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The Derivatives Time Bomb


Islamic Salvation

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ثم يكون ملكا عضوضا يشربون الخمور ويلبسون الحرير ويستحلون الفروج

وينصرون ويرزقون حتى يأتيهم أمر الله

Then will come a tyrannical regime, they will imbibe wine, wear silk and promote lewdness

And they will win for a while and be given sustenance until suddenly the affair of God will come to them [The Messenger of God]

The Real Wolves of Wall-Street Pt. III

 

« وعن بيع الغرر »

<< and [also prohibited] the deceptive sale >>

The whole Hadith has also been narrated in Sunan Abi Dawud from an old man of Banu Tamim who heard this address of Ali.

حدثنا محمد بن عيسى حدثنا هشيم أخبرنا صالح بن عامر قال أبو داود كذا قال محمد حدثنا شيخ من بني تميم قال خطبنا علي بن أبي طالب أو قال قال علي قال ابن عيسى هكذا حدثنا هشيم قال سيأتي على الناس زمان عضوض يعض الموسر على ما في يديه ولم يؤمر بذلك قال الله تعالى ولا تنسوا الفضل بينكم ويبايع المضطرون وقد نهى النبي صلى الله عليه وسلم عن بيع المضطر وبيع الغرر وبيع الثمرة قبل أن تدرك

This is an important variant because it gives us a clue as to the kind of deal which can fall under Gharar i.e. selling or buying something [in this case fruits] before they have matured and are ready i.e. وبيع الثمرة قبل أن تدرك

 

Deceptive Deals

غرر is an Arabic word which is associated with uncertainty, deception and risk. It is a significant concept in Islamic finance and is used to measure the legitimacy of a hazardous sale or risky investment. This can be pertaining to the selling of goods or assets of ambiguous quality or delivery, but also includes contracts that are not drawn out in clear terms.

Gharar is generally prohibited in Islam, as there are strict rules in Islamic finance against transactions that are highly uncertain or that may cause any injustice or deceit against any of the parties.

Elements of Gharar can be observed within derivative transactions such as forwards, futures and options, as well as in short selling and in speculation. In Islamic finance, most derivative contracts are forbidden and considered invalid because of the uncertainty involved in the future delivery of the underlying asset.

However, Muslim Jurists disagree on the degree of uncertainty in a transaction to be considered a Gharar transaction.

الغرر هو البيع المجهول العاقبة. ومن نوع الغرر ما نهى عنه صلى الله عليه واله من بيع حبل الحبلة، والسمك في الماء، وبيع الثمرة قبل بدو صلاحها ونحو ذلك. قال النووي: النهي عن بيع الغرر أصل من أصول الشرع يدخل تحته مسائل كثيرة جداً، فكل جهالة تؤدي إلى فساد البيع فهي غرر ولا عكس 

Gharar is a kind of transaction whose future outcome is uncertain. Examples of Gharar include those which the prophet صلى الله عليه واله explicitly prohibited such as selling the unborn animal (Habal-al-Habalah), the fish in the sea [whom you have not already caught], selling the fruit before it has ripened and etc.

al-Nawawi says: Prohibition of Gharar transaction is a principle from among the principles of Shariah under which come a lot of sub-issues, so any kind of uncertainty which can lead to damage of the sale then it is a kind of Gharar.

Other examples of Gharar taken from the narrations of the prophet include:

1. The “Pebble” “touch” and “toss” sale.

2. Selling the fetuses and embryos.

3. Selling the find of the diver in advance.

4. Selling the object of unknown identity without the buyer having the right to specify it.

This is particularly relevant because some of these derivatives are so complex that no one knows exactly what is being transacted, while Islam does not want the buyer to be in ignorance of what he is buying.

5. Deferment of the price to an unknown future date.

Derivatives in particular have an additional problem in that they are not representing a physical asset. In Islam something must be under your control (physically) before you can conclude a transaction. You cannot just create a virtual asset - not backed by a physical good - and start selling it. What exactly are you selling?!

And this point is what is used by some Islamic scholars to call for a return to the gold standard because the fiat currency has been the cause of a lot of inflation and destabilization that have even led to world-wars.

 

Derivatives and the 2008 Crash

It is interesting to note that Warren Buffet one of the most successful investors had this to say way back in 2002 about derivatives:

“I view derivatives as time bombs, both for the parties that deal in them and the economic system. Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values … Derivatives contracts are of varying duration, running sometimes to 20 or more years, and their value is often tied to several variables.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”

An increasingly dominant analysis of the causes of the crash consider unregulated derivatives to be at the root of the problem.

1. "The arguments of the cause of the financial collapse may go on for a long time, and there may never be a consensus explanation. However, we know that the use of derivative securities played a pivotal role in the system that collapsed" - Did Derivatives Cause The Recession?

2. During the financial crisis in 2008, the root cause of the meltdown was derivatives. Specifically, CDOs, or Collateralized Debt Obligations related to mortgages and CDSs, or Credit Default Swaps. Why would banks and holdings companies (whose primary asset is a bank), increase their risk to such a high level? There are a number of factors but it all boils down to one issue “ GREED!  The Root Cause Of The 2008 Financial Meltdown: Derivatives

3. The root cause wasn’t just the reckless lending and the excessive risk taking. The problem at the core was a lack of transparency. After Lehman’s collapse, no one could understand any particular bank’s risks from derivative trading and so no bank wanted to lend to or trade with any other bank. Because all the big banks’ had been involved to an unknown degree in risky derivative trading, no one could tell whether any particular financial institution might suddenly implode. Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable

Just imagine if an Islamic-inspired humane economy was in place - most of these shenanigans would have been avoided including the massive damage caused which has wiped out whole economies and caused untold human suffering. Having said this, derivatives remain a de facto pillar of the financial markets (ironically, if you trace the origins of the instrument - it was to provide resistance against risk, instead it creates risk out of thin air!). And there is a great need to develop an alternative for it or the Islamic finance market will not be able to develop further.

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  • Advanced Member

I like your economic posts good job!

I've been trying to get a good answer for a while about depositing money in interest bearing accounts for savings, or CDs (Certificates of Deposit). I've read all the Shiachat threads too.

Some say that it is okay to take interest from non-Muslims.

Some say the prohibition of interest is only applying to goods that are measured or counted, not fiat currency.

Some say all interest is forbidden, but if you have no choice then there is no blame on you (since all banks give interest here in the West).

Could you maybe break down what the Imams say about interest and how it applies to modern day savings, CDs, 401Ks?

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  • Veteran Member
4 hours ago, ChattingwithShias said:

I like your economic posts good job!

I've been trying to get a good answer for a while about depositing money in interest bearing accounts for savings, or CDs (Certificates of Deposit). I've read all the Shiachat threads too.

Some say that it is okay to take interest from non-Muslims.

Some say the prohibition of interest is only applying to goods that are measured or counted, not fiat currency.

Some say all interest is forbidden, but if you have no choice then there is no blame on you (since all banks give interest here in the West).

Could you maybe break down what the Imams say about interest and how it applies to modern day savings, CDs, 401Ks?

I do not have a comprehensive answer at the moment without researching the basis of the Mujtahid's Fatawa and the Ahadith. 

I will keep it in mind Akhi and get back to you. Maybe a blog-post.

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      قال أبو عبد الله عليه السلام: رحم الله زرارة بن أعين لو لا زرارة و نظراؤه لاندرست أحاديث أبي عليه السلام
      Abu Abdillah عليه السلام said: May Allah have mercy on Zurara b. A`yan, if it was not for Zurara and his peers the narrations of my father عليه السلام would have perished
      سمعت أبا عبد اللّه عليه السلام يقول: لعن اللّه زرارة!
      I heard Aba Abdillah عليه السلام saying: may Allah curse Zurara!
       
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      Abdallah b. Zurara said: Abu Abdillah عليه السلام said to me: convey my salutations of peace to your father and say to him …
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      I only defame you as a way of defending you, for the masses and the enemy hasten to whomever we draw near and praise his station so as to cause harm to the one we love and bring close. They accuse such a one because of our love for him and his closeness and intimacy with us, and they consider causing him harm and even killing him as justified. On the other hand, they praise every one whom we fault even if his affair is not praiseworthy. Thus, I fault you because you have become notorious as a result of your association with us and your inclination towards us, which have caused you to become blamable in the eyes of the people and your works to be looked upon unfavourably, all this because of your love for us and your inclination towards us. So I wished to fault you so that they can praise your religious stand as a result of my denigrating and diminishing you, and this becomes a way of warding off their evil from you. 
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      The Imam acknowledges a second problem which Zurara seems to have raised which is the Ikhtilaf [differences] of instructions which are attributed to them. The Imam accepts that these may indeed go back to them but notes that they have a reason for every instruction they give even if the companions cannot fully comprehend the reasons behind them. However, the Imam is very clear that despite the seeming diverse answers there is a way to reconcile them and all agree with the truth. 
       
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      However [if you do not submit wholly then], if our Riser were to rise and our Speaker speak and he recommences teaching you the Qur’an, the Laws of religion, the rulings and inheritance shares the way Allah revealed them to Muhammad the ‘people of insight’ among you will repudiate it on that day a bitter repudiation, then you will not remain steadfast upon the religion of Allah and his path except under the threat of the sword over your necks!
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      The people after the prophet of Allah were left to embark by Allah the same example as those who came before you, so they changed, altered, distorted, and added to the religion of Allah and reduced from it, consequently there is not a thing which the people are upon today [following] except that it is distorted when compared to that which was revealed from Allah. Respond then my Allah have mercy on you away from what you are calling for to what you are being called to, until comes the one who will renew the religion anew.
      Why did it have to come to this? This is the unfortunate consequence of the Umma betraying the will of the prophet. It has become utterly divided. Not having the correct leaders has meant that the authentic message of Muhammad has been irredeemably altered. There is not a single act of worship or belief that has been left un-corrupted because every middling scholar can peddle his interpretation. The temporal rulers are also more than happy to take advantage of the confusion and extend patronage to scholars whose interpretations were power friendly. The Imams themselves cannot openly propagate the actual version without repercussions.
       
      To be continued ...
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      Buying and selling in the market place may provide advantages to minority groups at the expense of the majority. A State that represents the majority may need to act in order to address the imbalance in a manner that may seem on the face of it to be discriminatory.
      The impact of buying and selling in the market place
      The problem with money and markets is that they strip exchanges between people of all social and cultural content. In market-based exchanges, you can buy/sell with complete strangers. This has its benefits and particularly for social/cultural/ethnic/ religious minorities within a society, the market provides an almost anonymous means of interacting with the majority.
      The impact of social networks
      In fact, the story can even become worse for the majority because the denser social links/networks between members of a minority may mean that they can exploit higher levels of trust between each other and thereby compete more effectively in the market-place.
      Over time, of course, this economic disadvantage may lead to significant differences between the wealth of the majority and minority communities.

      In the diagram below is your multiculti, fully assimilated, and integrated, fully equal nirvana. Everyone interacts with all others regardless of their colour or other distinguishing characteristics. There is one group (pink) who are the majority, and the others are minorities.

       
      The reality

      One group of people (coloured brown) realise that they come from the same village back home, they have a shared culture, heritage and so on, they start to spend more time together.
      Trust within minority groups
      These commonalities enable this specific minority to establish bonds of trust between themselves that are stronger than the ones that exist between people of different groups. So they decide to interact with each other more than they do with other groups.
      Role of religion
      The issue is even more acute when they share the same religion because then they are more likely to share the same values - which are even more important when it comes to building trust.
      Boundary spanners
      Accidentally, I drew the first picture in a way that helps illustrate another point. The minority group accrues another advantage, where it can become a 'boundary spanner' e.g. between two different societies (the red line). That advantage is less likely to be open to the majority groups in the two countries in which this minority lives.

      The economic impact
      There is an obvious economic angle to these social relations, since the bonds of trust help reduce the friction of doing business, in fact, trust is more valuable in some industries (the ones with more risk and potentially more rewards).
      Minorities outperforming majorities
      A social aspect to their interaction therefore has economic repercussions. Left unchecked a minority group will gain an advantage over others. Societies can persist with the multi-culti fantasy for years.
      Payback
      But at some point there will be a reckoning, there always is. Obvious trigger points are when the majority face economic dislocation and see how much better minority groups are doing. You can 'hope' that this time there won't be -  but that has not been the case over the previous millennia.
      Longer term implications
      Historically there are lots of examples of this all around the world and the end is never a happy one - with the majority usually seeking to address the problem via physical force. The challenge for societies is for them to offer minorities certain rights but at the same time put in place restrictions on the extent of their participation in the economic life of society so that they cannot dominate the majority.
      Islamic solutions
      In an Islamic society where distinctions between groups are not based on race, but rather of belief, this means that there has to be what seems like discrimination against non-Muslims, but which, is in fact, a sensible means of avoiding longer-term conflct between the majority and minority.
      An illustration of the problem in terms of resources
      The picture below illustrates the above idea. 
      The blue circles represent the majority in a society, each person gives an item of resource to the person immediately to their south and also one to their south-west. And they do so without regard to the 'colour' of the other person. Let's assume this is a very egalitarian society where the affiliations of individuals are completely ignored. The pink circles represent a minority and they behave in the same manner. However the yellow circles behave slightly differently, they give one item of resource without any discrimination to whoever is to their south, but instead of giving one item to the person to their southwest, they give instead to someone of their own tribe/religion/ethnicity/language group/cult or whatever other basis of commonality that they have established. Such an arrangement can be informal and communicated only to the group members - something which is helped by their being a minority in a society. Members of the yellow circle are able to identify each other due to their going to the same places of worship or gentlemen's clubs or 'lodge'. Such interaction may legitimately lead to higher levels of trust between members of the yellow group and their discriminatory behaviour could be argued to be inherently rational i.e. it makes sense from a business perspective.
      Economic performance of members of the yellow group may, as a result of this behaviour be better than that of other groups. It may seem to them that their accumulation is due to their greater intelligence, business acumen or another positive trait. There may well be elements of those present, but their discrimination in favour of their own group could certainly be an important factor.
      Such discrimination on their part can mean greater rewards for members of their own group and it may not be visible to outsiders, other than the realisation that this group of people are relatively better off than others.
      Is discrimination by the State a valid response?
      Any response by the majority to address this imbalance, e.g. by imposing restrictions on the economic or other activities of the yellow minority group is likely to attract charges of discrimination.
      Because such communications cannot be done discreetly, communicating with the whole of society requires broadcasting to everyone rather than taking the narrowcasting approach the minority group pursued when they decided to discriminate in favour of their own group. Such narrowcasting is possible because the minority group are able to communicate with each other discreetly and in a manner that excludes everyone else.
       

       
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