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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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  • Latest Blog Entries

         9 comments
      [amended 19 August 2023 to include references to the Irish potato famine and two Bengal famines]
      Surah Yusuf
      Prophet Yusuf (عليه السلام) advised Pharoah to hoard grains during the years of plenty. I think this episode is a noteworthy one because it shows how a State can intervene in the marketplace in order to improve the welfare of the wider population.
      But as we shall see below, the government intervention that Prophet Yusuf (عليه السلام) instigated favoured some sections of the population over others - it was not neutral in terms of how it spread gains and losses across the population.
      https://www.al-islam.org/sites/default/files/singles/633-yusuf.pdf
      While there is other material in the Qur'an that deals with transactions within the marketplace between individual participants - this story stands out in terms of its focus on state intervention. 
      I'll be coming back to this issue later - but I think it informs the discussions we have about Islam and contemporary socio-economic theories. In particular, I think it illustrates that Islam does see the State as an active market participant and that in an Islamic state, the role of government is not one that is hands-off or laissez-faire.
       
      What policy options did Prophet Yusuf (عليه السلام) have?
      We should not take the story as presented 'for granted'. In reality, the Prophet (عليه السلام). had a range of choices open to him, and thinking those through helps us better understand the reasons for the policy he undertook and the reason why. 
      No government interference
      Let's start with the simplest and easiest option that Pharoah's government could have pursued once they knew that there would be seven years of plenty followed by seven years of famine (as predicted by the Pharoah's dream which was interpreted by Prophet Yusuf (عليه السلام).) .
      Pharoah could have left the entire issue to the 'market'. During the years of plenty, the price of food would have fallen and people would have enjoyed a higher standard of living. For example, the lower grain prices could have led to people rearing more cattle and their diets would have improved with more meat.
      However, during the years of famine, grain prices would have risen and those people who had accumulated assets in the years of plenty would be able to pay the higher prices in the famine years. Those who had not had such assets would have starved.
      This assumes a fairly high level of self-discipline on the part of the population, but as Milton Friedman would say, the people would have been 'free to choose'. This is not a hypothetical option. The British lack of action to the Irish potato famine has been attributed to the British government's ideological adherence to a laissez-faire approach to macro-economics:
      https://kenanfellows.org/kfp-cp-sites/cp01/cp01/sites/kfp-cp-sites.localhost.com.cp01/files/LP3_BBC Irish Famine Article for Lab.pdf
       
      The Bengal famine is another one where government policy was different to the one Prophet Yusuf ((عليه السلام).) prescribed to Pharoah. In this instance, it was lack of government restriction over the action of privateers:
      https://www.theguardian.com/world/2019/mar/29/winston-churchill-policies-contributed-to-1943-bengal-famine-study
       
      Going back still further, the Great Bengal Famine of 1770 has been directly attributed to British government laissez-faire economic policy.
      https://worldfinancialreview.com/the-political-economy-of-famines-during-the-british-rule-in-india-a-critical-analysis/
       
      Light interference - provision of information
      A common policy option nowadays, where people do not want direct government intervention is to recommend improving the provision of information to the population who will then be better able to make the correct decisions for themselves. The government could have mounted an information campaign during the years of plenty and told people to hoard food themselves, hoarding when there is no shortage is allowed in Islam.
      However such attempts to influence awareness about the famine to come and changing peoples' attitudes so that they saved more than they were used to, would likely have run against increased social pressures on people to do the opposite. For example typically in societies as wealth increases there is social pressure to spend more, in this case, for example, have more lavish weddings.
      Also providing information would have been a practical benefit for the better off e.g. those with storage capacity, but not so good for the poor (who would not have room to store grain, for example).
      The government (using a bit more intervention) could have given tax breaks to people who owned granaries, to help the poor who needed such facilities. Again this solution would be to focus on market-based interventions and simply alter the working of the market using incentives. Current economic theory holds that people discount future risks very heavily i.e. they don't perceive them as much of a threat as they should. So, for example, just telling people they should save for a pension does not work. 
      So we can likely predict that the solutions described above would not have worked had they tried them.
      Heavy interference
      This is what they actually did.
      In times of plenty, Pharoah's government did not let prices fall as would have happened under free market conditions. They kept prices higher than they otherwise would have been because the government intervened and took excess stocks of grain out of circulation.
      All people (rich and poor alike) had no option but to pay the usual higher prices - effectively, the government was taxing everyone, but this was not seen as a loss by anyone because the prices were no higher than usual.
      The government stored the grain centrally and then they decided to release the grain according to their own policies.
      Assumptions made by Prophet Yusuf's government
      If you leave people to their own devices they may not make the best decisions (whether they are rich or poor), this could be due to: People do not have the resources to cater for future shocks (mainly the poor) People do not have the discipline to address future shocks (applies to both the rich and the poor) The government can make better decisions than individuals acting in their own self-interest because: The government can have access to more and better information than individuals do The government may not be as susceptible to a lack of self-discipline  
      Conclusion
      Of all the policy options open to Prophet Yusuf (عليه السلام) he advised Pharoah to pursue the most interventionist one. Some people may be tempted to call this socialist or communist, but I think those terms carry a lot of excess baggage, so I won't bring them into the discussion.
      What I think can be safely inferred from his choice of policy is a fundamental principle that could inform economic policy in any Islamic state.
      Facing an external shock to the Egyptian economy, he went for the option that would cause the least pain to the worst off in society. Other policy options would have caused more pain for the poorest but somewhat less for the better off.
       
       
         0 comments
      By the fig*
      And by the olive
      And by Mount Sinai
      You have certainly created me in the best of stature.
       
                                 *********

      Angels told you: "Don't create Human.It will cause corruption in the world".
      But I had not still been born so how could they prejudge me?!
      Despite the complaints, you were determined and therefore, I was born.
      "Peace be upon me on the day I was born, on the day I die, and on the day I shall be raised alive!"
       
       
      You put me in a very great cradle. It was extremely white and bright and Holy Spirit rocked it with his fingertip. I was filled with delight and embraced by light.
      Angels all came to see me. They were amazed that I was born without parents!
      But you kept silent and then I talked in the cradle. Suddenly, they uttered a loud exclamation of surprise.
      And you, pleased with you work, said:
      "So blessed is Allah, the best of creators".
      How beautiful lovely those days were! Alas, how quickly they went by!
      I had told you about my sad memories in exile; about the day when you banished me from your heavens and I was separated from you.
      I had told you about my battles against my ownself. Everytime I fought myself, the pillars of Satan's palace started shaking. And I could hear its sound and Satan's wrathful shout.
      Ah, what a time it was! I have many things to tell you. For narrating my memories, I need a long time, as long as the history of mankind!
      Footnotes:
      * Fig tree is very strong and resistant. It can grow in nutritionally poor soils and needs little water.
      It has a high tolerance of bad situations. It can tolerate droughts, and grow in dry sunny areas and still remain productive.
      When it recieves enough water, it cools the environment in hot places, creating a fresh and pleasant habitat for many animals that take shelter in its shade in the times of intense heat.

         0 comments
      در عالم حشر, تابنده رخش
      هر که نکرد گوش, بر اهریمن زشت
      کاخی است بهر او, فاخر, باشکوه
      پرده اش از حریر, وز طلایش خشت
      باغ آن پر گل, فصلش همیشه بهار
      در کنارش هیچ است, ماه اردیبهشت
      ...
      Part 2:
      This was Satan's last trick which didnt work.
      He said disappointedly: do you remember that once I gave you some helpful advice?
      I replied: yes.
      He said: so you owe me a lot! Now, ask God to forgive me!
      Gabriel appeared and told Satan: If you wish God to forgive you, prostrate before Human.
      Satan said: I will never do it. When Human was not my enemy, I didnt agree to prostrate before it. How can I do it now while it is my enemy?!
      Gabriel said: Once, when you lived in heaven, you heard that, in the near future, one of the worshippers would be punished and cast out of heaven.
      At that point, you prayed for everyone but yourself. You were so proud that you didnt think that you yourself could be the worshipper who would be cast out of heaven.
      Satan began crying.
      And I remembered him laughing while I was crying in the court.
      Satan became weaker and weaker until he died among the ruins of his palace.
      Then his corpse, as those of his followers, caught fire and burnt to ashes. And the earth swallowed the ruins of his palace.
      Satan died; on that day when I decided to never sin; on that moment when he became completely disappointed in me.

         0 comments
      "Indeed Allah taught me and He taught me well"*
      *"ان الله ادبنی فاحسن تادیبی"

      During these thousands of years, God tested me frequently until I got permission to return to Him.
      Now, I am going to fly; but how can I do it without my wings?
      Everytime I committed a sin, I lost one of my feathers. I must find the feathers and restore my wings.
      I found a feather at the foot of the Rocky Mount and another feather in a rivulet, floating in the water. One feather was close to the Mirror of Truth and many feathers were around the Square House.
      I am going to fly towards paradise... Towards paradise?!... No!...Somewhere higher...much higher than paradise!
      Somewhere that even Gabriel cannot go...I need to create two wings stronger than Gabriel's.
      I am going to fly to Qab-e Qawsain...To Qab-e Qawsain and maybe closer**
       
      The final part of my book, "From Earth to Heaven" (Az Khāk ta Aflāk)
      Footnotes:
      * a narration from the prophet (s)
      ** surah Najm: 8. Then he came near, and hovered around. 9. He was within two bows’ length, or closer.
       
      -----------------------------
         0 comments
      In Bait-al Ma'mur, Azazil-later called Iblis-sitting on a white minbar and holding a tasbih in his hands, was preaching for a crowd of angels and other residents of empyrean. He was deeply happy and proud to see that he had such a special superior status and that the angels listened to him with great interest.
      After he finished his sermon, angels started asking him theological questions and he answered with full confidence. One of the angels asked:
      O God's beloved, we have worshipping God the Almighty for hundreds of years but we have not achieved a status as high as yours. Tell us, please, the secret behind your success in rising to this enormous  dignity and supereminence.
      Azazil, pleased to hear such a joyful acknowledgement but unaware of that what he thought and what he uttered would put him in a difficult imminent test, smiled and replied: "My friends! Listen to me carefully: I don't deserve the status I have been granted but let me reveal the secret behind my sucess to you.
      Of course, I am not going to boast but to offer help to those who desire to approach our Lord and make him pleased.
      Pure intentions! Friends! Pure intentions! Your problem is that you dont worship God purely for himself but you do it for the purpose of achieving a higher status. Such insincere worship is worthless and is never of any benefit to you.
      Another important point is to avoid being arrogant for it is a major obstacle to...".
      Azazil was preaching when suddenly he found some of the angels talking and not listening to him.
      He shouted :"What is up?! Why are you making so much noise?!"
      One of the angels said :"Sorry, sir! Our minds have been occupied with the recent news!"
      Azazil asked: "the recent news?!"
      The angel replied: "Yes. The news about a new unique creature which God the Almighty is going to create. It is said that no other creature will be equl to it and that God has special plans for this beloved creature-to-be".

      Azazil, surprised at what he had just heared, was lost in thought for a few moments and then said:
      "What a good wonderful news! Indeed, every decision our Lord takes, is wise and praiseworthy. Now, it is better to go and prepare yourselves for celebrating the birth of this welcome creature".
      As the angels were leaving, the purple beads of tasbih, one by one, slipped from his lap and the stairs and scattered on the ground; the tasbih that had been pressed and torn among the fingers of its angry owner who tried to show himself happy and satisfied.
       
       
      Footnotes:
      1. Bait-al Ma'mur( بیت المعمور) is a place in 4th or 7th heaven. It is a Ka'ba for angels.
      2. Tasbih( تسبیح) is a prayer beads.
      3. Minbar(منبر) is a pulpit.
      4. Azazil: عزازیل

         0 comments
      Left alone in the dark desert of ignorance,
      With wings, one broken by greed the other by arrogance,
      Do you wish for deliverance?
      The gates of the heavens are always open to you,
      You just need two restored wings, strong enough and new.
      O you lost in the complete dark,
      You could be Noah, the owner of the salvation Ark,
      The mountains and the birds will sing praises with you*,
      Just get up and create two wings for yourself, strong enough and new.
       
      *surah34/v.10

      ای رها شده در بیابان ظلمت و تنهایی
      بالی شکسته ز شدت کبر
      بالی شکسته ز فرط آزمندی
      دروازه های آسمان همواره به رویت باز
      برخیز و بالهایت را ز نو بساز
      ای ماه بی پناه افتاده در اعماق چاه
      ای کودک سپرده به امواج رود نیل
      لحظه ای گمگشته در برهوت
      لحظه ای گرفتار در دل حوت
      خسته و بیتاب, نالان و پریشان در پی آب

      کوه ها و پرندگان با تو هم آواز
      برخیز و بالهایت را ز نو بساز



         1 comment
      Summary
      Just because something is not created via the scientific method, does not mean it can't be useful - implications about how we think about religious precepts.
      Serendipity (pot luck)
      I have previously remarked upon how, in some fields of human endeavour where the scientific approach is held to be the ideal, in reality human scientific and technological discoveries has often been the results of luck and even mistakes.
      Social science 'theories'
      There is a corollary in the field of the social sciences which also emphasise the value of the scientific approach to generate knowledge. In this domain the anomalies are various frameworks and models that are widely taught and even used, but which have no basis in rigorous scientific research.
      The famous work by Abraham Maslow on motivation and his resulting 'hierarchy of needs' is very widely studied and used. He posits that human motivation at the fundamental level is driven by physiological needs, and once these are satisfied (he did qualify this in later works) people try and address safety needs and then, social needs and self-esteem and finally self-actualisation. 
      But Maslow did not come up with this through any research that would hold up to scientific scrutiny.
      Does the lack of a scientific approach invalidate a model or framework?
      Yet the Maslow hierarchy is productively used by professionals in a variety of industries, managers, MBA students and others in universities. For example, people use it to understand why consumers buy certain products.
      The same issue applies to Bloom's taxonomy in the field of learning and also Elmo's buying funnel in the area of marketing. The three laws of robotics have their basis in science fiction and in the area of web searching there is no scientific basis for the information-navigational-transactional categories that are used.
      Face validity
      The implication from this is that while ideas and knowledge may ideally be the result of the scientific approach I.e. hypothesising and then testing, there are many instances where this is not the case. In the area of the social sciences and management the value of some types of knowledge seems to rest on their 'face validity', do they make sense to the individuals who are presented with them and can those individuals make better sense of their external environment as a result of using these tools and if they can, that is good enough.
      Implications for religion
      The same principle could surely apply to various aspects of religion. There may be no scientific proof underpinning various religious ideas, but if they have face validity, if they help the individual make sense of their external environment and manage it, surely that is good enough?
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