Reality Impact - Grasping the Cost of Not Acting to Restore Trust in Capital Markets

Implications: There are significant arguments today on what should or should not be done to address the current capital market crisis.  In reality, market economies first and foremost rely on trust.  When trust is lacking, the ramifications are significant and far reaching.  The mistrust of one sector multiples into problems throughout other sectors.  A good example is the impact of capital markets on nonfinancial services businesses.  This point is easily seen in the cost of credit, or the lack of credit.  However the impact is much greater than mere credit.  An example is unfudned pension and other post retirement benefit plans (OPEB). The cost of not restoring trust in the capital markets needs to be understood, in all aspects.  The price is high (e.g., government spending and assuming risk) on both sides of the argument.  However all costs, on both sides, must be understood and measured before judgements are made.

Analysis: The impact of our current capital market crisis is far reaching.  That is easily understood.  However the extent of this challenge is not always understood.  An example is pension and OPEB liabilities.

Firms with defined benefit plans assume the imbedded risk within their pension/OPEB plans.  A firm must make up (fund) the difference when its pension/OPEB plan has assets with market values below the present value of it's liabilities.  When the fund experiencing an under funding, the firm must quickly address this.  This has been accentuated in the US by a rather quick funding time table in the Pension Protection Act of 2006 (US law).

As we experience a crisis in our capital markets, the value of pension assets with go down.  Simultaneously we may see interest rates drop, thus increasing the present value of pension/OPEB liabilities.  The net impact is an expected increase in under funding of pension/OPEB liabilities, and the need for firms to contribute more cash to these funds under current law.  This need for corporate liquidity will exasperate the current economic challenges faced in the US and the world.
 
The point is simple.  Supporting and helping restore trust in the US and world capital markets is costly.  Bad decisions were made.  However the cost is more than the lost equity of investment banking firms.  The cost of not acting and restoring trust is found throughout society.