Forgetting what happened in 2008 will be the biggest mistake we can make. The world cannot afford another crisis or a recession for a very long time. By Vivek Sharma

Around this time last year, like many others, I too made some predictions for the new year. The economic and business environment back then could not have been more different. The world was kind of well-versed with sub-prime and was learning about the many mutations of credit derivatives. The global credit crisis was on, but only one Wall Street investment bank was in trouble.

Bear Stearns, the smallest of the then big investment banks, was bailed out by the US Federal Reserve and most of us said it was only a matter of time before the credit crisis ended. BRIC was still hot and investment banking was the preferred career option for freshly minted MBA's.

The last of my predictions for 2008, which I then thought was the least likely to come true, proved to be the most accurate. 'Reliance Power IPO may signal market top' was my brave call back then, when stock prices were surging as if there was no tomorrow. The Sensex touched its lifetime high the day the Reliance Power IPO opened and it has been downhill for the index ever since. It was not a very difficult call to make given the absurdly high stock valuations then, but caution was something to be scoffed at in those heady days. Even so, none were prepared for the carnage that followed.

Because this one prediction came true to such an extreme scale, some of my other forecasts turned out to be duds. I expected both interest and exchange rates to remain steady. But, like all other central banks, rapidly deteriorating economic conditions forced the RBI to cut interest rates sharply and the rupee tumbled. The 7 per cent GDP growth now forecast for this fiscal year is well below the 8 to 8.5 per cent I expected at the beginning of the year. Property prices have come down, but again the decline is much more than I anticipated.

To most, 2008 is a year best forgotten. Jobs were lost, savings vanished, increments and bonuses froze and everyone became preoccupied with preserving the little that remained. It has been a cruel year.

But, forgetting what happened this year will be the biggest mistake we can make.

Nothing is infallible
The biggest lesson of this financial crisis is that there is no such thing as a risk-free asset. Any investment that promises a superior return has to, and will carry, a proportionately higher risk, however sophisticated the financial engineering that has gone into creating that security. Every investor who poured money into the supposedly risk-free credit derivatives and other securitised assets ignored this principle and paid the price.

The same goes for any firm or institution, however large it is. Irrespective of their balance sheet size, pedigree or reputation, every firm is vulnerable to unexpected events. Large capital bases and sophisticated risk management tools mean little in such scenarios.

If it is too good to be true, ignore it
Bernard Madoff fooled many so-called sophisticated investors for decades by showing steady, but fictitious returns. As long as Madoff continued to report monthly returns of 1 to 1.5 per cent, not one of his investors suspected anything. It's only when losses elsewhere forced some of his investors to ask Madoff to return their money, this most audacious of Ponzi schemes unravelled.

The business projections by some Indian companies that came out with IPOs when the markets were roaring were incredible, but there were any number of takers. When some analysts predicted a non-stop surge in the Sensex to 40000 and beyond, many of us chose to believe them. Many among us rushed to take home loans at high interest rates to buy second homes, just because the property developers said real estate prices can only go up. We have all paid the price for the dangerous human trait of wanting to believe the incredible.

Economic cycles are not dead
Death, taxes and economic cycles - these are the only certainties in life. No economy, not even China, can continue to grow at faster rates. Every phase of rapid growth above the long-term trend rate will be followed by a phase of slower growth or even recession. Until last year, it seemed improbable that the global economy could slip into a recession. It doesn't take much time for such hopes to turn sour.

This lesson is particularly important for policy makers. They bask in the glory and appropriate all the credit for the good times. Then they go overboard and behave as if the prosperity will last forever. Like our government which finds itself saddled with an uncomfortably high fiscal deficit just when it is expected to step up spending.

Regulation is easy but effective regulation is tough
Anyone who has a cursory interest in global economic affairs must now be convinced that financial deregulation is the main culprit behind the crisis. So much has been written about the lightening of banking regulations in the US, which many blame for the excesses during the credit boom.

Indian communists have claimed credit for preventing such deregulation and saving our financial system from collapsing. Sonia Gandhi went a step ahead and credited Indira Gandhi for her farsightedness in keeping all evil out of our financial system by nationalising banks four decades back.

In our eagerness to find something to blame for this crisis, financial deregulation is fair game. But, the fact remains that loose monetary policy and ineffective supervision of existing regulations are more to blame. True, some of the excesses would not have happened if there were regulations in place to prevent the underlying transactions. That would be like saying we can avoid diabetes if we eat no sugar at all. Up to a limit, the financial innovations we saw over the last decade brought down the cost of credit and extended credit availability. Beyond that limit, they led to excesses and eventually imploded.

Policymakers and regulators failed in sensing such excesses and assessing their potential danger. It was not that the financial regulators could not control the banks and insurance companies which were creating, selling and investing in toxic credit derivatives. It is just that, like the rest of us, the regulators didn't know these securities were toxic.

Scarred by the crisis, the world will now see a phase of excessive financial regulation. The new regulations will be equally insufficient unless our regulators learn to be more effective and become more convinced about the need for better coordination among themselves and policymakers. In any case, it won't be long before we realise the folly of excessive and restrictive regulations and revert to a lighter regime. 

The year 2008 must never be forgotten. Instead, this year should remain in our collective memory with all its pain and disruptions. It deserves a memorial, to remind us about the mistakes so that we will not easily repeat them.