How Markets Fail

Published in 2009, How Markets Fail: The Logic of Economic Calamities is John Cassidy’s take on the behavior of the stock market and what happens when it goes south, such as when it creates bubbles, abundant inequality, and credit crunches. Cassidy looks at the rising influence of “utopian economics,” which he says is blind to the way real people act and to the multitude of ways an unregulated free market can be disastrous. Through a combination of reporting and explanation of economic theories, the author provides a clear warning that following old economic ideas is not merely misguided, it is dangerous.

Throughout the book, Cassidy interweaves two stories: the first is the history of modern economics, and the second is the 2008 financial crisis and how it was a product of a flawed set of ideas about economics. He begins with eighteenth-century thinker Adam Smith, hailed as the father of free-market economics by many. He traces economic thought through other economists, such as Paul Samuelson, Milton Friedman, Hyman Minsky, and Robert Lucas, eventually coming to develop the book’s central theme: the fallacy at the core of dogmatic free-market ideals is the presumption that human beings are self-interested and rational actors, whose behavior can be modeled with mathematical precision.

The rise of what Cassidy calls “utopian economics” began with British economist John Maynard Keynes, who wrote around the time of the Great Depression. Keynes argued that recessions are created due to the lack of demand in the economy, meaning that government spending has the ability to stimulate demand and have a smoothing effect on the business cycle until general economic demand rises again. Keynes and his followers held sway for forty years. Then, when industrialized economies entered into a period of prolonged “stagflation,” characterized by low economic growth, high debt, and high inflation, economists turned back to the markets to find a solution.



Cassidy then looks at the rise of neoclassical economics and the impact it has had on policy and thought in the twentieth century. Economists moved past arguments and were able to demonstrate proofs using mathematical equations. The development of general equilibrium theory allowed them to “demonstrate” that competitive free markets generate efficient outcomes. That sounded encouraging, but economists soon showed that the future of the economy is unpredictable, and the outcome is indeterminate in many cases. Such information, however, was largely ignored by free-market advocate Milton Friedman and US Federal Reserve chairman Alan Greenspan, says Cassidy.

Mathematicians also took on finance. Efficient market theory grew into acceptance and transformed financial markets, leading to investment strategies that merely mirror the markets and to the start of quantitative finance. According to Cassidy, this cemented the establishment of utopian economics—economics that enabled speculative bubbles in real estate, technology, and the financial sector.

Cassidy then spends some time focusing on the circumstances surrounding the current financial crises of the free market. He explains that the combination of a federal government that can print money and deposit insurance and a Congress that is able to authorize bailouts creates an extensive safety net for large financial firms. In this environment, the pursuit of easy money and deregulation do not amount to free-market economics—it is crony capitalism. The gains of speculation and financial innovation become privatized, and the majority go to a small group of wealthy individuals who sit atop the apex of the system. Moreover, once the government abdicates its role of preventing excessive risk-taking, irrationality ensures that the system will move toward Ponzi finance.



He then describes what occurred during the 2008 financial crisis, which he says was a failure of both monetary policy and economic analysis. Beginning in the late 1990s onward, the government refused to acknowledge the dangers presented by speculative bubbles, adopting a hands-off attitude. The refusal to address the stock market and credit bubbles was largely political as the government did not want to be seen as responsible for creating an economic downturn. This was combined with the notion that the American economy is a magically self-correcting mechanism of stability that would be able to quickly rebound from a speculative bust.

Utopian economics, the author argues, produces three illusions that pose dangers to the health of our economy. The first is the illusion of harmony, which would have us believe that free markets always produce good outcomes. The second is the illusion of stability: the argument that free markets produce stable, self-correcting mechanisms. The third is the illusion of predictability—the expectation that financial markets follow regular patterns that we can estimate.

Cassidy ultimately concludes that no particular single set of ideas can fix the economy. The enemy is ideology. While markets have always required regulation, and societies have always required innovative and dynamic markets, the trick, says Cassidy, is to find a balance between supervision and autonomy, innovation and regulation, and oversight and decentralization. Such balance also requires continuous adjustment.



The author advocates for what he calls “reality-based economics,” which is an analysis that is based on the idea that humans behave unpredictably in many circumstances. Governments must recognize that free-market principles operate successfully sometimes, but not always, and they must step in when markets fail.