Wednesday, August 24, 2005

Transfer of ownership in qarD (loan in classical jurisprudence)

When I made an assertion that in classical loans (qarD), ownership is transferred to the borrower, someone asked "what jurisprudence are you reading?"... So, here is a short summary:

The term qarD, derived from the past tense qaraDa, means "cut-off piece", since the lender (muqriD) cutts-off a piece of his property and gives it to the borrower (muqtariD). It is a contract of exchange: The Hanafis define it as an exchange of a certain amount of fungible property now for an equal amount of fungible property in the future. The other schools define it as an exchange of a certain amount of fungible property now in exchange for a liability (debt) established upon the borrower. (See Hashiyat Radd al-MuHtar by ibn `Abidin, and Al-SharH al-Kabir by al-Dardir).

Abu Hanifa and Muhammad Al-Shaybani ruled that ownership of lent property is transferred from lender to borrower upon receipt, whereas Abu Yusuf held the minority opinion that the lender retains ownership as long as the lent property is not consumed. (Hashiyat ibn `Abidin).
Most Shafi`is and Hanbalis agreed with the majority Hanafi view that ownership is transferred from lender to borrower upon receipt (Al-muhadhdhab by al-Shirazi and al-Mughni by ibn Qudamah).

The Malikis ruled that ownership of lent property is transferred to the borrower through the contract, i.e. before receipt. They used this ruling to conclude that returning the exact borrowed property may not be allowed if the property had changed -- since it was exchanged for a liability for equal amount. (al-Dardir)

So, as we can see, the vast majority of jurists ruled that ownership of lent money would transfer from lender to borrower.

Conditions that reinforce the lender's right to repayment (including rahn or mortgage of a property) are allowed. However, restrictive conventants, that determine how the borrower must use the lent money (e.g. to buy a particular property, as in the case of secured lending operations in the west) negate ownership of that money being transferred from lender to borrower... In sales and other contracts through which property is transferred, a condition that the established owner has restricted use of the property (including the ability to sell it) are deemed invalid.

I am not claiming that this is a final analysis, only that jumping to conclusions based on classical rulings on qarD, just because one borrowed money under American laws, seems premature. Serious juristic analysis of contemporary dealings, on which the Canonical Texts are silent, and on which classical jurists could not have ruled, is required. Otherwise, we end up creating arbitrage opportunities that cost Muslim customers without providing them with value.

Monday, August 22, 2005

mortgage discussion with David Loundy -- Part II

Let me reiterate that I appreciate your professional approach, and manifestly genuine desire to serve your clients' needs. That contrasts sharply with the vitriolic approach adopted by others, which I cannot dignify with a response. At any rate, their salient points are made much more coherently in your posting. Consequently, I hope that we can continue this dialogue.

I appreciate that you have superior knowledge of law and banking, and -- as you suggested in our earlier correspondence -- I am sure that I will learn from this dialogue, and hope that you may find it useful as well.

This is the second installment of my reply to your message regarding my mortgage challenge. For brevity, I am only quoting the sections on which I have comments, or which directly address my earlier assertions.

On Aug 20, 2005, at 12:40 PM, David Loundy wrote:

Next, you mention an institution that is facing penalty taxes due to use of an ijara transaction where the institution does not get the real estate tax exemption that applies to religious institutions. This is exactly the case that resulted in our creation of a murabaha product in the first place instead of using the ijara product that we had already developed. In this case, the legal mechanism employed does matter under U.S. law and produces a different result from a conventional mortgage. This argues in favor of a difference between conventional financing, not against. Yes, it is an increased "Cost of Being Muslim" (COBM), but it is a cost incurred BECAUSE there is a substantive difference-- the religious institution does not own its property. We run into this problem, and variations on it, frequently. Generally, the COBM for us on a transaction is very small, but tax issues can make a big difference to “special cases.”

I understand that some Muslims may feel that a "cost of being Muslim" or financial sacrifice is personal proof of piety. I do not feel that way. It is a general doctrine in Islamic legal theory (e.g. according to Al-Shatibi) that nothing purely useful is forbidden and nothing purely harmful is allowed, and in cases of mixed good and harm, the Law (Shari`a) aims to maximize net benefit. I recall in our private correspondence that you mentioned one of the younger scholars on your Shari`a board appealing to this COBM feature as a good thing. I disagree. Unless there is a proven benefit [worldly benefit] outweighing the harm, I cannot believe that the Almighty would require a financial sacrifice just for its own sake... Since there is no Canonical Text directly dealing with the case of mortgages, I find any jurist's analysis that relies on such claims to be unconvincing.

[Paragraph on IRS and 1098 forms: I sympathize, and hope that the IRS will issue an opinion.]
[Paragraph on Reg. Z "truth in lending": I am glad that US regulators are forcing providers to report the APR, and not to charge customers interest -- in the case of Murabaha -- despite pre-payment... At any rate, the OIC has allowed "Da` wa ta`ajjal", or discounting of debt for prepayment, which keeps you on the good side of traditional Shari`a scholars.]

Next, you have quoted Mohammed Fadel's distinction between equitable ownership and legal ownership as one with significance, but it is not. In part, this is an issue of timing and execution of the documents. If the documents are signed and recorded in the correct order, even where a mortgage, or "deed of trust" in some jurisdictions, conveys title, it is title that is conveyed only AFTER legal and equitable title has been transferred from the supplier to the bank and then on to the customer. All of the rights of the parties have properly attached, and in the correct order. Thus it IS true that you own the property, and in full—at least initially. First year law school property classes refer to property rights as analogous to a "bundle of sticks" which can be passed as a whole or divided up.

We teach the "bundle of rights" definition in undergraduate "Law and Economics" classes as well. This is a good point to recognize that classical Islamic jurisprudence evolved at a relatively early (primitive) stage of legal development, and thus resulted in a very limited bundle of rights recognition: You can split ownership of the property itself and ownership of its usufruct, and potentially divide those ownerships in unspecified co-ownership shares. Other than that, the only remaining rights are easement rights (Huquq al-'irtifaq), pre-emption rights (Haqq al-Shuf`ah) and possible entitlements ('istiHqaq). When property is used as security for debt (rahn), the mortgagee also has a right to extract the debt upon default.

Interestingly, even with this simple classification, jurists managed in the Albaraka London fatwa on real estate financing via Ijara to allow title to pass directly to lessee and eventual buyer: The mortgagee passes ownership of the property itself (milk al-raqabah) to the ultimate buyer, but retains ownership of the usufruct (milk al-manfa`ah), and collects rent accordingly through the lease period. This was derived from an old Shafi`i justification of sharecropping. This opinion, as I mentioned in an earlier posting, was signed in 1990 by Justice (retired) Taqi Usmani along with other prominent scholars. Why was this structure not used more recently to avoid the tax problems that we both agree should not be there?

I apologize for the digression... next you said:

At this point, the whole bundle is yours. Only then do you convey away part of your interest (one of the sticks in the bundle)-- only then is the legal and equitable title bifurcated by the customer/property owner as a means of securing its agreement to repay the incurred debt. If you gain ownership of the property and then run out of the closing without executing the mortgage, there is no mortgage, and thus no security for the debt. (However, you have a breach of your obligation and will 1. be sued, immediately; and 2. may not have your deed recorded by the title company which may result in the "defeasance" of any ownership.)

While your timeline explanation (and solution in the sequencing of an Islamic closing described in later paragraphs) seems compelling, I do not feel that it makes the difference between riba and non-riba: Allow me to paraphrase your description in terms of the existence of a short period of time when I theoretically have full ownership of the property (the full bundle of rights associated with ownership), before passing some of those rights to my mortgagee. Then, you say that the only way to make use of that full ownership is to try to run and register the title illegally (which may have been possible in the wild wild west, but seems logistically very difficult), which -- of course -- I would not do as a Muslim, and would have to face legal
consequences if I do.

In addition to the illegality of taking advantage of this short period of time during which all ownership rights are united in my possession, the formalistic difference between this and the "Islamic" alternative is very reminiscent of the assertion that bank ownership of the property of a very short time in Murabaha justifies "profit" in the ensuing credit sale (when in fact the return is clearly compensation for time and credit risk). In both cases, there may be a formalistic point, but one that is neither practical nor economically meaningful. It is impossible for such formalism devoid of economic content to justify the difference between permissible trade and forbidden riba.

You state that the bank never gave you the money, but I have confirmed with a real estate lawyer my earlier comments to you about agency. Essentially, yes, the bank did give you the money, via your agent.

Even if it theoretically "gave me the money" in the sense of paying it in my name, that is not the same as "lending me the money" in the juristic sense of qarD. (I just saw that someone has sent a vitriolic message as I am typing this asking "what jurisprudence I am reading"... for now, I assure you that very respectable classical jurists determined that lending of money would imply change of its ownership to the borrower-- which suggests that to borrow the money, I should be able to take it from the agent to do something else with it... I need to write a separate message citing the various opinions about ownership of lent property). In fact, having money "given to me" or "paid on my behalf" and tied to a particular transaction is a new form
of secured lending that cannot simply fit into the classical mold of "qarD".

[Lengthy discussion of role of Title Company, which I may have to address in a third installment. I had promised earlier in private to take a closer look at the argument, and hope to do that shortly. However, you can already see that I am leaning towards dismissing those temporally brief formalistic distinctions that carry little, if any, economic value]

You also state that if this were a real loan under Islamic jurisprudence then you could take the bank's money and use it for any purpose. Here, you are perhaps caught in an inter-legal system difference. In a conventional loan, under U.S. law, it is conditional. It is a loan of money being given to you for the specific purpose of acquiring a specific piece of property-- it is a mortgage loan, not a personal loan. Theoretically, you could take the money and buy something else-- money is money. However, this money comes with strings attached, and you'd also be buying at least one lawsuit (probably two). Practically, it will not happen because of the dual agency of the title company, and because the bank does not bring a suitcase of negotiable cash to the closing. Your agent, that receives the loan proceeds that your agent then conveys to the house seller, is also the bank's agent to make sure that the bank's collateral is in place, and if you try to divert the funds a check can be stopped.

This is precisely my point. I will make a separate posting on the nature of qarD in classical jurisprudence,
and the legitimacy of a "conditional loan with tied strings" in the classical sense of "qarD".

So, I invite either your convincing replies, or your new murabaha application…

As you can see, I am still not convinced. I think that the Shari`a arbitrage opportunity that has led to this brand of Islamic finance comes precisely from anachronistic translations of words like "loan" and "qarD". When jurists trained in that classical tradition see a document that says "loan" and "interest", they immediately feel compelled to say "Oh, that is riba" [although, as an aside, you can see from my weblog postings of the Rachid Rida manuscript, the idea that any increase stipulated at the inception of loans is riba is itself doubtful, as there is no acceptable Canonical Text justifying it, and the report is that Abu Hanifa considered it reprehensible, which means that he did not consider it riba]. Be that as it may, my argument is that this
is not necessarily a "loan" in the traditional sense anyway, but a relatively new transaction for which serious ijtihad may reach divergent conclusions. So, while the majority of contemporary jurists would deem it ribawi, that is not the nature of my challenge, and I appreciate your effort to address my concerns as an observant Muslim who nonetheless needs to be convinced... Of course, there is the suspicion of riba, as I cannot definitively prove that my mortgage is not riba. That leads to the issue of looking at "Islamic" alternatives and determining if there is sufficient substantive difference to reduce that suspicion of riba (which is difficult when the resulting "note" will be sold to Fannie Mae or Freddie Mac at any rate).

I suspect that there are hundreds of millions of Muslims like me, who are not convinced that what they are doing is indeed riba, or that there is sufficient substantive difference between what they have and what "Islamic finance" offers to conclude that one is riba and the other is not. An argument that convinces me can probably convince a large segment of that Muslim middle class, and thus would give a great boost to the industry. Otherwise, even if current arguments are not convincing to a sophisticated Muslim middle class, perhaps the dialogue can lead to other possibilities that will be more attractive to that group of Muslims whose views I hope to be representing honestly.

Sunday, August 21, 2005

Mortgage discussion with David Loundy -- Part I

AA David:

Thank you for taking your responses, and our debate, public. I appreciate your recognition that my challenge is legitimate:

On Aug 20, 2005, at 12:40 PM, David Loundy wrote:

So, I invite either your convincing replies, or your new murabaha application…

I have to admit that so far, your arguments are the most convincing. However, as the challenge is posed, the onus of the proof is on you/others to prove that my conventional mortgage is indeed riba, since the default in transactions is permissibility. So, all I need to do is to prove that your arguments are not convincing.


To carry on our discussion we had before I left for time away from the office with children (not to be confused with vacation), to recap for those on the list, and to pick up some of the new points:

First, I have a threshold question which you have not answered, and to which I do not know the answer, not being a Muslim jurist: If you sign a contract that contains a prohibited provision-- such as a default interest rate or other "inappropriate" penalty which penalizes you for hardship, is that prohibited even if you never incur the hardship that makes the penalty apply in your particular case? If it is prohibited, than your mortgage is riba, end of discussion.

I view the late payment provisions, if I make them, to be definitely riba. This condition becomes a riba contract only at the time the debt matures (each payment is due). So, if I make my payments before their due date (which I do automatically through direct electronic transfers), I can argue that the ribawi contract (more time for more money) never took place.

Now, I admit that there is a condition in my otherwise valid contract, financing my home purchase, which says that this riba contract would take place if I do not make my payment on time. I have taken precautions to never make that condition effective, and I have other options, such as selling the house, etc. to ensure that it never does.

The issue you raise is an important one: does that penalty clause render the entire contract ribawi?

You say that you are not a Muslim jurist, and neither am I. The discussion below reports from the section on "Invalid or nugatory conditions" attached to an otherwise valid contract - see that section on pp. 128-131 vol.1 of my translation of Dr. Wahba al-Zuhayly's jurisprudence encyclopedia (would be delighted to send you a complimentary copy if I hadn't already done that). The original thought on the issue raised a difference in opinion between Abu Hanifa and his two students Abu Yusuf and Muhammad Al-Shaybani. While Abu Hanifa deemed an otherwise valid contract with a defective condition defective, Muhammad and Abu Yusuf deemed the contract still valid, and the invalid condition nugatory. The latter is the opinion widely accepted by the Hanafis, as reported by ibn `Abidin.

I think the nugatory nature of the condition is strengthened by the precautions and plans I have taken never to make those late payments. Note that this is also the solution I have chosen when I rented an apartment, to make sure that I do not pay late payment interest on my rent, which is also a requirement of all rent contracts that I have seen. I treat my utility company contracts, credit card contracts, etc. the same way: negating the invalid ribawi conditions.

Notice that even if you accept the stricter opinion that the entire contract is defective, then you have to make it something else. There are many cases in Saudi Arabia, for instance, where debtors went to Shari`a courts, and had the ribawi components of contracts they had written revoked (to the chagrin of the bankers with whom they had signed contracts, as you might imagine). A number of lawsuits involving western companies have been taken global, with experts such as Wael Hallaq and Frank Vogel making the arguments regarding Islamic law before western courts.

In summary, I have strong authority backing the view that this condition is invalid from an Islamic point of view, but the contract itself remains valid and not ribawi.

(This posting is already getting long, ... I'll address the other issues you raised, in sha'a Allah, in separate posting[s]).

Saturday, August 20, 2005

Another mortgage discussion (with Abdulkader Thomas)

Abdulkader posted his reply to my mortgage challenge on ibfnet. The following is my reply to his. As usual, my own comments are in black, and my interlocutor's are in red and indented:

wa `alaykumu s-Salamu wa raHmatu Allahi wa barakatuh

Thank you very much Br. Abdulkader for an interesting, if predictable, response to my question about whether a conventional mortgage is riba.

In what follows, I shall respond to your posting section by section. However, I would like to begin by summarizing the main points where I think that your assertions are incorrect:

1. You claim that I borrowed money from the bank, when in fact that never took place, from a juristic/legal viewpoint. In Islamic jurisprudence ownership is transferred through a qard (loan). This would mean that the bank would have given me cash, which I could have used any way I wanted... The concept of "secured lending" as it exists today in the west was alien to classical jurists, and hence using the documentation of debt via a "loan" contract as proof that I borrowed money is fallacious. The anachronistic analogy to a medieval transaction where I borrowed the money first, then used the property as a rahn (pawned object) to secure the debt is incorrect, since the bank would never give me any period of time within which I could have run with the money and done whatever I want with it, and the seller would never give me a clean title, knowing that the bulk of his price is collected from the mortgagee (see point 2).

2. It is not true that I "own a property" when the bank has a lein on it, if you would allow me to quote Mohammad Fadel's comment on the issue on my blog, he said:

From the perspective of a lawyer, the transaction you describe has two aspects: one contractual and one relating to property rights. Mortgages are interests in property, in this case, real property, and under the common law, title exists in two forms, legal and equitable. When a person purchases a home with borrowed funds, his obligation to repay that money is contractual, and is documented by convention in the common law as a loan. If he grants a mortgage to the lender as security for repayment, he is transferring legal title to that property to the lender, until such time as he "redeems" his title by paying off (typically) all amounts owed to his lender under the loan contract. The mortgagor retains what is called "equitable title", since he retains the right to use the property and the right to redeem the property on condition of repayment of the loan. As a purely formal matter, therefore, the payments are not in respect of the mortgage, but rather in respect of the loan. Once the loan is repaid or otherwise discharge, the mortgage is "redeemed" and legal and equitable title are united in the owner (resident) of the house.

To repeat, the bank never gave me money, but only paid the balance of my home price on my behalf, and in essence retained legal title through the lein/mortgage, while my debt -- documented as a loan -- was being repaid.

3. The claim that substance trumps form is the way economists think is definitely true. It is also the way good jurists think, as ibn Qayyim al-Jawziyyah devoted an entire section in a`lam al-muwaqqi`in which he labelled "al-`ibrah fi al-`uqud bi-l-ma`ani, wa laysat bi-l-'alfadh w al-mabani" (what matter in contracts is substance, not terms and forms).

4. The claim that forms marketed as "Islamic" are different and that differences in form can entail differences in substance is also true. However, it does not follow that those differences ensure absence of riba in the resulting contract... If it is not accepted that the contract being replaced constituted riba, then adding those differences -- at a cost -- becomes very questionable.

I just happen to know of the principal of an Islamic school in CA who is in dire straits because he financed his non-profit Islamic school through an ijara wa iqtina' of the form you discuss (from a provider that you know well). He was shocked to learn that he owes many thousands of dollars in taxes, because the property title is not in the name of his non-profit school, but rather the SPV created by the Islamic financial provider.

This is the outcome of requirement that title is not in the ultimate owner's name. Mind you that Albaraka London had a fatwa, signed by Taqi Usmani, Yusuf Al-Qaradawi and others in 1990, that allowed title to pass straight to the eventual buyer in a lease-to-purchase.

There are so many other things that are wrong with the "Islamic" models that I will restrict my point-by-point responses to the more important issue that I raised: Is my conventional mortgage riba? Obviously, if I am not convinced that it is, then there is no need to migrate to a more expensive and ill-conceived alternative. (I so wish that Islamic finance was about something Islamic!).

Date: Fri, 19 Aug 2005 13:37:21 +0000
From: "Abdulkader Thomas"
Subject: FW: Dr. Elgamal's challenge

As salamu alaykum, Dear Fellow IBF Members, Please find below a practical analysis of an American mortgage loan and some points that demonstrate it to be ribawi.

The mortgage loan process in America works something like this:
1. The consumer goes to a bank or mortgage broker and applies for a loan.

In fact, I never applied for a loan separate from the property. I was referred to my mortgagee by the builder of my home. Then, I was "qualified" for secured mortgage-loans (not the same as qard, as argued above) up to some level of debt secured by a primary family residence, having already known the property builder, etc.

a. The loan, at this point, is unspecific and unconnected to a property.

Not true. There was no loan at this point, and never any "loan" in the sense
of qarD, whereby I would have owned the money and possibly used it to buy
a Bentley instead of my house.

b. The consumer qualifies for a loan amount based on how much he or she earns and what is his or her credit score; some ratios may be taken into account.

This is the same qualification process used by Islamic banks or any others. The question is simply whether or not the consumer can afford this property,and whether or not the financier/mortgagee would be taking too large a risk by investing in this credit.

c. The loan is "pre-approved" subject to certain conditions including an
appraisal of a property that will secure the loan.

Again, characterizing it as a "loan" is equivocal. The financier approves becoming a creditor to the home-buyer for an amount not to exceed a certain dollar value, and subject to the buyer holding sufficient home equity (determined by the appraisal and down-payment) to ensure that the mortgagee/creditor is not taking too much risk. That that debt is documented by a "mortgage loan" document does not make it a loan in the classical juristic sense of qarD.

2. The consumer contracts to buy a property.

This contract was never drawn independently from the mortgagee providing the funds with which the property is bought. We agreed on the property specifications, then they referred me to the bank to see if I can get funding, the bank agreed that
I qualify for the balance, based on my salary, etc., I made a first payment to begin the building, and that's how it started.

3. Any loan conditions are met and the property appraised.

The appraisal was done before closing, but approval was made based on thebulider's pricing formula for given specifications.

4. At the closing the lender funds the money on the consumer's behalf to an independent party (this is a legal requirement due to fraud in the 1960's) and the independent party manages the closing; delivering the consumer's down payment, the loan proceeds and any other requirements to the seller in exchange for title to the property

This is an accurate description of the Title Company's role as a mutual agent for me, the mortgagee and the seller (in my case a building company that had built my house to certain agreed-upon specifications, and only after they received
part of my downpayment, proof that I have the rest of the downpayment, and proof that the mortgagee will pay the balance).

5. At the closing, there may be 50 documents, depending upon the state in which the loan is made, three of them are contracts under American law:
a. Contract 1: The Purchase Contract: This is the contract conveying the property from a buyer to a seller subject to specific conditions and for financial consideration, i.e. give me money and I will give you title.
b. Contract 2: The Promissory Note: This is the evidence of a loan or debt and the maker, Dr. Elgamal in this case, promises to pay a set rate of interest for a specific period. He also promises to pay penalty interest at a specific rate if he is late in making his monthly payments. If he does not pay for three months, the lender will take the note to court in order to seize the property under the terms of the next item.
c. Contract 3: The Mortgage: this is a specific lien on the house mandating specific behavior by the grantor of the security, again Dr. Elgamal. When the note is presented to a court, the mortgage allows for the note holder to seize the property and take title.

The bare-bone structure of those three contracts are what I characterized as:
1. Some money from me and some money from mortgagee to seller/builder,
2. Property title from builder to me, simultaneously lein to mortgagee
3. Note promising that I will make payments to bank
No money-for-money transactions between any two parties!

As I mentioned in my previous response to Hood, the late payment interest provisions are definitely a defective condition, but I nullify it personally by planning never to make such payments -- giving up the property, declaring bankruptcy, etc. to avoid it. The same applies to credit cards, which I use for travel, my rental agreements when I rented apartments, and my past and
present utility companies, all of which would require me to pay interest if I am late.

The fact that the creditor can seize the property is the very nature of mortgage. Indeed, form a pure banking viewpoint, if you do not have the luxury of charging interest on late payments, you as mortgagor (Islamic or otherwise) would be much
more likely to foreclose earlier, to cut your financial losses. As one provider of Islamic mortgages told me in private correspondence "yes, of course, that's how a banker or economist would think about it, but we keep this out of our
sales pitch".

6. Curiously, if Dr. Elgamal wishes and can find the lender, then he can sign more notes and grant second or third mortgages that represent loans far greater in value than his house. These are home equity loans or second (third.) mortgage loans.

First of all, it is highly unlikely that any bank would give me a second mortgage exceeding my equity in the property. Second, if I were devious, what is to stop me from getting an unsecured loan? The point again is not whether there are options to pay illegitimate interest, but whether I am forced to engage in riba.

In summary, Dr. Elgamal contracted to borrow money.

False! I never owned the money, and hence I never borrowed it. I engaged in a debt contract, yes. The bank paid for my house, and in some legal sense co-owns the property. I owe the bank for what it paid on my behalf, and that debt is documented as a "loan" for my protection. That does not make it a loan in the classical sense of qarD, and I certainly never borrowed money (see 1. above).

The terms of the loan were interest for a specific period; a grant of sufficient security (the house);

I have not read the word "interest" in the Qur'an and Hadith, only "riba". From where I stand, and where regulators stand under Reg. Z "truth in lending", what you call profit in murabaha or rent in ijara *is* interest. There is no finance (Islamic or otherwise) without interest (in the modern sense)!

Moreover, all providers of "Islamic mortgages" in the U.S. of whom I am aware send appropriate form 1098 to their debtors to deduct the "mortgage interest" on their personal income tax forms -- despite the tragic fact that the IRS has never ruled that they allow this!!

and an agreement by Dr. Elgamal to pay more interest if he is ever late. The bank did not insert itself into the sales process or title and takes its primary risk on Dr. Elgamal being able to pay with a secondary risk that the value of the house as collateral will be less than the value of the house.

Where does it say in the Qur'an and Sunnah that the bank had to do any of this? The mortgage transaction is a modern one, on which the Canonical Texts of Islam are silent. Contemporary jurists (who happen to be on the payrolls of "Islamic financial providers") have reasoned that way, thus creating an arbitrage opportunity. I am questioning whether I should pay the rents that come along with the costs of arbitraging it.

Let's compare this process to an ijara wa iqtina transaction, currently not available in Texas where Dr. Elgamal has borrowed money, but with which I am very familiar.

Not to advertise for anyone, but at least one provider that I know does
operate in Texas, and they describe their model as one based on lease.


The rest, deals with ijara wa iqtina' as offered in the U.S., which can be
the topic of a separate discussion, if you wish.

Thursday, August 18, 2005

Finance Professor puzzled by Islamic mortgages

In his blog last week, Jim Mahar expressed his incomprehension of the prohibition of interest. He said that Christianity eventually reached the conclusion that it is usury that was forbidden and not interest. Of course, the term usury itself was used differently at the time Luther and Calvin struggled with this distinction, since many had used the two terms interchangably, "Ocker" being the name they gave for the Hebrew ribbis or Arabic riba.

Jim wonders if Islam will ever reach the same conclusion. Of course, as I had indicated in previous postings, there have been somme jurists who tried to address the issue, in effect leading an Islamic reformation early in the Twentieth Century. It is difficult to tell from where we stand today whether that effort failed because it failed to capture the essence of Islamic and Biblical law (which is more than just avoidance of excessive indebtedness), or because it failed to justify an independent "Islamic finance" (which seems to have become an end in itself). I have argued elsewhere that the issue -- following the analysis of ibn Rushd (see my previous postings) -- may be more about fairness in exchange, regardless of the value of the interest rate. In other words, interest below the proper value is just as bad as interest above, and interest above the proper value is unfair even if it falls below the benchmark for predatory lending or usury. In my paper on riba, I have argued that the issue may be one of marking the time value embedded in any particular contract to market, to ensure equity/fairness in exchange.

The dangers of Islamic finance fatawa

In his comment on an earlier blog post, heraish pointed me to this article on "random fatwas" affecting investment patterns in Saudi Arabia. His prescription, and the one endorsed by the article, is to follow the opinions of some higher council or academy of specialized `ulama. While this approach would add some predictability, and reduce confusion in a period of market development, it has its great shrotcomings.

The first problem is that traditional `ulama, including specialized ones, have a very limited understanding of the economic and financial issues with which they deal. For instance, I gave the example of the strange and economically incoherent fatwa regarding indexation by the OIC Fiqh Academy, which is perhaps the most respected international juristic body.

As if jurists' misunderstanding of economic and financial affairs, and their inability to reason coherently on such issues, is not enough, Islamic finance has now made jurists the gate-keepers for new innovations, the market effects of which are often not known even by bona fide financial experts. Shari`a board-certification of products is solicited before the products are offered, and the possibility of abuse to effect riba and gharar -- or lack thereof -- is not yet understood.

The institution of fatwa (responsa) was put in place so that jurists/mufti who fully understood the circumstances of the mustafti (questioner), and fully understood the issue about which he was asked, can tell the questioner whether or not a specific activity violated Islamic law. Making jurists part of financial engineering and product development, under the excuse that this ensures Islamicity of the products, is the ultimate in incoherence, for even a very informed jurist should only be able to issue such an opinion after they have observed the product in action for some time.

The net result is very bad finance, which frustrates true innovation, Islamic or otherwise. Moreover, many of the rules devised by jurists (e.g. the incredible one-third debt to market capitalization screening rule that forces Muslims to buy-high and sell-low!) become difficult to replace, even if their financial effects are proven to be disastrous, and/or if they are found later to be ideal vehicles for effecting the forbidden riba (if at a higher cost).

Wednesday, August 17, 2005

Exchange on conventional and "Islamic" mortgages

The following exchange took place today on IBFnet. My interlocutor's remarks are indented and in red, mine are in black.

Salaamu Alaikum


After asking around here is one answer that i got:
"There are two problems with the mortgage as Dr. El-gamal explains it.
1. The ownership of the house is transferred directly from the first owner to the customer. The bank never owns the house at any stage during the process. This means that the bank is making money just for money. It is making profit without assuming liability of the asset ربح ما لم يضمن) which is riba from the lender's side.

This is not a convincing argument. The bank, Islamic or otherwise, makes profit based on the differential between its cost of funds and the interest rate it charges the customer, even if the latter is characterized falsely as profit in a credit sale. The guaranty (ضمان) ostensibly existing in a murabaha financing transaction is comical: it lasts for all of 30 seconds, and even then, there are sufficient insurance and other provisions to make sure that this risk is never carried by the bank. Characterizing the total interest payment (which could be as high as 200% of the original price) as profit and justifying it by that theoretical guaranty is a symptom of the irrationality characterizing Islamic finance.

Let's call things what they are: the bank makes a profit on the differential between the interest it pays for its funds (directly or indirectly) and the interest it collects from its financed party. The justification for that profit is the usual battery of risks to which conventional banks are exposed (credit risk, which included an implicit guaranty of the borrower, especially if the bank issues a mortgage backed security, liquidity risk, interest rate risk, etc.).

The fact that the customer never receives cash denies riba from the borrower's side. But riba does arise from the lender's side
as it is money for money without ownership in between. To describe a transaction as "riba-free", BOTH sides must avoid money-for-money.

Well, that is not that mode of operation in Islamic banking! The HSBC FAQ issued a few years back regarding their auto financing in UAE said that all the customer should care about is his relationship with the bank. The bank's source of funds, dealings in riba, benchmarking of the "profit rate" to ribawi rates, etc. are all irrelevant. That was the declared opinion of their Shari`a board.

Let's also recognize that banks are not in the business of buying and selling houses: it is still money for money regardless of putting a piece of property in between... As the Arabic proverb says: ذهب بذهب و بينهما حريرة
If you accept this paradigm of a degree of separation, the bank still never has a money-now for money-later with any one party... which is the narrow demarcation of riba. It is a triangle transaction, money now to seller, money later from buyer... where is the riba?

2. The contract allows the borrower to refinance and reschedule etc. This is riba al-jahiliyyah, for both sides: the lender and the borrower."

Well, if you make what the contract allows for to determine what constitutes riba al-jahiliyyah, then you should condemn all apartment rents, utility company contracts, etc., for they all include provisions for late payment penalties which would constitute riba al-jahiliyyah. A much easier makhraj would be to say that I have no intention of making such late payments, and would sooner sell the property or declare bankruptcy than get involved in that riba al-jahiliyyah, which would result in a war from Allah and his messenger.

Thus, the conditions for refinancing and rescheduling, etc. are defective conditions appended to the contract, and following a famous rule, consider those defective conditions nugatory, but keep the contract as I plan to follow it valid.

Obviously the issue of whether the mechanics of the "Islamic" home financing and those of a conventional mortgage are one in the same is a different issue, but as quoted above can the the main difference be mere liability assumption? or must the "Islamic" contract differ in more than this?

And if there is no difference, how can you justify charging the Muslim customer more for selling what is essentially an "indulgence" (a note from a jurist certifying that you and they have done your best)?

I would also like to hear, preferably from someone in an institution dealing in such contracts, about the contract stipulations that are a matter of venue and are not present to make the contract particulary "Islamic" in other words if you didnt havent to hurdle the regulatory systems of many countries would these contracts be one and the same? or would stipulations and conditions be left out?


Interestingly, many of those provisions, such as documenting the debt as a loan, listing the annual percentage rate being charged, etc. are means of protecting the Muslim consumer. I would loathe to think that it would be more "Islamic" to have less transparency and no "truth in lending" provisions, when the nature of the contract is clearly one of finance and not trade.

Tuesday, August 16, 2005

Failure of Islamic finance in Sudan

At a recent interview with, Hassan Al-Turabi admitted the failure of his Islamic experiment in Sudan. He indicated that he has come to admit that this was a human effort, and like all human efforts, it was imperfect and it has failed. He said that his was an experiment in the Sunni Islamic world, and hinted at another experiment in the Shi`i world (I assume he meant Iran), indicating that both have failed. However, he said that one should learn from those failures, rather than feel despair. Unfortunately, the bulk of the interview focused on the new constitution, the relationship with the South, etc. I wish the interviewer had asked him about economics and finance.

So, I went ahead and made my own interview with a friend who has done some significant work trying to fix the Sudanese economy over the past few years, after it was falling down the drain. His prognosis, which he says officials in the central bank, bankers, etc. would admit in private, is that "Islamic finance" has virtually destroyed the financial sector in Sudan. While the "Musharaka certificates" have been popular with Islamic banks, who hold them to maturity, that is mainly a signal of the lack of other investment vehicles or credit creation. My friend said that the list of failures was too long, but the most important effects of years of bad economics is the central bank's loss of control over the money supply, and its inability to conduct monetary policy more generally, due to lack of open market operations. The misconceived Islamic finance experiment in part contributed to de-monetization of the Sudanese economy, with estimates of money supply to GDP at a disastrously low 12%.

In economics as in politics and military action, jumping before you calculate future steps often leads to disaster. That has been the Sudanese tragedy of following the fantasies of idologues. Islamic scriptures and traditions have much to offer, and the first lesson of early Islamic history is care in making any changes, and openness to borrowing successful models from other traditions. The Prophet (p) and his companions (r) were very pragmatic people, who sought knowledge and expertise wherever they found it, to the point where the Prophet (p) told his companions "you know more about your worldly affairs, "أنتم أعلم بأمور دنياكم", and the Qur'an orders us to seek knowledge from those with expertise "فاسألوا أهل الذكر", and yet, Islamic economics has set as its aim to replace advances in economic thought, rather than to build on those advances in light of scripture. The result has been catastrophic... Have we learned that lesson, as Al-Turabi has said, or should we expect other Islamic countries to repeat the same tragic mistakes?

Sunday, August 14, 2005

Inconsistency with pietist views

A friend sent me the following question by email:

Salamu alaikum,

That is interesting. I have a pdf here that seems to indicate Prof. El-Gamal considers conventional loans non-permissible, by virtue of his discussion on permissible Islamic loans. Yet his blog asks the rhetorical question: is there really a difference? Am I missing something?

I replied as follows:


The primer was written from the vantage point of those in the Islamic finance industry. From that vantage point, interest-based loans are definitively a form of riba, and trade or lease-based alternatives are good "makharij shar`iyyah" (means of reaching a licit end -- in this case extension of credit -- without violating forbidden forms that were often used to harmful end -- i.e. usury).

In my academic writings (see, for instance the paper on economic explication of the prohibition of riba, and the paper on interest and the paradox of Islamic law and finance -- which discusses the Azhar fatwa, what constitutes a loan, what constitutes interest, and what constitutes riba), I alternate between this view and my view as an economist. That is, I alternate hats to uncover paradoxes in the classical juristic analysis.

I guess [name] is uncomfortable with this approach, since religious issues are usually discussed in "black and white" fashion, and we expect every religious legal question to have one correct answer. That is far from obvious, of course, given the analysis, e.g. of Al-Amidi, and the famous example of "do not pray `asr except in the village of bani Quraydhah".

To recap: the primer was written for a pietist ISNA audience, to explain how Islamic finance addresses their concerns, and thus written from that vantage point. The bulk of my writings, on the other hand, tend to focus on substance rather than form, and to question the legitimacy of the pietist viewpoint adopted by Islamic finance, its jurists and its customers...

It is interesting in this regard that the pietist-minded exposition in the primer is widely read, but the critical analysis of its content isn't nearly as widely read. That would be like reading Al-Ghazali's _Maqasid al-Falasifa_, without reading _Tafafut al-Falasifah_, the latter part requiring the former and requiring its writing.

As for what I "consider permissible" or "consider non-permissible", that is totally irrelevant. For one thing, I am not a jurist, and therefore my opinions carry no juristic weight. Rather, I try to dissect the issue from different angles, challenge the assertions made by various parties, and hope that readers will make up their own minds... In most cases, those issues are best presented in the form of paradox, by switching from one vantage point to the other. That is a standard style, e.g. used by Martin Luther to communicate to his readers through paradoxes requiring resolution.

(Note: I do not mean to compare my meager contributions to those of Al-Ghazali or Martin Luther, only to suggest that their methodologies are useful to emulate).

A painful question following khutba

This Friday, I gave a khutba at our local mosque on the institution of fatwa and its abuse in Muslim communities. My main point was that fatwa plays different roles at the individual and collective levels, and we do not use it correctly. The argument went as follows:

  • We all wish to apply hukm-ullah, and I seriously doubt that any of us transgress against indisputable Canonical Texts with indisputable import (نص قطعي الثبوت قطعي الدلالة), e.g. by eating pork despite the clear prohibition in the Qur'an. So, let us recognize that issues addressed by fatwas are by definition issues where there is no definitive knowledge, but only opinions.
  • Choosing always to follow the strictest opinion on each issue is incorrect, since that would constitute (التنطع), which was explicitly forbidden by the Prophet (p) (هلك المتنطعون x 3), where (تنطع = الأخذ بالعزيمة في موقع الرخصة), and also contradicts the established sunnah of always taking the easier of any two options, as long as it's not a sin (ما خير صلعم بين أمرين إلا اختار أيسرهما ما لم يكن مأثما).
  • Equally wrong would be going to the other extreme, and searching for the easiest opinion on each sup-issue, which can lead to permitting what was forbidden -- thus leading to the classical requirement to follow a single madhhab to avoid such violation of Islamic rules through what got to be called (تتبع رخص المذاهب).
  • So, on all fatwa issues, we seek opinions with which we are comfortable, based on the proof from Qur'an and Sunnah (multiple quotations here from ibn Qayyim's A`lam al-Muwaqqi`in, regarding the impermissibility of seeking opinions without "knowledge" or proof from Qur'an and Sunnah, which Al-Shafi`i likened to collecting fire-wood at night, and carrying it without knowing if there is a snake therein that will bite). We should share knowledge, in the form of such proofs, but should not transmit fatwas blindly, as Abu Hanifa forbade transmission of his own fatwas without knowing the grounds upon which they were issued (which include the specific circumstances of the questioner, the Texts he used as proof, and the grounds for applying those Texts to this instance).
  • As we share knowledge as part of mutual advice (تناصح), we should accept that on issues where there are differences in opinions (requiring fatwas), different people should be open to accepting different opinions that they find compelling based on circumstances and mufti-proof. We should not denounce one another based on issues of furu` (legal details) where we follow different opinions (citing Imam Malik's famous letter to the Abbasid Caliph, refusing to put his Muwatta' in side the ka`ba and enforcing its rulings throughout the empire, wherein he told the Caliph that the Prophet's own companions differed in opinion regarding furu`, went to different lands, and each thinks himself right).
  • That applies on the individual level, where tolerance for informed differences in opinion should be the norm. However, there are many aspects of religion that are by definition social in nature (e.g. congregational prayers, time of commencement of Ramadan and Shawwal, etc.). In collective matters for which legal norms exist, we should simply follow the law of the land. On community issues in non-Islamic countries (such as the examples cited), our institutions may seek a fatwa, and we may try to influence the collective decision through consultation (shura), but in the end, we should follow one rule. As proof for this, I cited the Prophetic tradition that "you may join people who pray at the wrong time; so pray in your homes at the time you know to be right, and then pray with them, and consider it a super-erogatory prayer, قد تدركون قوما يصلون الصلاة لغير وقتها فصلوا في بيوتكم للوقت الذي تعرفونه ثم صلوا معهم و اجعلوها شفعة). Similarly, I cited the famous refusal of Abu Hanifa to issue a fatwa for the people of Madinah, while they had Malik as their mufti, and `Umar's insistance that the companion who returned from Damascus fast a 31st day in Madinah, despite having cited the hilal earlier in Damascus, and having already fasted 30 days based on that citing.
  • Unfortunately, I argued, we have reversed the approach to fatwa: trying to impose our own accepted opinions on others on individual issues, and then partitioning the community on social issues (such as commmencement of ramadan, eid, etc.) by soliciting fatwas from different far away countries. (Those familiar with ISNA's problem a few years ago based on a fatwa by Justice Taqi Usmani -- that we need not align eid al-adha in the US with the day after Arafa -- would know what I mean, but I did not raise the issue explicitly in this khutba, since the point was not specific fatwas, but our use of those fatwas that relate to social issues, where we should settle on one opinion, even if we think that it is wrong).

After the khutba, someone came and asked me "I am studying to become a loan-officer, but people tell me that this is haram riba, and I shouldn't do it. They are right, aren't they, that on the issue of interest, there are no specific circumstances to consider, and this is haram. I mean, I have a mortgage, but I know that something is wrong with that, and I should repent..." I did what I had to do, by telling him that I am not qualified to issue fatwas, and that if he wants fatwas on what is Halal or Haram, he should ask someone who is. I was tempted to tell him: "what is forbidden is riba and not interest", or Abu Hanifa's opinion on dealing with riba in non-Islamic countries, etc. However, that would have violated my own assertion regarding such transmission of fatwas. Unfortunately, I also was present at the same mosque a few weeks prior, when another khateeb (who is also not qualified to issue fatwas) said that "if you took your house or car on interest, you should repent, and not argue -- for what was forbidden in Madina is also forbidden here -- so you should just ask Allah for forgiveness and promise to get out of this interest as soon as you can..." In other words, the misleading equation of riba with interest is so deeply entrenched in our (post Mawdudi) religious dialogue that it is impossible for the congregation to seek knowledge with an open mind...

I felt helpless in my helplessness regarding this community member being told that he shouldn't become a loan officer. I thought of telling him that the tools he would use as a loan officer at any bank would be the same, whether he works for an "Islamic" bank or otherwise. I thought of telling him that even if contemporary banking practice was a form of riba, it can't be equated to the riba so strongly condemned in the Qur'an (the Muhammad `Abduh statement quoted in a previous blog entry). I thought of telling him that even if this was riba, how can you find an alternative if Muslims would not become bankers to learn how credit extension is done, and to think of better alternatives... I thought of a million replies that I could have (and perhaps should have) given, but I was left mute, with only one answer: "brother, if you want a halal-or-haram statement, you should find a jurist".... I so wish that he had asked for an argument rather than a fatwa. I so wish that we can abolish the instution of fatwa altogether.

Saturday, August 13, 2005

The vicious circle of Islamic legal scholarship

Mohammad Fadel and others have lamented the quality of intellectual discourse in the Arab and Islamic worlds today. Indeed, it is impossible for a Muslim who is trained in economics or legal studies not to feel a terrible pain reading contemporary discourses on "Islamic economics", "Islamic finance" or "the Shari`a". Such writings expose terrible misunderstanding of economics (e.g. equating "riba" with "interest"), as well as terrible misunderstanding of Islamic law (completely ignoring the objectives enshrined in the Canonical texts and the fact that classical Islamic jurisprudence borrowed copiously from Roman and Sassanid legal traditions). Of course, there are few exceptions, but they are very few in comparison to the volume of low quality work being produced on those topics.

One may wonder why current writings on Islamic law, economics and finance generally lack rigor and intellect. Where are the Shafi`is, Shatibis, or even Sanhuris of the current era? Yes, of course, we have the likes of Ahmad Al-Raysuni (read his comments on Al-Shari`a w al-Hayah last week), but even his writings have focused on the past arguments of Al-Shatibi and earlier scholars of Usul, with minimal original content that integrates advances in modern scholarship.

Why is that? And how did we get that brief period in the early twentieth century that gave rise to the likes of `Abdul-Razzaq al-Sanhuri, `Abdul-Wahhab Khallaf, Muhammad abu Zahra, and the younger generation in al-Qaradawi, Mustafa al-Zarqa, etc.?

The answer may be in simple economics: If you are a bright young person in Pakistan, you and your parents will plan on your becoming a physician, or perhaps (as a second resort if you can't stand the sight of blood) as an engineer or scientist. The same is true if you are a bright young person in Indonesia, Egypt, or any other Islamic country. However, economic incentives alone cannot explain this trend:

In early Twentieth Century Egypt, the study of law was briefly elevated to the same level of those high-paying fields... yielding Saad Zaghloul on the political front, and the names I mentioned in Islamic legal scholarship. The first generation of Khallaf and Abu Zahra, Shaltout etc. made fundamental contributions that could have elevated Muslim societies to modernity. The second generation (al-Qaradawi, al-Zarqa, etc.) was quite respectable, but not as good as the first. And the current young generation is extremely depressing in terms of schoalrship (I am not including western writers like Tariq Ramadan, Khaled Abou El Fadl, etc., who remain outside the mainstream for Muslim minds worldwide).

You can see the same trend in Pakistan by following a particular family that has been bequeathing ifta from one generation to the next: The grandfather grand-mufti was a first-rate scholar (of the generation of Abu Zahra, etc.). His sons are respectable scholars, but no match for their father's scholarship, and the grand-children merely advertise the family name and recount their parents' opinions (without the capability of following the simplest legal arguments).

Interestingly, later generations of jurists earn incomes that are many orders of magnitude higher than their parents' and their grandparents'. One would think that such financial incentives would have encouraged them to seek a real education, and would have attracted some intelligent people to the field, rather than leaving it to those whose academic abilities would not allow them admission to the areas of medicine, engineering, etc. Of course, higher financial compensations have invited some "jurists" with street-smarts -- who were mainly trained as economists (which is unfortunately another field that generally does not attract the brightest in Islamic societies). Also, higher financial rewards have prompted the older generation to protect the "family business" from more talented competitors who are not their offspring.

Perhaps the problem is merely one of inertia. While many Muslims show reverence to jurists (who continue to wear interesting costumes, including furry hats -- appropriate for the icy mountains of central Asia -- in the scorching heat of Karachi or Houston, or sunny desert garb in the icy London winter-time), they would hate for their own children to go into the field of Islamic legal studies. I have yet to meet an Arab or Pakistani cardiologist who agonized over whether his straight-A student should become a cardiologist or a jurist (or even an economist)!! Perhaps it is the stigma driven by the intellectual ineptitude of contemporary jurists, together with their anachronistic language and garb, that make their profession a symbol of the past, to be revered in religious moments when one feels charitable with one's money and time -- but secretly despised for not keeping up with modern developments.

Until significant numbers of intelligent Muslims decide that Islamic and legal studies are respectable fields (rather than the areas you get into if your high school grades do not qualify you to join the prestige fields of medicine, etc.), we will continue to live in this vicious circle: (1) Jurists are revered simply as symbols of the sacred, (2) those jurists' lack of intellectual abilities reinforces the view that their pronouncements rest upon sacred authority rather than logical proof, and (3) young Muslims who possess intellectual abilities will refuse to seek careers in this field.

How do we break this vicious circle? Perhaps the answer lies in the experience of our past century: The generation of enlightened Azhari jurists that I mentioned were the product of scholarships to Europe, started by Muhammad Ali in the previous century. The merger of classical Islamic scholarship and western intellectual advances produced Muhammad `Abduh and `Abdul-Razzaq Al-Sanhuri. Thoroughly western thinkers like Tariq Ramadan and Khaled Abou El Fadl may produce writings that satisfy western-trained Muslims such as myself, but lack the formal eastern style and credentials to influence mainstream Muslim thought. Perhaps Al-Azhar, Dar Al-`Ulum, and other Islamic Universities should re-start western scholarship programs for their best students. In the meantime, the crisis currently facing Muslim societies may prompt some of the more intelligent young Muslims to get into the areas of religious and legal studies, thus making best use of such scholarships....

Then, maybe in two or three generations, we may have a literature in Islamic studies that can give rise to meaningful areas of "Islamic economics", "Islamic finance", etc. For now, it is best not to demean the name of Islam by attaching the term "Islamic" to the stupid creations of our contemporary minds.

Saturday, August 06, 2005

Islamic legal theories are man-made too!

The bulk of the Amman declaration (dealing with differences in madhahib, etc.) is praiseworthy: You cannot declare a person apostate because he accepts the Ash`ari view vs. the Wasatiyya creed, or any other, because they exercise "correct Sufism", follow the Salfi school or belong to any of the eight major schools of jurisprudence. On the other hand, such "open-mindedness" (historically limited and myopic as it may be) is definitively negated by the following passage:

3) Acknowledgement of the Schools of Jurisprudence within Islam means adhering to a fundamental methodology in the issuance of fatwas. No one may issue a fatwa without the requisite personal qualifications which each School of Jurisprudence defines. No one may issue a fatwa without adhering to the methodology of the Schools of Jurisprudence. No one may claim to do absolute Ijtihad and create a new School of Jurisprudence or to issue unacceptable fatwas that take Muslims out of the principles and certainties of the Shari‘ah and what has been established in respect of its Schools of Jurisprudence.

The reason for this announcement is clear: to discredit criminal elements and misguided people from issuing fatwas that others may follow blindly. However, it also closes many doors of ijtihad, yet again. It is curious to note that the schools that are put on equal footing by those present at the Amman conference would not themselves had emerged based on the methodology advocated here.

Worse yet, there is a continuation and formalization of a fundamental problem that I see even in the most progressive forms of ijtihad done today: The issue of Usul or methodology. Jurists accept that rulings in furu` (specific spacio-temporal incidents) change with the circumstances of place and time. That follows not only from the view that different circumstances merit different application (tanzil al-naSS) of Canonical Text rulings, but also from the fact that temporal rulings based on fatwa are man-made, and may simply be wrong!

A tenth Century fatwa in medical affairs would be changed now not because human physiology has changed, but because that fatwa would have been based on faulty medical knowledge -- i.e. its understanding (taSwir) and framing as a juristic question (takyeef fiqhi) were both wrong, rendering the fatwa useless today. Many jurists choose to discuss differences in fatwa based on circumstances, and forget this fundamental ability of secular knowledge (YES, THE S WORD) to inform us regarding the CORRECTNESS and relevance of previous fatwas: A fatwa issued by the most knowledgeable person in the 2nd Century AH, based on an assuption that the earth is flat, is irrelevant.

Likewise, in the area of economics, I would say that -- rather than looking for an "Islamic Economics" that agrees with the outdated worldview of great minds of the past such as Ghazali and others -- much of what great scholars of the past said regarding economic and financial affairs is wrong and irrelevant, because their understanding of economics (as a secular social science) was wrong. Of course, our understanding of various secular sciences today will also be proven wrong in the future, hence the need to continually revisit earlier thought in light of that secular knowledge, which is also "knowledge" in the sense of "`ilm"!

Many (though still a minority) may agree with this view in the areas of medicine, physics, etc. Fewer still will agree with this view in the fields of economics, psychology, etc. But the more fundamental question I wish to raise in this posting goes beyond all of that, and addresses the quotation from the `Amman conference conclusions:

Just as our medical knowledge should inform (and allow us to change) our fatwas in certain areas, and economic knowledge should inform (and allow us to change) our fatwas in other areas, advances in logic, legal scholarship, social science and scientific method should inform our Islamic legal methodology and legal theory. Brilliant as Al-Shafi`i, Al-Sarakhsi, Al-Juwaini, Al-Shatibi, Al-Qarafi, etc. may have been for their time, their formulation of legal theory was shaped and constrained by their knowledge of Roman law and Aristotelian logic... Advances in legal scholarship, formal logic, and social science have allowed modern societies to develop better (though by no means perfect) legal theories. Why can't Muslims also revisit their "methodologies" (mentioned in the quotation above) in light of Islamic Canonical Texts as well as those advances in logic, etc. Afterall, those legal theories were themselves man-made. To restrict us to the use of a legal theory developed 10 centuries ago is no less harmful than to restrict us to specific opinions (fatwas) issued at that time.

Tuesday, August 02, 2005

Is my conventional mortgage riba? -- A public challenge

At the last ISNA conference to which I was invited, I mentioned at a session on "Islamic home finance" that I have not seen a single convincing argument that my conventional mortgage is riba. I challenged those present to prove to me that my mortgage is riba, and promised to refinance with the institution of their choice if they can provide such a proof. Needless to say, I was not invited to any subsequent ISNA conferences, but that is not the problem. I have yet to receive a convincing argument.

Last Saturday, some friends and I stayed at the mosque after fajr, and I drew the following figures on the carpet to illustrate my confusion about the characterization of my mortgage as a ribawi loan. Now, I understand that the debt I owe my mortgagee is documented by a "loan", but so are "Islamic" mortgages (e.g. by HSBC, etc.).

Let me explain. My mortgage procedure went roughly as follows (with some simplification):

In words, this is what happened:

  • I brought a check for my downpayment payable to the title company.
  • The mortgagee wrote a check for the balance of the home price, which is equal to mortgage amount (again ignoring various legal fees, etc.).
  • Title company combined the two payments to pay the home seller (had the homeseller had a mortgage, it would have been paid off first, and the difference given to the seller, after fees, etc.)
  • Title company transferred propety title in my name, and gave mortgagee a lien on the property.
  • Simultaneously, I signed "mortgage loan" documents, documenting my debt to the bank for the balance of the home price (plus any closing fees) less my downpayment.
  • My loan document specified the amortization schedule, which I currently follow in making my monthly mortgage payments.

Notice that while the debt is documented as a "loan", there was never a money-for-money transaction between me and the mortgagee. In fact, I never received any money from the mortgagee. The only thing I received was the home title (and right to live in the home), and I paid a certain amount of money to the title company at closing, and then make periodic payments to the mortgagee. So, as far as I am concerned, my transaction has always been one of house-for-money.

Now, one interpretation of how jurists forbade this transaction may be their fixation on the "loan" characterization, which may have suggested a simplified transaction of the following form:

Under this imaginary scenario, I would have gotten the loan money, and combined it with my downpayment to pay for the house. Then, as I would have gotten the title, I would have given the mortgagee a lien on the property. There is actually a logistic problem here: I couldn't give the mortgagee a lien at the time I receive the money, since I would not yet have title at that time. Indeed, that problem is the one solved by the title company, acting as an agent to facilitate the simultaneous parts of the transaction (I pay, mortgagee pays, the seller collects, the seller gives up title, I get title, mortgagee gets lien and "loan" documents). In the process, it appears to me that the Title company has also avoided the riba charge of money now for money later dealings between me and the mortgagee!

Never mind those details, the solution proposed by Islamic financial institutions is for the bank (or a fully owned SPV thereof) to first gain title to the property, and then to either sell the property to me (murabaha model) or lease it (ijara or musharaka mutanaqisa models). The murabaha variation would look something like this (again in overly simplified form):

There are many reasons the latter structure is inefficient, and somewhat meaningless -- since "truth in lending" Reg. Z requires mortgagee to report the APR in this financing transaction, the "interest" component is usually deducted as mortgage interest on IRS filings (even though the IRS has not to-date ruled on whether such a price mark-up installments -- or rent payment in the lease model -- may be deducted as such).

But my purpose here is not necessarily to criticize the murabaha, ijara and other models used for "Islamic home financing" in the U.S., U.K., etc. My primary concern is to wonder: if the issue is simply to create a buffer so that I never have a money-for-money transaction, why isn't the agency of the Title Company (which I have argued to be required primarily for logistical reasons of simultaneity of multiple transactions) sufficient to break the charge of riba (money now for more money later).

So to summarize, we have a triangle transaction in reality:

  • Bank pays money now to home owner
  • Home owner gives me the house
  • I pay money later to bank

Some buffer mechanism is needed to avoid the bank giving me the money now, to be paid plus interest later. However,
that is already done through the intermediation of the Title company.

Why is this riba?

Please explain this to me.