Merill Lynch deals on mortgage debts targeted by SEC

The Wall Street Journal reported Friday that the Securities and Exchange Commission had launched an investigation into deals Merrill Lynch & Co. undertook to allegedly cloak its vulnerability to risky mortgage debt.

The Journal reported Merrill Lynch struck deals with hedge funds to take certain positions that did not transfer risk, but merely delayed when Merrill Lynch would have to disclose its exposure to the risk.

For example, the Journal said, Merrill engaged a hedge fund to lend a "Merrill-related entity" $1 billion (EUR690 million). This normally means the hedge fund assumed the risk of the Merrill-related entity failing to repay debt. However, Merrill guaranteed it would buy the loan a year later. Thus, Merrill assumed the risk without reporting the company's exposure on its own books.

The Journal reported Merrill has been seeking help from hedge funds in shifting as much as $5 billion (EUR3.4 billion) in bonds backed by mortgages under a "mitigation strategy."

A spokesman for Merrill Lynch was not immediately available for comment. SEC spokesman John Nester in Washington declined comment and would neither confirm nor deny that the agency was investigating.

Merrill Lynch shares fell 7.4 percent to $57.57.

Merrill Lynch shocked Wall Street last month when it reported $7.9 billion (EUR5.4 billion) in mortgage credit costs for the third quarter. Not only was this charge easily the biggest among Wall Street's banks related to the mortgage crisis, it was more than three-quarters higher than the cost Merrill Lynch had estimated just three weeks earlier.

Deutsche Bank analyst Mike Mayo on Thursday issued a report predicting $10 billion (EUR6.9 billion) in additional writedowns on Wall Street for the fourth quarter, including $4 billion (EUR2.7 billion) at Merrill.

These charges have stemmed mostly from bonds and other investments backed by mortgage debt, and commitments to finance corporate takeovers. These types of investments and commitments have become less valuable amid a flight to safer investments this year.

If Mayo's prediction comes true, the banks will collectively have recorded around $35 billion (EUR24.2 billion) in charges in the second half of 2007.