The only way that buying the questionable assets will increase capital on the liability side of the balance sheet is if the Treasury overpays for them.
Of course, if the Treasury overpays for distressed assets, there's less chance it will eventually recoup its investment in them. Hussman's preferred solution would be for the government to infuse capital directly into firms as needed, in the form of a "super-bond" senior to all of a company's existing debt but subordinate to customer liabilities:
The “super-bond” would [...] be seen by customers as a legitimate cushion of protection. However, in the event of bankruptcy, it would have a senior claim in front of both stockholders and even senior bondholders. Do that, and you've actually got a mechanism to protect the financial system while at the same time protecting customers and taxpayers. Ideally, the super-bond accrues a relatively high rate of interest so that financials have an incentive to shift to private financing as soon as possible, but you would also defer the interest until the bank meets a minimal level of profitability to make sure that the financing doesn't strain the institution's liquidity.
But then, Congress didn't do this because nobody thinks in terms of balance sheets.
Hussman isn't the first to suggest direct government investment in financial firms as a way of recapitalizing them; John Paulson, of Paulson & Co. -- the man who made billions of dollars last year shorting sub-primes -- recommended something similar in a Wall Street Journal op/ed last week ("The Public Deserves a Better Deal"); both Hussman and Paulson point to Buffett's investment in Goldman Sachs last week and suggest the government should follow a similar tack in any rescue. Others (including the editors of the Financial Times, if memory serves) have advocated both approaches: buying distressed assets and direct, preferred investments to recapitalize key financial firms.
A proposal along the lines of the one I or University of San Diego Professor Frank Partnoy) suggested ("Why Not This?") might have been an easier sale. Since we proposed buying only mortgages, and not the securities derived from them, this sort of proposal would have been more difficult for populists to characterize as a bail out of Wall Street at the expense of Main Street. There might have also been less concern about the government overpaying for distressed assets, since houses and first mortgages are easier to value than complex securities such as CDOs. Now that the the House has rejected the plan for the government to buy distressed assets though, perhaps it will consider a plan along the lines of what John Hussman and John Paulson have suggested.