image: NJIT finance professor Michael Ehrlich predicts that the strong profits reported by banks in the first quarter will soon be followed by more losses. view more
Credit: New Jersey Institute of Technology
NJIT finance professor Michael Ehrlich predicts that the strong profits reported by banks in the first quarter will soon be followed by more losses. Ehrlich, a market failure expert, notes that the unexpectedly strong profits reported in the first quarter by many large banks were the result of significant accounting manipulation. For some of the banks, these earnings were a crucial addition to their net equity positions at a time when government "stress tests" were evaluating their future viability. With more losses, serious pressure could mount on the Federal Deposit Insurance Corporation, which, of course, insures bank deposits.
"Accounting rules allow banks to use their judgment in reporting profits," Ehrlich said. "And this quarter, they were quite optimistic." These and other issues will be further explored by Ehrlich in the "The Unexpected Consequences of Financial Innovation" to be published in Bank Accounting and Finance (August, 2009).
Earlier this year, financial news readers learned about exotic structures like Collateralized Debt Obligations (CDO), Credit Default Swaps (CDS) and Structured Investment Vehicles (SIV) as banks reported enormous losses. Soon readers will learn of more three-letter losses: Collateralized Loan Obligations (CLO), especially those with Payment In Kind (PIK) provisions that allow corporate borrowers who are in trouble, to make little or no payments while the loan balances grow without creating a default or forcing the banks to mark down their positions.
A much better way, Ehrlich believes, is for the Fed to establish new rules to control future risks as it works to contain the damage to the financial system. In this case, there should be tighter regulation of the establishment of loan loss provisions to offset expected future losses.
Ehrlich was a government arbitrage trader at Salomon Brothers and senior managing director for fixed income emerging markets at Bear Stearns before joining NJIT. He received his bachelor's degree from Yale University and doctorate from Princeton University.
NJIT, New Jersey's science and technology university, at the edge in knowledge, enrolls more than 8,400 students in bachelor's, master's and doctoral degrees in 92 degree programs offered by six colleges: Newark College of Engineering, College of Architecture and Design, College of Science and Liberal Arts, School of Management, Albert Dorman Honors College and College of Computing Sciences. NJIT is renowned for expertise in architecture, applied mathematics, wireless communications and networking, solar physics, advanced engineered particulate materials, nanotechnology, neural engineering and e-learning. In 2009, Princeton Review named NJIT among the nation's top 25 campuses for technology and among the top 150 for best value. U.S. News & World Report's 2008 Annual Guide to America's Best Colleges ranked NJIT in the top tier of national research universities.
ATTENTION EDITORS: To interview Ehrlich, call Sheryl Weinstein, 973-596-3436 or Ehrlich directly at 516-330-5810.