For months now we have been hearing how Shariah-Compliance provides an insulation against the effects of the financial crisis, specifically the subprime mortgage debacle. The argument states that the prohibition against interest and the requirements for asset-based transactions would prevent the securitization of mortgages to begin with and prohibit investments in such instruments.

Of course, this argument is flawed based on the fact that so-called “interest-free” Shariah-Compliant mortgages still charge a convoluted formula of fees and charges that end up adding up to the same rate as prevailing interest rates. The proof lies in the fact that the IRS allows homeowners who have such mortgages to take the interest deduction for such fees.

But now another factor has arisen that was perhaps unforeseen. Derivatives are complicated financial instruments and have a deservedly bad reputation as a result. However, not all derivatives are alike. Some derivatives are designed as hedges to control and reduce risk. These types of instruments are very useful for money managers, especially in the midst of the tough markets we are experiencing today.

This is a problem for Shariah-Compliance because these hedges are in fact not available for the most part for those who seek to be Shariah-Compliant. The article at the link below explains that this could very well mean trouble ahead for investors who invest in Shariah-Compliant products. (The article is obnoxious in ways as well, especially in erroneously touting the “strict transparency” of Shariah-Compliant products.) So, we now have a situation in which a claimed strength of Shariah-Compliance could very well be a crippling weakness…


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