MDI comment: Willem Buiter, the chief Economic for the multinational investment banking and financial services corporation Citigroup, is a keen advocate for Islamic Economics, and has criticised the current traditional Western financing as “poor financial design” while praising  Islamic solutions to financing peoples’ homes and other developments, as “good financial engineering”.

Previously, he has co-written an article for the journal, JKAU entitled ‘Why Economists (and Economies) Should Love Islamic Finance’.

If leading economists in Capitalist multinational corporations have acknowledged the superiority of the solutions that Islam can offer, then Muslims should not only be heartened, but strive to implement the full range of Islamic solutions and become an example of the justice of Islam to the world.

To find out more about the Islamic Economic System and how it would work, please see our video presentation “The Solution to Poverty – the Islamic Economic System”.

Few economists would look to religion for the solution to a growing household debt problem, but Willem Buiter says Islamic finance is an unlikely future source of much needed innovation.

A traditional mortgage – which is the core offering of a traditional bank – is “poor financial design,” Citigroup’s chief economist tells The Australian Financial Review.

“Households are the last entities that should take on debt. They should take on equity-like stakes,” he says from his office overlooking New York’s Hudson River.

Households, he explains, have the least amount of collateralised wealth, which they can pledge against a loan – making them ill-suited to take on large amounts of debt.

“They have two big assets: human capital, which is not ‘collateralisable’, and the property, itself, which is illiquid and hard to realise,” he says.

The solution, he says, is an Islamic style mortgage. The faith outlaws the charging of interest, so to skirt this restriction “financiers” instead charge rent and allow the borrower or tenant to gradually purchase equity in the property. The motivation may be to adhere to religious codes but the result is a less risky financial arrangement for the household than a standard home loan.

“A classic Islamic mortgage is a dual equity mortgage where the bank owns the house to begin. I buy the house from the bank with two payment streams. One is a rental stream related to the [rental] market. As long as I keep up that payment I won’t be affected,” he says.

“But the second is discretionary: for example you buy 5 per cent from the bank each year.”.

Less financial risk

The benefit of the arrangement is there is less financial risk assumed by the tenant than would otherwise be incurred by a large loan.

“If you have disruption in your employment you can stop buying equity in the house or even sell back what you have already bought – the chances of eviction and dispossession are much lower.”

As Buiter explains these arrangements extend beyond Islam and have proved practically useful in places where housing is unaffordable.

“Stanford University does this. It’s too expensive for an assistant professor to buy a house [in Palo Alto, California] so they go 50-50 with the university. If you make tenure you buy out Stanford and if you don’t they buy you out. So it turns into equity.”

The Islamic mortgage is a rare example, Buiter says, of “good financial engineering” rather than attempting to avoid paying tax or skirting regulation.