July 16 (Bloomberg) -- Hezbollah turned over the bodies of two Israeli soldiers it held for two years as part of an exchange for five Lebanese prisoners captured by Israel, including a terrorist who killed a girl and her father in 1979.

The bodies of Eldad Regev and Ehud Goldwasser were presented in black coffins by Hezbollah representatives to the International Red Cross in the Lebanese border town of Naqura. They were taken to the Israeli side and positively identified before the Lebanese prisoners were sent across the border.

``Today we hand over the two Israeli soldiers that the resistance captured on July 12, 2006, and whose fate was uncertain until this moment,'' Hezbollah's Wafiq Safa said as the caskets were taken from two vehicles and laid on the ground before international television crews. Behind him was a banner that said in English, ``Pain in Israel, Joy in Lebanon.''

The returned Lebanese were welcomed at a rally in Beirut tonight by Hezbollah leader Sheik Hassan Nasrallah, who embraced them and told a crowd of thousands that their time of victory has arrived, the Associated Press reported.

The prisoner exchange closes a circle from Israel's 2006 war against the Iranian-backed Shiite Muslim Hezbollah militia, which a government commission criticized as hasty and poorly planned. Prime Minister Ehud Olmert, who made the recovery of the two soldiers one of the primary goals of the 33-day war, resisted demands for his resignation, even as his defense minister and military chief of staff quit.

Hezbollah's Terms

After Hezbollah refused to disclose whether the soldiers were alive or dead, the return of their corpses in exchange for live prisoners underlines the humiliating consequences of the war for Israel, Yitzhak Reiter, a Hebrew University political scientist, said.

``At the end of the day, Israel accepted the conditions of Hezbollah which puts Israel in a weaker position,'' Reiter said in a telephone interview from Jerusalem.

Regev and Goldwasser were captured in a cross-border raid by Hezbollah that sparked the war. It is not clear whether they died immediately or after they were taken captive. In return, Israel agreed to free Samir Kuntar, who was convicted of killing a four- year-old girl, her father and two police officers 29 years ago, as well as four illegal Lebanese fighters.

Kuntar was 16 when he landed on the Israeli coast from Lebanon in a small boat with three fellow members of the Popular Front for the Liberation of Palestine and broke into the apartment of Danny Haran in the town of Nahariya.

Murdered 4-Year-Old

According to court testimony, Kuntar killed Haran in front of his 4-year-old daughter and then crushed the girl's skull with the butt of a rifle. Kuntar said Israeli soldiers were responsible for at least one of the deaths. Haran's wife, Smadar, was hiding in a small space in the apartment and accidentally smothered her other, 2-year-old daughter as she tried to stop her crying.

Outside the Regev family home in the northern town of Kiryat Motzkin, neighbors in tears gathered and lit memorial candles, video footage on Israel Channel 2 television showed. Regev was 27 and Goldwasser was 31 when they were taken.

In Naqura, Hezbollah's Al-Manar television showed supporters waving the group's yellow flag as they gathered to welcome the returning prisoners. Hezbollah fighters in combat fatigues lined up alongside a red carpet.

Besides strengthening Nasrallah, Lebanese political analyst Amal Saad-Ghorayeb said, the prisoner exchange was a setback for the U.S., Israel's biggest military backer.

`Blow to U.S.'

``This is a major blow to the U.S. project in the region, a major blow to Israel and to America's moderate Arab allies,'' Saad-Ghorayeb, author of ``Hezbollah: Politics and Religion,'' said in a telephone interview from Beirut.

Israel also agreed to hand over the bodies of 199 ``enemy combatants.'' It sent the first group of 12 across the border shortly after the Israeli soldiers were returned, including the remains of Dalal al-Moghrabi, a Palestinian woman who was killed by Israeli troops in 1978 after blowing up an Israeli bus, killing 36 people.

``Today we are demonstrating the high premium that we attach to all of our servicemen,'' Olmert spokesman Mark Regev said today in a telephone interview. ``Israel will not leave servicemen behind enemy lines.''

Hezbollah, designated a terrorist organization by the U.S., has been linked to scores of attacks since its 1982 founding, including rocket strikes on Israel, the 1983 Beirut bombings that killed 241 U.S. and 58 French servicemen, and the 1994 killings of 85 people at a Jewish community center in Buenos Aires.

Missing Airman

The Israeli cabinet approved the exchange yesterday even as it rejected a report on the fate of missing Israeli airman Ron Arad, according to a statement on the prime minister's Web site. Israel will continue to seek information on the airman who disappeared in Lebanon in 1986, Olmert's office said.

Israel is still negotiating with the Islamic militant Hamas, that rules the Gaza Strip, for the release of Gilad Shalit, a soldier captured outside the Gaza Strip three weeks before the abduction at the Lebanese border. Shalit is believed to be alive.

Hamas hailed today's exchange in a faxed statement from Gaza as a ``victory for Hezbollah,'' saying ``it proves that a useful way to liberate prisoners from the jails of the occupation is to capture Zionist soldiers.''

In a 2004 prisoner swap with Hezbollah, Israel exchanged about 400 Palestinian detainees and the bodies of 59 Lebanese for one Israeli citizen and the bodies of three soldiers.

Olmert told United Nations Secretary-General Ban Ki-moon in a meeting in Paris on July 13 that the UN resolution that ended the 2006 conflict was being ``grossly violated'' as Hezbollah rearms itself with weapons brought from Syria.

The UN resolution, which went into effect on Aug. 14, 2006, called for an international force of 15,000 soldiers to police Lebanon's border with Israel along with a Lebanese Army contingent of equal size. The force was to stop cross-border smuggling of arms to Hezbollah.

To contact the reporters on this story: Jonathan Ferziger in Tel Aviv at jferziger@bloomberg.net; Massoud A. Derhally in Amman at mderhally@bloomberg.net.

Last Updated: July 16, 2008 15:07 EDT