By KATY BURNE

A group of 16 banks resolved a quandary that has dogged the $1 trillion Islamic financing market for nearly three decades: how to represent rates on interbank funding when Islamic principles prohibit firms from charging interest.

The banks—working with industry associations and data provider Thomson Reuters—created a reference rate called the Islamic Interbank Benchmark Rate, or IIBR, which was put into use for the first time Tuesday. The banks say the solution, which complies with Islamic moral codes, known as Shariah, lies in considering money flowing between banks as investments that depend on the performance of underlying assets, rather than as interest-bearing loans.

Scholars and bankers involved in the project say it is an industry milestone akin to the first globally issued Islamic corporate bond in 2001, or the first Islamic sovereign bond in 2002. They say the rate brings transparency to the Islamic financing process and could encourage broader use of Islamic banks.

“The establishment of the IIBR marks an important milestone in the maturation of Islamic money markets by providing an international reference rate for interbank transactions,” said Nasser Saidi, chairman of the Islamic Benchmark Committee and chief economist at the Dubai International Financial Centre, in a statement.

Islamic banks aren't allowed to earn or pay interest, yet have been using an international interest-rate benchmark—the London interbank offered rate, or Libor—since 1986. While Libor isn't compliant with Shariah, religious leaders permitted its use because there was no alternative benchmark based on socially ethical investing.

Rather than measuring interest on loans as Libor does, IIBR uses expected profits from short-term money and a forecasted return on the assets of the bank receiving funds. Both are considered investments rather than loans, and therefore interest-free.

Associated Press

Chief economist of the Dubai International Financial Centre, building above, calls the Shariah rate a 'milestone'

Sheikh Yusuf Talal Delorenzo, chairman of Thomson Reuters's Shariah committee, said the significance of IIBR is that it allows firms participating “to see the interbank market in their own terms.”

“Earnings are lawful,” he said. “What is unlawful is earnings from interest.”

Hassan Demirhan, director in the treasury department at the Islamic Development Bank, added that the introduction of an “indigenous Islamic benchmark” will prove to be a “major milestone in the growth and sustainability of the industry.”

IIBR on everything from overnight to one-year funding will be determined from rates the member banks contribute each day. The data will go through a type of cleaning called a “fixing,” where the top and bottom rates are removed and an average of the middle eight contributions is taken.

The results are blessed by a panel of Islamic banks and approved by a committee of Shariah scholars. Also involved in the launch were the Islamic Development Bank, the Accounting and Auditing Organization for Islamic Financial Institutions, the Bahrain Association of Banks and the Association of Islamic Banking Institutions Malaysia.

As of Nov. 16, the theoretical overnight IIBR would have been 0.1%, which was slightly below overnight Libor of 0.14%. Libor was cheaper over one year, however, at 0.91% versus 1.01% for IIBR.

Such differences could encourage corporate borrowers to use Islamic banks when IIBR is lower than Libor, on the theory that banks could pass savings on to customers.

“It will facilitate liquidity into the Islamic banks,” said Rushdi Siddiqui, global head of Islamic finance at Thomson Reuters in New York, who helped launched the first Islamic equity index in 1999 for Dow Jones.

Islamic banks have attracted liquidity from outside investors interested in diversification, said Mr. Siddiqui, and this will provide those funding sources with “a transparent, visible benchmark” that will encourage increased funding flows, helping to finance a wave of infrastructure projects in the region.

The development of a Shariah-compliant benchmark rate also comes amid regulatory investigations into the way the Libor rate is fixed by investment banks. Regulators have opted not to specifically endorse IIBR over other benchmarks, preferring to remain neutral, but they are aware of its creation and have supported it.

Write to Katy Burne at katy.burne@dowjones.com

The Islamic finance industry has often battled with the question: How Islamic is Islamic banking?

The question's pertinence was raised in March last year, when Sheikh Muhammad Taqi Usmani, of the Accounting and Auditing Organization for Islamic Finance Institutions (AAOIFI), a Bahrain-based regulatory institution that sets standards for the global industry, said that 85% of Sukuk, or Islamic bonds, were un-Islamic.

Usmani is the granddaddy of modern-day Islamic finance, so having him make this statement is synonymous with Adam Smith saying that free-markets are inefficient.

Because Sukuk underpin the modern-day Islamic financial system, one of its pre-eminent proponents arguing that the epicentre of the system was flawed sent shockwaves through the industry.

It also gave ammunition to the many critics who see Islamic finance as an industry more driven by cultural identity than practical problem solving: as a hodgepodge of incoherent, incomplete, impractical and irrelevant ideas.

Recognisable products

The products that modern-day Islamic bankers have created are very similar to conventional products.

So similar, in fact, that to an outside observer they could be considered the same.

Islamic banks now offer Islamic mortgages, Islamic car loans, Islamic credit cards, Islamic time deposit and guaranteed return accounts, Islamic insurance and some even offer Islamic managed and hedge funds.

This point is conceded by Samir Alamad, Sharia, or Islamic law, compliance and product development manager of the Islamic Bank of Britain.

“The industry does not want to alienate its products,” he says.

“They have to be recognisable, produce the same outcome as conventional products, but remain within the guidelines of Sharia.”

No interest

The core of Islamic economics is a prohibition on interest.

This immediately creates a problem for Islamic banks, as conventional banks charge borrowers an interest rate through which they can reward their depositors and make some profit for being the broker.

With interest ruled out it is harder to make money.

The modern Islamic banker has found a way around this prohibition, however.

As in many Islamic products, the bank enters a partnership with its depositors and invests his money in a Sharia compliant business.

The profit from this investment is then shared between the depositor and the bank after a set time.

In many cases this “profit rate” is competitive with the conventional banking system's interest rate for savers.

Lease agreements

Alternatively, an Islamic banker might enter into a lease agreement for a car or a house with an individual.

The bank would buy a vehicle outright and then lease it back to the person who wanted it, over a time period that would ensure that the capital was repaid and the bank made a profit.

Alternatively the bank would enter into a partnership with a person wanting to buy a house. The bank would buy 70% of the house, the individual 30%.

The bank then rents its share of the house back to the individual until the house is fully paid for.

The bank makes a profit on the rent, which would be higher than equivalent rents in the area, but on an annualised percentage basis, would look very much like a conventional mortgage interest rate.

To the casual observer, a spade is a spade.

Whether the product is dressed up in Arabic terminology, such as Mudarabah, or Ijarah, if it looks and feels like a mortgage, it is a mortgage and to say anything else is semantics.

Sophisticated finance

The potential wealth locked up in oil-rich Gulf states encouraged the conventional banks to enter Islamic finance.

HSBC established the Amanah Islamic Finance brand in 1998 and Deutsche Bank, Citi, UBS and Barclays quickly joined the fray, all offering interest-free products for wealthy Arabs.

However, this new generation of Islamic bankers had cut their teeth in the City and Wall Street, and were used to creating sophisticated financial products.

They often bumped heads with the Sharia scholars who authorised their products as Sharia compliant.

However, these bankers had a way of dealing with this, as one investment banker based in Dubai, working for a major Western financial organisation explains:

“We create the same type of products that we do for the conventional markets. We then phone up a Sharia scholar for a Fatwa [seal of approval, confirming the product is Shari'ah compliant].

“If he doesn't give it to us, we phone up another scholar, offer him a sum of money for his services and ask him for a Fatwa. We do this until we get Sharia compliance. Then we are free to distribute the product as Islamic.”

No consensus

This “Fatwa shopping”, which was carried out by some institutions, brings us back to the Sharia scholars.

Even these scholars do not agree all the time, which means that in some cases a product is deemed Sharia compliant in one market and not in another.

This is especially the case with Malaysian products, which are often deemed not Sharia complaint in the more austere Gulf.

“Often no rulings exist for modern day problems, such as use of narcotics,” Alamad explains.

“In Islam intoxication by wine is forbidden, but at the time of the Prophet Mohammed there was no crack cocaine.”

Modern scholars had to interpret the rules on intoxication, and the consensus was that crack should also be forbidden to Muslims, as it is a dangerous intoxicant.

“This is how we make rulings, whether in finance or societal,” Alamad says. “The consensus rules, which usually will become mandatory for all Muslims to follow, but there are some opinions and sometimes scholars are not in the consensus.”

Banking is banking

This makes it more important to be in the consensus, and so getting a favourable ruling from a leading Sharia scholar is important for a product manager.

That is why the top scholars can earn so much money – often six-figure sums for each ruling.

The most creative scholars are the ones in the most demand, says Tarek El Diwany, analyst at London-based Islamic financial consultancy Zest Advisory.

“To date, most Islamic financiers have been looking at examples of financing in Islamic history and figuring out how to apply them to today's financial products.”

But banking is banking.

It is the taking of a deposit and then using it to finance a purchase or business.

The lender pays the depositor compensation for the opportunity cost of his money, and the person borrowing the money “rents” it off the bank.

The same symbiotic relationship occurs whether it is conventional banking, ethical banking, Islamic banking or Presbyterian banking.

As Majid Dawood, chief executive of Yasaar, a UK-based Islamic finance consultancy says: “Everything that is not forbidden in the Holy Qur'an is OK.

“Yes, the industry has to evolve, but it is only 40 years old and its competing with a conventional finance system that is over 800 years old.”

Source: BBC News

CNN reports,

Just last month, Bank of America CEO Ken Lewis warned …  that he had no doubts 2009 would be an “awful year” for the credit card industry … Fearing a wave of credit card-related losses, banks have been aggressively setting aside funds to help cushion the blow. One problem, note analysts, is that banks aren't quite sure just how severe the losses will be.

….

Facing additional losses, credit card issuers are doing what they can to insulate themselves from further losses, including lowering credit limits for some cardholders, closing accounts or getting out of the business altogether.

American Express (AXP, Fortune 500) made headlines recently after it offered to pay some of its cardholders $300 if they paid off their balances and closed their accounts by the end of April.

Reuters also gives some eye opening statistics 

Currently, there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon, she said.

“Lenders, regulators and politicians need to show thoughtful leadership now on this issue in order to derail what I believe will be at least a 57 percent contraction in credit-card lines,” she said.

Over the past 20 years, Americans have also grown to use their credit card as a cash-flow management tool, she said adding that 90 percent of credit-card users revolve a balance at least once a year, and over 45 percent of credit-card users revolve every month.

I have no sympathy whatsoever for these banks that are flopping during this crisis. They made billions upon billions exploiting people, especially the poor and students, turning them into life-long wage slaves [get this DVD if you can]. The problems they are facing pale in comparison to the oppression they inflicted on others. 

This is a wake up call to everyone (Muslim or not – but especially Muslims) to stop using credit cards. Unfortunately, when someone says that people immediately begin saying things like, “But it's not technically haram if you pay it off at the end of every month.”

Ok. Let's grant that it's not. That doesn't automatically mean it is the wisest and most prudent decision for you to make. Being the person who pays off their balances and avoids riba is the equivalent of the person who drinks wine every day and has never once gotten drunk in his or her life. 

If the recession doesn't wake you up, I don't know what will. This is a failed system that is founded upon something that is not only haram, but one of the most destructive sins a person can partake in. We often discuss keeping things in perspective and focusing on priorities – this is one of the top priorities of any Muslim. There are not a lot of other things that can bankrupt you in this dunya, deprive your sustenance of barakah, force you to provide for your family from haram (even if your actual income was earned through halal), be on par with committing adultery with your MOTHER, and on top of that put you at direct war with Allāh(swt). 

It is time to do two things,

1. Implement the Islamic financial system in our own lives, and

2. Teach others about it. 

Implementing it in our lives is easy, but comes with a high degree of difficulty. It is more mental than anything else. It requires making up your mind to not live in debt anymore, and create a plan to pay it down. If you don't have debts, then you have no excuse to hold on to a credit card anymore. Go to the bank, take out some cash, and use it. 

More importantly, now is the time to present our solution to the rest of the world. Every single corporation in America is suddenly buckling down and being frugal. They are cutting unnecessary travel, cutting extra perks, and trying to work within their means. These are Islamic principles. 

If we want to show the world Islam can positively solve their problems, let's start getting the message out. The sad thing is, instead of preaching this message to everyone from day one, we ourselves have succumbed to chasing the American dream by digging ourselves into the hole of mortages and monthly payments that we cannot afford. This is not the way the Muslim should live. We must be the beacon of light to others, especially in these times, to show them that no matter how bad things get, inshā'Allāh Allāh (swt) will put barakah in our rizq because we do not live outside our means. We have learned to be content with what we have been blessed with. 

Instead of showing this example to others though, it is unfortunate that for many Muslims their only hope of freedom from the shackles of debt slavery is a haram life insurance plan that will cash out only after they are 6 feet under the ground. 

Please see our previous posts on this issue for more details on these issues.

He has twice been a recipient of the Euromoney award for Best Legal Advisor in Islamic Finance (2004 and 2007) and has also received the Sheikh Mohammed Bin Rashid Al-Maktoum award for Best Legal Advisor in Islamic Finance for North America. He is currently the Chair of the Islamic Law Forum, a division of the International Law Section of the American Bar Association

I will be covering the course-work through part of the Spring semester next year (my last semester, yoo hoo). So, I thought that as I studied this material, I would share it with all of you. I know there is a lot of interest in Islamic finance, especially in light of the current financial turmoil, and interestingly Islamic financial principles take a big stab at one of the main sources of the financial collapse, debt. I touched upon this in this article.

I have to caution you that some of the stuff may be a bit too technical, but it is not necessary to grasp every word of this. Rather, I hope to give a general understanding in the simplest terms possible. If you don't understand something, ask, and I'll try to answer (“try” is a key word, because I am hardly an expert on finance myself!)

Before I embark on this journey with you all, I have been wanting to share an interesting learning from my core finance course last year. This is not part of the Islamic finance course, just something I found quite remarkable.

This revolves around the theory by two Professors, Franco Modigliani, Merton Miller, commonly known as the Miller-Modigliani theorem (M&M!) who won a Noble Prize for this. In fact, the theory itself is quite simple, and as we are learn several times in academics, many of the Noble Prize winners haven't come up with ground-breaking new research, but rather summarized/clarified/put-in-a-nutshell what was already obvious, i.e. be able to explain a phenomena that everyone kind of already knew but couldn't quite explain before!

Here's what M&M proposed:

In the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the Modigliani-Miller theorem is also often called the capital structure irrelevance principle. [Wiki]

The point? Debt is irrelevant. In other words, debt, by itself does not create value. In fact, an individual could mimic a company's debt structure and make the company's decision irrelevant.

So, let's say there is a company A that has 20% of debt in its capital structure (i.e. how the company is financed) with the balance 80% being equity (shares, etc.). There is another debt-free company B, with exactly the same operating performance as A (i.e. they both generate the same profits and have the same assets). An individual could then use 80% of his money to buy shares of company A, and borrow 20% from the bank, and essentially mimic company A (assume that interest rate is same for individual and company). So, in essence, B cannot differentiate itself from A by simply borrowing, because an individual investor could do the same. And then in a perfect market, where everything is known about A and B, arbitrage will prevent one company from being valued higher than the other. Miller said it best:

“Think of the firm as a gigantic tub of whole milk. The farmer can sell the whole milk as it is. Or he can separate out the cream, and sell it at a considerably higher price than the whole milk would bring.” He continues, “The Modigliani-Miller proposition says that if there were no costs of separation, (and, of course, no government dairy support program), the cream plus the skim milk would bring the same price as the whole milk.” The essence of the argument is that increasing the amount of debt (cream) lowers the value of outstanding equity (skim milk) – selling off safe cash flows to debt-holders leaves the firm with more lower valued equity, keeping the total value of the firm unchanged. Put differently, any gain from using more of what might seem to be cheaper debt is offset by the higher cost of now riskier equity. Hence, given a fixed amount of total capital, the allocation of capital between debt and equity is irrelevant because the weighted average of the two costs of capital to the firm is the same for all possible combinations of the two. [Read more here]

Okay, what's the point? Why do I find this so interesting? The point is that it is taxes, or the deductibility thereof on interest that makes debt a tool for adding value. A firm that has a constant financial structure (debt:equity ratio constant), then its value with debt can be summed up as the following (in a state where interest is tax deductible):

Original Value: Vu  (the subscript “u” is usually for value of unlevered firm = a firm that has no debt, and “l” is the value of a firm that is levered or has debt)
Borrow an amount = D
Taxes = T
New Value of Firm: Vl = Vu + TxD

So, the value of a firm that borrows an amount “D” goes up by “TxD”. This is due to tax shields. Basically, interest is tax-deductible. If you pay any interest (which as Muslims we shouldn't be), then you can subtract that from your income and basically save taxes. So, in essence there is a transfer of money from the government to you because you borrowed. And who benefits in the end? Yes, you benefit, but there is an ultimate winner, which brings me to the punch-line.

The banks are the ones who owe their economic viability and “need” on government subsidy

Now remember that a firm has to two claims against it, from its two sources of finance: the equity holders (shareholders), and the debt-holders (banks, etc.). Interestingly, while the dividends to shareholders are not tax-deductible, the interest to debt-holders is… even though they are both fundamentally returns on investment. Furthermore, the bond/debt-holders have first dibs on the money, so they get their money before any other class of financeers. And as I mentioned, all the interest that bond/debt-holders are paid, can be written off by the company, so that their after-tax interest rate is even lower. But they get no such benefit in giving dividends.

For instance, if a company has a 10% interest rate on a debt of $100. Then it has to pay $10 interest. But it can deduct that $10 from its income. If taxes were 50%, then the company now has to pay $10 x 50% = $5 less to the government. In essence then, while it paid $10 as interest, it paid $5 less to the government. So, in effect, it only gave up $5 from its coffers. Thus, its after-tax interest rate was really only 5% (which is tax times interest rate = 10% x 50% = 5%). Debt creates value for the company by reducing government claims to its income.

The entire system of tax-deductibility of interest actually has no real economic sense. I asked my Professor in class why the government would do this, what is the point? He said he didn't really know, and he especially didn't get the discrimination between interest and dividend in terms of tax-deductibility. But what is known is that the ultimate winners of interest tax-deductions are the banks. Remove the tax benefit, and banks suddenly become quite useless (according to M&M).

For Muslims, this is an intriguing conclusion. Banks, the source of so much riba, would be really quite useless if the tax rules for dividends and interest were either uniform (i.e. tax deductibility on both) or if there were no tax (like in an Islamic state). So, if perfect market symmetry existed, say in Dubai (where there is no tax), theoretically debt would add no value. Had we had no debt, wouldn't we have been so much better financially in the world these days??

Next: Introductions, “what is riba”

Related Posts:

• Economic Crisis and Wisdom of Islamic Regulations – Yaser Birjas
• Khutbah: Lessons From The Current Financial Crisis
• The Financial Meltdown and its Underpinnings of Debt
• Some Thoughts on Islamic Finance and the Mortgage Crisis
• Non-Muslims & Islamic Finance
• Islam’s Free Market Heritage

Image credit: Dinar Standard

Lessons from the financial crisis we are seeing.

Download

Many people all over the world, especially America, are looking at the financial meltdown and wondering what is going on.

The entire “setup” and all of the associated drama is quite complex, and even the smartest financial wizards are struggling to completely understand the underpinnings, or to see the light at the end of the tunnel.

I claim no financial expertise. The few finance courses that I have taken at school only provide a glimpse into the house of cards that started unraveling this year. In order to gain a bit more insight, I turn to a book by Kevin Phillips “American Theocracy: The Perils and Politics of Radical Religion, Oil, and Borrowed money” [by radical religion, the author is referring to Christian fundamentalism, and not the Islamic bogeyman for once]. See NY Times book review here.

The book's section on “borrowed money” is almost prophetic in nature. Keep in mind that this book was published in early 2006, still in the days of a booming economy. The first line in this section of the book says it all:

“It's finally happened: Moving money around has surpassed making things as a share of the U.S. gross domestic product”.

In other words, making money on money, mostly through the instruments of riba (interest/usury), became a bigger part of the American economy than actually making tangible goods! The sectors of finance, insurance and real estate sector (FIRE–> what an appropriate acronymn!) swelled to 20% of GDP, ahead of manufacturing at 14%. Deregulation encouraged the three sectors of FIRE to be so interwoven that the combined sector became to be considered a single economic entity with assets of $60.4 trillion in 2007, up from $45.3 trillion in 2004 [Source].

Profits of the financial sector soared, from single digits in the 50s to nearly 40% of all US profits in 2004, and manufacturing followed the opposite trend, dropping from nearly 60% to single digits. What was the engine behind this growth? One word: debt! American financial companies conduct much of their business in “managing, packaging, or trading debt and credit instruments, as well as handling debt-related corporate restructurings”. Significant profits flowed from providing American households with artificial purchasing power, charging upwards of 25% interest rates on the credit card binging.  Phillips argues that this “financialization- a sign of late-stage debilitation, marked by excessive debt, great disparity between rich and poor, and unfolding economic decline, constituting the third major peril hanging over the future of the US” [in addition to oil and Christian fundamentalism]

The section of the book dealing with debt spans nearly 150 pages, definitely worth the read.  I have scanned just 2 ½ pages of some what I find to be most apt in the current situation (click here for pdf download). Phillips talks about collateralized debt obligations (CDOs), credit-default swaps (CDSs) and hedge funds, all woven together with housing and mortgage markets. If you have been following the news, you would be hearing these words repeated quite often. On pg. 378, Phillips predicted what we are seeing today:

“Between 2000 and the market bottom in 2002, when US stocks lost $7 trillion of their $15.5 trillion value, home values held up and then spurted ahead. To critics, the rescue was essentially a rebubbling. Should a credit and financial collapse follow that second stage in the manner than Volcker and others feared, stock and home prices would presumably sink together, making the second downturn the more destructive of the two”

What’s Kevin thinking now? “I told you so”

And for Muslims who kept off the mortgage binge, from taking sub-prime mortgage loans, or interest-only loans, depending on rising property prices to bring payments under control (betting on the future essentially), or for Muslims who kept their stocks clean of financial institutes that live and die off riba, and for Muslims who weaned off or never had credit card debt, the good news is that you have done much better financially, than those who said we were fools not to take the joy-ride. Yes, we all will suffer from depressing stock and home prices (if you owned either or both), but our religion saved us from far worse.

As I write this article, the government is planning another grand-scale bailout for all the financial institutes. The FIRE sector will be able to dump all their bad and “toxic” debt into a government entity. Everyday Americans (you and me) will have to shoulder the burden one way or the other. Our government continues failing in recognizing the dangers of “moral hazard“. Everything’s “just too big to fail”, which begs two questions: (1) How do you know? and (2) How did we let any entity become so big to fail? What happened to capitalism and pure market forces? One good thing in this new plan, I should mention, is the banning of short-selling for financial stocks. Short-selling involves the practice of selling a financial instrument the seller does not own, in the hope of repurchasing them later at a lower price. Islamically, selling what you do not own is forbidden, but I should caution that scholarly advice should be sought on this issue. If there are scholarly articles dealing with short-selling's prohibition or permissibility, please feel free to link in comments.

Through this new government plan still in the making, those who profited over Ponzi-type schemes will obtain a “get out of jail free”. New regulations will surely sweep in (hopefully), but the “free” market and the financial wizards will find other ways to rebubble another debt-based boom to rise from the dead. How long before the bubbles all fizzle out? Only Allāh knows. What Kevin Phillips predicts is that the soaring debt (personal, corporate, government combined) will eventually take its toll on the nation. And if there is one thing that history teaches us is that no one nation dominates forever.

I know I haven't laid out the entire story here…I think enough smart people have said enough smart things. We just need to find those smart articles, read them, and understand them. So, I'll leave readers with one link for now, and I hope the smartest readers in the blogosphere (i.e. YOU) can point to other simple, lucid articles that explain the meltdown for the benefit of others, and I'll keep updating the list.

More Articles/Info:

• Comment on bloggingstocks.com

Also See:

•  The Destructive Rise of Big Finance by Kevin Phillips at Huffington Post
• BAD MONEY: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. Book Review of Kevin Phillips's new book at NYT.
• Buy Kevin Phillips's books on Amazon: American Theocracy | Bad Money

Related Posts on MM:

• Some Thoughts on Islamic Finance and the Mortgage Crisis
• Muslim’s Guide to Debt and Money Management: Intro | Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6
• The Problem with the Economic System – The Oil Price Crisis (Part 1)
• Pay Off Your Debt – Khutbah by Muhammad Faqih

As business analysts appear on the media almost every single hour preaching their ‘economic wisdom' to the layman, it has become a common knowledge now, at least for observers, that there is a serious problem in the world economic system. This problem, as controlled by and economy running on capitalism and free markets, has become systematic and cannot be tolerated any more. Ok, this is not a call for socialism or communism, nor it is a leftist conspiracy against globalization or a call for policing the economy, but even if you were the least bit interested person in business and economy, or someone who hates numbers, charts and figures, this current crises should concern you as it affects your life directly and indirectly.

Since the beginning of this current rise in gas prices, how often have you been monitoring gas price signs on the gas station next to your home, business or even school? You probably never even noticed the sign or the gas station ever existed until you became concerned with the issue. Have you noticed that gas prices have changed your daily driving habits? Now at least, you keep looking at the gas gauge more often than you used to do before, and you probably have started to plan your refueling trips more carefully.

Oil prices today are causing greater threat to global stability because of the pressure placed on the world food market. If you live in the west or any country with a rich economy, you could feel that your dollar value has shrunk dramatically. Remember the good old days, when you used to get out of the Wal-Mart on a shopping spree with a cart full with all these goodies for less than a hundred dollars?! Well, it's getting harder today to enjoy the same old habits without feeling the pain creeping out of your heart before your pocket. Starbucks is closing 600 of its locations because common people decided to cut down on unnecessarily expenses; after all coffee is coffee anyways. In addition, whether it was Starbucks or Seven Eleven; it will now, even if you had doubts before, taste the same. For people living in countries of poor economies, the dream of immigrating up north or to the west is becoming more of a necessity than fantasy. The harsh conditions of their daily life activities and the struggle to survive in this age of global economical inflation make one wonder if we were on the verge of global uprising, or massive human disaster.

So, what is the problem then? For a Muslim, this crisis is a symptom of a greater and deeper problem that is worth investigating. It is a sign of violation to the divine order; the order of maintaining this creation of Allāh by the laws of Allāh. When Allāh created Adam to serve, and his offspring, as vicegerent on earth, angles predicted -or were inspired with knowledge- that this creation would create on earth mischief and bloodshed, but Allāh knows best that this creation would do better.

“Behold, Your Lord said to the angels: “I will create a vicegerent on earth.” They said: “Will You place therein one who will make mischief therein and shed blood? While we do celebrate Your praise and glorify Your holy (name)?” He said: “I know what you know not.” Al-Baqara 2:30.

In order to achieve his role, man was sent down to earth equipped with fundamental instruments; hearing, sight and comprehensive and affectionate heart.

“It is He Who brought you forth from the wombs of your mothers when you knew nothing; and He gave you hearing and sight and afi'dah (intelligence and affection): that ye may give thanks (to Allāh).” An-Nahl 16:78.

When the Qur'an speaks about processing thoughts and making intelligent and educated decisions, the processor presented had always been the ‘Fu'aad' (singular of afi'dah). The Fu'aad in books of Tafsir (commentary of the Qur'an) was mostly referred to as the heart itself or one of the functions of the heart. In Bukhari and Muslim, in hadith an-Nu'man ibn Bashir, the Messenger of Allāh salla Allahu alayhi wa sallam mentioned:

“Beware, in the body there is a flesh; if it is sound, the whole body is sound, and if it is corrupt, the whole body is corrupt, and behold, it is the heart.”

In contemporary business studies and self development seminars, people are taught to use both a cool mind and a warm heart when making decisions. If you don't have feelings for the intellectual decision you are making, then do not do it. Likewise, if you do not rationalize the passionate decisions you make, it might backfire and bring back detrimental results on you. The Messenger of Allāh salla Allahu alayhi wa sallam said:

“Consult your heart. Righteousness is that about which the soul feels tranquil and the heart feels tranquil, and sin is what creates restlessness in the soul and moves to and fro in the breast, even though people give you their opinion (in your favour) and continue to do so.” Reported by Imam Ahmad and ad-Darimi from hadith Wabisah ibn Ma'bad.

Many decisions in global market today are made based on intellectual and observational facts and statistics. Compassion is probably not found in the economic agenda, and does not even exist in their manuals. Consequently, few businesses, if any, would think of the human welfare -let alone the environment- while shaping their strategies. If they do, then it is for PR reasons and limited to customer service. After all, capitalism is a brutal economic system where the rich usually get richer and the poor get poorer. There is no denying the fact that capitalism has its economical virtues, but in the long term, it will definitely cause harm and damage to fragile economies of the global world system.

Today in the world of business, Muslim economists are not doing any better either. A recent study assessing the experience of Islamic financial institutions for the past fifteen years, found Islamic banks – many of which are not so Islamic – have failed to present an acceptable alternative of both a halal and effective banking system without falling into the snares of the entangled global economy. It was hard to operate in an economy based on very different mechanism form Islamic legal system. The competition was harsh, and the temptations at stake were enormous. There is a huge demand for an Islamic financial system, at least in the Muslim world, and many Muslims due to their religious adherence to the divine law, Shari'ah, hold their money back once they feel suspicious of any phony financial transaction. Many others however, are satisfied with the Islamic slogan raised by these institutions, leaving the heavenly responsibility of such dealings to the Fiqh council that legitimized this system for them. Conventional banks in the Muslim sphere have acknowledged that fact; realizing the marginal difference between them and many other so called Islamic banks, they started providing legal financial Islamic services to expand their customer base and attract religious people.

Islamic financial system, different from conventional systems, springs out from the higher objectives of Shari'ah known as Maqaasid al-Shari'ah. The consideration of universal values and public welfare are two of the main objectives of Islamic system; this consideration which is found very consistent throughout the entire system, makes the Islamic system peculiar. One of the fundamentals of the higher objectives of Islamic system is the preservation of the five human necessities, two of which are the preservation of wealth and life. In the practical provisions of Shari'ah  known as Fiqh, the law should always be consistent with these values. Economic law as known in the tradition of Islamic law has been present in books of Fiqh since the inception of this discipline.

These books of Fiqh were the foundation of Islamic traditional studies, and many Muslim scholars were considered the experts in the theory of economics for generations. Economic law intertwined with faith was particular to the Islamic system and hence had to follow the general ethics of Islamic tradition.  The Islamic system answers to a divine authority, and therefore the ethics of the system were divinely organized in order to fulfill the obligation of maintaining this wonderful creation of Allāh. If people chose to defy this divine system and tamper with its foundation, they will create a great imbalance and this disequilibrium as a result will cause a major disorder until things are put back where they should be. In today's economic system, the consideration of public welfare was left for governments and governmental agencies, leaving the free market and its natural forces to decide the ethics of engagement into the global economic system. Without divine authority overseeing the system in the global economy, man-made ethics will prevail.

Muslims have always been creative in their economic system, due to the fact that it has a deep and strong structure in religion and religious practices. The code of ethics in the Islamic economic system did not prevent Muslims from becoming economically prosperous for more than twelve hundred years in the history of their civilization. As a matter of fact the prohibition of ‘riba' or usury which is the base of today's economic banking and mortgage system, the prohibition of gambling which is the base of today's insurance industry, and some other rules in Islamic economic system were inspirational to Muslim merchants and business people. It helped create a vibrant, active and self-stimulant system that is heavily dependent on investment and capital share holding. People always owned something tangible, and their money always reflected real value, not imaginary value. There are numerous reports from the Prophet salla Allahu alayhi wa sallam encouraging people to invest; and many Fiqh rulings were enacted based on this principle. Hoarding and holding the wealth of the orphans was not recommended for fear it might be consumed by zakat; investment was highly advised to avoid this from happening. Inheritance system and its sophisticated and precised fractions were the vehicle that always protected the economy from feudalism and broke monopoly in society “in order that it may not (merely) make a circuit between the wealthy among you” al-Hashr 59:7.

In agrarian societies prior to the industrial revolution and until this present day, the land was the most precious commodity. Islamic agricultural system presented revolutionary ideas to the world contrary to those feudalistic systems crushing the middle class in Europe. One of these fundamental rules was very basic but revolutionary, leasing the land for a portion of the produce in which the landlord keeps the ownership of his land and enters a separate transaction with the worker based on the lease agreement. Moreover, in another rule set to maintain agricultural production and satisfy human instinct of capital ownership, anyone who brings a barren land back to life for a certain number of seasons would own it. Overall, the Islamic system follows a sophisticated set of guidelines; these guidelines however do not entail strictness. On the contrary, these guidelines leave a huge margin of flexibility for practical rules of Shari'ah. They only set the ground for what is permissible and what is not. As for actual practical transactions, all considered legal and acceptable, as long as they conform to these general guidelines.

Part Two

What is going wrong in the oil market?

(download talk in mp3)

Please also see, Thoughts on Islamic Finance and the Mortgage Crisis, and

The Muslim’s Guide to Debt and Money Management: Intro | Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6

While I am glad the government is taking steps to help keep people from getting kicked out of their houses, I do not feel that this addresses any of the real fiscal issues facing society, namely that of fiscal responsibility and education. Instead of teaching people to purchase what they can afford, or passing laws preventing companies from preying on people they know will never be able to pay the loan back, they are simply helping the rich get richer.

The Washington Post had an article entitled A Higher Law for Lending that sheds light on how Islamic finance companies have faired in this latest crisis. Since they do not have variable interest built into their contracts, they have been unaffected by this debacle.

Whether or not we all agree 100% with the schemes or set up of some of these finance companies, it is important to at least acknowledge that in the grand scheme of things Muslims are contributing to the solution of societal issues that are of immediate concern to the general populace. There's a lot of work to be done in this field still, but I believe this is a huge step forward for us as a community.

Another thing that comes to mind from this is that it is a proof in front of our very eyes that Allāh (swt) has made the good things lawful, and the bad things unlawful. I cannot count the number of people I have met who think buying a house with a traditional mortgage is ok or 'necessity' and that it is just something we do since we live here. But this shows us, that no matter how easy it is, or what assurances we may get from the bank about these schemes, in the long run they can do far more harm to people than good (and that is speaking strictly in the worldly sense). How many people are losing thier homes, savings, and the “dream” that they have been planning for their entire lives?

It really is a time to reflect on the benefits of having taqwa in Allāh. As we know, He will provide for us from sources we could never imagine if we simply uphold our duty to Him and rely on Him alone. This should also give us some added motivation to continue our progress as an ummah, not just in the financial sector, but other sectors of society as well. The same way we can show that Islamic finance is in fact better for the economy (even with the 'capitalist' system in place here), we need to show the world how our family and social structures can help benefit those around us – be a part of the solution to the problems our society here at large is facing.

Lastly, this is an old article from the Baltimore Chronicle in March, but I have been wanting to highlight it for a while. It basically shows how the public take down of Eliot Spitzer was linked to his fight against sub-prime lending. This article is a must read, and I have quoted a few passages below.

This week, Bernanke’s Fed, for the first time in its history, loaned a selected coterie of banks one-fifth of a trillion dollars to guarantee these banks’ mortgage-backed junk bonds. The deluge of public loot was an eye-popping windfall to the very banking predators who have brought two million families to the brink of foreclosure.

Up until Wednesday, there was one single, lonely politician who stood in the way of this creepy little assignation at the bankers’ bordello: Eliot Spitzer.

Who are they kidding? Spitzer’s lynching and the bankers’ enriching are intimately tied.

How? Follow the money.

….

Now, what kind of American is ‘sub-prime’? Guess. No peeking. Here’s a hint: 73% of HIGH INCOME Black and Hispanic borrowers were given sub-prime loans versus 17% of similar-income Whites.

….

Instead of regulating the banks that had run amok, Bush’s regulators went on the warpath against Spitzer and states attempting to stop predatory practices. Making an unprecedented use of the legal power of “federal pre-emption,” Bush-bots ordered the states to NOT enforce their consumer protection laws.

Indeed, the feds actually filed a lawsuit to block Spitzer’s investigation of ugly racial mortgage steering. Bush’s banking buddies were especially steamed that Spitzer hammered bank practices across the nation using New York State laws.

….

When the housing bubble burst and the paint flaked off, investors were left with the poop and the bankers were left with bonuses. Countrywide’s top man, Angelo Mozilo, will ‘earn’ a $77 million buy-out bonus this year on top of the $656 million – over half a billion dollars – he pulled in from 1998 through 2007.

….

Then, on Wednesday of this week, the unthinkable happened. Carlyle Capital went bankrupt. Who? That’s Carlyle as in Carlyle Group. James Baker, Senior Counsel. Notable partners, former and past: George Bush, the Bin Laden family and more dictators, potentates, pirates and presidents than you can count.

The Fed had to act. Bernanke opened the vault and dumped $200 billion on the poor little suffering bankers. They got the public treasure – and got to keep the Grinnings’ house. There was no ‘quid’ of a foreclosure moratorium for the ‘pro quo’ of public bail-out. Not one family was saved – but not one banker was left behind.

Every mortgage sharking operation shot up in value. Mozilo’s Countrywide stock rose 17% in one day. The Citi sheiks saw their company’s stock rise $10 billion in an afternoon.

And that very same day the bail-out was decided – what a coinkydink! – the man called, ‘The Sheriff of Wall Street’ was cuffed. Spitzer was silenced.

Please also see, Muslim's Guide to Debt and Money Management:

Intro | Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6