Joe Public will pick up tab for subprime

The Bank of England has so far pumped in almost £35 billion, the equivalent incidentally of the entire annual UK defence budget. This has in effect been used to rescue the other bankers who had earlier lent money to Northern Rock. It is they who have moved smartly to the exit, not the everyday retail depositors who have largely remained loyal and who were supposed to be the ones who deserved to be protected.

When, in due course, it turns out that no one will buy Northern Rock and thereby provide a mechanism for the Bank of England in turn to get its money back, it will be the taxpayer one way or the other who will pick up the tab. There is no other way. The Bank of England's balance sheet is tiny - it could not afford to commit this kind of money without the Government standing behind it.

Continuing this thought, the interesting thing about the subprime crisis is that so far it looks as if it is just the professionals who are suffering. Some hedge funds have admitted publicly that they have been badly burned, though there are very many more that have huge exposures, if this stuff has dropped in value as much as people think it has, but who have not yet worked out how to break the bad news to their investors.

The investment banks, of course, such as Citi and Merrill Lynch and this week Morgan Stanley, have also been seen in public bearing the losses. But don't be fooled. It goes against the natural law of financial markets for the professional to take the hit and it won't last.

There is much worse to come. The amount of the losses that have thus far been owned up to is a tiny fraction of the total money lost - which many estimate to be at least £100 billion on subprime alone before we begin to factor in the amplifying effect of gearing. This is where the public will find it reluctantly has a role. Some time in the coming weeks and months the fund management industry will admit it is their money that has been lost.

They will have to come clean about the amount of this rubbish they have absorbed. That's when the public will begin to see it is their pensions that once again have taken the hit.

There are several ways this will come through but here are two of the more horrific. One of the most popular savings vehicles around the world is the money market fund, loved by conservative investors because it is sold as totally safe but offering a little bit more than you can get from a bank deposit.

French bank BNP Paribas came clean weeks ago about the problems its money funds faced because they had invested in subprime structured products, but there has been a deafening silence everywhere else.

This is incredible because they were all at it. Getting a yield above Libor is very difficult if the fund manager simply buys safe commercial money market paper, so they made life easier for themselves by going the subprime route, where yields were higher. Many of these money market funds are supposed to guarantee the capital of their investors, which given the scale of their nasty mistakes will be an interesting challenge. Sooner or later, they will have to own up.

The other shock to come is even more unnerving. There are three tranches of a typical subprime CDO derivative, and in descending order of quality they are the triple A tranche, the mezzanine tranche and the equity tranche.

The equity tranche was the most risky and as a result investment bankers did not even try to sell it but kept it on their own books. So now it is plunging in value they should be taking the hit.

But not so fast. As they were stuck with them, the investment bankers insured these tranches against the risk of loss. Every month they would pay a small premium to fund managers who would gratefully accept this little bit of extra income as a useful top-up to their overall performance - much as they also do with stock lending fees. Little did they realise, or certainly little did they think, that they were in effect insuring the most toxic tranche of the subprime CDO market against the possibility of loss.

Those equity tranches have in many cases been rendered almost worthless by the credit crunch and the level of subprime default. Once the scale of these losses is agreed and crystallised the investment banks will go looking to collect on their insurance. That is when the investment community collectively will have to hand over vast sums - we are talking hundreds of millions, possibly even billions, of their clients' funds. And that is the point when we will know for sure again that it is Joe Public who ends up the loser.