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Federal Reserve and Treasury Department officials did not advise Bank of America Corp. (BAC) to withhold publicly disclosing mounting losses at Merrill Lynch & Co. last year, according to a government watchdog.

The special inspector general for the U.S. government's $700 billion financial rescue plan said in a report that investigators found that officials did pressure Bank of America to complete the acquisition, but did not tell officials to keep quiet on the losses. Bank of America CEO Kenneth Lewis, who this week announced he would leave the bank by year's end, told investigators that "no such instruction was given to him" by then-Treasury Secretary Henry Paulson or Fed Chairman Ben Bernanke.

Investigators also revealed that Bank of America did not think it was required to disclose the losses.

"Bank of America's legal counsel informed [investigators] that he believed that the bank was under a legal obligation to announce those losses at the end of each quarter, not mid-stream," the report from special inspector general Neil Barofsky's office said.

The government's role in ensuring Bank of America completed its deal for Merrill, and whether the bank should have publicly disclosed the Merrill losses ahead of a shareholder vote, have sparked concern on Capitol Hill and led to a number of ongoing investigations. Barofsky is currently conducting a criminal investigation into the matter.

More broadly, the new report warned that federal officials need to be careful when announcing new government programs, particularly in cases such as the dramatic interventions in the financial markets of the last year. Investigators said that the government hurt its own efforts to promote public confidence by changing the goals and focus of its programs and by describing as "healthy" financial institutions that federal officials had serious concerns about.

"Treasury and the TARP program lost credibility when lending at those institutions did not in fact increase and when subsequent events ... demonstrated that at least some of those institutions were not in fact healthy," the report said.

Paulson, the report said, acknowledged that some of the initial nine banks to receive TARP funds were healthier than others, and that he was concerned that one of the nine firms "was in danger of failing."

Barofsky's office warned that inaccurate statements could have the long-term effect of eroding public confidence in future government programs.

The Fed, in a written response to the report, acknowledged the importance of transparency in government programs, and said effective communication is paramount "especially during a financial crisis."

The Treasury, in a separate written response, defended the statements made by officials last year. "While people may differ today on how the contemporaneous announcements ... should have been phrased, any review of such announcements must be considered in light of the unprecedented circumstances in which they were made," Herbert Allison, Treasury's assistant secretary for financial stability, wrote to Barofsky.

Barofsky's office has been conducting a number of investigations and audits of the government's rescue of the financial system. The report said that a review of American International Group Inc.'s (AIG) controversial payments to its counterparties is expected to be released within the next 30 days.

-By Michael R. Crittenden, of Dow Jones Newswires; 202-821-2159; michael.crittenden@dowjones.com