Middle-east Arab News Opinion | Asharq Al-awsat

When Individual Debt Causes a Global Financial Crisis | ASHARQ AL-AWSAT English Archive 2005 -2017
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Riyadh, Asharq Al-Awsat-Whilst flicking through my magazine archive I stumbled across the August 2001 issue of Newsweek. The magazine’s front page grabbed my attention as it contained the headline “Filled to the Brim? American Consumers Drowning in Debt.” I began thumbing through the pages looking for the featured article as I felt sure that this had some connection with the global financial crisis. However after reading it I was surprised to discover that it contained information that actually predicted the current global financial crisis. Here is an excerpt from the article, keep in mind that this was written in 2001.

“Homeowners are borrowing against their houses’ rising value to fuel discretionary spending. Banks are peddling risky loans to people with poor credit history. As the economy slows, mortgage delinquencies and credit-card write-offs are already rising. Forecasters say a record 1.4 million people may file for bankruptcy this year. The phrase debt crisis used to refer to Mexico’s or Argentina’s defaulting on bonds. In the months ahead, some economists warn, a growing number of families may experience one firsthand. Of course, the disaster scenarios may be premature.”

As we can see, property is being used like piggy banks by American consumers. The article even gives examples, such as Rock Gibbons and Linda Gossett from the city of Dallas who paid for a $7,000 diving trip to the West Indies by refinancing their house, which they had bought for $42,000 in 1995, and was worth a reported $123,000 in 2001 [at the time of the article’s publication]. This means that the couple added $77,000 dollars in debt to their mortgage, in order to pay off credit card debt and car loans as well as make home improvements.

The article gives other examples of this rash and unwise expansion in consumer spending at the expense of accumulating debt on the mortgage. This foreshadowed the [financial] disaster that occurred in 2008, causing the global financial crisis that the world continues to suffer from today. This shows how individual credit can harm the domestic and international economy.

And so it is necessary to learn the lessons from the American experience, and never allow such a tragedy to occur in our Arab world. In fact, Saudi Arabia, the biggest credit market in our region is only beginning to implement [credit] systems like the mortgage system. This mortgage system is expected to contribute to solving the housing problem that Saudi citizens are currently suffering from as a result of high market prices and banks refraining from providing finance to individuals due to the absence of a mortgage system. By implementing such a system it is expected that Saudi Arabia will witness a housing boom due to public demand for property ownership. This may, in turn lead to a rise in house prices.

In order to take advantage of this system while avoiding its disadvantages, I suggest that legislative bodies like the Shura Council, as well as regulatory bodies that monitor the financial sector like the Saudi Arabian Monetary Agency [SAMA], and the Stock Exchange, undertake the following:

– Prohibit remortgaging of real estate so that real estates cannot be used as piggy banks to finance consumer spending, as this ultimately harms the national economy by increasing import prices and raising inflation rates.

– Apply strict oversight procedures on awarding credit when offering mortgages, checking the credit rating of the prospective home owner in order to ensure that the he is able to pay off the mortgage in order to reduce the number of cases that fail to pay off their mortgage.

– Provide a securitization system [for sukuk bonds] in accordance with Islamic Shariaa law to encourage banks to grant long-term mortgages. The presence of such a system will help banks to strike a balance between funds coming in, and how these funds will be spent. This system will also help banks to reach the required capital liquidity, as well as increase efficiency with regards to risk management. However this system should only allow the securitization of valid credit bonds, otherwise risk would be transferred to the investors holding the sukuk [bonds]. In the event of the system allowing the securitization of invalid or weak credit bonds, banks should facilitate the granting of credit. However one must bear in mind that this could lead to a financial crisis that results in the collapse of the entire banking system, just as that which occurred in America.

– Provide a secondary market for the circulation of sukuk bonds.

– Prevent the establishment or circulation of derivatives linked to mortgages, whether these are new or traditional, even if they comply with Islamic Shariaa law.