How Markets Fail: The Logic of Economic Calamities

Overview

For fifty years, economists have been developing elegant theories of how markets facilitate innovation, create wealth, and allocate society's resources efficiently. But what about when they fail, when they lead us to stock market bubbles, glaring inequality, polluted rivers, and credit crunches? In How Markets Fail, John Cassidy describes the rising influence of "utopian economics"-the thinking that is blind to how real people act and that denies the many ways an unregulated free market can bring on disaster. ...

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Overview

For fifty years, economists have been developing elegant theories of how markets facilitate innovation, create wealth, and allocate society's resources efficiently. But what about when they fail, when they lead us to stock market bubbles, glaring inequality, polluted rivers, and credit crunches? In How Markets Fail, John Cassidy describes the rising influence of "utopian economics"-the thinking that is blind to how real people act and that denies the many ways an unregulated free market can bring on disaster. Combining on-the-ground reporting and clear explanations of economic theories, Cassidy warns that in today's economic crisis, following old orthodoxies isn't just misguided-it's downright dangerous.

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Editorial Reviews

From the Publisher
“A brilliant intellectual framework for the story of our economic collapse.” —Paul M. Barrett, New York Times Book Review

“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

“The most intellectually sophisticated account of what went wrong.” —Lucas Wittmann, The Daily Beast

“[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

“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: 9780312430047
  • Publisher: Picador
  • Publication date: 11/23/2010
  • Edition description: First Edition
  • Edition number: 1
  • Pages: 416
  • Sales rank: 428,636
  • Product dimensions: 8.14 (w) x 11.70 (h) x 0.74 (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

Part 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

Part 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

Part 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

Afterword: The Great Disconnect 347

Notes 363

Acknowledgments 389

Index 391

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Sort by: Showing 1 – 17 of 14 Customer Reviews
  • Posted June 10, 2010

    I Also Recommend:

    The best explanation for the 2007 - 2009 financial crises I have read so far

    (My review is of the unabridged audio book, in digital format.)

    Mr. Cassidy's book is a comparison of reality-based economics verses utopian economics and how these opposing viewpoints relate the financial turmoil during the last part of the decade. The book is almost 3 books in one. The first part discusses the overview of utopian economics, which is the belief that free market forces and minimum government interference lead an economy to its best outcome for the greatest number of people. This "invisible hand" view originally started as a good approximation for microeconomics and how competition can, on the small level, lead to better productivity. Unfortunately, this approximation morphed into a macroeconomic dogma, with the ultimate belief that free markets are near perfect and should be allowed to play out naturally. The second part of the book, reality-based economics, is more of a mix of different examples of how utopian economics fails, rather than a unified theory. It seeks to show how human behavior can cause unexpected results which deviate dramatically from what we would expect under a perfectly rational free market. Since humans have limited knowledge and rely on rules of thumb and personal biases, we must take this into consideration when thinking about economic policy. Mr. Cassidy shows many examples of how unexpected "spillovers" from a free market have an overall negative effect on the economy.

    In the third part of the book, Mr. Cassidy uses the basic ideas introduced in the first two parts to explain how we got ourselves into the debacle which started in 2007. And unlike many other books on the subject, the author manages to do so with little blame or judgment on any one person or government entity. His "rational irrationality" explanation does an excellent job of showing how the various economic players were only following their own rational interests (or interest of the company or organization they represented), as opposed to some conspiracy theory of how Wall Street or the government did this to us. It would be much easier to point fingers or label Wall Street executives as corrupt or greedy. But that would not help us understand how to prevent this sort of thing from happening again.

    In his conclusion, the author states, "Effective government is a matter of getting the balance right between autonomy and coordination." This one sentence pretty much sums of the thesis of the whole book. And indeed, Mr. Cassidy provides compelling arguments to back up his thesis. Easy to understand as well as entertaining, I highly recommend this book.

    1 out of 1 people found this review helpful.

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  • Posted July 22, 2011

    One of the best books on economics available

    Warning: if you devoutly read the Wall Street Journal editorial page and worship Ayn Rand, you will hate this book. Anyone else with a basic knowledge of economics and an open mind will learn a lot from When Markets Fail. Read it twice, it's that good. Cassidy does a great job of explaining, well, why markets fail (Unlike many books, the title is very accurate here).

    0 out of 1 people found this review helpful.

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  • Posted January 27, 2011

    I Also Recommend:

    Fine study of the free market's bankruptcy

    In this brilliant book, financial journalist John Cassidy traces the rise and fall of free market ideology. Part 1 traces the story of utopian economics from Adam Smith to Alan Greenspan; Part 2 looks at reality-based economics and Part 3 at the crisis.

    He pops the illusions that capitalist economies are harmonious, stable and predictable. He observes, "Markets encourage power companies to despoil the environment and cause global warming; health insurers to exclude sick people from coverage; computer makers to force customers to buy software programs they don't need; and CEOs to stuff their own pockets at the expense of their stockholders." As he notes, "the American health care system is chronically inefficient." The USA spends twice as much per person as Britain, yet its life expectancy is far lower.

    Life has proved the free-market theorists wrong: Nobel Prize winner Robert Lucas said in 2003 that the 'central problem of depression-prevention has been solved'. Federal Reserve Chairman Alan Greenspan said in 2005 that falls in house prices, 'were they to occur, likely would not have substantial macroeconomic implications'.

    But there are always uncertainties, imperfect information, monopolies and spillovers. Probabilistic risk is not the same as inherent uncertainty; actuarial tables of mortality are accurate, but the future is still unknowable.

    The new financial instruments, far from spreading and thus diluting the risks of subprime, focused them into the centre of finance capital, the giant global banks, unleashing the crash. World industrial production fell 15 per cent between April 2008 and March 2009. In the USA alone, more than 5 million jobs went between September 2008 and June 2009.

    Pursuing individual (or corporate) self-interest can be rational, yet bring irrational effects, can be individually optimal but socially sub-optimal. In the financial markets it causes positive feedback and disaster. In the real world, it leads to pollution, congestion, overfishing, desertification and deforestation. As Cassidy warns, "blind reliance on self-interest and the market is a recipe for further environmental catastrophes."

    He writes, 'the biggest lesson we have learned . Wall Street needs taming'. Otherwise, it's back to crony capitalism. But the regulatory changes proposed so far aren't enough. As he notes, "no thought has been given to splitting up the essential utility aspects of the financial system - customer deposits, check clearing, and other payments systems - and the casino aspects, such as investment banking and proprietary trading."

    Cassidy concludes, "Imposing restrictions on the biggest hedge funds and private equity firms could well lead to a drastic shrinkage in these industries, which would be no great loss. Much of the activity that such firms engage in amounts to a zero-sum game, which doesn't yield any economic gains for society at large."

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