Friday, September 15, 2006

Short Selling and the Travesty of Islamic Finance

I received an email this morning from a young practitioner in the Islamic finance field:

Dear Professor El Gamal

I would like to pick your brains regarding some recent developments In Islamic finance, if I may.

I have just returned from an Islamic Funds conference in Dubai. I was somewhat surprised to find there was a widespread assumption amongst the fund managers speaking that taking short positions was now Islamically acceptable and basically a done deal. Names of Sharia scholars who had accepted it were bandied about

2 questions please.

1. How does it work ? I was told that there was some combination of Murabah + Arboun but no one would tell me exactly how it worked, for obvious proprietary reasons.

2. Is it a done deal Sharia speaking ?

3. If it is a done deal why is everybody not doing it ? Or are they ?

Here is my response:

Dear Mr. ______:

As I have argued repeatedly, every contract can be "Islamized" in the age of financial engineering. That is why the industry's obsession with the Islamicity of contracts, and the identities of jurists-for-hire who certify them, is a disastrous combination.

Every beginner's textbook in financial engineering shows how to synthesize short sales and leveraged buying from forwards. The easiest way to get a forward "Islamically" is with the use of salam, which has an element of short-selling already built-in. The use of `urbun as call option allows you to use call-put parity to do the same and synthesize a forward.

It is a silly game. The distinction between contracts that are "now allowed in Islam" and those that aren't is only a function of who is willing to pay sufficient fees for the rent-a-jurists to certify an engineered product, and how high are the transaction costs of the reengineering.

Those people have made a mockery of Islam.

In my recent book, I have shown in detail how to synthesize a forward from salam and a credit facility characterized as murabaha or tawarruq, depending on preference and cost. From forwards, we can then synthesize everything. That is a theorem. So, why are we wasting everyone's time with those big announcements of "the first ever Islamic this or that"? Because it is the selective prohibition of some modern practices and synthesis of others from medieval contracts that creates rent-seeking Shari`a arbitrage opportunities, and that is -- regrettably -- the nature of Islamic finance as practiced today.

Unfortunately, my interlocutor responded back with this:

Yes the Salam route was discussed but the Murabaha Arboun route was the one alluded to throughout. I will try to find out how it works.

I responded as follows:

Why do you care about the specific mechanics?

Short-selling is short-selling. So do it in the most efficient manner possible, or don't do it at all.

I obviously don't get it.