Visions for the Future of RF Banking


As I started writing the first edition of this book in 2009, the world was experiencing the deepest economic and financial meltdown since the Great Depression of 1929. This meltdown has touched every citizen in the world because of the efficient communication systems that have successfully interconnected the world's financial and banking systems. It is unfortunate and sad to experience the laying off of many employees who had nothing to do with what happened; the loss of their homes through foreclosures; the decline in living standards, not only in the developed world but also in the developing countries; and the increase in poverty worldwide.

The core reason for what happened has been a culture of “making” money on money by renting it with interest (ribit/riba) and speculating with it instead of working hard to earn it. The financial and banking system in the United States is well designed and regulated. Unfortunately, it has been abused by some who claimed that they could create money by using hedge funds, financial speculation, and gambling. The unfortunate thing is that many pension funds joined the party because they were impressed by the high returns realized by these speculative investment funds. These pension fund managers should have known better; they were entrusted with the future retirement funds of millions of Americans. Many of those who speculated and gambled with people's money and life savings as well insurance premiums paid by the public to insurance companies to protect against unexpected catastrophes in the future did not abide fully by the regulations. They had the wrong idea about money and what money is all about. They believed that if you have a lot of money, you can make a lot more — not necessarily by investing in productive activities, but by using options, derivatives, and financial gambling techniques that speculated on what the future holds. The 2008 meltdown proved that this was the wrong way to look at and invest money. It is unfortunate to report that as I am writing this second edition of the book in 2014, the situation has not changed much. The government successfully rescued many mega-banks and insurance companies, as well automobile manufacturers, using creative monetary policy. However, banks are still using derivatives and options to hedge against fluctuations in interest rate and to earn money through fees, spreads, and commissions on trading stocks, bonds, and commodities. Major banks are using interest rate hedging to give loans at artificially reduced interest rates for periods of 5 to 10 years. Mega-banks have the capital, staff, and know-how to do this. Small community banks do not have this luxury available to them, which allows larger banks to charge a fixed interest rate for 7 to 10 years. Small banks cannot fix rates for such long periods of time and end up losing customers to the larger banks.

It is interesting to note that only 25 employees in the Financial Products division at AIG (AIGFP) — the huge international insurance company that employed 113,000 professionals worldwide and was rescued by the U.S. government in 2009 and recovered fully three to four years later but as a smaller-size company — were responsible for bringing the whole company down. One of their tools was a product they designed to speculate on the movements in the levels of market interest rates. For example, one of their bets would result in a profit or a loss of $500 billion if interest rates changed by a small percentage in either direction. This loss, realized by the company, is equivalent to paying for the loss and damage caused by 62 California- size earthquakes.[1] Unfortunately, AIG grew so big that even with the most sophisticated management and supervisory tools and techniques, no one could regulate the activities of this small group of employees.

What is most sad, concerning, and disappointing is the fact that we all were warned many times about the outcome of such speculative activities in the market. Those who were in charge used a bandage approach to fix these problems temporarily. No one took the time or spent the effort needed to meticulously and permanently fix the root causes of the problem. Here is a list of some of the small earthquakes that introduced us to what was waiting to happen in 2008:

■ The savings-and-loan junk bond crisis ($240 billion loss in 1989).

■ The German commodity and metals company Metallgesallschaft ($1 billion loss in 1993).

■ Barings Bank (speculation by one of its traders in Asia cost more than $410 million).

■ Procter & Gamble (loss of $160 million in 1994).

■ Orange County, California ($1.7 billion loss in 1995).

■ Long-Term Capital Management Corporation ($4 billion loss in 1998).

■ Global Crossing Corporation (billions lost in 2001).

■ Enron Corporation (billions lost in 2001).

■ WorldCom Corporation ($3 billion lost in 2002).

■ Societe Generale unauthorized trading ($7 billion lost in 2007).

Analysts in most of these cases concluded that the main reasons for not avoiding these losses were management's lack of clear and thorough understanding of the products and the risks involved, and the faulty assumptions used in structuring these speculative financial products.

  • [1] The highest insurance cost paid by AIG for a California earthquake was around $8 billion.
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