The debt used to finance last summer's leveraged buyout boom is returning to the womb.

The Wall Street Journal reports Citigroup (C) is selling around $12 billion of leveraged loans to a contingent of opportunistic investors including Apollo Management, TPG and Blackstone Group (BX). The loans are said to be priced at just below 90 cents on the dollar.

Throughout last summer, private equity firms used bridge loans from banks like Citigroup to make enticing offers to take public companies private. Banks are now unable to offload the debt, clogging up balance sheets and causing deals to fall apart. Most recently, Clear Channel Communications (CCU) saw its deal fall apart on tepid demand for its debt.

According to The Journal, the sale is the biggest in the leverage loan market in recent history and represents about 10% of the current backlog of this type of debt. However, as of December 31, 2007, Citigroup still had $43 billion buyout debt on its books.

If this all sounds a bit circular, it is. Private equity borrows from banks to buy companies. Banks are unable to sell the debt. Private equity firms (probably) borrow from the banks to buy the debt back at a discount, so banks are just selling the debt back to its originator, moving the leverage from one entity to another. Professor Sedacca's Hot Potato Market comes to mind.

Despite selling the loans at a loss, Citigroup is moving in the right direction by starting to clear out its balance sheet. Price discovery is one of the first steps in removing bad debt from the system.

Optimistic the credit markets are returning to normalcy, Morgan Stanley (MS) CEO John Mack said yesterday that the subprime crisis could be over within six months. If he's right, it will be a challenging period during which hundreds of billions in bad loans are dumped onto the market. This would be the difficult -- but necessary -- purging the system badly needs to get back on track