Merrill, Lehman Say: Let the Liquidations Begin!

This post first appeared on Minyanville.

While the broader markets appear to have tunnel vision with respect to the price of both crude and stocks, the latent mortgage crisis continues to tie up human -- and financial -- capital throughout Wall Street.

Lehman Brothers (LEH), whose negotiations to sell a piece of itself to Korea Development Bank are now confirmed, is trying to unload its still-bloated residential and commercial loan portfolios. With the debt markets effectively closed and equity markets punishing its stock price, the troubled investment bank is now being forced to liquidate real assets to repair its balance sheet.

Merrill Lynch's (MER) recent sale of distressed collateralized debt obligation for pennies on the dollar led this trend. Capital must still be raised, and financial firms will be increasingly forced to comb through their balance sheets for assets to put on the block.

The Wall Street Journal reports CEO Richard Fuld’s firm is establishing a so-called good bank/bad bank structure to rid itself of a chunk of its more than $65 billion in real estate-related assets.

Under the plan, Lehman would split the assets into 2 groups: The "bad" ones would go into an entity to be spun off to shareholders and private investors; the good ones, it'll keep.

Lehman is also considering what part of the sale, if any, it will finance itself. As with the Merrill transaction, where Merrill loaned the buyer, Lone Star, 75% of the purchase price, its unlikely Lehman will find a willing buyer without retaining a significant portion of the risk.

Liquidations are gaining steam across asset classes. Whether its complex mezzanine CDO tranches or foreclosed homes, banks and other financial institutions are running out of capital-raising options. After months of trying to ride out the credit crunch by ignoring the true extent of their losses, firms are being forced to hack off wounded sections of their balance sheets just to stay alive.

Delinquencies continue to rise on all types of consumer debt, and -- despite a brief drop in record-high fuel prices -- household budgets are still stretched. As more real losses are realized, cash must be raised to fill the gap.

Flocks of scavenging investors (vultures who feed on sellers motivated by necessity rather than rationality) have been quietly raising money to take advantage of this very situation. And while a few ventured in early and paid for their boldness, the patient ones are just beginning to spread their wings.