Professional Documents
Culture Documents
June 2009
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Abstract
There is no doubt the United States pensions industry has been badly bruised by the
global financial crisis. These are tough times in the United States, but if the current crisis
continues to spread, it will surely deteriorate the employee’s retirement income.
Certainly the road ahead isn’t easy, but it’s not an impossible one, there are still many
possible avenues for individuals to diversify their portfolios to make sure they could
achieve their retirement goal. Therefore this paper will first explain the connection that
relates subprime mortgage crisis towards the retirement plans in the United States.
Furthermore explain how the financial crisis affecting one of the popular retirement
plans in United States, the 401(k) plan. Lastly, the author believes that some of the
Islamic finance instruments could help the employees in achieving their retirement goal
in the crucial time of crisis by exercising some important fundamental investment
principles.
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1.0 Introduction
A crisis that affects the entire financial system began in the mortgage financing sector of
the financial system of the United States and spread rapidly to the global financial
system. As mentioned by Abbas (2009), since U.S financial system is the epicentre of the
crisis, therefore the analysis of recent crises has to start with the U.S. system’s financial
structure and the conditions that led to the crisis. According to Baker (2008) the central
elements that we call as the housing bubble lead the house prices peaked but began to
turn down in the middle of 2006, this result a rapid rises in the default rates especially in
collateralized debt obligations (CDO), frozen credit markets and credit default swaps.
First and foremost, it relates with two groups mainly the home owners and the investors;
the home owners represent their mortgages while the investors represent their money.
These mortgages represent houses and this money represents large institutions like
pension funds, insurance companies, sovereign funds, mutual funds and etcetera. The
financial system brought these people together, in addition with the banks and broker
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who commonly known as Wall Streets. Directly or indirectly, these banks on Wall Street
It happens when the home owners default on their mortgage, the lender gets the house
and houses are always increasing in value. Since they are covered in the home owners
default, lenders can start adding risk to new mortgages not requiring down payments, no
proof of income, no documents at all and that is exactly what they did. So instead of
lending to responsible home owners called prime mortgages, the lenders approved
applications even the applicants can be considered as among those who are not
creditworthiness (Baker, 2008). These are the turning point when it get involves the sub-
prime mortgages.
Thus the sub-prime mortgages that are comprised of defaulters are like bombs that are
waiting time to explode. The subprime mortgage crisis in the grip of which the U.S finds
itself at present is also a reflection of excessive lending. When the mortgage broker
connects the family with the lender and the mortgage, this way the family could get the
house easier as well as the mortgage broker able to get his commission. The lender sells
the mortgage to the investment banker who turns it into a CDO and sells slices to the
investors and others. This way works out nicely because everyone selling off their risk to
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Therefore, the home owners default on their mortgage which at this moment is owned by
the banker. This means forecloses on one of his monthly payment turns into a house. It’s
been reported that according to the Mortgage Bankers Association, roughly 4.2 million
mortgages were overdue or in foreclosure at the end of 2007 (Chapra, 2008). Now when
there are so many houses for sale in the market, creating more supply than there is
demand and housing prices aren’t rising anymore, in fact, they plummet. This creates an
interesting problem to the home owners who are still paying for their mortgages, since
most of the house in their neighbourhood up for sale, their house started to devalue.
Home owners now realizes that they have to pay higher mortgage while their houses are
The home owners walk away or so called default, and default rates sweep the country and
prices plummet. Now the investment bankers like Merry Lench, Lehman Brother Inc. are
basically holding a box full of worthless houses. The investment banker tried to sell the
CDO to the investors but they refuse to, because they already bought thousands of these
CDO. On the other hand, the lender also tried to sell their mortgages but the bankers
won’t buy it, thus the broker is out of work. These lead the whole financial system went
frozen.
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Besides number of causes that lead to the crisis, Chapra (2008) quoted the BIS in its 78th
Annual Report by saying that the fundamental cause of today’s problems in the global
economy is excessive and imprudent credit growth over a long period. The worrisome
that lead to the crisis is already detected earlier because of the imbalances in the U.S
economy when it’s public-sector budgetary deficits and the private-sector saving
Furthermore, some hold a view that human characteristic that was most responsible for
the credit crunch is human greed. This opinion is not only according to The Archbishop
of Canterbury, Dr Rowan Williams but also agreed by most of the Muslim scholars like
Nejatullah Siddiqi (2006), Umer Chapra (2009), Hussein Shehatah (2009) and so forth.
Human greed come into picture when the absence of ethics and morality lead the
investors, bankers, and people in the market becoming greed to maximize profit, wealth
and consumption by any means in keeping with the mores of the prevailing secular and
materialist culture. Hence Muslim leaders from around the world are calling for world
leaders to work together to prevent the burden of the financial crisis from falling on “the
For many individuals, social security is the primary sources of retirement income. Keown
(1998) states that 95 percent of all Americans are covered by Social Security and the size
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of the social security benefits is differ between one to another depends on the number of
years earning, the average level of earning and an adjustment for inflation. Pension funds
in the private and the government sectors collect pension contribution and invest them
according to goals of the employees for their funds (Encyclopaedia of Business and
Finance, 2007). U.S retirement plans for an individual can be classified into several
categories which are defined benefit plans (employer funded pensions) and defined
contribution plans (employer sponsored retirement plans) to those who work in private or
public sector. There are also retirement plans for the self-employed and small business
employees.
Generally these plans are non-contributory retirement plans where the employer provides
all the funds and the employee need not contribute, while contributory retirement plans in
which the employee with the help of the employer, provides the funds for the plan. The
advantage that defined benefit plans offer is that the employer bears the investment risk
associated with the plan, which means the retirees still promised the same amount
regardless of what the stock and bond markets do (Keown, 1998; Kapoor, et al., 2007).
However, besides this traditional defined benefit plans, many companies started to
switched to cash-balance plans where employees are credited with a percentage of their
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The other pensions plan namely defined contribution plan, this kind of pension plan bring
either the employer alone or the employees and the employer together contribute directly
to an individual account set aside specifically to the employees (Keown, 1998). This
plans also sometimes called individual account plans. Generally defined contributions
plans take one of the several basic forms, including profit-sharing plans, money purchase
plans, thrift and saving plans, or employee stock ownership, and salary reduction or
In this plans, what the employees get is depends on how well the retirement account
performs. Most of the defined contribution plans allowed the employees to choose how
they would like the account to be invested. These kinds of plans involve no risk for the
employer, thus employer pass the responsibility to the employees and don’t really care
In addition, the retirement plans for the self-employed and small business employees
consists of three basic types of plans which are simplified employee pension plan (SEP-
IRA), savings incentive match plan for employees (SIMPLE plan) and self-employed
retirement plan (Keogh plan). Besides that U.S also provides individual retirement
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account (IRA) as another method to fund retirement, there are three types of IRAs which
are traditional IRAs, Roth IRAs, and Cloverdell Education Savings Accounts (Keown,
1998).
However, despite of many retirement plans in the U.S, Weller (2009) statement are
parallel with research done by Retirement Confidence Survey in answering how much
have American workers saved for retirement? The result shown that many Americans
have little money put away in savings and investments, “53 percent report that the total
value of their household’s savings and investments, excluding the value of their primary
home and any defined benefit plans, is less than $25,000. Twenty percent say they have
less than $1,000 in savings”. Thus older workers tend to have more saved than younger
4.0 Implication of world financial crisis on the retirement plans of the individuals
Poerio and Chapman (2009) reported that U.S pension plans have lost as much as 2
trillion in the current volatile market. Falling stock prices really affected the pension
funds since majority of the pension funds are held in form of equities (Weller, 2008;
It is believed by Weller (2008) that the pension funds of Americans already bad before
the crisis hit, he says that “retirement security has been growing concern for Americans
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for many years due to limited retirement plan coverage, little retirement wealth, and
increasing risk exposure of the individual” (p.2). This means too few people in the
Americans people are covered by a retirement savings plan at work. The spiral effect of
the crisis not only impact the houses prices, but also affecting the American pension’s
fund. Weller (2008) also sees that most of the American treats their home as their primary
source of household wealth. Thus when the crisis hit, the declines in house price quickly
According to Munnel, Aubry, and Muldoon (2008), the financial crisis crystallized the
differences between the traditional defined benefit plans and the defined contribution
plan such as the 401(k) retirement plan since the 401(k) is where the individuals bear the
risk, thus when the stock market collapse, they take immediate hit towards their
retirement plan. Those who in this plans am about to retire less, or had to be re-employed
after their retirement. Kansas (2009) feels the underscoring the anxieties that faced by the
employees that about to retire and the younger employee who wonder whether is it still
worthwhile to invest in stocks, the 401 (k) system puts too much burden to the people
Amid the crisis, the public is worried about their retirement security in terms of their
ability to afford a comfortable retirement. The April 2008 Gallop poll also concludes that
the increasing of worries among the Americans in several matters such as will they have
enough money for their retirement, will they able to pay their medical cost if serious
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illness or accident happens, and will they able to maintain their current standard living.
This is why the public viewed retirement as a more important issue for Congress rather
than the mortgage crisis, taxes or even education. The rising cost of necessities explains
why both the retirement age and younger concerned about their retirement security
(Weller, 2009). If this continues, surely people will tap their retirement plan even before
A 401(k) plan is a popular defined contribution plan in the U.S and can be defined as a
employers may contribute a full or partially matching amount, and may limit the
The fragility of the 401(k) plans, as the sole supplement to social security has been
highlighted even before the financial crisis. Why the researchers concentrate into this
plan mainly because most employees (the Americans) today have 401(k) as their primary
or only plan (Munnel, 2009). In some cases, the companies force the employees to invest
their 401(k) contributions to the employer’s stock in order for the employee to participate
in an employer’s retirement plan (Madura, 2006). This action is not only unethical but
also leaves the employee’s present and future wealth expose if the firm’s financial
condition deteriorates.
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The crisis dropped the 401(k) value up to 30 percent. This result due to people that losing
their jobs and lead to a fewer contribution and more hardship withdrawals (Mundell,
2009). As mentioned by U.S Bureau of Labour Statistic, about 3.6 million people losing
their jobs during the financial crisis. People without jobs could not contribute to 401(k)
plans, while those with jobs are turning their 401(k) plans for help.
Besides that, Mundell (2009), Kansas (2009), Sallisbry and Buser (2009) realizes that
companies that under pressure are suspending their matching contributions. In addition,
some companies that are eliminating or curtailing the employer match entirely in the
401(k) plans which are General Motors, Cushman & Wakefield, Eastman Kodak, Vail
Resorts, Saks, Sears Holding, Motorola, UPS, Hewlett-Packard, and National Public
“Don’t invest in something you don’t know” said billionaire, Warren Edward Buffett
(Bianco, 1999). These words of wisdom reflects the consequences of what happens
towards recent 401(k) litigation when participants suing the plan fiduciaries on the
grounds that the participants were not adequately warn of the risk of the investing in
certain stocks, or the employer inadequately monitored the investment performance of the
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Obviously, the recent financial crisis has accelerated a re-examination of U.S retirement
from traditional defined benefit into 401(k) plan, while at the same time pursuing the
same approaches that are harmful to the same defined benefit plans that are used as
model for retirement savings. What the congress should do is to consider both
strengthening the existing defined benefits plans and also try to improve the existing
401(k) plan. This suggestion parallel with what stated by Weller (2009) where he thinks
that the public policy should strengthen the existing defined benefit plans that already do
a good job of offering retirement security to American families, and policymakers should
adopt policies that will allows plans that lack of important criteria to incorporate features
that will bring them to closer to the ideal retirement plans. He before that stated that an
ideal retirement plans should covers all these criteria which are broad-based coverage,
secure money for retirement, portability of benefits, shared financing, lifetime benefits,
spousal and disability benefits, professional management of assets, and lastly low costs
and fees (Weller, 2009). This may sound idealistic, but it is not possible to build such
retirement plans. Mundell (2009) and Weller (2009) both agreed that shore up the
retirement current retirement income system, besides avoiding the further reductions in a
If the Congress and the administration did not take this matter seriously, they will most
likely see how American’s workers’ retirement security continue worsen since it has been
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building a better defined contribution plan and strengthening defined benefits plan.
5.0 Other possible avenues to prevent the deterioration of the retirement income
The retirement planning is a requirement, it’s also reflects good wealth management that
are encourage in Islam. There are many other possible avenues that individuals can
involves in to avoid the deterioration of their retirement income, ponder the retirement in
advance so that the retirees won't feel rushed into making last-minute decisions when it's
time to quit.
The most important fundamental principles that could guide an individual in investment
categories, such as stocks, bonds, and cash. The process of determining which mix of
assets to hold in individuals portfolio is differ from one person to another, depend largely
on one’s time horizon and ability to tolerate risk. On the other hand, the practice of
the investors may be able to limit their losses and reduce the fluctuations of investment
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returns without sacrificing too much potential gain. The last important fundamental
principles that investor should know is rebalancing, rebalancing basically means to bring
the entire portfolio back to the investor original asset allocation mix in order to meet the
investment goals, through rebalancing the investor could manage the portfolio so that it
does not overemphasize one or more asset categories, and the investor could have a
return portfolio with a comfortable level of risk (Keown, 1998; Kapoor, et al., 2007).
financial crisis. Many Muslim economist and renowned scholars like Chapra (2009)
believes that Islamic finance is the best alternative towards the current economic crisis.
This is due to the framework of Islamic economics that encourage risk sharing along with
the availability of credit for primarily the purchase of real goods and services and
restrictions on the sale of debt, short sales, excessive uncertainty (gharar), and gambling
(maysir) that surely could help to inject a greater discipline into the economic system.
Thus, the year 2009 is a milestone for Islamic banking where it passed the test of the
crisis and proved its resilience and choosing Islamic products or type of investment may
be the right choice. Even the Vatican's official newspaper, L'Osservatore Romano
reported that the basic rules of Islamic finance could relieve suffering markets and
Abide by the fundamental principles that already explained, to avoid the deterioration of
the retirement income through the practice of assets allocation, diversification and
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retirement investment goals. Among the other possible avenues that are available as
alternatives that could be think of are several Islamic products such as Islamic bonds or
also known as Sukuk, Islamic Real Estate Investment Trusts (Islamic REITs), investment-
Since there are many Islamic banks started growing in the U.S, Islamic products should
be the best alternative for the investors especially if it is regards to long term investment.
Among the best choices are Islamic bonds or so called Sukuk, it is now one of the world
fastest growing capital market products today. As what reported by the Islamic Finance
Information Service, the average growth rate stands at 40% with the total volume issued
securities that grant investors a share of the asset along with the cash flow and risks that
Dawood (2009) also believes that U.S will become a leading target for sukuk issuers, and
as familiarity with the asset class increases, the investor base will broaden. Thus sukuk is
a better portfolio to be included in since it is one way of a long term investment that can
be exercised by the retirees to make sure the availability of extra income during
retirement period.
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Real estate investment trusts (REITs) are collective investment vehicles that are typically
in the form of trust funds which pool money from investors to buy, manage and sell real
estate. Returns in Islamic REITs are generated from rental income plus any capital
appreciation that comes from holding the real estate assets over an investment period
(Rosly, 2007). Unit holders will receive their returns in the form of dividends or
Islamic REITs extend the lives of portfolios based on equity-oriented strategies, but
provide even greater benefits. Moreover, specific types of investment in real estate, either
directly or in securitized fashion (a diversified real estate fund), could provide steady
guarantee each other against loss or damage. Each participant fulfils his or her obligation
managed by a third party which is the takaful operator (Rosly, 2007). Moreover, an
investment-linked takaful is one kind of family takaful plan that combines investment and
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takaful cover. With the monthly contribution, it gives the contributor a takaful coverage,
which includes death and disability benefits, and also an investment in a variety of
Some of the advantages of holding a family takaful policy are that the participants can
select the maturity date, profit sharing is according to the agreed ratio, and the policy can
be terminated at any time. There are also exists some flexibility to change the premium
paid, the period and the number of instalments in one year, and there is additionally
exemption from income tax (Billah, 2003). Therefore, this could help the retirees to have
an extra income when it comes to maturity period as well as gives them medical
Gold is largely seen as a safe haven from the volatile markets threatening to wreak havoc
almost every other investment instrument known to men. Gold has always been the best
means of storing wealth. The consistently stable purchasing power of Gold creates a
strong foundation to ensure protection from currency speculation and the instability of
paper currencies. Sykora (2009) reported that a portfolio manager of Tocqueville Gold
Fund, saying that when investors don’t feel they can safely place their money into
financial assets, gold is usually come to the top of the list of investment. Gold’s ‘perfect
storm’ rages on especially when there has been a tremendous increase in the desire to
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Among the methods that can be use to invest in gold are by investing in gold bullions or
coins, investing directly in the stock of gold mining company, or even to gold-related
funds where it is invest partly in gold and the rest in related instruments but it is very
volatile. Besides that, if the investors don’t have storage space for physical gold,
investing and trading on physical gold stored in a vault is an alternative where some
banks provide a gold passbook accounts. Those who want even more diversification into
gold companies, an exchange-traded fund (ETF) will provide the cheapest way to buy
into the gold bullion market. Lastly, gold structured products are themselves in the form
6.0 Conclusion
In a nutshell, for many people, the ideal retirement destination is the ultimate goals. The
goal should be to accumulate the highest value of investments by retirement age. People
may just question how much it would be consider being enough at the age of retirement
and the amount is differ from one person to the other. But due to the impact of the world
financial crisis, most of the people that nearing their retirement period may need to be re-
employed or are forced to rely on grown up children. Therefore, to ensure this is not
happen, it is important to plan for the retirement if the retirees want to be independent in
the golden years. The choices for investments that available in the market are so wide,
with careful research; all of the planning will surely pay off.
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