Weighing the cost of subprime crisis

Markets are braced for another turbulent week on Wall Street as the big four US investment banks release their fourth-quarter results - giving the clearest insight to date of the full damage from subprime rout and the summer credit crunch.

Lehman Brothers, Bear Stearns, Morgan Stanley and Goldman Sachs are all expected to write off hundreds of millions of dollars. Merrill Lynch has already warned in a regulatory filing that it had made "fair value adjustments" in the face of potential losses and admitted to "significant risk" from further exposure.

The banks have seen their combined share prices fall 22 per cent during the quarter amid concerns about their exposure to the subprime market.

Fed decision

The disclosures come as the US Federal Reserve's board meets for the first time since the summer crisis to mull a cut in interest rates. A quarter-point trim to five per cent is seen as the most likely outcome, but an increasing number of economists expect a half percentage point cut amid a growing consensus that the bank will have to ease monetary policy dramatically in coming months to prevent contagion.

Paul McCully, from the giant bond fund Pimco, said the Federal Reserve may have to cut rates by a percentage point during the next three months. "It needs to ease and will ease substantially, not to bail out Wall Street but to make certain that weaker economic growth does not morph in a recession," he said.

Lehman Brothers is already badly bruised by its heavy exposure to the $2,000 billion subprime market, mostly as a boutique slicing and dicing housing loans into packages for resale - usually in the form of collateralised debt obligations (CDO).

It had a large share of the total $500 billion issuance of CDOs last year, generating bumper pay of $40.5 million for chief executive Richard Fuld. New CDO sales plunged by 73 per cent in August.

The bond yields on Lehman debt have fallen below that of Colombia, rated BBB-. It is a fate shared by Bear Stearns, which set off the panic in the credit markets in May when it revealed huge losses in two of its hedge funds. One of the two funds was allowed to collapse, while the other was bailed out by the bank.

The spreads paid by Goldman Sachs and Morgan Stanley to raise money have doubled since February to about 165 basis points, badly denting profit margins. But the pair are viewed as safer bets in the current squall.

Citigroup estimates the four banks, plus Merrill Lynch, have been left with $75 billion of loans for leveraged buy-outs contracted before the credit squeeze that they have been unable to place in the markets without taking a hefty loss.