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Saturday, May 10, 2008

A Secular Market Nightmare

By Alyssa A. Lappen
FrontPageMagazine.com | Friday, May 09, 2008

The global sub-prime mortgage mess would have been “unthinkable in the Islamic capital markets sector,” Malaysian Islamic finance scholar Mohammed Mahmud Awan told Arab News on April 24; Islamic law, or “shari'a principles” would prohibit selling “a debt against a debt,” Awan said at a Bahrain university globalization conference. Trading trillions of dollars in debt without assets backing them caused the crisis, Awan claimed, adding that the “Islamic finance model...would have easily prevented the current economic crisis.”

Others disagree. All “Islamic finance today is interest based,” notes Rice University Islamic economics, finance and management chairman Mahmoud el-Gamal in the Financial Times. Islamic banking, merely “shari’a arbitrage,” is “first and foremost about religious identity,” el-Gamal says.

Indeed, Islamic finance debt instruments are no better than Western mortgage securities, and probably worse. Islamic sukuk al-ijara (shari’a bonds) are merely reverse-engineered structured finance instruments. Many grave secular risks accompany the growing foothold of shari'a finance in the West.

Despite claims of their superior safety by International Center for Education in Islamic Finance professor Awan, Islamic financial institutions manufacture “special purpose entities” (SPEs)---which coincidentally helped destroy Enron. Islamic financial engineers merely renamed the prickly SPEs “special-purpose vehicles (SPVs)”---legal devices to “restructure interest-bearing debt, collecting interest [as] rent or [a] price mark-up,” el-Gamal observes.

Here's how they work: sukuk bond issuers sell real estate or assets to SPVs, which then capitalize their investment by selling share certificates. In turn, the SPVs then lease back the assets they purchased to the sukuk issuers, collecting principal plus interest, which they pass on to sukuk investors as “rent.” When the sukuk matures, the SPVs sell or return the property to the sukuk issuers. Supposedly safe “alternative” Islamic finance instruments that claim to avoid usury, in short, use Western structured finance tools---“some of the most complex ever created.”

Repeat. Using Western securitization technology, shari’a finance banks now transform liquid, traceable cash flows from interest-bearing debt---that is, real interest-bearing assets---into illiquid assets.

“Junk” synonymous with high yields; continue reading under this topic here.

Religious banks obviously cannot prevent financial crisis.Therefore, U.S. government and IRS regulators, bankers and investors should insist on keeping the best, safest and fairest secular markets in the world strictly unIslamic."