Thursday, March 21, 2013

Global Credit Crunch and wider implications
Adnan Khan

1. What is the financial crisis termed the ‘credit crunch’? What are the potential implications of the financial crisis for the economy?

The credit crunch crisis is the term given to the crisis which led to banks to stop lending to each other creating a freeze on the financial markets, leading to the collapse of Northern Rock, as one example. There are a number of implications as various aspects of the economy are directly or indirectly linked to the crisis:

• Both the US and the Britain have witnessed debt driven growth other the last decade, this is now coming to an abrupt end.

• In Britain the economy is worth £1.3 trillion whilst consumer debt is £1.4 trillion

• The easy availability of credit drove the housing bubble, now the main engine for that - debt is running out of fuel

2. What are the main causes of the financial crisis?

There are a number of causes which caused the crisis some a result of other factors and some more important then others:

• The lending of money to high risk customers, with very little chance of them being able to meet the obligations i.e. sub-prime loans.

• Banks then turning such debt into ‘tradable commodities,’ CDO’s, MBS’s etc. i.e. debt became a product that was brought and sold.

3. Is the main problem poor homeowners in the USA who couldn’t pay their mortgages or are there more fundamental reasons in the way the financial system works?

• The financial side of the economy is now the largest sector in Western economies, this has resulted in governments giving huge concessions e.g. the non-regulation of hedge funds, tax breaks and cuts as well as bailouts.

• The ability of banks and Western governments to continually print money at will, will always create bubbles. For example the US only has $1.4 trillion in circulation, its banks have used that to create a further $11 trillion through fractional reserve banking.

• The philosophy of Capitalism of perpetual economic growth is actually unsustainable and is what causes the periodic crash, recession and crisis when people’s excesses reach boiling point.

• Capitalism believes if all people pursue their self-interests/Greed then the right things will get to the people who want them. Greed is seen as a good thing and necessary for Capitalism to work, hence predatory mortgage lending, exuberant interest rates, dodgy credit ratings all show greed.

4. What has been the response of the governments to address the crisis, is it enough and has it worked?

• Central banks around the world poured money into the markets to shore up the freezing of funds

• The British govt nationalised Northern Rock which was on the verge of collapse

• The US govt arranged the eventual sale of Bear Stearns, the 5th largest investment bank in the US when it was on the verge of collapse

• The US plans on tax rebates in September to a large chunk of the population in the hope the US economy can ‘spend its way’ out of the crisis.

• The British government cut a deal with the banking sector to the tune of £50 billion where it would swap their bad debts for government money, and then use this as collateral in lending.

Government actions have lead to the halting of complete economic collapse as was seen with Northern Rock, However with debt having driven the economies in the West in the last decade, this will have series repercussions - potentially a recession

5. Does the government bailouts not contradict non-interventionist capitalist thought and potentially accentuate the crisis through ‘Moral Hazard.’

The free market has once again been brought into question; there are many that believe the government should intervene due to market failure. Banks most certainly would not have created toxic products if they knew they would have to face the full consequences of their actions.

6. Some have suggested greater regulation and transparency will this work?

This is the standard answer after every crisis; regulation on lending was brought in after the great depression, the stock market crash of 1987 brought in more regulation. No amount of regulation can deal with something which goes down to the very belief of Capitalism - Greed

7. What lessons can we take from this crisis about how western financial markets are fundamentally flawed?

The financial markets in essence is a parallel economy, rather than work in the real world, participants gamble on what is going to happen in the real world - by betting on how businesses are performing and by betting on their profits. This is the fundamental problem with financial markets, they produce nothing real

8. The economist magazine faithfully defended western financial markets, while acknowledging the flaws in the system, by dogmatically stating ‘bubbles, excess and calamity are part of the package of western finance, and still worth it,’ Is it still worth it.

No, and this avoids any discussion on free markets, Financial markets played a miniscule role in the economic development of Britain, US, Germany, Japan and France. They are not necessary to have for the development of nations and are not part and parcel of modern life; they are part and parcel of Capitalism. Communism and Islamic history did not suffer from such crisis (or more at such regular occurrence).

9. What alternatives does Islam offer, given that the Islamic financial system is not based on interest?

• Islamic system is based on the real economy, not parallel economy

• Investment in Islam is in real goods and services not on the value of a business etc

• Finance can be raised through banks who will pool deposits, and invest them around the economy and share in the risk of ventures.

• This is actually what lead to the development of the first corporations

• State grants

10. How will Islamic companies raise finance in order to start up and grow which is important for a thriving and vibrant economy

Through state grants and loans and as stated above through banks. The economic development of the British Empire and the US was primarily thorough state intervention in key sectors of the economy, protecting those markets through tariffs and providing cheap loans and grants and monopoly rights i.e. economic development is generally always centrally driven.
Submitted by a Mujahid

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