Now let's say that Webmaster Tools indicates that on one of those sites, Googlebot is hitting a large number of 404 errors. No big deal, right? Google has stated very clearly that 404s are the proper response to a request for a URL that doesn't exist, and they don't hurt your ranking
But what about the site that's causing Googlebot to head off on all of these wild goose chases? (And have you guessed yet that it's your other site? OK, that first sentence kind of ruined the mystery.) What does it do to the authority of a domain to have it regularly generating links that 404? And does it make a difference that these two sites just happen to be subdomains of the same root domain?