By Karoly,
An out-of-work money manager in California loses a fortune and wipes out his family in a murder-suicide. A 90 year old Ohio widow shoots herself in the chest as authorities arrive to evict her from the modest house she called home for 38 years. In Massachusetts, a housewife who had hidden her family’s mounting financial crisis from her husband sends a note to the mortgage company warning: “By the time you foreclose on my home, I’ll be dead”. Then Carlene Balderama shot herself to death, leaving an insurance policy and a suicide note on a table. The insurance money was to be used to pay off the funeral home she had picked out, as she wrote in the suicide note.
These are some disturbing anecdotes from the financial meltdown episode unraveling in the mightiest military and economic power in history – the United States. The crisis that has further spilled over to the whole world and threatens to sink the world economy into recession should open our eyes to the extremely flimsy fundamentals of the capitalistic economy and change our perceptions about many canons of the financing practice.
How can we explain this phenomenon? Is it a vindication of the Marxist schools of thought, whose proponents tout it as the end of liberal democracy and a victory for the nationalization dogma? At a time the Chinese are moving toward private ownership, even as America and Europe are moving away from it, it seems not fair to resurrect an ideology already in its eternal slumber in the graveyards of Soviet Union just to explain a phenomenon which we can certainly do otherwise. Moreover it is hard to appreciate the free fall of stock-markets, which are key indicators of the economic well-being of the country, as a “fall of capitalism”.
It may be accurate to explain this phenomenon by ethical considerations and doctrines rather than economic theories and differential equations. As is obvious the meltdown was induced by sub-prime mortgages, which relies on usurious and predatory lending practices by banks and investment agencies in an unregulated environment, that too focusing people with poor credit-history, which led to massive volumes of foreclosures and subsequent fall in housing prices, causing the banks to break down.
The inter-banking lending, which is again based on debt-financing ensured that the losses spread over to other banks too. Further lending was affected in the new environment where banks faces losses and don’t trust each other, leading to credit crunch that we behold today. This combined with the dependence of the world economy on U.S economy and the role of dollar as world’s leading reserve currency, led to the cascading outages or weakening of many major banks and investment agencies the world over, looming in recession – reduced production and consumer spending- since almost every aspect of production, distribution and consumption are based on debt-financing today.
Interestingly the Islamic banks, who are the main (if not the sole) proponents of interest-free lending, have been relatively less affected by the crisis so far, thanks to their inherent business ethics, even though they too have been feeling the pinch of the commodity slump as fallout of the crisis. Strict lending requirements, insistence on transparency and requirements that physical assets underpin transactions helped the Islamic industry survive the sub-prime mortgage meltdown.
As is well known, Islam is highly antithetical to the practice of interest-based financing, and probably has played the ideologically seminal role in infusing an anti-usury sentiment to the world.
Under Islamic banking, equity financing is not granted by mortgaging assets, but after analyzing the investment proposal, and the credit/equity finances remains unaffected with changes in assets values. The investment risk under Islamic Finance is not very much a function of asset values; instead it varies according to actual market trend. This provides stability and insulation in the financial market. Further, the investors are required to produce convincingly strong business proposal, sound projections and rational planning to attract the financer – which is in contrast to subprime mortgages which largely exploits the gullibility of borrowers with poor credit credentials. [1]
If we examine the economic history of many Muslim countries in the middle ages, where we can find little famine, poverty and meltdowns, we can see its financial system was not a banking based system, rather market based system. Financing needs in the market were met through trade contracts. The financing needs that market could not or did not want to meet were met by the institution of charities, Zakat and Awqaf promoted by Islamic teachings. This eliminated the need for financial intermediaries for either purpose, despite ensuring robust economic growth. [2]
This episode should also quell any claims by even some practicing Muslims that bank interest is not the “usury” prohibited by Islam, and is hence allowed to be taken. In a better regulated system as in India, the chain reactions wrought by debt-financing may be reined in better and the situation may not escalate to where banks break down and you lose your entire “investment”, but still any interest you accrue is at the cost of the borrowers, which God does not like the least.
“O you who believe, do not consume your property among yourselves wrongfully, but let there be trade by mutual consent…- Quran verse 4:29
However a financial system based on interest-free lending should not be stereotyped as something concerned with only Islam; and it is in the interest of the conventional economists too to look into it considering its many salubrious aspects. As M. Fahim Khan, an expert in Islamic economics, suggests the developed world can take lead in introducing market based financial system and show the way to the developed world too to get out of the trap of banking based financial system.
The days of ignoring the financing system based on the humane values of justice, equity and charity may be over with the legacy of this financial meltdown to haunt us. It is high time that we bank on ethical financing as a viable alternative to the illegitimacy of capitalism and illogicality of Marxism to bail out the common man, better than just his funeral home.
References:
[1] “Islamic Banking restrains Financial Sector Crisis”, Syed Zahid Ahmad, TwoCircles.net
[2] “World Financial Crisis: Lesson from Islamic Economics”, M.Fahim Khan, TwoCircles.net