Rating agencies, shoddy risk analysis, and sukuk
A recent article in the Wall Street Journal identifies the role played by rating agencies in perpetuating the credit boom that is currently imploding. The primary fault of investors, of course, is that they believed that credit ratings of new and unknown instruments, such as credit derivatives, are meaningful in any way. It is obvious that credit and asset-backed derivatives are signficantly different from the types of bonds that rating-agency experts are qualified to to assess (in terms of default risk).
In the case of sukuk, the silly bonds marketed as "Islamic" by rent-seekers, there are numerous legal risks that are very poorly understood, including by the lawyers and bankers who structure the instruments. The problem in this case is self-inflicted: the lawyers want to structure the instruments, e.g. lease-backed bonds or sukuk al-ijara, in such a way as to assure "Shari`a scholars" that bond-holders have material ownership of the underlying assets and receive "rent" rather than "interest". At the same time, they want to assure markets and rating agencies that the instruments are indistinguishable from conventional bonds, where the only mateiral risk is credit risk of the issuer. The rating agencies read the legalese and conclude that the lawyers are right: the "Islamic" structure is merely a fiction, and there is only credit risk. They give the sukuk the same credit rating they would give any other unsecured bond issued by the same entity (see, e.g. S&P's analysis of Qatar's Global Sukuk, where the rating was based on the soundness of the Qatari economy, without any significance lent to the asset ostensibly being leased back by the issuing SPV).
Unless and until we have a high-visibilty case of bankruptcy, we will not know with any certainty who owns what in the maze of SPVs that lawyers and structured financiers love to use. Until then, many will continue to line their pockets with legal, structuring, and advisory fees, as they congratulate themselves on "innovative Islamic products." What a shame!
In the case of sukuk, the silly bonds marketed as "Islamic" by rent-seekers, there are numerous legal risks that are very poorly understood, including by the lawyers and bankers who structure the instruments. The problem in this case is self-inflicted: the lawyers want to structure the instruments, e.g. lease-backed bonds or sukuk al-ijara, in such a way as to assure "Shari`a scholars" that bond-holders have material ownership of the underlying assets and receive "rent" rather than "interest". At the same time, they want to assure markets and rating agencies that the instruments are indistinguishable from conventional bonds, where the only mateiral risk is credit risk of the issuer. The rating agencies read the legalese and conclude that the lawyers are right: the "Islamic" structure is merely a fiction, and there is only credit risk. They give the sukuk the same credit rating they would give any other unsecured bond issued by the same entity (see, e.g. S&P's analysis of Qatar's Global Sukuk, where the rating was based on the soundness of the Qatari economy, without any significance lent to the asset ostensibly being leased back by the issuing SPV).
Unless and until we have a high-visibilty case of bankruptcy, we will not know with any certainty who owns what in the maze of SPVs that lawyers and structured financiers love to use. Until then, many will continue to line their pockets with legal, structuring, and advisory fees, as they congratulate themselves on "innovative Islamic products." What a shame!
posted by Mahmoud El-Gamal at 7:08 PM
19 Comments:
I think that using money supply as a monetary policy tool is shariah compliant. However instead of doing it on an interest rate basis it should be done on a service charge basis.
What do you think?
Salaam
Nazir, my understanding - in light of this blog - is that the presence of interest (whether in a mortgage or a central bank's monetary policy) does not need to be 'Islamified' by changing the key tool from interest to a service charge. The presence of interest does not always mean that riba is also present. Furthermore, it would seem highly artificial to try to retrospectively quantify open market operations* on a service charge basis.
Of more relevance to the original post is this article by Bill Gross of Pimco:
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2007/IO+September+2007.htm
Gross calls for a fiscal response to the sub-prime related 'crisis' instead of just a monetary response.
Wasalaam
* http://www.federalreserve.gov/fomc/fundsrate.htm
Ben Bernanke in this article is making a call for more innovative, more consumer friendly mortgage products.
This is a great oppurtunity for Islamic Finance practitioners to present their ideas.
http://www.marketwatch.com/news/story/new-mortgage-products-could-help/story.aspx?guid=%7B69E9EB78-D404-4305-82E2-7892DB5EA2B8%7D
Are you a member of the "Egyptian Center for Economic Studies"
http://www.eces.org.eg/About/Index2.asp?L1=1&L2=1
Mohamed A. El-Erian the big Harvard dude is a member interestingly.
Quick qn: Isn't there (or Shouldn't there) be a monitoring body which actively monitors & influences the 'innovative' products out in the Islamic finance market? Does the Islamic Fiqh Academy hold limited influence in ensuring products are truly Shariah compliance? Just curious.
“The danger was that the sub-prime collapse…”
Mort Kontracke
It’s worse than these people know (or let on to). For every sub-prime loan, there are many highly leveraged investor-owned homes.
Average number of houses built in the 1990s: 100,000/mo.;
Number of foreclosures in July: 168,000;
Number of foreclosures in August: 244,000; plus
People still building new homes because of inertia and economic situation; and
Lending standards reactionary anal;
Supply spikes, demand drops, price drops faster, investors bail, cycle continues, lenders on the hook.
Hello Airstrip One banking issue. Check out the Federal Reserve site re: bailouts (press releases).
Print money, gold up, borrowing costs up, prices rising, no habla ingles- here’s the emergency room bill.
Miniplenty bellyfeel doubleplus ungood.
Dayorder blackwhite reserved for Big Brother.
Blackwhite by others plus ungood.
CAIR blackwhite doubleplus ungood.
Vaporize CAIR.
UAE is now working on reviving the practice of the Prophet of setting up endowments. These endowments were for the poor and the orphans etc.
I think this is a great contribution to Islamic Finance.
http://archive.gulfnews.com/articles/07/10/04/10157999.html
Mr Ahmadinejad is on record as saying, "I pray to God I never know about economics". That echoes a comment attributed to the late Ayatollah Ruhollah Khomeini, leader of Iran's 1979 Islamic revolution, who is alleged to have said that "economics is for donkeys".
"There is an honourable butcher in our neighbourhood who knows all the economic problems of the people. I get my economic information from him," he said.
http://www.guardian.co.uk/iran/story/0,,2172852,00.html
Presidential candidate Ron Paul confronts Ben Bernanke about the economic system. He prefers the gold standard to maintain the value of the currency as opposed to the manipulation of the FED.
Interesing stuff.
http://www.youtube.com/watch?v=sVCStbbIvDg
Hi,
I would like to make exchange links.
My blog is http://TrafficGold.us
Title : Forex Blog
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http://online.wsj.com/public/article/SB119543449000297483-BXoRE495Izg5flc7Sg0s0oKF0fo_20071219.html?mod=tff_main_tff_top
According to this article Amana Funds is doing well due to its adherance to following the scholars recommendations of not investing in the finance sector.
Dear Brother Mahmoud,
Assalamualikum!
In Sukuk, if the rating agencies rate the Obligor and not the underlying assets that is their problem.
How a rating approach will make the structure non-shariah compliant? Rating has nothing to do with the shariah compatiblity.
As you are aware rating is for the comfort of the investors.
In ijara sukuks, if you feel there are numerous risks which are poorly understood both by lawyers and bankers then as a sane individual you should either tell us what the risks are or you should take up legal practice to draft risk free ijara sukuk contracts.
Arm chair criticism should not become your benchmark. Either be clear or show us how to do things clear.
Ali
http://www.ronpaul2008.com/endorsements#academics
Here is a list of academics endorsing Ron Paul. You should also evaluate his economic program and see if you can endorse him. He believes in Gold standard, small government and non-interference in foreign countries.
The famous compantion Al-Zubair practiced partial reserve banking. People used to trust him so they used to leave their money with him. He said that since he did not have a place to store all the wealth people gave him, he requested that people consider the money they gave to him for safe keeping to be a loan. And when people needed any money they should ask him and he would give them what they needed. He would then give out a good portion of the money in charity.
When he felt that he was close to his death he requested his son Abdullah to clear his accounts by various means including giving people part of the properties he owned in lieu of the money he owed them.
http://www.ft.com/cms/s/0/eae873b0-d4e6-11dc-9af1-0000779fd2ac.html
http://www.guardian.co.uk/feedarticle?id=7286868
It looks like the Shariah scholars are getting back in the game of stricter conditions on the islamic financial transactions.
We can also consider this to be the revenge of the shariah scholar against the bankers. Putting the brakes on the ever expanding industry with a fatwa.
http://money.cnn.com/2008/02/07/markets/rating_agencies/?postversion=2008020805
According to this the bond agencies are not really very reliable. So the argument that you make regards to rating the sukuk the same as a regular bond may not be a completely accurate rating.
The sukuk even with their shariah diffiency should still be rated a little riskier as their contracts make them open to litigation. For example the government can refuse to keep paying on the bond, the case could go to court and the bond holders could theoretically lose.
http://www.mikehuckabee.com/?FuseAction=Issues.View&Issue_id=5
It seems that the fair tax plan of Mike Huckabee would be shariah compliant.
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