Lehman Brothers eight years later
Eight years ago this month, Lehman Brothers filed for Chapter 11 bankruptcy. With that, the Global Financial Crisis (GFC) kicked off in earnest, and millions of families lost their homes, savings, and jobs.
Concepts from Islamic finance can offer simple yet effective guidelines to help us avoid the worst of financial crises. With the Lehman debacle squarely in the rear-view mirror, let’s take a look at some of those ideas and how they might help in the future.
Lehman was highly leveraged near its end; in 2007, the firm’s ratio of assets to shareholder equity was 31. This made it increasingly sensitive to market turbulence. Islamic finance principles call for companies to avoid excessive debt. In tough times, companies with less debt are likely to do better because they have flexibility and fewer outstanding liabilities. Low debt keeps a company’s interest costs down and gives it more latitude to grow the business.
Promote risk sharing
Unlike Lehman, Islamic finance practitioners do not invest in interest-based loans generated by financial and insurance companies. Speculation and short-selling are also discouraged, in keeping with internationally accepted guidelines.
Those excesses were at the heart of the GFC, when an unconstrained banking sector was allowed to issue loans at exorbitant rates to home buyers who defaulted on their payments. As Azzad Senior Investment Strategist Fatima Iqbal said in an analysis at the time, “the aggregate default and the trading of mortgage-backed securities led to weakened banks and, finally, to a weakened economy.” Iqbal went on to outline the Islamic injunction to never charge a gain without sharing the risk–an apt lesson that many financial institutions have yet to learn.
Give charity to grow the economy
Hoarding wealth, which is enabled by usurious banking practices, is the opposite of what Islamic economics calls for–namely, the circulation of capital in order to contribute to the real economy.
Economic well-being is surely part of the wisdom behind the Islamic wealth tax (zakah) assessed on individuals and corporations in possession of a certain amount of assets above a bare minimum; these funds are distributed to the needy. The positive “multiplier effect” from money that is given to the disadvantaged has been affirmed by countless economists. French economist and author Thomas Piketty has advocated for a global wealth tax not unlike zakah to address the underlying global inequality we see today.
The principles of Islamic finance can equip us with the tools to be better, more disciplined market participants. As we look back at the Lehman collapse eight years later, it would do us good to remember that.
Joshua Brockwell is Investment Communications Director at Azzad Asset Management, a socially responsible registered investment advisor located in Falls Church, Virginia. He can be reached at email@example.com.