The worst is yet to come," said Michael Ehrlich, a finance professor in NJIT’s School of Management. Ehrlich, who specializes in market failure, predicts $30-$50 billion more in losses, due to Structured Investment Vehicles (SIV).
The SIV rescue attempt, led by JP Morgan, Citibank, and Bank of America with US Treasury Dept encouragement, will not stop the losses, Ehrlich said. The SIV bailout fund known as the Master-Liquidity Enhanced Conduit (M-LEC) will, at best, slow down losses because there is no Federal bailout money in the plan.
"The fundamental market mispricing of the real estate and also the credit risk markets will be corrected," said Ehrlich. “In the best case, the M-LEC might forestall a panic leading to an over-correction in pricing. Unfortunately, there is likely to be the unintended consequence that the M-LEC will discourage new capital from flowing into this market.”
The roots of the current crisis stem from the 1988 guidelines established by the Bank for International Settlements known as the Basle II agreements. The structural defects in the establishment of the SIV's doomed them from the start. It was only a matter of time until the inherent mismatches and conflicts of interest would create a crisis.
Individual long-term investors should review their holdings to make sure that they are not "accidental" SIV investors. Many money market funds and bond funds have purchased assets backed by SIV's. "Funds that wanted to improve yields bought many of the AAA rated securities,” noted Ehrlich.
Before joining NJIT, Ehrlich was a government arbitrage trader at Salomon Brothers and senior managing director for fixed-income emerging markets at Bear Stearns. He received his bachelor's degree from Yale University and doctorate from Princeton University.
For further information, contact Ehrlich, Ehrlich@adm.njit.edu or at 973-596-5305 (office) or 516-330-5810 (cell).