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What would Muhammad say about put-call parity?
Mahalanobis explains how Islamic mortgages are being created using put-call parity. Islamic finance expert Mahmoud El Gamal sums up the situation nicely:
...I have shown in detail how to synthesize a forward from salam and a credit facility characterized as murabaha or tawarruq, depending on preference and cost. From forwards, we can then synthesize everything. That is a theorem.
Posted by Alex Tabarrok on June 6, 2007 at 07:03 AM in Economics, Religion | Permalink
Comments
The islamic prohibition on "usury" seems rather bizarre. Economists would recognize that kind of mortgage,
which is commonly used, as implicitly charging interest, however otherwise it might be labled. Also, Islamic
scholars claim that, to give a discount to customers who pay for an item upfront, rather than in installments,
does not violate the prohibitions on usury, even though that too involves an implicit interest charge. Go fig.
Posted by: Person at Jun 6, 2007 9:21:48 AM
It's the oldest trick in the book.
http://lsr.nellco.org/cgi/viewcontent.cgi?article=1053&context=upenn/wps
Posted by: kharris at Jun 6, 2007 10:10:36 AM
By the way, if you'll note in the last paragraph of the paper, the author notes that muslims were using put/call parity to create mortgages back when the paper was published, in 2004.
Posted by: kharris at Jun 6, 2007 10:20:15 AM
The Islamic world is slowly dealing with secularism, they are just a few hundreds years behind Christianity. I'm sure they'll catch up shortly (maybe only 50 years from now). From the above mentioned source, we find:
"If you lend money to my people, to the poor among you, you are not to act as a creditor to him; you shall not charge him."
Exodus 22: 25
"Lend freely, hoping nothing thereby."
Luke 6: 35.
Posted by: Mr. Econotarian at Jun 6, 2007 12:58:34 PM
I think the real issue with these things involves the state creating a law out of a stricture which leads to an information asymmetry, e.g. those with the ability, luck, or plain old influence to create an arbitrary definition which passes muster with the government succeed where others do not. The incentive to get around it is there, and someone will find some way to define around it. Of course, with a change in the people/party in power in any particular Muslim country, this particular definition could be over turned for another definition that someone else has arbitrily created.
Posted by: Darin London at Jun 6, 2007 1:38:36 PM
I think the real issue with these things involves the state creating a law out of a stricture which leads to an information asymmetry, e.g. those with the ability, luck, or plain old influence to create an arbitrary definition which passes muster with the government succeed where others do not. The incentive to get around it is there, and someone will find some way to define around it. Of course, with a change in the people/party in power in any particular Muslim country, this particular definition could be over turned for another definition that someone else has arbitrily created.
Posted by: Darin London at Jun 6, 2007 1:38:41 PM
There is an ongoing split within Islamic economics over these
matters. Thus, the Islamic Development Bank, founded by Emir
Muhammed ibn Faisal ibn Abdulaziz al Sa'ud, and the fountainhead
of the modern Islamic banking movement (now operative in over
60 countries), allows for 18 different forms of financial
contracts that supposedly avoid the forbidden "riba" (literally,
"increase"). These vary in the degree they involve profit-
sharing, as they are supposed to in theory but then become
subject to principal-agent problems as debtors obfuscate
about their costs and thus lower the profits to be shared,
and forms that more nearly resemble standard interest but
with some form of window dressing to make them look like
profit-sharing. These latter have tended to predominate
over time in actually existing Islamic banks that are successful.
However, there are Islamic economists who denounce these
latter forms, seeing through them to the fact that they really
do involve interest. M. Umer Chopra, a Pakistani who works
for SAMA, the Saudian Arabian Monetary Authority, has been one
of the most prominent of these, writing several several books
that make such points. He effectively argues that the principal-
agent problem arises from parties being insufficiently good
Muslims, and so that what is needed is a thorough-going Islamic
revolution to change the underlying behavior of people, thereby
bringing about the possibility of fully riba-free finance. An
example of this argument can be found in Chapra's _Islam and
the Economic Challenge_, 1992, Leicester, UK: Islamic Foundation.
An opponent of this view is Timur Kuran, _Islam and Mammon: The
Economic Predicaments of Islamism_, 2004, Princeton University Press.
He argues that in fact in the Qu'ran, "riba" specifically referred
only to a particular form of lending practices in which the principal
of a debt would be doubled if a debtor failed to make payments on
time. This form of widely used financial practice in a pre-industrial
era with monopolistic money-lenders often led not only to people
losing their land, but in their eventually becoming enslaved. It is
not surprising that a promulgator of moral codes of such a society
who was also a practicing merchant, such as the Prophet Muhammed,
might find such practices evil, and the language in which they are
denounced in the Qur'an is indeed spectacular in its fire and
brimstone invocations of damnation of the guilty, who are really
going to get it in the hereafter big time. However, according to
Kuran and some other scholars, this view was distorted in later
interpretations that declared that it implied a forbidding of all
forms of interest. In practice, of course, actually existing
Islamic financial practices have long managed to elide these
prohibitions by means of one method or another.
Posted by: Barkley Rosser at Jun 6, 2007 2:35:32 PM
Keep in mind that when most religions were founded capital constraints were exceedingly high, so the occasional fortunate lender could expect huge returns (recall parable of the man who goes on a journey and when he returns his servants have doubled the investment through trading).
In that environment borrowing was most likely a fools errand there were likely few opportunities that would earn enough to cover the interest payments, think Pottersville from it's a wonderful life combined with check cashing/payday loan places.
Posted by: nelsonal at Jun 6, 2007 2:51:46 PM
Note that the medieval catholic usury law forbade the charging of usury, whereas the islamic law is significantly more restrictive in forbidding the paying of usury. A medieval catholic could in good conscience borrow from a jewish moneylender, but the practicing muslim cannot borrow with interest, even if he lives in jurisdiction where such financial practices are allowed.
Posted by: Cyrus at Jun 6, 2007 3:02:05 PM
Also note that while the use of alternative financial vehicles to get around usury restrictions seems specious, because the results seem the same, the results are only the same if the loan is paid on the agreed-upon schedule. The results can be quite different if the borrower fails to pay, or wants to pay the debt early.
Posted by: Cyrus at Jun 6, 2007 3:04:48 PM
My favorite medieval Italian method of circumventing the usury law, although certainly not the most elegant, was that of the late payment fee. The law allowed loan contracts to specify a late payment fee, and creditors strongly hinted to their borrowers that if they wanted to borrow again in the future, they would be well advised to pay late.
Posted by: Cyrus at Jun 6, 2007 3:10:01 PM
The law allowed loan contracts to specify a late payment fee, and creditors strongly hinted to their borrowers that if they wanted to borrow again in the future, they would be well advised to pay late.
Sounds exactly like my credit cards.
Posted by: Andrew Edwards at Jun 7, 2007 6:41:16 AM
Wouldn't Allah see that they are trying to 'get around' his laws? Religious people are weird.
Posted by: adrian at Jun 8, 2007 1:25:53 PM
They certainly are.
Witness the machinations that Orthodox Jews undertake to circumvent strict Sabbath prescriptions.
I don't understand why one would want to follow a religion whose tenets require constant undermining.
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