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The much whispered-about Lehman Brothers have some harsh words for their detractors: the investment bank today downgraded the outlook for four of their Wall Street stablemates.

Lehman downgraded third and fourth quarter earnings as well as the 2008 outlook for Morgan Stanley, Bear Stearns, Merrill Lynch and Goldman Sachs.

Say Lehman:

The reality, in our view, is that 3Q earnings should be significantly impacted by the dislocation in the credit and asset backed/mortgage markets, only partially offset by strength in currencies, rates and commodities as well as decent equities comparisons and favourable investment banking conditions at least through July.

But, perhaps tellingly, it’s not the decline in earnings we should be watching, insists Lehman:

That 3Q earnings will likely be down is not an insightful observation. The magnitude of the declines, insofar as they speak to the negative mark-to-market marks that investors expect the brokers to take in their credit businesses this quarter, is of far greater significance, in our view.

We admittedly have limited conviction about 2008 ourselves sitting here at the end of August with a wall of worry to climb between now and October.

Lehman’s shares have indeed had a rocky time of late. On Tuesday traders reported that Merrill had issued their own downgrade of Lehman and rumours about their murky subprime exposure have cast a pall over the bank for weeks over.

While the banks can’t downgrade each other fast enough, Standard & Poor’s haven’t missed the trick either and engaged in a spot of bank bashing, suggesting banks will be harder hit by current credit woes than they were by LTCM. Banks could be facing revenue declines of 47 per cent in the second half of this year - and profit falls of 70 per cent before tax, the ratings agency said.
And if that’s just all too theoretical for you, then follow the money: GLG partners, a UK hedge fund manager took out some big options on the shares of their prime brokers - Goldman Sachs, Morgan Stanley and Lehman Brothers.

According to Financial News, GLG’s filings with the SEC show the fund manager has put options on 1.2m Goldman shares, 1m in Morgan Stanley and 1.8m in Lehman.

Votes of confidence all round then.