Tuesday, April 25, 2006

The monumental mistake: Contract-centric thought

There is much that is depressing in the house of Islam today. As an economist, I find little that is more depressing than what is falsely called "Islamic" finance. The premise of that industry is that Islam permits or forbids contracts only. Thus, all that we need to do is to synthesize the forbidden contracts with permissible ones. Indeed, that is much for what is peddled today as Islamic finance: e.g. if you can't take a loan -- just buy some commodity on credit and sell it for cash, paying the same interest you would have paid for loans plus added transaction costs for the trades. That so many Muslims can view this as permissible is truly symptomatic of the malady that has afflicted Muslim minds. Contrast this with what Ibn Qayyim reports of his teacher saying about tawarruq (in I`lam Al-Muwaqqi`in in the book on changes in fatwa -- proof of the prohibition of hiyal:

And our teacher (God bless his soul) forbade Tawarruq. He was challenged on that opinion repeatedly in my presence, but never licensed it [even under special circumstances]. He said: “The precise economic substance for which riba was forbidden is present in this contract, and transactions costs are increased through purchase and sale at a loss of a commodity. Shari‘a would not forbid the smaller harm and allow that which is more harmful”.

In other words, Ibn Taymiyya did not simply look at the contract, but how and why it was used. Even though tawarruq technically used sales, it was clearly a device for extending an interest-bearing loan, in which we cannot verify if the interest rate charged was fair -- hence forbidden riba. In other words, if the purpose of the sale was not genuine interest in that commodity, then one could trade Aluminum to mimic the rate of return to LIBOR, or to mimic the rate of return on pork bellies, etc. In what sense would one be a trader of Aluminum? In what sense is this genunie bay`.

Given the advances in structured finance, one can easily disguise riba in any contract, and it would be the ultimate of disingenuousness to say "but this is bay` (sale), and Allah has permitted bay` and forbidden riba". The objective of the Legislator (S) cannot possibly be to enrich lawyers and consultants at the expense of Muslims who receive no value for the added price that they pay for credit or other financial services. This was done in the past by loan sharks, who would sell a piece of cloth to a needy farmer for a credit price of 200, when its cash price -- which everyone knew was the only thing that the farmer sought -- was only 100. That is riba of the worst kind, an unjustified increase that can eventually enslave the poor farmer, as had happened for many centuries.

Conversely, advances in structured finance, information technology and regulatory frameworks can also allow us to remove riba and gharar from forbidden contracts. For instance, in the famous Hadith of trading dates for dates, the Prophet (p) told Bilal (in one narration) to sell the low quality dates and buy high quality dates with their proceeds. If there were posted spot prices on an exchange, forcing the barter trade to take place at the appropriate ratio of spot prices would effect the same equity in exchange that the Prophet (p) sought.

Should we then look for the objectives of the Law: justice and fairness in exchange, and see how best to achieve them by utilizing the advances in legal and information technologies, or should we use those technological advances to arbitrage the gap between ancient contract forms and modern financial practices? In the former case, Muslims would prosper by achieving fairness and justice while cutting down costs. In the latter case, they will pay more and receive less, without necessarily ensuring equity and fairness.

Is this really a difficult choice to make?

I suppose that it is only a difficult one to make if you decide that Islamic law need not make sense. That it is a set of formulae to follow, and the only objective is thus to follow the rules, even if you incur what some bankers have been calling "cobm" (cost of being Muslim). Of course, that would require abandoning the primary Usuli principle (as articulated, e.g. by Al-Shatibi) that God never forbids beneficial things unless there is a greater harm.

Of course, one may argue that there may be a greater harm that we cannot see with our current economic knowledge. However, that argument cannot possibly be reconciled with consulting "Shari`a scholars" who have extremely limited knowledge of economics and finance, let alone ones who are hand-picked by bankers and paid handsomely for sanctioning their "Islamic" products.

Do those sincere people who give this sanctioning so much weight fail to recognize that jurists of the classical period were the economists of their time, and thus were the best qualified to rule on the basis of benefit-analysis?

Do they simply wish to hang their potential sins on someone else's neck (the literal meaning of imitation or "taqleed")?

Do they not distinguish between issues that relate to man's relationship with the incomprehensible Deity (e.g. acts of worship), wherein logical analysis plays a minor role (although we do defer to engineers on the direction of qibla, for instance, despite early resistance by jurists who thought only in terms of Cartesian maps), and matters that relate to life and transactions, where the vast majority of today's jurists are clearly unqualified to issue opinions?

I can't understand my fellow Muslims' minds.


Blogger Kashif said...

Dr Mahmoud:

While I can understand your concerns about the lack of critical thinking about this very important subject, I think the average Muslim is not sophisticated enough to be expected make the determination between a good and bad Islamic financial product. The onus, ostensibly, would then be on the people espousing Islamic finance, but they seem to be motivated by objectives other than Islamic correctness. Therefore your efforts in trying to educate people like myself on the differences between halal and haram from a financial perspective are truly appreciated. I look forward to your continued insightful comments on this subject.



2:15 PM  

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