Golobal Financial Crisis

GOLOBAL FINANCIAL CRISIS
REASONS AND ISLAMIC SOLUTIONS

WHEN DID IT BEGIN?
Early signs appeared in 2007
Very reason was funding of external wars
Bush administration spent >$ 5 trillion in 7 years of military expeditions
It lead to increase in public debt of > $4.5 trillion between FY 2002-2008
This is a crisis of accumulated debts beyond the capacity of US financial system

Steps which led to this crisisCollapse of Real Estate Market
Undue burden of real estate funding contracts

Loan guarantee contracts
Securitization
Debt securities trading
Credit derivatives
Credit default swaps

Collapse of semi-wholesale finance institutions
Mortgage corporations like Fannie Mae & Freddie Mae
Collapse of other banks
Confidence upon financial institutions deteriorated
Banks ceased to give short term loans to companies and institutions

Crisis in services and production sectors
Down sizing and closure of businesses
Reducing employment and laying off workers
Decline in demand for consumer goods
More decrease in employment

Structural causes that aggravated the crisis
1-Large expansion in speculation transactions in financial markets
Including conducted through internet
They overshadowed the real transactions
Real transactions affect the fluidity of capital and moving investments
Speculation transactions are unproductive since they merely move capital from the losers to the winners.

2-Emergence of many transactions merely for speculations on prices
These transactions do not produce any added value to the market
Huge amount of money and great human capacities are invested in them

3- Culture of quick profits
Without consideration to the long term results of the transactions
Deficiency of laws, regulations and administrative oversight on the methods of creating new forms of transactions
When there are no laws or regulations to control people’s behavior then why would they not extract maximum profits

4-Shift of capital from service and production to financial institutions
There was inflation of financial sector profits
It led investors to believe that this is the way to make quick gain of wealth
Layers of mere financial transactions accumulated and ballooned moving capital away from production sector
This brought the theory of upside down pyramid- which is very unstable

Upside down pyramid

5-Dependence on interest based loans
This has been the foundation of funding in capitalist system
It does not produce any added value by itself

6-Securitization
There was prevalence of securitization
It led to culture of “strike and place the burden upon others”
It created interconnection among the financial institutions. So all the institutions fell with the fall of first piece of domino

7- Exchange and trade of debts
Enormous investments were attracted to such transactions
It does not result in any real increase in productions
These are often quickly influenced by the media and political events
These would not happen if interest was not adopted as the part of finance and re finance

8-Investors trend towards being more cautious
This led to increase in the processes of derivatives
It inflated the size of mere financial swaps
There was more interconnection among institutions
Hence the retrogressive impact spread from one institution to the other

9-Dependence upon public debt rather than taxes
This led to inflation in the process of financial exchange at both levels:
1- Local
2- International

10- Exorbitant rise in US military spending
No doubt it increases labor and employment in defense sector
However, it does not tend to improve the productive capacity of the economy
Competitive capacity of US products in foreign markets diminished
Deficit in the balance of trade accumulated
This undermined the confidence in US economy

Short Term Solutions(Usurious) by experts in capitalist milieu
1-Rescuing the failing banks, specially retail banks.

They can resume short term loans to companies
This will alleviate the financial crisis in the production sector

2-Income increasing program specially for middle class

Enable the debtors to overcome the housing crisis
Ease the problem of diminishing demand for consumer goods
This will send signal to the factories not to cut productivity or to lay off workers
Increase spending on service sector ( education and healthcare) which has large workforce

3-Freeze installments and interest rates for buyers of houses
Interest be frozen, decreased or cancelled for a short period of time
Give respite to debtors who took house loans
Real Estate pricing will regain stability
Real estate construction will resume

4-Decrease the public debt
Avoid increase in public debt
Measures be taken to decrease public debt
Taxes be imposed upon wealthy

5- Dealing in derivatives
Dealing in derivatives be immediately stopped
Their remnants must be gradually dissolved, specially the credit derivatives

Long term solutions1- New legislations and oversight
1-New legislation to curb expansion of financing beyond the capacity of the debtor
2- This is specially needed in real estate and credit card market
3- Retail banks and finance companies must be forced to abide by strict standards
4- These institutions should be under strict Government oversight and be held accountable for any attempt to lure customers into contracts beyond their capacity

2-Turning the financial markets to support goods production and services
Ban or minimize the deals based on mere speculations:
. Index related deals
Contracts on differences
Credit derivatives
Short term deals
Future deals
Restricting choices as means of caution, in a way that is based or linked to an existing situation in assets or liabilities

Turning the financial markets
Limiting or banning the currency trade on the internet and cancelling licenses for platform of currency speculations on the internet
Platforms of goods and stock speculations on the internet should also be banned
Generally, the financial markets be turned back to support services and goods production and not at investments and profits involving speculations

3- Limiting Securitization
Securitization of debts be banned
Only taskik ( financial documentation) be used. In taskik, the financial documents represent real assets excepting debts and money.

4- Legislation to ban circulation and trade in debts
These processes do not create any added value.
Strict restrictions be placed for discounting and rediscounting of debts

5-Developing institutional funding from banks and non institutional funding from the markets
This is to be bound by 2 main constraints:
Establishing a direct connection with the real market of services and goods. This way the funding in the society does not go down the drain or transform into financial accumulations that turns away from the real market
Giving preference to moral criteria in funding over the criteria for mere profit gains. It means funding be withheld from goods and services which are harmful to the society and environment.

6-Individual’s right of ownership is a fundamental right
It is improper for an individual to cede this right or right to freely benefit from it.
Only exception to this rule is if individual wants to give it up voluntarily
Contractual increase in debts and loans for deferred payment is unjust. It is not compatible with the requirement of rights to property and entitlement.
Debts should not be susceptible to increase. No added value is generated from them.

Islamic Banks and current crisis of debts
Islamic banks were less affected because:
They do not buy financial papers based on debts
They do not deal with usurious debts

Setbacks for Islamic Banks in this crisis
Islamic banks which dealt with traditional banks through goods Murabihah have billions of dollars to be paid by the latter
Banks that dealt in Tawarruq (securitization) with their clients and holders of credit cards also have lot of inflated debts to be paid by ailing clients
Banks that invested in global stock markets are also affected
Islamic banks are affected by the financial difficulties of their clients (falling income etc)

Lessons for Islamic Finance
1- There is deep seated confidence in the correctness of Islamic finance because:

Its adherence to funding by sales leases and partnership
Avoidance of usurious loans
Avoidance of loans that takes away finance from real market of production and exchange
Its rejection of circulation and securitization of debts

2-Stop imitation of financial practices devoid of reality of goods
Avoid contracts that produce no added value but only shift wealth from one hand to other
Funds of Islamic caution
Contracts of compound promises
Imaginary contracts of investment
Other practices founded upon no real production or exchange

3-Re evaluate certain financial dealings adopted by some Islamic banks
Dealings which separate finance from real market and avoid relying on the production of an added value
Avoid dealings which rely on accumulation of debts not accompanied by movement in services or goods
These dealings widen the gap between the real market and the financial market. This leads to financial instability.

4-Transactions of Tawarruq and Murabaha for local and international commodities
These represent debts not based on real exchange of goods but on overlapping contracts
They result in illusory financial accumulations
They do not reflect the true identity and goal of Islamic finance
Islamic finance, hence, would fail to maintain its moral purity and fail to apply its moral standards to the measures it follows

5-Financial markets in Muslim countries must be reviewed
Financial speculations should be limited and restrictions should be laid down on their different types
Transactions that do not involve real investment should be banned
Systems in some Muslim markets do not allow many derivatives which is one of the most important causes of the crisis

6-Views,opinions and some practices be revised
Short term sale
Derivatives and dealings on the same day
Markets of caution
Mudawalat (speculations) via the internet using currency
These practices create mentality of quick profits with spirit of selfishness and speculations

7-Principles of Islamic finance should be presented to the world
This is part and parcel of true image of Islam
This message is directed to all mankind
This is a message of mercy to the world
Implementation of these principles guarantee elimination of oppression
They guarantee justice and human rights.
These rights include reaping the fruits of one’s property, protection against encroachment upon personal property.

8-Re evaluation of financial documents from Sharia perspective is needed
Attempts are to be made to perfect their (documents) rules
We need to lay down the organizational and jurisprudential regulations
These regulations should ensure that they will not slip into forms of securitization that dominated the Western financial markets

9-Firm stance against selling debts
There must not be any selling of debts
There should be no discounting and rescheduling the debts even under false names

Islam’s Guidance
There hath come to you from Allah a (new) Light and a perspicuous Book.
Wherewith Allah guides all who seek His good pleasure to ways of peace and safety and leads them out of darkness by His Will unto the light guides them to a Path that is Straight.
Surah Al Maidah 5:15,16

Contrast of financial systems
Conventional Finance
Islamic Finance
Interest and interests based transactions
Deposits and loans
Banks create and destroy money
Interest is forbidden and so no interest based transactions
Equity shares and ownership of real assets in investment projects
Banks do not create or destroy money

Islamic Finance
Asset-liability mismatch, illiquid
Money multiplier depends on reserve ratio, very high; infinite with securitization
Speculation, a casino, debt trading
No asset-liability mismatch, liquid
Money multiplier depends on the savings ratio, very low
No speculation, no debt trading

Islamic Finance
Interest rate not related to real economy, high price distortion
Social inequality: inflation tax, redistributive issues, food riots
Highly cyclical: booms and busts, uncertainties, unpredictable growth
Profit rate determined by real economy, no price distortion
Social equality: no inflation tax, no redistribution
Stable economic growth, predictable

Contrast of Financial Systems
Islamic Finance
Massie bankruptcies, contagions, bailouts
Interest rate policy, highly destabilizing
No systemic bankruptcies, no bailouts
No interest policy, money aggregates are used, highly stable