Federal prosecutors are exploring whether or not a criminal case is warranted against Merrill Lynch and its treatment of mortgage bonds, the Wall Street Journal reported Friday. From the WSJ:

The Justice Department’s U.S. attorney’s office in Manhattan, based near Wall Street, has notified the Securities and Exchange Commission that it wants to see information the agency is gathering in its investigation of Merrill Lynch & Co., according to people familiar with the matter. The SEC is examining, among other things, whether the securities firm booked inflated prices of mortgage bonds it held despite knowledge that the valuations had dropped, the people say.

While the interest of federal prosecutors is preliminary at this point, their inquiry comes as the SEC has upgraded the Merrill probe into a formal investigation, according the the Journal. The Merrill investigation follows another criminal investigation by the U.S. attorney’s office into UBS AG, which also is alleged to have improperly inflated MBS holdings; the WSJ broke the UBS story last October, which detailed alleged impropriety at a hedge fund owned by financial services giant. If that weren’t enough, Bear Stearns faces a federal indictment over two highly-publicized mortgage-led hedge funds that failed last year. (HW covered the hedge fund failures last year in great depth).