Merrill Lynch (NYSE:MER) shocked investors today after it announced a steep loss in the third quarter resulting from a $7.9 billion writedown on its fixed-income trading business. The investment company's first quarterly net loss since 2001 totalled $2.24 billion and sparked concerns about the company's risk management policies.

The losses stemmed from collateralized debt obligations (CDOs), subprime mortgages and management's misvaluation of the assets. The big surprise was the firm's $32 billion exposure to CDOs at the end of the second quarter - am amount that is much higher than expected. The firm also wrote down losses from its corporate restructuring business, although they were not nearly as severe.

Standard & Poor's cut Merrill's credit rating on notch to A+ calling the net loss "startling" and the scale of the writedowns "staggering". The company also experienced downgrades from Moody's Investors Service and Fitch. Combined, these cuts may increase the firms cost of capital and ipact its earnings.

Meanwhile, Merrill insists that it is financially secure and comfortable with its liquidity but the bank warned that conditions could become even more secure in the future due to liquidity. It is worth noting, however, that Merrill was the only one of the five biggest investment banks to swing to a quarterly loss - all the others were able to better weather the storm.

These losses have led to speculation that the bank could even become a buyout target for someone like Warren Buffet - who was rumored to have an interest in Bear Stearns not long ago. The firm's stock is certainly cheap at these levels while the brand and reputation is still relatively in tact. Combined, these factors make MER a stock worth watching!

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