Wall Street's Big Sell-Off

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Lehman CEO Fuld may not be able to shed enough assets to keep the bank afloat Richard Perry / The New York Times / Redux

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Wall Street's big yard sale, however, may not be well attended. Distressed funds, the main scavengers, have raised $70 billion in the last 18 months, according to Dow Jones Private Equity Analyst. Other money managers may have an additional $30 billion earmarked for financial assets. Sellers may toss in generous financing terms that would turn that $100 billion into $400 billion of purchasing power, taking their cues from Merrill Lynch. In late July, private equity firm Lone Star Funds bought $30.6 billion of collateralized debt obligations for $6.7 billion from Merrill, which financed 75% of the purchase price. Even by stretching their dollars in such ways, vultures and other opportunistic buyers can't possibly sop up the flood.

Although banks have been pruning assets to beat a potential logjam, they haven't done enough. Some players have been reluctant to unload holdings in weak markets. Other sales have been offset when banks had to take securities back on their balance sheets—akin to bailing a sinking boat with a sponge. For example, Citigroup sold its German retail bank for $7.7 billion to Crádit Mutuel of France in July. A month later, Citi agreed to buy back as much as $7.3 billion of auction-rate securities from clients in a settlement with regulators.

In trying to cut the weight on its balance sheet, Lehman took the unusual step of creating ready buyers. Earlier this year, the investment bank gave seed money to some of its former traders and bankers, who started hedge funds in Lehman office space. The two portfolios, R3 Capital Management and One William Street Capital Management, accumulated nearly $5 billion of Lehman's mortgage-backed investments, junk-rated corporate loans, and securities based on leases for flight-training gear.

Tarnished Inventory

That's a pittance compared with what Lehman may yet have to sell. CreditSights' David A. Hendler estimates the bank will report a quarterly hit of $4 billion to $6 billion, which could necessitate $40 billion or so in asset sales. That may be why Lehman CEO Richard Fuld is trying to cobble together an independent entity to buy up commercial real estate securities, according to Bloomberg News.

Such moves may come too late. "The answer was to get out of the bad stuff before people realized how bad it was," says Brad Golding, a portfolio manager with Christofferson, Robb & Co. "There is no market for many of those assets so they're being forced to sell the family silver."

Complicating matters, buyers may be sitting on the sidelines—either waiting to see how juicy the bargains get or worrying that a glut of assets would drive down the prices on any early purchases. Some analysts suspect Lehman may be having a tough time striking a deal on Neuberger since there's speculation other money managers may be on the block, including troubled lender Wachovia's (WB). Publicly, Wachovia has said its investment group is not for sale, but it will off-load "noncore" assets.

Some banks may be able to avoid shedding massive amounts of assets. New buyers could emerge, such as pension funds. "As the crisis lingers, there's more time for people to evaluate products that they might never have thought of buying," says Anil Kashyap, a professor at the University of Chicago Graduate School of Business. Banks could also cut expenses. And the Federal Reserve, by keeping rates low, is making it more profitable to capture the spread, or difference, between the bank's borrowing costs and the higher rates they charge customers on loans.

That kind of rehab, though, takes time—a luxury many banks don't have.

Henry is a senior writer at BusinessWeek. Goldstein is a senior writer at BusinessWeek.