Merrill Lynch stunned Wall Street after it admitted to a far bigger loss than expected arising from toxic subprime mortgage-backed investments.

The investment bank said it would write-down $7.9 billion the third quarter of the year to cover bad investments and the falling price of mortgage-backed collateral it usedto raise money.

The write-down was far bigger than either the bank or Wall Street had expected. Last month, Merrill Lynch said that it had to write down $4.5 billion because some of the investments it made in bonds backed by mortgage assets were effectively worthless. Wall Street analysts expected that the bank would take a $7 billion charge, as a worst case scenario.

Stan O'Neal, chairman and chief executive, explained the large discrepancies between Merrill's first estimates and those published today. He claimed that the bank had since re-examined the position of some of its collateralised debt obligations (CDOs) with "more conservative assumptions" and losses arising from them had soared.

CDOs are bonds backed by a pool of mortgages. A number of those mortgages, which were offered to Americans with low incomes and poor credit histories, have fallen into arrears as the US housing market plunged into recession and the adjustable interest rates on the mortgages soared. As a result, the bonds have either fallen in value, or become untradeable and therefore worthless.

The loss makes Merrill Lynch one of the biggest casulaties of the sub-prime fall-out. In the summer, Bear Stearns closed two of its hedge funds, which lost $1.5 billion between them, Goldmans made a cash injection into one of its hedge funds and Citigroup last week admitted to a $3 billion of higher losses and provisions against bad loans.

The third quarter figures were published before Wall Street was set to open at 2.30pm London time. However, overall, anticipation of a large loss has hit the stock which is now down 32 per cent since the beginning of the year.

Merrill, one the world's biggest broking firm, said that it had plunged into a net $2.3 billion loss for the three month period compared with a profit of $2.2 billion for the same period the year before. The result marks its first loss since the fall-out of the dotcom boom six years ago.

For the three month period, the net loss of $2.24 billion also included a $967 million, or $463 million including underwriting fees, of write-downs on loans related to leveraged buyouts.

Mr O'Neal said: "We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact from our positions. Away from the mortgage-related areas, we continue to believe that secular trends in the global economy are favorable and that our businesses can perform well, as they have all year."

Three weeks ago, Mr O'Neal ousted two bond executives after estimating the first, smaller writedown.

Today's bigger writedown will apply pressure on Mr. O'Neal's own position as he seeks to reassure the bank's board that the firm's exposure to risk is under control. Three weeks ago, he sacked two top bond executives after publishing the bank's first estimated write-down.

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