Halal Islamic finance based on real not virtual economy

THE Brunei Times of October 31, 2008, carried an article "Islamic finance investments leave wealthy Asians cold".

And it mentions a statement by Carolyn Leng, co-head of CIMB Private Banking that, among others: "Offering of Islamic products are not great here (in Malaysia)... (and that Islamic finance must be good in) "Product innovation (which) is (the) key, (and that) we need to be a lot more creative" (to open investment opportunities to those wealthy Asians, to absorb their surplus cash). (Words in brackets are the additions of this contributor to complete the flow of the statement made by Carolyn Leng).

Carolyn Leng's view or opinion requires a "corrective enlightenment". It is not correct to imply that Islamic finance investments are deficient, insufficient, lacking sophistication in attracting direct investments (of those wealthy Asians). The fundamental safeguard in Islamic-finance-banking-economic system and practice is the prevention of making money out of money (for example refer: Richard Thomson's book "Apocalypse Roulette-the Lethal World of Derivatives" (1998). Making money out of money is just a creation of layers of "innovative and creative" IOUs upon IOUs, that is, virtual money/virtual wealth upon more virtual money and virtual wealth, which is disallowed in Islam. This is what Carolyn Leng seems to have ignored or misunderstood when she suggested that product innovation in Islamic/Syariah finance must-not only be "innovative" but "creative".

Islam clearly directs that any financial investment must be made direct into the real productive economic enterprises, production, distribution, consumption which involves labour and services, not on IOUs, money making money, or more money, eventually ballooning into trillions of $IOUs. Just mere bigger bubbles than actual soap.

In another words what Carolyn Leng infact unwittingly has suggested is that to cater for the investment needs of those wealthy Asians, to absorb their surplus cash, Islamic finance should also ape the creative ingenuity of those Western financial engineers in creating various, complex, mathematically esoteric IOUs as financial instruments.

In Islamic economic requirement, which is pro economic growth and development, "innovation" and "creativity" must meet the real needs of the economy rather than simply satisfy the craving appetites of those wealthy Asians (and others).

If Carolyn Leng cares to go deeper into the "destructive pitfalls and incidences" of making money out of money, IOUs upon more IOUs (which has just in fact imploded recently in the US due to the implosion of the ballooning of their sub-prime mortages and now has had destructive domino effect on other major US financial and banking institutions, some guesstimated involving US$5 trillion ($7.5 trillion) so far, and has spread to Europe, Japan, Korea, and has even reached the shores of our neighbours adversely affecting their real economies.), she should digest for example that prescient book "Apocalypse Roulette-the Lethal World of Derivatives" by Richard Thomson (1998), and "Liar's Poker~Two Cities, True Greed" by Michael Lewis (1989).

Richard Thomson basicly asserts that the earlier financial innovation created in the 1970s by Western financial engineers were financial derivatives. (eg "swaps", "forwards", "futures", "options"). Both financial observers and regulators then considered this creation of financial instruments, IOUs, as the major innovation.

According to Richard Thomson, by 1996 the total value of those financial derivatives had shot up to US$64 trillion (US$64,000,000,000,000) industry).

Richard Thomson asks: How do you imagine a number that big? "You could say that if you laid all those dollars bills end to end they would stretch from here to the sun 66 times, or to the moon 25,900 times; or that it is roughly 60 times the size of the British economy, or about six times the size of the US and Japanese economies combined; or that it is many times bigger than every stock and bond market in the world add together."

Richard Thomson then asserts: "In this new age of finance the rewards and the dangers of making money out of money are many times what they were only a few years ago."

Now, the recent financial/banking implosion which started in the US has revealed that the financial derivatives industry has reached a mind boggling value of US$668 trillion (US$668,000,000,000,000!) in September 2008 (Re: Newsweek, Oct 27,2008). Then, how do you imagine a number that stupendously huge?

This mind boggling increase in the total value of those creative financial instruments, according to Philip Molyneux and Nidal Shamroukh are due to:

Absence of patent law;

Many new financial products require little capital investment;

Can be developed within a much shorter period of time than the real economic sector (our emphasis);

Deregulation (Remember what Allan Greenspan said last week at the Senate Finance Committee hearing? He didn't expect deregulation and free capitalism would cause the massive financial collapse in US!, therefore, he admitted that he was partly wrong but the financial victims are now suffering, even one Egyptian had been reported to have committed suicide.);

Improved information and communication (internet) technologies;

Growing competition;

Volatile exchange rate; and,

Volatile interest rate. (Re: "Financial Innovation" by Philip Molyneux and Nidal Shamroukh(1999))

Now , if that US$668 trillion had been the total value of the world real economic growth and development, almost every one of us would have been happily "half-millionaires"! But unfortunately this US$668 trillion is not the value of real productive economy of the world! It is the value of US securitised financial instruments, paper debts, IOUs!, the virtual wealth bigger bubbles than the actual soap!

So it is now getting more obvious, clearer that what is Islamic finance-banking-economic principle and practice against is this easy ability to create money out of money by creating paper IOUs: US$1,000 trillion? US$10,000,000 trillion? No problem! Just print and have those paper financial instruments securitised! But the big question again is where is the real, actual economic productivity and hence economic growth which directly creates employment opportunities and real salaries and wages as required by Islam?

Newsweek (Oct 27, 2008) asked this question: "What role do regulators play in keeping tabs on all those exotic, complex financial shenanigans?" It adds: "And in a world where our ability to trade those exotic financial instruments vastly exceeds our ability to understand and value them, that is very dangerous thing indeed."

"That is a very dangerous thing indeed" is exactly what Islam has since 1429 years ago advised its followers not to indulge in! Because in our Islamic religious context it is haram (forbidden) to create virtual money/virtual wealth upon more virtual money/virtual wealth through interest (riba).

According to Nobel Laureate in economics Prof Paul Krugman, securitisation such as buying those derivatives (which recently have brought down those banks and financial institutions and have caused financial havoc in other countries and have adversely affected their real economic well being) was like buying insurance for the Titanic from someone on the Titanic. (Newsweek Oct 27, 2008).

According to the Newsweek (Oct 27, 2008) there is an entire language required to understand in this new generation of financial technologies, from credit default swaps to collaterised debt obligations to residential mortages-backed securities not to mention the corresponding three-and-four letter abbreviations (eg ABX.HE.AB.062-2; ABX.HE.AA.06.1). Most people faced with this tsunami of data, do the only rational thing: they give up.

Profits by all means become more important than the safety of clients' investments.

But then, there are, there will always be those individuals who have very high tolerance for risk taking, for bearing losses.

Wealthy, rich people, in our case in this discourse, wealthy, rich Asians, have very low value utility. To wealthy rich Asians, $1,000 per meal is very normal. "Losing $1,000 is like nothing!" goes our cliché. Thus, those wealthy Asians don't care about the means, as long as they satisfy their "investment itches" to risk their surplus cash.To a poor man, one dollar is so precious, sweat, blood and tears.

"Riches rather enlarge than satisfy appetites" (Thomas Fuller, MD.)

Thus a very apt recent example where, when wealthy, rich Asians had surplus cash and could "comfortably afford to lose it as was mentioned in a series of reports in The Straits Times (Oct 31, 2008, and Nov 2, 2008):

"Risk (DBS's High Notes and Lehman's Minibond series) listed in bold, but... Investors went ahead despite warnings" (The Straits Times, Oct 31, 2008).

"Flaws in product, say investors"; "High-risk high notes should not have been sold at all, they contend" (The Straits Times, Oct 31, 2008).

"A man stands to lose $50,000, a woman $200,000. But neither will be lodging a complaint about the Mis-Selling of Lehman-linked products because. 'I walked in with my eyes open"' (The Straits Times Nov 2, 2008).

With the above elaborations on the destructive pitfalls and incidents of creative, complex, esoteric financial IOUs instruments making money out of money, (which in fact, to repeat, is disallowed in Islamic financial-banking-economic system and practice as those IOUs are not related to actual real productive economic activities), it should now be obvious to Carolyn Leng of CIMB Private Banking (Malaysia) that it is not the Islamic finance-banking system and practice that is in anyway deficient or lacking innovative, creative financial instruments. Rather, it is due to the economic state of almost Islamic countries which is relatively under developed (in the jargon of IMF: "those developing countries") thus lacking the absorption capacity to absorb any voracious investment appetites of those wealthy Asians. By the way, how would those Islamic countries absorb those cash of the wealthy Asians, when one of the richest oil producing countries, Saudi Arabia, was said to bear about 30 per cent of their young citizens who would be unemployed by 2030!?

Appropriate, suitable innovative, creative halal Islamic financial instruments can of course be tailor-made to enable invested cash of those wealthy Asians to be directly invested in the growing productive economic activities of an Islamic country.

Thus, the only constraint on investment absorption capacity is the lethargic or staganating economic situation which "rejects" that financial injection from those wealthy Asians, not the absence of the direct innovative/creative channel or conduit of cash investment into the real economy.

A common sort of macabre story goes: When we are ill in the ICU somehow our relatives/friends have suddenly become more concerned and generous. They bring all very delicious food and fruits "presents" to our bedside! In the end our healthy relatives enjoy those "presents". This frustrating situation prompts us to recover quickly!

Likewise, all Islamic countries must quickly recover from their economic lethargy and be growing steadily to be able to directly absorb those investments of the wealthy Asians.

No need to be "innovative" and "creative" to produce those exotic, complex, esoteric financial IOU bubbles, when we can invest directly into the dynamic growing real economy.

The basic essentials for economic progress are: All round honesty, trust, skills, efficiency, transparency, diligence and drive.

24/7 is always too short.

Yang Dimuliakan Pehin Orang Kaya Lela Raja Dato Seri Laila Jasa Haji Awang Abdul Rahman bin Haji Abdul Karim DSLJ, PJK was formerly Permanent Secretary of the Ministry of Finance and the Ministry of Defence. The views expressed by Pehin Dato Rahman Karim are his own and do not necessarily reflect those of The Brunei Times.