My Research On The Subprime Mortgage Crisis 2008 and How It Relates To Islamic Finance…
When I meet, my non Muslim clients who are learning more about Islamic finance, sometimes they are curious, and they asked me, why Muslims cannot take interest. (riba)
Why, Muslims, cannot include speculative investments, like derivatives etc2, in their investment portfolio? (maysir)
I will normally answer, that God doesn’t allow us and stop at that. Today, I decide to blog about it. 🙂
Prohibition of interest and speculative activities are clearly mentioned in the Quran.
Allah S.W.T said in the glorious Quran, Surah Al Baqarah, Verse 275
“Allah has permitted trade and has forbidden interest”
Charging and earning interest is haram (forbidden) in Islam. Islamic finance advocates profit and risk sharing. If Islamic institutions lend out money, it becomes partners with the borrower in the venture. Profits and loss will be shared according to agreement.
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Islamic finance also prohibits gambling and speculative activities
As stated in Surah Al-Maeda, Verse 90:
“O ye who believe! Intoxicants and gambling, (dedication of) stones, and (divination by) arrows, are an abomination,- of Satan’s handwork: eschew such (abomination), that ye may prosper.”
On the other hand, conventional banking and finance operation, accepts speculative financial instruments like derivatives.
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When I research about every single financial crisis that has happened in this world, and I went deep to the root of it, I realised that it is always because of interest (riba) and speculation.
Subprime mortgage crisis, Euro Debt Crisis, Asian Financial Crisis, Baring’s Bank case, you name it, most of the financial crisis that have happened in the world were due to interest and speculation.
I have written a 24 page report on the subprime mortgage crisis that happened in the year 2008, and how it lead to the global financial crisis in the year 2009. You can scroll at the end of this blog post, input your email and download it immediately. Its FREE.
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Speaking of subprime mortgage crisis, if we go to the root cause of it, it happened because of speculation and because people cannot afford to pay burgeoning interest from the loans they take. The subprime mortgage crisis happened because of the availability of subprime mortgage.
Subprime loan is a type of mortgage loan, being offered to those who are not qualified to get loans from mainstream lenders. These people are usually low income earners, first time borrowers or people who has a poor credit history.
Under normal circumstances, when people borrowed money from the bank, they were subjected to few criterias before their loan is approved.
They need to have strong credit scores and repayment histories, provide documentation for income and assets, and provide a down payment of 20% or alternatively purchase private mortgage insurance. If these criteria are fulfilled, their loan application is approved.
These groups of people are known as prime borrowers.
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However, competition amongst banks ensued, coupled with the view of treatment of loans as “assets” in the bank perspective, has lend to the lenience, of now, accepting loans for people who are previously not qualified.
Due to competition amongst banks, they now allow people who are previously not qualified to borrow. They are people whose FICO scores are under 660, defaulted on credit payment in the past 2 years or currently, owe more than half of their annual income in debt.
These people are called subprime borrowers. Their loan mortgages are known as adjustable rate mortgages.
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Adjustable rate mortgages have an initial interest rate. During the real estate bubble, many lenders offered mortgage loans with a very low initial interest rate designed to lure borrowers to loan products.
These very low interest rates, referred to as teaser rates, ended up getting a lot of borrowers into trouble. When the initial interest rate period ended, the interest rate and loan payment increased, sometimes drastically. This phenomenon has come to be referred as rate shock.
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For example, the monthly payment for a $300,000 mortgage loan amortised over thirty years with an initial interest rate of 5% is $1,610.46.
If, after the initial interest period, the interest rate jumps to 10%, the monthly mortgage payment jumps to $2,632.71.
Thus, lots of borrowers cannot service their monthly mortgage payments, and then default on their payments. With the interest rates rise and housing prices fall, the borrowers do not have enough equity to refinance or sell.
So you can see here that the root cause of it is the adjustable rate mortgage where initially the interest rate is low, but subsequently, it skyrocket.
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I will also touch on the speculative nature of human beings, thinking that property prices will always go up, till the property bubble happens. There are simply too many things to be discussed, and I have discussed it extensively in the report below. Key in your name and email below, and you can download it right away.
p.s. By the way, if you wish to discover a simple & halal way to create a positive monthly cashflow and calculate your net worth for FREE, then please click here…
