How Markets Fail: The Logic of Economic Calamities / Edition 1

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Overview

Behind the alarming headlines about job losses, bank bailouts, and corporate greed is a little-known story of bad ideas. For fifty years or more, economists have been busy developing elegant theories of how markets work—how they facilitate innovation, wealth creation, and an efficient allocation of society’s resources. But what about when markets don’t work? What about when they lead to stock market bubbles, glaring inequality, polluted rivers, real estate crashes, and credit crunches?

In How Markets Fail, John Cassidy describes the rising influence of what he calls utopian economics—thinking that is blind to how real people act and that denies the many ways an unregulated free market can produce disastrous unintended consequences. He then looks to the leading edge of economic theory, including behavioral economics, to offer a new understanding of the economy—one that casts aside the old assumption that people and firms make decisions purely on the basis of rational self-interest. Taking the global financial crisis and current recession as his starting point, Cassidy explores a world in which everybody is connected and social contagion is the norm. In such an environment, he shows, individual behavioral biases and kinks—overconfidence, envy, copycat behavior, and myopia—often give rise to troubling macroeconomic phenomena, such as oil price spikes, CEO greed cycles, and boom-and-bust waves in the housing market. These are the inevitable outcomes of what Cassidy refers to as “rational irrationality”—self-serving behavior in a modern market setting.

Combining on-the-ground reporting, clear explanations of esoteric economic theories, and even a little crystal-ball gazing, Cassidy warns that in today’s economic crisis, conforming to antiquated orthodoxies isn’t just misguided—it’s downright dangerous. How Markets Fail offers a new, enlightening way to understand the force of the irrational in our volatile global economy.

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Editorial Reviews

From the Publisher
Praise for How Markets Fail

“Cassidy clearly knows a great deal of economics, and he tells his story extremely well . . . Many of his chapters—on the development of general equilibrium theory (how everything in the economy systematically depends on everything else), for example, or marginalism (why prices are determined by what we’re prepared to pay for the very last item of something we buy, rather than what the whole amount is worth to us)—would make useful supplementary reading in an undergraduate economics course.” —Benjamin M. Friedman, The New York Review of Books

“[A] wonderful book . . . The most concise and elegantly written account, among the many that have come out, of how we got into this mess.” —Liaquat Ahamed, The National Interest

“[How Markets Fail] brilliantly dissects much of what has passed for economic wisdom, and decries the lack of humility from those whose theories helped cause the disaster.” —Floyd Norris, The New York Times

“Highly readable . . . Cassidy offers a clear and occasionally colorful exposition of the evolution of relevant economic thought in a way that is accessible to non-economists.” —Richard N. Cooper, Foreign Affairs

“Fascinating and important.” —Eliot Spitzer, Slate

“An admirably lucid account of how ‘utopian economics’ drove us to disaster . . . This is a compelling synthesis that derives most of its narrative energy from the author’s clarity of thought and exposition.” —James Pressley, Bloomberg.com

“An essential, grittily intellectual, yet compelling guide to the financial debacle of 2009.” —Geordie Greig, London Evening Standard

“The last major attempt of 2009 to make sense of what has become of the discipline of economics.” —Stefan Stern, Financial Times (Best Books of the Year)

“A well constructed, thoughtful and cogent account of how capitalism evolved to its current form.” —Edmund Conway, The Daily Telegraph

“[How Markets Fail] is more than just an account of the failures of regulators and the self-deception of bankers and homebuyers, although these are well covered. For Mr. Cassidy, the deeper roots of the crisis lie in the enduring appeal of an idea: that society is always best served when individuals are left to pursue their self-interest in free markets . . . An ambitious book, and one that mostly succeeds.” —The Economist

“An ambitious, nuanced work that brings ideas alive . . . Cassidy makes a compelling case that a return to hands-off economics would be a disaster.”—Chris Farrell, BusinessWeek

“Brilliant.” —Paul M. Barrett, New York Times Book Review

“Both a narrative and a call to arms, [How Markets Fail] provides an intellectual and historical context for the string of denial and bad decisions that led to the disastrous ‘illusion of harmony,’ the lure of real estate and the Great Crunch of 2008. Using psychology and behavioral economics, Cassidy presents an excellent argument that the market is not in fact self-correcting, and that only a return to reality-based economics—and a reform-minded move to shove Wall Street in that direction—can pull us out of the mess in which we’ve found ourselves.” —Publishers Weekly

“An elegant, readable treatise on economics, swathed in current headlines . . . Cassidy delivers on the promise of his title, but he also offers a clear-eyed look at economic thinking over the last three centuries, from Adam Smith to Ben Bernanke, and shows how the major theories have played out in practice, often not well . . . Cassidy writes with terrific clarity and a finely tuned sense of moral outrage, yielding a superb book.” —Kirkus Reviews (starred review)

Publishers Weekly
Market disasters—and the cycle of delusions responsible—receive lively, engaging analysis by Cassidy (Dot.con), a journalist at the New Yorker. The author focuses primarily on the rise and fall of free market ideology and the mostly unrealistic ideal of a self-correcting marketplace. An excellent comprehensive history of the economic thought that led to this kind of utopian economics provides a refresher course in Adam Smith, Friedrich August von Hayek, Kenneth Arrow and Hyman Minsky. Both a narrative and a call to arms, the book provides an intellectual and historical context for the string of denial and bad decisions that led to the disastrous “illusion of harmony,” the lure of real estate and the Great Crunch of 2008. Using psychology and behavioral economics, Cassidy presents an excellent argument that the market is not in fact self-correcting, and that only a return to reality-based economics—and a reform-minded move to shove Wall Street in that direction—can pull us out of the mess in which we’ve found ourselves. (Nov.)
Kirkus Reviews
New Yorker and Conde Nast Portfolio contributor Cassidy (Dot.con: The Greatest Story Ever Sold, 2002) presents an elegant, readable treatise on economics, swathed in current headlines. "[P]ursuing a policy of easy money plus deregulation doesn't amount to free market economics; it is a form of crony capitalism," writes the author. The decline of 2007 and collapse of 2008 make convenient handles for the narrative, and players such as Alan Greenspan-busy making the absurd claim that the market economy is inherently stable-make fine symbols for the schools of thought that underlie the whole mess. Conventionally, these come down to the free-market types such as Hayek and Friedman on one hand and interventionists such as Keynes and Galbraith on the other. However, Cassidy does a nice job complicating that picture by drawing on the entire history of economic thought and introducing such overlooked figures as William Stanley Jevons and Leon Walras, who, it turns out, had a great deal to say about the overall subject of the book-namely, why economies can collapse so rapidly. In an ideal world, Cassidy writes, a market is a win-win environment: "Markets," he declares by way of introducing the ever-pleasing Pareto equilibrium into the narrative, "facilitate mutually advantageous trading." Ah, but there are wolves out there in possession of secret information, including players of Ponzi schemes (Madoff) and Ponzi economics (Greenspan et al.). In the case of the subprime mortgage problems that precipitated the current catastrophe, "too many mortgage lenders exploited the information advantage they had over their customers." Cassidy delivers on the promise of his title, but he also offers a clear-eyedlook at economic thinking over the last three centuries, from Adam Smith to Ben Bernanke, and shows how the major theories have played out in practice, often not well. The dismal science coupled with dismal news-it doesn't make a promising premise, but Cassidy writes with terrific clarity and a finely tuned sense of moral outrage, yielding a superb book.
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Product Details

  • ISBN-13: 9780374173203
  • Publisher: Farrar, Straus and Giroux
  • Publication date: 11/10/2009
  • Edition description: First Edition
  • Edition number: 1
  • Pages: 390
  • Product dimensions: 6.40 (w) x 9.10 (h) x 1.30 (d)

Meet the Author

John Cassidy is a journalist at The New Yorker and a frequent contributor to The New York Review of Books. He is the author of Dot.con: How America Lost Its Mind and

Money in the Internet Era and lives in New York City.

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Table of Contents

Introduction 3

Pt. 1 Utopian Economics

1 Warnings Ignored and the Conventional Wisdom 17

2 Adam Smith's Invisible Hand 25

3 Friedrich Hayek's Telecommunications System 37

4 The Perfect Markets of Lausanne 49

5 The Mathematics of Bliss 61

6 The Evangelist 72

7 The Coin-Tossing View of Finance 85

8 The Triumph of Utopian Economics 97

Pt. 2 Reality-Based Economics

9 The Prof and the Polar Bears 111

10 A Taxonomy of Failure 125

11 The Prisoner's Dilemma and Rational Irrationality 139

12 Hidden Information and the Market for Lemons 151

13 Keynes's Beauty Contest 166

14 The Rational Herd 177

15 Psychology Returns to Economics 192

16 Hyman Minsky and Ponzi Finance 205

Pt. 3 The Great Crunch

17 Greenspan Shrugs 221

18 The Lure of Real Estate 235

19 The Subprime Chain 251

20 In the Alphabet Soup 268

21 A Matter of Incentives 285

22 London Bridge Is Falling Down 299

23 Socialism in Our Time 317

Conclusion 335

Notes 347

Acknowledgments 371

Index 373

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  • Posted November 2, 2009

    How Mainstream Economic Writers Fail

    I don't wish to be unkind to Cassidy, but I keep waiting for a logically respectable refutation of genuine free markets to come forth and John Cassidy's How Markets Fail is yet an additional disappointment in reason.

    Out of the chute, I was left slack-jawed by Cassidy's opener in the book; Alan Greenspan's now-famous testimony to Congress where he describes his change of heart and admits that free markets fail. One of the most in vogue, terrifically shallow and common errors pop critics of free markets make is to paint Alan Greenspan as a "free markets guy" or an "Ayn Rand disciple". Logic easily brings this assertion down when one considers that, in honest economic circles, Greenspan is famously recognized as a traitor to free markets by his venal ascendancy into the post of Chairman of the Federal Reserve during the Reagan administration - the same Federal Reserve that exercises de facto centralized economic planning through forced interest rates (read, interventionist capital markets) and fiat money printing. Greenspan is a bane of free markets and soul-sold poster boy of government created economic disasters.

    Among Cassidy's disjointed examples of why rational, self-interested people cause markets to fail is the story of a pedestrian bridge built over the river Thames. I am expecting to read the account of how a bridge was built by a free-market entity (usually a "infrastructure" task that unimaginative thinkers cede to governments) and how the venture failed. Instead, he gives an example of how people begin to step in unison, setting up a dangerous rythmic sway of this bridge. It turns out to a cute metaphor with dubious applicability to markets, especially considering that people were reacting with instinct on the bridge and not the rational behavior that the author intends to lambaste. It fails to recognize good investors' first rule: venture where others are not. It is an example best left for structural engineers and not markets.

    Cassidy is contradictory in that the regulations he calls for are well known fences that create the 'self-interested and rational' herds he condemns.

    The book discusses banks in the housing bubble of 2002-2007 as exemplary of free market failures. He fails to notice the blaringly obvious fact that banks did not and do not operate in the free-market, especially in regards to the housing market (Fannie? Freddie?). Banks are the first recipients of inflated Fed funds (printed money), highly regulated and shot through with implicit governmental guarantees behind them and thusly, for failure.

    Cassidy uses the period between 1945-1980 as an example of how regulation works to spur economic growth, citing depression-era laws as the reason for "enormous prosperity". He called this a lab. Every scientist knows that any experiment can endure a certain amount of infiltration or deviation. Cassidy's reverence towards regulations as promoting of economic growth is likely spurious and non-causal.

    So, another book hits the shelves of the genre, full of poorly researched economic history and logically inept conclusions. With it, Cassidy joins the seemingly coordinated chorus of anti-freedom drones, making philosophically and historically unsound arguments in favor of the financial nanny state.

    8 out of 21 people found this review helpful.

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  • Posted December 4, 2009

    Best Book I've Read in 2009

    There is finally a book out that extends Keynes ideas about what to do when markets fail to how they fail in the first place. This books goes into a history of different economic writers and their ideas.

    Now my problem is how to get my congressmen to read this book before they gut the Federal Reserve.

    6 out of 6 people found this review helpful.

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  • Posted January 9, 2010

    I Also Recommend:

    Terrific Book! One of the best explanations of the genesis of the current economic crisis.

    Very clear presentation of America's economic history from the Great Depression through the Great Recession. Cassidy uses language that general readers can appreciate to explain the economic theories, financial practices, and lack of governance that led to the near miss.

    2 out of 3 people found this review helpful.

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