INTERVIEW-Maine Treasurer Criticizes Merrill for Subprime Bet

BOSTON Wed Nov 28, 2007 6:00pm EST

BOSTON (Reuters) - Maine's state Treasurer blamed Merrill Lynch & Co Inc MER.N and credit agencies on Wednesday for leading the state into a failed commercial paper investment that later sparked a ban on these popular securities.

Controversy is heating up in the state over who is at fault for having put $20 million, about 3 percent, of the state's roughly $725 million cash pool this summer into an investment fund called Mainsail II -- two weeks before its sterling ratings crumbled to junk.

The investment met all of the state's investment criteria, but exposed the state to the mortgage market-related losses that have roiled credit markets for a few months. It also prompted the Treasurer to prohibit new commercial paper investments that could cut the interest the state earns.

"I have deep concerns about the recommendations and the process by which that (paper) was delivered to us," Maine state Treasurer David Lemoine told Reuters in an interview. "What was in the background at Merrill Lynch for funneling that suggestion through their broker to us for purchase?"

Mainsail II assets were frozen in late August.

Standard & Poor's on Tuesday cut the ratings on Mainsail II and three other "SIV-lite" investment funds. Other agencies acted more quickly, but not soon enough to keep Maine and others, including Connecticut, Florida, Montana and King County in Washington from getting in.

Some Maine lawmakers are now saying the Treasurer misstepped and are questioning the state's entire investment process.

"They are critical of me because somehow this has happened and it must mean that the Treasurer made a mistake," Lemoine said.

But Lemoine, a lawyer who has been in the job since 2005 and served in the state legislature before that, said he was convinced by the Merrill broker that it was a good choice.

"It is not like we go out shopping for commercial paper," Lemoine said. "We have approved brokers who bring suggestions to us and we rely upon them to fully vet them before bringing the paper forward."

Merrill Lynch spokesman Mark Herr said: "The investments were in line with the investment policies that Maine developed for itself. When we executed these sales for Maine, we provided Maine with the relevant information."

So far, Lemoine is the Mainsail II investor most critical of Merrill Lynch, whose subprime-related losses totaled over $2 billion in the last quarter, prompted a roughly $8 billion write-down and cost former CEO Stanley O'Neal his job.

While Maine has not lost any money on the Mainsail II investment yet, Lemoine said it will take weeks if not months for the investment to be unwound carefully. Mainsail II was run by British hedge fund Solent Capital Partners.

Only after that can the state consider possible next steps against Merrill Lynch, one of a handful of approved brokers the state has long relied on for investment advice.

"If there is no harm, there is no foul. We need to see how it unfolds eventually in terms of the payment process," Lemoine said, declining to say how he might move against the New York investment bank and its brokers.

Currently, Maine is also reviewing its entire investment process and sidestepping all commercial paper investments.

"As a practical matter, we are not using commercial paper anymore and so we are not dealing with any brokers, including Merrill Lynch," Lemoine said.

Instead, some of Maine's short-term cash is now being invested in fully collateralized bank deposits, which earn the state less money, but are deemed very safe.

(Reporting by Svea Herbst-Bayliss; editing by Andre Grenon)

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