Two Diamonds in the Rough
The resignation of Barclays chairman, Bob Diamond, earlier in the week took some of the heat off of his counterpart in the U.S. at J.P. Morgan Chase ,CEO, Jamie Dimon, who continues to stare at mountain losses from his trading unit and the infamous ‘London whale” Personally, Dimon’s candid style and management skills at Smith Barney, Capital One and Morgan are refreshing but he finds himself in more roughs than Tiger Woods three years ago. Let’s focus on the other Diamond for a moment at Barclays, one of the largest and most respected investment banks in the World, and what it means to U.S. consumers who may consider investing in the Barlcays Index or Premium Finance.
I remember in 2007-08 expressing concern to a Senior Executive at a trillion dollar Global asset manager about the perils of premium finance utilizing life insurance. The concept of paying pennies on the dollar for a beneficiary or businesses comfort in knowing they will pay no estate tax and live with a piece of mind as life insurance provides is a well known fact. There is very little market timing involved unless one buys a variable product at the top of a secular bear market, underfunds the contract and picks the wrong assets. Premium finance however is much about timing and puts the sound principle of life insurance on hyperdrive if mistimed for a business owner or individual. In this concept, a bank loans money to an individual or a business to pay premiums so immiately, credit risk, interest rate risk, and as always moral risk enters into the transaction. Most of the loans that were being made in the mid 2000s by Global banks were linked to LIBOR(London Interbank Offered Rate) which is an average rate that banks in London would be charging other banks if they were borrowing. This is the area where CEO Robert Diamond, of Barclays had responsibility and finds himself in the rough patch after resigning. As I told the executive and leader of the Life operation that was immersed at the time in LIBOR based loans on premium finance, if credit dries up and rates on the bank loan funding the contract to pay the premiums go north, the loan rate on a life contract is priced into the policy and stays fairly steady, the policy’s cash value without tapping the collateral for the loan is upside down. Therefore the consumer is forced to tap into risk based collateral to fund the insurance policy. Now in the midst of one fo the greatest bubbles in history driven by massive cnetral bank purchases and a nasty scandal involving the benchmark LIBOR rate around the world, what is the next shoe to drop now that two of the three variables to policy underperformance have been exposed. Since the alleged LIBOR Rate has been held artificially low for 5 years, when the end of this interest rate cycle comes, will their be a bigger spike in LIBOR. Who knows? If it does come, however, without significant market performance of cash surrender value in the life contract, it will be ugly.
Finally, guess what else Bob Diamond oversees at Barclays. The Barclays Capital Aggregate Bond Index, successor to you guessed it -the defunct Lehman Brothers bond index. I am amazed at how there has been significant pushing off all derivatives based contracts linked to this index strictly based on the 10% plus performance of this index over the last 25 years. In a future bear market for bonds, any contract with crediting based on this index will be featuring a lot of zeros, which means a negative real rate of return. It’s kind of like walking with a Yo-Yo uphill with your eyes closed. One tends to run into a lot of headwinds and get hit in the nose even with investing with the pros-At Annuity Think Tank, we believe in blending and diversification still and always will. Big bets anywhere run contrary to safe money investing and saving. Big bets mean big problems later for investors and savers alike.