Merrill Lynch wrote down more than $16 billion (£8.12 billion) of high-risk sub-prime mortgages in the fourth quarter, forcing the bank into a $9.83 billion loss as it became the biggest casualty on Wall Street of the crisis sweeping the bond insurance industry.

Yesterday's writedowns included an $11.5 billion charge to cover the falling value of investments, such as collateralised debt obligations (CDOs), and a further $949 million related to mainstream home loans. Merrill Lynch also took a $126 million charge on loans used to finance private equity transactions and a further $230 million on property loans.

But Wall Street was most concerned about the $3.1 billion charge the bank revealed in relation to insurance it had taken out on some of the mortgage securities on its books. The group's shares fell by $4.40 to $50.69 at midday trading.

Banks had transferred billions of dollars of credit risk to bond, or monoline, insurers. These insurers promised to cover the banks in case the underlying assets, which in many cases were sub-prime mortgages, defaulted. But the surge in bad loans that triggered last year's credit crunch has triggered fears that bond insurers would not be able to afford to honour all the claims that came pouring in from the banks.

Ratings agencies have slashed the insurers' credit ratings and shares in the companies have plunged as a result. Merrill Lynch was forced to write down the value of the insurance it had taken out, to reflect the possibility that its insurers would not be able to cover its losses.

To make matters worse, Merrill Lynch still has more than $20 billion of insurance contracts on its remaining CDO portfolio. Analysts said that Merrill could need to take additional substantial writedowns if mortgage defaults continued to increase and the bond insurers were required to make even more payments to the bank.

Chris Whalen, managing director of Institutional Risk Analytics, a consultancy that assesses the level of risk at the banks, said: “This is a big issue and the question everybody is asking is, what is the true risk of the insurance the banks have taken out? The assessment is made much harder still because the insurer will often sell the insurance on.”

“This kind of insurance is dangerous. You are buying protection, but you don't know where the contract may end up and the market is largely unregulated. There will be a lot of litigation over this.”

Although the insurance company that originally underwrote the policy is ultimately responsible for it, even if it sells it on, it could potentially be overwhelmed if too many of the “secondary” buyers of the policies have insufficient cash reserves, Mr Whalen added.

Merrill Lynch declined to comment on the holders of its bond mortgage policies and would not say whether Ambac was one of them. Moody's, the ratings agency, put the credit rating of Ambac, America's second-biggest bond insurer, on review after its profit warning on Wednesday. Ambac also ousted its chief executive, cut its dividend by two thirds and announced plans to raise $1 billion to boost cash reserves.

Merrill Lynch said yesterday that it would cut jobs, particularly in its debt business, but said that the axe would not fall on “thousands and thousands of people” as the group reported its first full-year loss, of $7.8 billion, since 1989.

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