Have we learned nothing? Here come the "Islamic Credit Default Swaps"

Mohammed Khnifer, Islamic Banking Senior Editor at Al-Eqtisadiah and Al-Masrifiah Islamic Banking Magazine, pointed out this new development to me.

In a recent article, it is reported that the end of the year 2009 was punctuated with 10 defaults on "Islamic Sukuk" (otherwise known as poorly designed bonds), and then suggested that the "experts" want Credit Default Swaps to protect investors against the risk of default on Sukuk!! Here's a translated excerpt:

A group of informed experts on the Islamic finance industry called for a "partnership" between Islamic takaful (insurance) industry and Sukuk, toward the end of assisting the latter in providing "protection" for investors against losing their funds that they invested in these Islamic instruments.

Those calls became louder after the recent registration of the Pakistani cement company Maple Leaf as the last company with defaults on its Rupis 8 billion Islamic bonds.

The experts suggested during their interview with "Al-Iqtisadiya" that Takaful companies should find a new insurance instrument for Sukuk, which can protect the Sukuk holders from the risk of default, by providing "partial" compensation in the case of default.

This only months after the conventional CDS industry nearly brought down the entire international financial system.

"Islamic finance" started with a suggestion that the "Islamic economics" philosophy rests on sharing in profits and losses through partnership (i.e. equity) finance. In practice, of course, the industry moved toward debt finance, where the only risk is default risk. Now, they want to insure against credit risk as well, which is of course possible, but defeats the entire purpose.

You see, risk -- like matter -- can neither be created nor destroyed. Sharing in profits and losses provides for continuous risk sharing at moderate magnitudes. Debt financing provides for less frequent but larger losses in cases of default. Debt financing together with credit default swaps provides for very infrequent but catastrophic systemic collapse, which is very unlikely at any point in time, but highly likely to occur sometime within an extended period.

So, the most recent crisis has not taught the participants and experts of today's "Islamic finance" much (I use the quotation marks because they do Islam a great disservice by using it as a brandname to market their grossly inferior and poorly construed products for a profit). Will the customers at least finally see that this is not an infant industry that needs to grow?