Weekend Edition
September 27 / 28, 2008
An Islamic Perspective
Meltdown in American Markets
By LIAQUAT ALI KHAN
Call it the consequences of irresponsible American invasions, call it the
irrational exuberance of short sellers, call it the catastrophe of subprime
lending, call it the mismanagement of leveraged products, blame it as you may,
American markets are facing unprecedented meltdown and doomsayers see little
promise in the federal bailout package. Ironically, the Wall Street has noticed
that Shariah-compliant investments--which avoid speculative risk and
debt-ridden greed--have fared much better in these troubled markets. In the
past few years, Shariah-compliant investments in Western markets have grown to
more than half a trillion dollars.
Islamic financing is attracting huge academic curiosity. Many experts
participating in the 8th Harvard University Forum on Islamic Finance held this
past April wondered if Islamic financing could have prevented the meltdown that
American markets are facing primarily due to mortgage debt and mortgage-backed
securities—now known as "toxic investments." This legal commentary highlights
the two fundamental principles of Islamic financing that I presented at the
Forum.
High Risk Investments
The Quran prohibits al-Maysir or speculative risk, warning the faithful to
avoid games of chance in which the probability of loss in is much higher than
the probability of gain (2:219). Shariah-compliant investments, therefore,
avoid speculative risk, including interest rate options, naked equity options,
futures, derivative and numerous leveraged products purportedly designed to
hedge investments. Many of these financial products attract speculators in
hopes of making quick money. When trusted fund managers, under institutional
pressures to show profit, resort to speculative risk, hedge investments turn
into suicidal strategies for financial destruction.
In pursuit of greed and thrill, straightforward investments in companies
engaged in socially useful activity has become unattractive, even boring,
because of their presumably lower rate of return—frequently a self-fulfilling
prophecy. Billions of dollars are dumped into companies that promise huge
profits but produce nothing. While Islam would allow risking investments in
socially beneficial research projects, it prohibits investments in companies
peddling alcohol, tobacco, pornography, debt, and weapons—products that
undermine our health and safety.
Some investment strategies rampant in the markets are not only morally corrupt
but socially harmful. Short sellers, for example, make money when companies
collapse and close. Turning the conventional logic of investment on its head,
short sellers wish companies to crash rather than prosper for they make most
money when companies go bankrupt, workers and employees lose jobs, and pension
funds evaporate through declining company stock. Such cynical investments,
touted as useful forces that balance the market, are contrary to Islamic law.
Interest-Bearing Debt
In addition to prohibiting high risk investments, the Quran also prohibits no
risk investments. The prohibition against riba, interest on loans, is strictly
forbidden. Islam does not prohibit passive investments. Nor does it prohibit
giving interest-free loans. Debt is not contrary to Islamic law. Charging
interest is. Although some experts argue that usury, and not interest, is
prohibited under Islamic law. Most Muslim scholars agree, however, that
interest on loans is contrary to the Shariah.
Refuting arguments that money has time value or that interest is analogous to
profit, the Quran offers a categorical principle that "trade is permitted but
interest is not." (2:275). The prohibition against interest was revealed not
only to save the poor from unscrupulous lenders but also to deter investors who
demand a set return on their investments and decline to take the risk of
engaging in useful trade.
Contrary to Islamic principles, lending in general and subprime lending in
particular was predestined to harm American financial markets for two distinct
reasons. First, debt braced with high interest was being extended to persons
who simply could not afford to pay back loans. This was usury. Second, the real
estate mortgage was no longer a prudent investment decision, since numerous
investors were trading in real estate with inflated prices. Investment bankers
and other geniuses on Wall Street were securitizing mortgage debts, turning
them into interest-bearing securities. These fancy securities began to fail
when their underlying assets were foreclosed or deflated. The debt turned
deadly and its holders bankrupt.
Shared Destruction
Between the prohibited limits of maysir (speculative risk) and riba (no risk),
however, Islamic Law permits creativity in financial markets where investors
mobilize surplus monies for the production and distribution of halal (Kosher)
goods and services. These permissible markets are neither risk-free nor prone
to irresponsible risk. Though innovative and authentic, the markets are infused
with the values of fairness, transparency, and reasonable profits. They are
free of predatory practices that corrupt transactions with greed and inflict
hardship on the poor, the elderly, and the novice.
The federal bailout package that the Bush Administration is selling as a quick
cure of all problems will only aggravate the underlying cancer of
interest-bearing debt. It is unlikely that the infusion of more money will
reform institutions and companies built on layers of interest-bearing debt.
When the best and the brightest are engrossed in finding ways to make money
with money, and no more, the system may look creative and intelligent but it is
geared toward shared destruction.
Ali Khan is Professor of Law at Washburn University in Topeka, Kansas.
Iqbal Soofi
P.O Box: 24179 | Safat 13102 | State of Kuwait
Tel: 804050 Ext. 329 | Fax: + 965 243 5856 | Cell: +965 652 0620 | Voice
Mail: +1 51 6620 9920
