Even with many of the largest banks and investment banks reporting disappointing earnings and major portfolio writedowns, the flop that Merrill Lynch (NYSE:MER) is expecting for its third quarter is impressive.

In a press release Friday, the company revealed that it would take a $4.5 billion (that's net of hedges) writedown on collateralized debt obligations (CDOs) and subprime mortgages, and nearly another $1 billion on financing provided for noninvestment grade lending -- including loans for leveraged buyout (LBO) deals. The losses will push Merrill into the red for the quarter, to the tune of $0.50 per share.

So, many may have found themselves scratching their heads as Merrill's shares went up more than 2% on Friday. In fact, the firm's shares finished the week up more than 7% over the close a week earlier. The news about Merrill's losses is certainly no secret -- there were plenty of articles screaming out the writedowns in their headlines.

Is the press release some odd flavor of good news? Well, not exactly. The reason we're not seeing catastrophic movements on the part of Merrill, Citigroup (NYSE:C), Deutsche Bank (NYSE:DB) and others that have revealed major writedowns is that the markets have been preparing themselves for this for months.

Impatient as always, Mr. Market hates waiting until news actually happens, and so is always trying to read the tea leaves and guess what might happen in the future. In the case of the banks and investment banks, midway through the year, investors started getting very bearish about the problems the group would face from the subprime meltdown. Bearishness fired up further in August when the credit markets started locking up.

For Merrill, this meant a 25% drop in its shares between mid-May and August as investors estimated what the troubles might mean to Merrill's numbers. Now that the losses are being tallied, it's time for investors to start evaluating whether Merrill's big price drop was enough to factor in its losses or if the market has been too harsh.

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