Shockwaves from the rescue of Northern Rock will serve to focus attention on the leading investment banks, which this week will begin to reveal their exposure to losses in the sub-prime mortgage market.

Lehman Brothers, Goldman Sachs and Morgan Stanley, which report third-quarter figures this week, will come under scrutiny for their valuation of securities linked to sub-prime loans.

The investment banks legitimately may be able to avoid writing down some of their billions of dollars of more illiquid assets, according to one auditor with a Big Four accounting firm.

To mark assets down to market value under accounting rules, there has to be what is known as an active market in the security, meaning a sufficient volume of willing buyers and sellers.

But the paralysis in many credit markets means that there has been no active market.

Instead, bankers are preparing to value some of their more illiquid assets according to a model based on assumptions of more normal market conditions.

“They may be able to depart from the normal mark-to-market model if they think another way gives a better estimate of fair value,” the auditor said.

The big investment banks are looking at two particular exposures – asset-backed securities secured on sub-prime and prime mortgages and loans and commitments to finance leveraged buyouts.

Merrill Lynch triggered fresh jitters on Friday when it reported that it would have to make “requisite fair-valuation adjustments” on the securities on its books. Its shares fell by as much as 3.5 per cent, but regained most of the losses.

Merrill, which had $10.3 billion (£5.1 billion) of securitised assets on its books at the end of June, was forced to make the disclosure in a US Securities and Exchange Commission filing as part of its $1.8 billion cash-and-shares-based acquisition of First Republic Bank, a private bank.

Since the credit crunch hit, analysts have reduced their profit forecasts for Lehman by 19 per cent, for Morgan Stanley by 17 per cent and for Goldman by 2 per cent.

For Bear Stearns, which also reports soon, forecasts are down by about 48 per cent because of its greater proportionate exposure to sub-prime mortgages.

“This is the most anticipated earnings season for the brokers in recent memory,” Brad Hintze, of Bernstein Research, said. Third-quarter revenues among the big five Wall Street firms are expected to be down by about $23 billion, compared with the strong second quarter.

Fox-Pitt Kelton predicts declines in fixed-income and currency-trading revenues of 31 per cent and in principal transactions of 63 per cent. Other areas, such as asset managements, should be more resilient.

Fox-Pitt Kelton is confident that investment banks will weather the storm. “We believe that the corporate credit crunch – the fodder for so many doomsday reports in recent weeks – will resolve itself over the next few weeks, or the Fed will be forced to act,” it said. “A sharp recovery is looming.”

Two weeks ago Josef Ackermann, the chief executive of Deutsche Bank, urged banks not to muddle through but to mark positions down to market.

Bob Diamond, the president of Barclays Bank, said last week that Barclays Capital, its investment banking unit, had marked all its securities to market in August and still made a profit.

Several senior bankers suspect that there may be a temptation to “airbrush” the figures and fear that until they “kitchen sink” their accounts, investors will continue to fret.

How the lender has developed

1965 Formed after a merger between Northern Counties Permanent Building Society, established in 1850, and Rock Building Society, established in 1865

1997 Floats on the London Stock Exchange in October, after amalgamation with 50 smaller societies. Customers receive cash windfalls averaging £2,255

1997 A charitable body, the Northern Rock Foundation, is created to accompany the flotation. The foundation receives about 5 per cent of Northern Rock’s pretax profits

2001 Adam Applegarth is appointed chief executive of the mortgage lender, becoming the youngest person to lead a bank in the UK, at the age of 39

2002 Launches a new mortgage in June that allows customers to borrow up to 120 per cent of the value of their home, to help first-time buyers

2002 In August buys Legal & General’s mortgage business for £131 million

2004 Mr Applegarth predicts that the number of large mortgage lenders will halve over the next five years, amid booming new mortgage business and market-share gains at the lender

2007 Treasury, Financial Services Authority and Bank of England agree to make loans available to Northern Rock, secured against its £130 billion mortgage book

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