Those troubling troubled assets: What should the U.S. Treasury do with them? There is one tried and tested remedy not to be found in the Obama administration's recently announced plan. The administration is attempting a "public-private partnership" in which the government will supply 75 percent or more of the funds for purchasing the troubled assets - at a total cost, including loan guarantees, of at least $500 billion. Instead of this costly, untried, and risky adventure, why not try a solution that has been tried before - and which has worked? The Treasury could issue special bonds - call them Restitution Bonds - and swap them for the toxic assets held by financial institutions. This solution is not new. It was used at the start of the American republic by Alexander Hamilton; during the 1980s, in the form of the Brady Bonds that covered the Mexican default on debts held by American banks; and over the past 35 years in many debt workouts by Third World countries and the Paris Club, in which banks and countries meet to resolve debt problems. Here's how it would work: The Treasury would issue special bonds to be swapped for toxic assets. The bonds would be used solely to scoop up toxic assets from financial institutions that want to participate. At the end of the transaction, the financial institutions would have U.S. Treasury-backed bonds, be relieved of troubled assets, and enjoy enhanced capital on their balance sheets. This last feature is crucial, because one of the main reasons banks are not lending is that their capital-to-loan ratios are so bad. Increasing banks' capital and reducing their bad loans improves the ratios and begins to unclog credit markets. A further advantage of this approach is that it would involve no current federal budget expenditure and therefore no government borrowing. Instead, a government IOU would be substituted for bad paper on the books of financial institutions. The Restitution Bonds would slosh around the bond markets over time and, as with the Brady Bonds, become indistinguishable from other Treasury bonds. As with all Treasury bonds, a secondary market for the Restitution Bonds would likely develop - not in the current conditions, but perhaps down the road. This prospect would provide an incentive for the financial institutions to participate in the program. If the troubled assets held by the Treasury increase in value in the future, the "profits" earned should go into the Social Security trust fund as a gesture of acknowledgment of taxpayer forbearance. Finally, there is the thorny problem of how to determine the ratio at which the Restitution Bonds would be traded for troubled assets - the implicit, or "shadow," price. This is always the final problem faced during debt workouts - whether by Alexander Hamilton in the 1790s, or by Treasury Secretary Nicholas Brady and the U.S. banks holding bad Mexican debt in the 1980s. Without minimizing the complexity, scale, and scope of this problem, the banks would want a "price" as close to face value as feasible, and the Treasury would start with the current (low) market price. Inevitably, a price point would be struck somewhere between face value (the banks' preference) and market value (the Treasury's starting point). The price point probably would end up near the midpoint of the two extremes. (Trying to find a "truer" market price through auctions, as in Treasury Secretary Timothy Geithner's plan, is clumsy, time-consuming, and quixotic, because there will be few private-capital bidders for the troubled assets.) There would be understandable public anger over allowing the banks to get more than the market price for their assets, when the same banks insist on valuing a homeowner's property according to the current market price. But there is, unfortunately, no escape from this double standard that would not worsen the present crisis. As to the scale of this proposed swap, it would be large. As a share of U.S. gross domestic product, however, it would be lower than the circumstances Hamilton faced, and less daunting than many of the debt workouts undertaken by the Paris Club over the past few decades. So let the negotiations commence, and let's get on with addressing the troubled assets. Copyright 2009 The Philadelphia Inquirer

---

Howard M. Wachtel, a Fellow of the Transnational Institute, is a professor of economics at American University. His most recent book is Street of Dreams - Boulevard of Broken Hearts: Wall Street's First Century. (2003)