The pending $700 billion bail out of Wall Street presents an interesting problem for Economic Theory. How do you get the real value of an asset when the market for that type of asset has entirely collapsed?

You see the assets that we the taxpayers, will be buying are not entirely worthless. When people calm down and somebody can actually figure out what they are they may be worth quite a bit.

Secretary Paulson, on behalf of his former comrades in the revolutionary capitalist movement, would like to see that they get a high price for their assets so they can use the funds to continue in their accustomed lifestyle, innovating other markets - perhaps health insurance?

Wonks Anonymous and a growing number of economists, populists and others would like to be sure that the government did not take a loss on these assets, clinging to the belief that the fools who got us into this should pay the price for their foolishness.

Two solutions are presented:

• Paulson would like to use an auction mechanism to value the securities. Not a real auction which at this point in time would set the securities value somewhere near zero. Instead a carefully designed pretend auction. Which auction mechanism would no doubt be blessed by some high powered economic theorist and several pages of abstruse equations.
• The Dodd proposal would give the government warrants on the stock of any financial company that chose to use the bailout.  After the government disposed of the assets that it purchased it could use these warrants to recoup any losses that it incurred on the resale of the assets. For every dollar that the government lost it would have a claim on $1.25 of company stock.

The auction mechanism is vague - probably because they are still waiting to fund the consulting that its design will require. It has been a called a "reverse auction" which means that the government will call out prices on a class of asset and then sellers will state their willingness to give up the assets. It would seem that the government must stop somewhere or our friends on Wall Street will just hold out for a ridiculously high price. Maybe when we run through the $700 billion?

Of course auction mechanisms have a great track record. Folks from California will remember public utility deregulation and the subsequent brownouts. They may not realize that the complex system that Enron and others gamed was designed by some very fine economic theorists.

The Dodd proposal is more direct and depends on simple arithmetic. If a firm overvalues its assets now it will lose more in equity later. If management does not want to lower the value of its own stock or lose shares to the government it will need to set the price of its assets at its best estimate of their actual value.

So why $1.25 payback per $1.00 lost? The government is taking a risk. By the end of the day stock in some of these firms will be worthless. Also, beggars can't be choosers.

You be the judge, will it be economic theory or common sense? Contact your representative here. Write your senators here.