Buried in Merrill Lynch's fourth-quarter results on Thursday was a $3.1billion (£1.57billion) write-off on its bond insurance that sent a chill down Wall Street's spine.

Bond insurers, such as MBIA, Ambac and ACA, guarantee the interest and principal on the securities that they underwrite in the event of a default. However, insurers of bonds backed by home loans face such enormous claims that their ability to honour them has been called into question.

Most of the big banks rely on the insurers to hedge the risk of their mortgage bond portfolios and they could be forced into further write-offs.

Merrill Lynch said that it still had $30.4billion of sub-prime bonds at the end of December and $23.6billion in insurance. If more of its insurance contracts are deemed to be worthless, further writedowns may be necessary.

Merrill's writedown is not the first such charge, but it is the largest. Citigroup set aside $935million on Tuesday to cover the possibility that some of its mortgage bond insurance would not pay out. Canadian Imperial Bank of Canada and Calyon, the US brokerage, have announced writedowns of $2billion and $1.7billion respectively.

Other banks also rely heavily on the bond insurers. Lehman Brothers, Morgan Stanley and Bear Stearns are among a host of Wall Street firms that use insurance to hedge against sub-prime investments.

It is almost impossible to tell how big a threat the bond insurers pose, partly because few banks have revealed how much they are relying on insurance to bail them out of mortgage investment losses. More importantly, insurers have sold many of these contracts to other parties such as hedge funds so it is often unclear who is liable for what and whether they can meet the claims.

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