NJIT business prof says first-quarter bank profits will soon prove ephemeral

"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.

Source: New Jersey Institute of Technology