Merrill Lynch Shennanigans Deepen - Enron Redux?

Yesterday it was reported by the Wall Street Journal that Merrill Lynch's attempts to hide its Structured Investment Vehicle (SIV) liabilities that are backed by U.S. mortgages are much greater than thought. Merrill Lynch and other financial institutions have already been criticized for opaque off-balance sheet entities that make it difficult for investors to know the extent of its exposure.

Now it appears that Merrill Lynch has employed "Enronesque methods" to further delay exposing potential losses. Merrill Lynch reportedly has engaged in deals with hedge funds to move SIV's to the hedge funds in exchange for loans. Normally this would mean that the SIV liability would belong to the hedge fund. But in this case Merrill continues to own 100% of the liability, even though it is not on its books. This is precisely the type of maneuver that got Enron and EDS in so much trouble a few years back: setting up off-balance sheet arrangements that removed debt from their balance sheets but without removing the ultimate liability if it blew up.

The whole point of financial statements is to disclose to the shareholders, the owners of all publicly traded companies, the facts of income, expenses, debt, assets and other liabilities. I'm not an accountant, so I can't pass judgement on the legality of these maneuvers, but they certainly are in the spirit of fraud.

The often absent SEC has finally opened an investigation. Frankly, I'm not sure that at this point we wouldn't send a whole army of federal auditors into these firms and sort out the valuation mess once and for all.

I predict that there will be additional substantial writedowns at Merrill Lynch and other investment firms and banks as all of this unravels. The faster all this stuff gets truly marked to market and the whole lot gets written off the better off everyone will be.

I don't know if Merrill Lynch is a good short candidate at this point. The stock has already come down to levels not seen in many years. But the writedowns will continue and I suspect there will be shareholder lawsuits filed as early at this next week.

On a side note, a regulatory group is looking into Goldman Sachs impressive profits for this last quarter to make sure everything was on the up and up. Goldman Sachs is the only major investment firm that appears to have made money on the subprime fiasco due to taking major short positions in the sector.

Disclosure: at the time of this posting the author was long GS.