Islamic Bond Crisis?

Yesterday, Bloomberg News ran a story, "Islamic Bond Decree Cripples Sukuk, Imperils Projects."  Two things entered my mind when I read this;

1. Hundreds of years ago, when Islam came up with this way to lend without interest, they HAD to have had some premonition of how much fun they could have with infidel structured product groups.
2. Mixing Citigroup, HSBC, money and The Accounting & Auditing Organization for Islamic Financial Institutions was bound to produce a whole lot of losses and comedy.

Actually, the first thing that struck me when I read this article was, "Citi has a Islamic finance business?"  Pandit is calling things like its German consumer lending unit "legacy assets" and selling them, but the Islamic Finance group is part of the plan?  Very interesting.

Anyway, it appears that despite having a whole group of Islamic scholars on board, HSBC and Citi managed to bungle what appears to be a pretty straight forward rule and now billions of Islamic bonds or "Sukuks" are not in compliance with Islamic law.  Under Islamic law if I lend you money, you have to give me assets that I can generate income on.  As long as you don't buy guns, alcohol or go gambling with the money its cool.  Here's the catch though.  When you give me an asset, you aren't posting it as collateral, you are giving it to me, I have to own it.  That means I am subject to price movements.  If I lent you $1million and you gave me an apartment building worth $1.1 million, when the loan is over I have to sell the building back to you.  If the value of the apartment building goes down to $900,000, that's too bad for me.

It's a tough way to do business but it seems pretty straightforward no?  Apparently not because a group of Shariah scholars in Bahrain decreed in February that about 85% of the sukuks that have been issued ($77 billion out of $90 billion) are not compliant.  These sukuks guaranteed the lender that the asset he "owned" would not effect the amount of money he got back from the borrower.  Now according to Bloomberg, these outstanding bonds are worth 50 cents on the dollar.  Oops!  It also doesn't help that we are going through a bit of asset deflation right now either.

James Milligan, head of HSBC Middle-East Fixed-Income trading said, "In times of distress, the first thing investors sell are the credits they don't fully understand."  I think Mr. Milligan has that backwards.  It should read, "In times of ridiculous prosperity, people create and invest in markets they don't understand."  That's what seems to have happened here.  Sound familiar?

Now, if the scholars really want to have more fun with the western banks, they should let us do what we do best, create a derivative market around the process.  Lenders of sukuks need protection against declines in the assets they are getting from the borrowers.  We could create an entire business around insuring all kinds of assets sold to lenders against depreciation.  I'm kind of surprised this hasn't happened all ready.  In fact, has it?  I'd like to know because it almost seems like we wouldn't be able to resist adding some fancy structuring to the deal.  All it takes is one decree from a Scholar in Riyadh to ban total return swaps on sukuk assets and there's going to be a lot more losses!  So we have that going for us.

Comments

[eric]

Why the hell not right??

[kosmo]

Yeah, and we can get MBIA and AMBAC insure those assets. "Dont worry Mr. Investor, it doesnt matter thats it's a Sukuk, you're protected by the monolines. So many can you buy?"

[mike]

love those a-rabs!