, s&p profit growth slowing and retail weakness now being observed, all in conjunction with a 15-month-old inverted yield curve, sensible observers must conclude that the conditional probability is that recession is now imminent -- more probably than not a severe one.

how much longer -- or if -- equity markets can continue to go north under these circumstances is highly debatable. the pace of fed money creation offsetting real contraction in lending -- keeping broad money supply rising in spite of corrective action in banking -- will be key.

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New consumer confidence numbers may point to housing-led recession:

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Monday, March 26, 2007


the swinging pendulum

i've found it very difficult to come to grips over time with investing long. it has always seemed to me that, as a risk-averse person, knowing that ponzi finance more often than not drives bull markets, knowing that ponzi finance ends quickly and devastatingly, it was simply too much to ask to put one's hard-won fortune on the line. i've sought to mitigate the risk in any number of ways -- including not participating -- but in the end, you have to be in at least some of the time to win.

the fact that i'm finding it easier to get in based upon a long-short technical construct that, in a blatant bit of hyperreality, i consider to be both rewarding AND secure may itself be signal of a top in this four-and-a-half-year bull.

moreover, the signs of a top are literally everywhere. economically, the housing market jitterbug has ended and is nosing over into what promises to be an event with only depression-era precedents -- probably, not possibly, down 50-70% in real terms in many markets -- even as mainstream sources continue to dissemble fraudulent tales about how the damage will be minor. retail has been flat for a year and may now be following housing as mortgage equity withdrawal and the construction sector -- source of much of the bull's real economic fuel -- both unwind and essentially end. indeed, transport, steel and bank data have now begun to indicate the onset of a credit crunch. closer to the markets, margin debt is once again at roaring 20's levels and mutual fund cash is at all-time lows. and perhaps most interestingly, the careless hubris of jim cramer -- "symbol of the bull market" -- is a ringing bell of complacency.

the three engines -- corporate stock buybacks, price-insensitive foreign central bank purchasing and petrodollar recycling -- continue apace, and the hubris of the market is largely just a consequence of it.

but for how long? corporate profits are now declining. the oil rally has been paused. china is creating the world's largest asset diversification fund. the dollar is falling again.

bill cara put an excellent analysis in this week which outlines why this is probably the final leg of the great bull of 2002-7.

So, what is happening today is that inflation data, housing data, mortgage banking data, and so forth, if it can’t be buggered beyond belief, will be ignored.

Why? Well, that’s another hypothesis I have. It is to give the US Administration, the Fed, Humungous Bank & Broker and Friends and Family sufficient time to line up their ducks (ie, put options, stock sales, M&A deals, and so forth).

The equity market is not going higher because corporate fundamentals and guidance are pulling it up, but because a very few vested interests are pushing it higher. And they will do it until they can’t do it any longer. But by then they will have rotated their sectors, told their lies, and prepared themselves for the other side of the pendulum’s swing.

as cramer implied, it is the fiction that counts -- the market itself is a bit of hyperreality that is thoroughly contrived and managed by any number of interested parties. but the consequences are real -- and when that pendulum swings, i fear that this could be one of the epic financial collapses in american history. the imbalances against are so unprecedented, so vast as to beggar description.

with problems now seeming to appear everywhere and volatility escalating, the market is being characterized by many as somehow healthily climbing a wall of worry. that's a fit axiom for march 2003, but probably not march 2007. indeed, i wonder i the tipping point won't come very suddenly indeed.

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the supply-demand imbalance

a fine elementary post from calculated risk about what is going on in housing with regards to pricing and what can be expected to happen.

Inventory of 4.5 million units, and sales of 5.7 million, means 9.5 months of supply this summer. For the more optimistic, use 4 million units of inventory, and sales only falling to 6 million units, giving 8 months of supply.

Usually 6 to 8 months of inventory starts causing pricing problems, and over 8 months a significant problem. With current inventory levels at 6.7 months of supply, inventories are now well into the danger zone. By mid-summer, months of supply will likely be a significant problem.

a "significant problem" for pricing, that is. big picture notes that today's data release indicates a supply overhang of now some 8.1 months of inventory -- and not in august per the optimist's case, but in this february just past. one has to expect that price declines are just beginning, and that the nascent downtrend in home prices will not only reinforce but probably accelerate all this summer. one look at the arm rate reset graph from this wonderful post at wall street examiner indicates that, beginning in may, a terrific amount of pressure will fall upon the real estate foreclosure and personal bankrupty engines of what appears to be a recession.

for someone who sold their home in 2006 and has been renting, this is just what was hoped for. but the flip side of a slow, traumatic return to reason in the housing market is that credit will be scarce.

Lenders are increasingly refusing to lend to homebuyers who can't make a down payment of more than 5 percent, especially if they won't document their income. Until recently such borrowers qualified for so-called Alt A mortgages, which rank between prime and subprime in terms of risk. Last year the category accounted for about 20 percent of the $3 trillion of U.S. mortgages, about the same as subprime loans, according to Credit Suisse Group.

``It's going to be very difficult, if not impossible, to do a no-money-down loan at any credit score,'' said Alex Gemici, president of Parsippany, New Jersey-based mortgage bank Montgomery Mortgage Capital Corp. Companies that buy the loans ``are all saying if they haven't eliminated them yet, they'll eliminate them shortly.''

Tighter lending standards may slash subprime mortgage sales in half this year and Alt A mortgages by a quarter, according to Ivy Zelman, a Credit Suisse analyst in New York who covers homebuilders. The new requirements will force some prospective homebuyers to save more money for a down payment or risk being denied credit.

fannie mae and freddie mac are forbidden from buying such loans, so liquidity in these markets is dependent on investor appetite for mbs's -- and investors have recoiled sharply in recent months, not only from subprime but alt-a. as things go from bad to worse and the credit crunch widens into alt-a and prime, this writer would not expect old-fashioned standards to once again apply -- sparkling fico scores, 20% down.

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I certainly hope that you are correct in this Gaius, for purely selfish reasons.
I'm buying a house/condo for the first time this summer or fall. I have 20% to put down and wouldn't want it any other way. I lost my stomach for creative financing long ago.
Still, I had an acquaintance in real estate try to talk me into seeing "his guy" and recommending that I go for 100% financing just this weekend.

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fwiw, imk -- i find it difficult to poke a lot of holes in this assessment.

the arm reset spike from the 2/28s taken out in summer 2005 -- the top of the market -- starts in may. a lot of people with subprime and alt-a arms are going to find their payments way up -- and it's probably going to add a lot of fuel to the foreclosure fire. adler is talking about a 10-30% price collapse between here and september, as bank reo and truly desperate builders forget profit and start working very hard toward mere loss mitigation.

now, i have no idea if he's got the pricing *and* the timing right.

and one has to remember that the fed, in the heat of an election season, will be pressured hard to keep the easy money coming -- rates and money supply both -- the liquidity pump will be working overtime.

but in real terms -- figuring that real inflation may be 6-7% already -- that kind of real price cut is not only coming but will be exceeded in years to come.

i wonder how many people remember sir john templeton's warning about housing:

Sir John also had a few words about debt -- a four-letter word that folks seem not to care about: "Emphasize in your magazine how big the debt is. . . . The total debt of America is now $31 trillion. That is three times the GNP of the U.S. That is unprecedented in a major nation. No nation has ever had such a big debt as America has, and it's bigger than it was at the peak of the stock market boom. Think of the dangers involved. Almost everyone has a home mortgage, and some are 89% of the value of the home (and yes, some are more). If home prices start down, there will be bankruptcies, and in bankruptcy, houses are sold at lower prices, pushing home prices down further." On that note, he has a word of advice: "After home prices go down to one-tenth of the highest price homeowners paid, then buy."

be careful about buying too soon -- it's in no one's interest to try to catch a falling knife, and there's likely to be a long denouement. if you're like me, other factors are also at work to determine when you have to move -- but (if you're renting) at least take a look at extending your lease.

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perhaps importantly, the economist this week:

A new study by Christopher Cagan, an economist at First American CoreLogic, based on his firm's database of most American mortgages, calculates that 60% of all adjustable-rate loans made since 2004 will be reset to payments that will be 25% higher or more. A fifth will see monthly payments soar by 50% or more.

Few borrowers can cope with such a burden. When house prices were booming no one cared. Borrowers refinanced or sold their homes. But now that prices have flattened and, in many areas, fallen, those paths are blocked.

The greatest difficulties threaten borrowers whose house is worth less than their mortgage. Just under 7% of all American homeowners had this “negative equity” at the end of December 2006 estimates Mr Cagan, using a sample of 32m houses (see chart 1). Among recent homebuyers, the share is even higher: 18% of all people who took mortgages out in 2006 now have negative equity. A quarter of all mortgages due to reset in 2008 are in the same miserable state (see chart 2).

Higher payments and negative equity are a toxic combination. Mr Cagan marries the statistics and concludes that — going by today's prices — some 1.1m mortgages (or 13% of all adjustable-rate mortgages originated between 2004 and 2006), worth $326 billion, are heading for repossession in the next few years. The suffering will be concentrated: only 7% of mainstream adjustable mortgages will be affected, whereas one in three of the recent “teaser” loans will end in default. The harshest year will be 2008, when many mortgages will be reset and few borrowers will have much equity.

Mr Cagan's study considers only the effect of higher payments (ignoring defaults from job loss, divorce, and so on). But it is a guide to how much default rates may worsen even if the economy stays strong and house prices stabilise. According to RealtyTrac, some 1.3m homes were in default on their mortgages in 2006, up 42% from the year before. This study suggests that figure could rise much further. And if house prices fall, the picture darkens. Mr Cagan's work suggests that every percentage point drop in house prices would bring 70,000 extra repossessions.

2008 is my target year, fwiw -- the point at which i will no longer be able to hold off my wife and growing family, when arguments for fiscal prudence start losing out to the need of another bedroom and a yard. :)

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I may not be able to hold on much longer either. My daughter and I are sharing living quarters with my parents. Very practical, but it does take a toll on my sense of self.

However, I'm going to take your advice and hold out a bit longer. If it works out, I owe you one. At the very least, I should send you a copy of Tolstoy's What is Art?. I do think that you would find it amusing.
Hope the family is well.

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Wednesday, March 21, 2007


ratings agency complicity in the mortgage bubble

this article from cnn money online does much, unfortunately, to clarify why the bbb- tranches of mortgage-backed cdo's are not the only ones at risk -- it turns out that the ratings agencies responsible for slicing the debt by risk systemically exaggerated the safety of many cdo securities to make them more saleable.

To appreciate the role that the rating agencies play in today's housing market, you have to understand a piece of Wall Street alchemy: the process by which mortgages are combined, carved up, recombined and carved up again in almost endless permutations to create new forms of debt (which usually go by three-letter abbreviations).

A bank or brokerage bundles up hundreds of mortgages and sells investors debt that is backed by mortgage payments and secured with homes. These asset-backed securities - ABS's, in Street parlance - are sold in slices, each of which carries its own theoretical level of risk, ranging from the supposedly invulnerable (AAA) all the way down to the bottom rung of investment grade and even past that, to a highly speculative unrated slice.

It's possible to create a AAA-rated asset out of somewhat shaky collateral, because the first dollar of income goes to the securities with the highest rating, while the first dollar of loss is assigned to those with the lowest. The bottom layers provide a cushion that supposedly protects the higher-rated securities.

Lately much of the bottom rung of investment-grade ABS's has been snapped up by another Street creation called a collateralized debt obligation (CDO), which, like an ABS, is sold in slices. A large chunk of a CDO that consists of barely investment-grade securities can still secure a coveted AAA rating - again, because any losses have to eat through the bottom layers.

These products exploded in popularity in recent years because investors - including pension funds and insurance companies, which must mostly buy investment-grade-rated debt - had a voracious appetite for them. That in turn encouraged a historic increase in subprime lending.

The amount of subprime mortgages issued shot up from $35 billion in 1994 to $625 billion in 2005, says Josh Rosner, a managing director at research firm Graham Fisher. Brokerage firms, which packaged, sold and traded these creative instruments, made big profits. And so did the credit-rating agencies. At Moody's (the only one publicly traded), net income went from $159 million in 2000 to $705 million in 2006, in large part because of increases in fees from "structured finance," the umbrella under which this mortgage alchemy falls.

Today all the rating agencies say they have scrubbed the numbers, and slices of debt that are rated investment grade will mostly stay that way, even if the collateral consists of subprime mortgages.

Critics have their doubts. A paper co-authored by Rosner and Joseph Mason, a visiting scholar at the FDIC, argues that if home prices depreciate, even investment-grade CDOs will suffer "significant losses."

Janet Tavakoli, who runs Tavakoli Structured Finance, points out that AA-rated tranches of CDOs backed by subprime mortgage paper now yield far more than AA-rated debt backed by other assets - a sign that the market doesn't trust the ratings. "No one believes the ratings have any value," she says. Opined Grant's Interest Rate Observer: "We are willing to bet that the agencies assigned too little weight to greed, ignorance, and soft criminality."

All this has real-world implications. If the rating agencies do downgrade some of this paper, investors who can't own non-investment-grade debt would be forced to sell in droves. The losses could affect the bottom line of an untold number of companies, including insurers and possibly even mutual funds.

And if CDOs stop purchasing mortgage paper, then a major source of liquidity will evaporate. That tightening of credit could affect the demand for homes, thereby turning the virtuous circle of recent years into a vicious one of falling home prices. That, say Rosner and Mason, creates the "potential for prolonged economic difficulties that also interfere with home ownership in the U.S." And who will take credit for that?

more in this dow jones wire story.

in short, thanks to moody's and others in search of profit, many institutional holders have bought large blocks of subprime mortgages rated as investment-grade securities -- and what may result, in an environment of falling home prices, is a devastating institutional flight from any and all mortgage-related abs and cdo instruments that will make getting a home loan much more difficult for most people.

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Tuesday, March 06, 2007


plankton and minsky

an elegant tract from paul mcculley on why the subprime collapse means the end of the housing boom and the start of fed interest rate easing, albeit with a probable lag.

UPDATE: mcculley is not the only one making allusions to the ponzi economy.

UPDATE: not only minsky but baudrillard from the wall street examiner.

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Monday, March 05, 2007


subprime crushed

panic takes hold:

Shares of subprime lenders including NovaStar Financial, Accredited Home Lenders and Fremont General dropped more than 25% on Monday as investors dumped holdings in an industry rocked by tighter regulation and bad debts.

"There's a lot of panic selling today," Rich Eckert, senior research analyst at Roth Capital Partners, said. "People are deciding they don't want to be exposed to this sector at all."

Subprime mortgages are offered to homebuyers who don't meet the strictest lending standards. Companies that specialize in these loans have suffered as housing prices stopped rising and interest rates climbed from record lows.

In the most acute example on Monday, shares of New Century lost more than two-thirds of their value to close at $4.56. The second-largest subprime lender in the U.S. said late Friday that it's facing a federal criminal probe and has breached a covenant with some major lenders that provide important financial backing.

Fremont said that it's getting out of the business after the Federal Deposit Insurance Corp., which helps regulate lenders, ordered it to stop selling some subprime mortgages.

there's got to be a dead-cat bounce in here, but subprime lending is pricing for bankruptcy.

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Friday, March 02, 2007



as noted by brad delong, brad setser saw in the aftermath of the february 27 dislocation that the flight to currency quality was -- for the first time in a long time -- not into the dollar but the yen.

Fair enough. The currencies of countries with big current account deficits facing a shortfall in private inflows aren’t classically considered the gold-standard by those looking for a safety.

That though is a bit different than last spring, when the dollar did benefit for a while from the flight out of emerging markets in May (more here). I think Macro man probably has this story right: after the April 2006 G-7 communique (the one that briefly made Dr. Roach an optimist) some big players started to bet that the dollar would fall. In practice, that meant that they ended up using the dollar to finance their high-carry bets on Turkey and Brazil. Or to finance their bets on Turkish, Brazilian and Russian equities. When those bets unwound in May and June, the dollar got a bit of a boost. Today, though, it was the yen that got the big boost. Bloomberg:

The yen also advanced 4.1 percent against the Turkish lira, 3.9 percent versus the South African rand and 2.8 percent against Iceland's krona as investors shunned riskier assets in emerging markets following a rout in Chinese stock market shares.

Yet more circumstantial evidence that leveraged bets on the emerging world right now are – or were -- financed not with dollars but with yen and swiss franc.

this is the unwinding of the carry trade, which is clearly spooked by what has transpired in the last week. setser further notes the commentary of simon derrick of the bank of new york:

USD/JPY’s 2.19% fall, understandably enough, captured a great deal of the attention yesterday given that this was the pair’s 6th largest daily decline this decade, dwarfing the somewhat anaemic 0.44% rally seen in EUR/USD. However, it is on the JPY crosses that the really interesting story emerged. GBP/JPY, for example, managed to stage its largest daily decline since May 2001, losing a substantial 2.27% before making a modest (0.4%) recovery overnight. AUD/JPY and NZD/JPY were even more extreme, losing 2.89% (the largest drop since 2002) and 3.72% (the largest daily move we have a record of) respectively. ZAR/JPY collapsed by 4.46% (the largest decline since early 2004) while HUF/JPY dropped a slightly more modest 3.48%. In short then yesterday was not about the USD at all but rather about the use of the JPY as a funding currency to invest in a variety of high yielding (and, in some cases, relatively illiquid) currencies and what happens to these trades when risk appetite declines.

The question now is whether this unwinding will continue. Although we cannot speak as to whether the more general retreat from risk will continue (we suspect it will), the conditions are certainly ripe for a more sustained sell-off in JPY crosses. If we assume that a significant number of JPY funded investments were put back on in the latter part of last week in the aftermath of the BOJ policy boards decision then it seems reasonable to estimate that the overall scale of the JPY carry trade going into yesterday was at close to record levels. It therefore also seems reasonable to suppose that there are still a substantial number of positions to be unwound despite the events of the past 24 hours. With valuations still looking stretched (on a yield basis) in a number of these crosses, yield spreads narrowing smartly (particularly in GBP/JPY and NZD/JPY) and the technical picture looking increasingly negative (major trendlines either under threat or broken and declining momentum), we maintain our view that there is plenty of space for something more substantial to develop to the downside from here. It is certainly worth remembering that the unwinding (from much smaller extremes of positioning) that developed between April and May of last year saw USD/JPY collapse from JPY119 to JPY109.

it's deeply uncertain if anyone can forecast what comes next -- but derrick is obviously correct in saying that massive yen-debt-funded trades remain in place -- and that the continuing strengthening of the yen is a mortal threat to them. (notably, many asia ex-japan markets have continued to trade downward without respite as the yen strengthens against their home currencies.) the strengthening of the yen should be proeprly contextualized as well -- the zero-rate policy of the central bank went into effect in 2000, and the carry trade in higher-yielding ex-japan assets probably didn't truly begin until the volatility of the february 2000 - march 2003 period had ended. its growth was noted here in march 2005. the central bank is notorious for trying to weaken the currency in favor of exporters, but has little to do with the decline since 2005 which has seen the yen depreciate 20% -- much of that is probably short-selling of the yen to fund the carry trade despite signs of japanese economic strength. considering further the weakness of the dollar itself due to trade balance concerns, this is a considerable force in the market -- and what has transpired in the last week is only a very small move in comparison.

the carry trade may not unravel immediately, but when it does there may be a tremendous upheaval in this market.

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Thursday, March 01, 2007


chicago housing market

a bit from the tribune:

A January chill for Chicago home sellers

By Mary Umberger
Tribune staff reporter
Published February 28, 2007

Though local observers say the slumbering Chicago housing market has started to stir, it snored right through January, when sales slid by nearly 11 percent from a year before, according to data released Tuesday by the Illinois Association of Realtors.

It was the 10th consecutive month that sales declined in Chicago, though prices squeaked upward by 2.2 percent, the association said.

Nationally, the market fared better, at least in terms of sales. On a month-to-month basis the January numbers gave some encouragement, with existing-home sales climbing 3 percent to their highest level in seven months, according to a separate report from the National Association of Realtors.

However, the more closely watched year-over-year data still showed a national sales decline of 4.3 percent, and the median price for an existing home fell for the sixth straight month, by 3.1 percent.

The national group cautioned that brutal February weather might be a blow to the gradual market recovery the trade group still predicts.

"Some unusually warm weather helped boost sales in January," said the NAR's chief economist, David Lereah. "On the flip side, the winter storms that disrupted so much of the country in February could negatively impact the housing market.

"We shouldn't be surprised to see a near-term sales dip, but that will be followed by a continuing recovery in home sales."

Some Chicago agents and long-suffering home sellers say they see signs of a recovery.

"So far, we've had more showings [in the last several weeks] than we had all of last year," said William Dahms, a North Side mortgage banker who has been trying to sell his condo in the Ravenswood Manor neighborhood since July and has dropped the price to $225,000 from $235,000.

Dahms says he is firm on the current price, but acknowledges that buyers continue to be picky because they have many properties to choose from.

"They're a tough crowd," agrees Glen Ellyn agent Gaylyn Genovesi, who says buyers are turning up their noses at homes that are not pristine.

She recently got a firm contract on a house that had been for sale for about a year, during which time it cascaded through several price cuts to settle at $449,000 from $517,000. After that, the owners got three offers almost simultaneously.

The national report said inventory, considered glutted in some areas, was easing. But new listings taken in anticipation of the so-called spring selling season put the January inventory right back where it had been in December, at a 6.6-months' supply. The supply peaked at 7.4 months in October, the group said.

"Generally, the market has begun to stabilize," said Tim Rogers, chief economist for "I don't think it will take much more thinning [of the inventory] before we'll see prices starting to improve."

Sales after the spring activity gets fully under way will determine whether housing is on its way to righting itself, which could happen within one or two quarters, he said.

But economist Mike Larson said the inventory problem has a long way to go before it is resolved.

"Inventory has come down [since last year], and a lot was made of that," said Larson, who tracks housing for Weiss Research in Jupiter, Fla. "But frankly, if you look at historical data, that happens just about every year.

"Inventories are climbing again because of what I call `the march of the relisters,'" Larson said. Sellers who failed to move their homes in spring and summer pulled them from the market around Thanksgiving and now are relisting them, he said.

"I expect the inventory numbers to continue rising in February, March and April, and we may very well set a new high," he said.

One bright spot in the national report was in the Northeast, where January sales rose 5.9 percent year over year. The Midwest held its ground, with sales increasing by less than 1 percent from January 2006, though the median price slid by 3.5 percent.

Sales were off by 7.3 percent in the South and by 4.6 percent in the West, the NAR said.

In the Chicago area the biggest decline was in Grundy County, where home sales fell more than 15 percent. In DeKalb County, however, sales jumped 33 percent, though median prices slipped by 11 percent, according to the Illinois Realtors.

Chicago-area condo sales were down 3.4 percent, though prices rose by 3 percent. Cook County condos led the region in price increases, climbing 6.4 percent year over year, the group said.


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