What the Lehman Brothers anniversary teaches us about Islamic finance
Nine years ago this month, Lehman Brothers investment bank filed for Chapter 11 bankruptcy, triggering a global financial crisis in earnest as millions of families lost their homes, savings, and jobs.
Though most of the world has since recovered from the crisis, it benefits us all to consider measures to prevent similar problems in the future. Concepts from Islamic finance can offer simple yet effective guidelines to help us avoid the worst of financial crises. With the Lehman debacle in the rearview 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 debt to equity was around 30:1. It was even borrowing to invest in risky mortgage-backed securities, which 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 fare 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
Islamic finance practitioners don’t invest in interest-based loans generated by financial and insurance companies. Speculation and short-selling are also discouraged, in keeping with internationally accepted guidelines for Islamic finance.
Such excesses were at the heart of the financial crisis, including at Lehman. An unconstrained banking sector was allowed to issue loans at exorbitant rates to home buyers, who then defaulted on their payments. As Azzad Senior Investment Strategist Fatima Iqbal said at the time, “The aggregate default and the trading of mortgage-backed securities led to weakened banks and, finally, to a weakened economy.” She 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.
Hoarding wealth — which is all too common in an era when the largest economic gains accrue to the wealthiest and least likely to spend — is the opposite of the Islamic economic call for the circulation of capital in order to contribute to the real economy.
Economic wellbeing is surely part of the wisdom behind the Islamic wealth tax (zakah) that is assessed on individuals and corporations that own assets above a specified 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 tax on wealth rather than on income — a concept similar to zakah — in order to address the underlying inequalities we see today.
The principles of Islamic finance are intended to promote social justice and fairness in financial transactions. Regardless of religious belief, concepts like these can guides us to be better, more disciplined market participants. As we look back at the Lehman collapse and its consequences, it would serve us well to bear them in mind.