15 of 15 people found the following review helpful
Amid the plethora of books about the credit-crunch (which has become a boom industry in itself), this account stands out for providing the context in which these events occurred. While many others have dealt with the immediate causes of the crisis and its aftermath, Cassidy takes the time to provide a short history of the economic theories that inform these processes - without which any explanation is inadequate.
Running through 200 years of economic theory might not enliven the spirits, but it's a measure of Cassidy's achievement that he makes it both informative and entertaining. And it is only through understanding how beliefs about the free market and economic efficiency serve certain interests, and feed into an ideology that uses circular reasoning to justify its relevance, that the contradictions that have imploded so spectacularly can really be understood - and how a theory which emphasises transparency could result in a system that depends on the kind of asymmetries of information and off-balance-sheet accounting that ensures that markets are so opaque and impenetrable that even the bank's own managers don't understand them.
From myths such as the Efficient Market Hypothesis and the rational individual, to the Prisoner's Dilemma (which ensures that we are condemned to act against our own best interests), Cassidy provides a balanced and thought provoking overview of market behaviour, before rounding it off with an explanation of the current crisis.
An essential read for anyone wishing to grasp the fundamental processes at work.
7 of 7 people found the following review helpful
John Cassidy explains brilliantly the rise and fall of the free market ideology. Its application ended in the most sweeping extension of State intervention in the economies all over the world since the 1930s. The recent financial panic could have brought down any number of financial firms worldwide, which meant the total collapse of capitalism.
The Free Market and its ideologues
The `free market' ideology (laissez-faire) is an all-compassing way of thinking about the world and about man (the perfect homo aeconomicus) with markets as divine efficient and self-regulating processes.
Its prominent ideologues were A. Smith (the invisible hand of self-interest), F. Hayek (a system of price signals), V. Pareto (an efficient economy), K. Arrow and G. Debreu (the combination of efficiency and social equity), M. Friedman (monetarism), E. Fama (efficient stock markets) and R. Lucas (governmental intervention in the economy is counter-productive).
Criticism (no market nirvana)
For its critics, a free market economy is utopian, based on illusions of stability (bubbles are not aberrations), of rational irrationalities (124 banking crises in the last 40 years) and of predictability (markets don't follow regular patterns).
The prominent critics were J.M. Keynes (governmental intervention is needed in recessions), A. Pigou (no spontaneous coordination of private and social interests), F. Bator (oligo (mono)-polies destroy free markets, no markets for public goods), G. Akerlof and J. Stiglitz (market prices don't reveal all information) and H. Minsky (free market capitalism is inherently unstable).
The actual housing and financial crisis was an outcome of deregulation (abolition of the Glass-Steagall Act), too long and too low interest rates, criminality at the top, greed (in the face of monumental risk), incentive-based compensation of officers, stupidity (NINJA loans, no income, no job, no assets), lax oversight of the banking system (SIVs off balance sheets), the incest between rating agencies and Wall Street firms, moral hazard (privatizing gains for a tiny oligarchy of extremely wealthy people, and socializing losses) and the mind-boggling amounts of money involved ($ 42.6 trillion CDSs).
But the `special interests' are back downplaying the massive (5 % of GDP) governmental bailout. The author gives a stiff warning: if those special interests can block meaningful reform, crony capitalism of the few will rule again at the cost of the many.
Milton Friedman's monumental blunder (the Fed is not a branch of government)
His comment about the Great Depression is as follows: `The Great Depression was produced by governmental mismanagement rather than by any inherent instability of the private economy. A governmentally established agency, the Federal Reserve System, exercised its responsibilities so ineptly...'
The comment should have been as follows: `The Great Depression was produced by private mismanagement. A private established agency, the FRS, exercised its responsibilities so ineptly ...'
The blunder destroys his whole theory.
John Cassidy wrote a formidable overview of essential economic theories and practises. His book is a must read for all those who want to understand the world we live in.
38 of 40 people found the following review helpful
on 15 February 2010
There has been almost as much comment and media analysis of the credit crisis as there were panicked trades in the markets at its peak. Most comment has taken an aggressive or defensive position around the role of bankers. John Cassidy's outstanding book is a dispassionate but engaging look at the historical, economic, sociological and academic context of the sub-prime crash and its terrible aftermath.
Cassidy does have a message, eloquently argued: the vast majority of economists, bankers and policy makers of the last three decades have been blindly irresponsible in their wholehearted espousal of the unfettered free market. Indeed, he refers to the ideologies of the Chicago school as "Utopian Economics". His arguments are deep, broad and lucid. He shows, quite irrefutably, how the perfect market, enlightened self interest, full information and other such axioms of the Friedman revolution are disastrously simplistic. The evidence of huge areas of hidden information, beauty contest group psychology and the paradoxical force of game theory outcomes is undeniable. The underlying force of markets, "rational self interest" often or even usually works against the mathematics of supply, demand and perfect information. His analysis of the reality of how bubbles happen and how disturbing they are for traditional economic theories of the market is explosively enlightening.
"How Markets Fail" also looks at the agents behind the disaster of the last two years. Cassidy is especially unforgiving of the once God-like Alan Greenspan. The old Fed Chairman's explanation for his arrogant irresponsibility in allowing - indeed encouraging - two major speculative bubbles (dot-com and sub-prime) to explode unchecked was a pathetic "The problem is.. a critical pillar to market competition and free markets did break down...that shocked me. I still do not fully understand why it happened."
Cassidy also looks at the bankers, in particular, the brilliant mathematical minds behind all their risk calculations and the lethal Value at Risk (VAR) model so widely touted as the unsinkable ship for navigating the icebergs of the market. I was shocked to find that these models and, indeed, the bedrock Black-Scholes option pricing formula, are based on long outdated analyses of how markets work, namely the random walk of share prices and a normal distribution curve for market pricing in general. In other words, all that sophisticated, grotesquely overpaid risk analysis edifice was built on an infantile assumption that all trades are independent of each other and traders never follow the herd.
Although there is a good deal of solid economic and financial analysis in this book it is imminently readable, sometimes un-put-down-able. His description of how the sub-prime market came into existence, grew and exploded reads like a thriller.
If, like me, you were once enthralled by the mathematical, organic beauty of the free market, the self correcting forces that would always take us back to a satisfying and essentially good equilibrium, this book is essential reading. John Cassidy's alternative prescription, a plea for "reality based economics" that takes into account how bankers, traders, business managers, house-owners and consumers" act in the real, non-utopian world is powerfully defended and should make us take stock and rethink. After all, what has happened is, fundamentally, a massive intellectual failure, a collapse of an ideology of hubristic wishful thinking. We've had enough of all that Master of the Universe stuff: what we need is rational, modest, realistic wisdom. "How Markets Fail" gives us exactly that.
2 of 2 people found the following review helpful
on 5 September 2010
I bought - and read - a number of books related to the recent financial crisis, including Fox's 'The Myth of the Rational Market', Johnson & Kwak's '13 Bankers', Lenchester's 'Whoops', Sorkin's 'Too Big To Fail' and, of course, Cassidy's 'How Markets Fail'.
I found John Cassidy's book very comprehensive, balanced and informative. Like most of the others, he provides a good background of free-market ideology and a clear, lucid description of the events and interconnections that led to the financial crisis.
Cassidy's key message is that market failures are intrinsic features of economic and societal processes and systems. With that understanding, the ideology of the market's invisible hand and its subsequent developments - from Adam Smith to Milton Friedman - are essentially theoretical simplifications that may be useful for a few practical and special cases, for example in the markets for many material goods and commodities goods where information asymmetries, adverse selections and externalities do not play a significant role. Reality however is much more complex: in particular for labour, financial and information systems, market failures actually dominate and the free-market approach fails miserably in its basic task of allocating resources efficiently.
In keeping with the basic premise of the book, Cassidy does not come with a new ideology to replace the old, rather he provides a useful set of insights and practical policy recommendations that may give us a better chance to avoid such catastrophic (or worse still) failures in the future. In that, the message is also clear that there is no free lunch, and to avert future disasters we need to reassess very carefully and honestly our basic premises as to what future sustainable growth should we really aim to.
Strongly recommended reading.
11 of 12 people found the following review helpful
on 29 December 2009
This is a great book for understanding the credit crunch but rather than a chronological account of financial deregulation, banking greed and the phenomenal scale of the credit bubble he looks first at the evolution of the economic ideas which supported the boom. He explains why the free market became seen as an economic panacea and how many of the financial tools, which were supposed to manage risk, were actually based, in part, on these ideas. He then looks at newer ideas in economics such as behevioural economics and game theory which, when linked with Keynsian macro-economics, explain much better how the current crisis came about. It is only in the last 3rd of the book that he explains how this relates to the credit crunch. This is not a dry explanation of theory and ideas but a fascinating insight into why individuals at all levels convinced themselves the good times would never end.
1 of 1 people found the following review helpful
on 27 April 2012
How Markets Fail by John Cassidy provides a detailed review of economic theories relating to the operations of markets and illustrates the power of ideas; sometimes - bad ideas.
Cassidy provides the reader with a highly relevant historical journey that weaves the development of economic theories (particularly in finance and macroeconomics) with their practice in the real world leading up to the breaking of the financial crash of 2008-2009 centred on the US housing bubble. Key characters include economists from both sides of the spectrum together with pivotal policy makers.
This is definitely one of the better books I have read on the financial crisis since Cassidy illustrates how we came to be in this dreadful place through a combination of factors. Grounded in a fair representation of the conflicting theories of finance and macroeconomic policy this books avoids the kind of ranting witnessed in certain other publications on the subject.
Perhaps most valuable in this book is the way in which Cassidy traces the thinking of theoreticians about how markets operate from the classical to the contemporary period and illustrates how these various theories were adopted by politicans and financiers in the real world. Sometimes with disastrous results.
Hence whilst the book goes to some lenghts to explain the relevant theoretical constructs of the economics community, it is complemented by an equal consideration of the psychology and political economics at play amongst some of the key players.
As recorded in other publications on the financial crisis the book reinforces the sense that the demise of millions of people results from the games played by a relatively small number of players at the top of the power pyramid.
Sadly, although the conclusion of the book offers up some suggestions on how the crisis might be turned into an opportunity for significant reform in banking (particularly investment banking), the intervening three years since the book was published witness very little has been changed. A seriously missed opportunity.
At its heart this is a book that revisits the intellectual struggle by top economists from Adam Smith to Friedrich Hayek and Milton Friedman, from the ideas of Karl Marx to the insights of John Maynard Keynes. But it also includes some less well known figures whose contributions have greatly enriched our understanding of how people behave in market situations, in particular Daniel Kahneman and Amos Tversky in their contributions from psychology and Hyman Minsky's grasp of reality of how markets really work.
It reminds us that as students of political economics, there are two sides to consider; namely, the political (in particular the use of power) and the economic. The same can be said of financial economics, where there are the increasingly mathematically based models to consider, but there are also the psychological and political elements of the players. At its heart, this book reads as a review of the ideological battle between those (both theorists and practitioners) who believe in the efficiencies of the market and the need to minimise government intervention, versus those who take a more pragmatic approach that acknowledges the realities of market failure and the need to insulate society from its excesses. It is of course a conflict that continues to this day.
1 of 1 people found the following review helpful
on 27 January 2011
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."
1 of 1 people found the following review helpful
on 16 February 2011
Having read a lot of books picking over the bones of the financial crisis I was a little sceptical and a tad jaded by the topic. This was an excellent book, however and well worth a read.
It grounds the current crisis firmly in the development of conventional economic thought, preoccupied by complex mathematical models and ignoring the real world risks exogenous to the models. The book traces the development of economic though back to Adam Smith et al up to the present day, including the rise of Behavioural Finance.
Very accessible to non-economists and a succinct refresher of all the models you've forgotten about if you have studied it (Kaldor-Hicks, Lorenz curves and all your favourites!)
on 24 January 2012
This superb book gives not only a wonderfully comprehensive and readable insight into the 2007/8 financial crisis in the U.S., but also a lucid and articulate look into the world of economic theory, which is especially important given the Federal Reserve's totally misguided (some might describe it as downright negligent) attitude towards Wall Street during the Alan Greenspan regime.
If, by any chance, you believe that something called the Efficient Market Hypothesis has any validity in modern-day financial markets, then this book will surely demonstrate to you the error of your ways.
The book is extraordinarily detailed but never gets bogged down.
Amongst other things, the book enables us to stand back and see how the legislative protections put in place after the Great Depression (in order to avoid a repeat, naturally) were unceremoniously dismantled, particularly over the ten years or so leading up to 2007. We can only guess at the motivations that drove certain Senators and Congressmen to press for the dismantling of this protective framework which had helped to preserve a certain amount of sanity in the financial markets in all of those decades since the Depression.
And with the facts laid out so clearly in front of us, we can at least see who was supplying the matches before the house burnt down. Step forward Alan Greenspan, the revered (at least up to 2007/8) Chairman of the Fed, who now looks like a one-trick bull market pony, who not only exercised atrociously poor judgement when it came to understanding where the out-of-control bull markets were heading, but seemed hell-bent on wiping out all forms of regulation for U.S. financial institutions and markets as soon as was humanly possible.
Yes, we know lots of other individuals and entities were also culpable, but when the man at the top of the Fed seemed to spend most of his time opening all of the doors, we shouldn't be surprised when the fire burns the whole house down.
The author deserves a big pat on the back for weaving the various strands of this very involved story into one coherent body of work.
Economics students could do far worse than ditch their degree course and just read this book instead.
In 'How Markets Fail' John Cassidy (a former Business Editor of the Sunday Times and a business journalist of long standing) considers the crisis of 2007-9 and its roots in the history and theory of economics. Briefly, Cassidy considers that the crisis was brought about by the dominance of free-market fundamentalist ideas that had become a de facto orthodoxy since the 1970s in government, in finance and in the business world alike.
Cassidy divides his book into three roughly equal sections. The first, 'Utopian Economics', exposes the extent to which free-market theories have become an ideology that departs from observed reality - and how they have become imbricated with particular political positions in a way that makes rational analysis and criticism both difficult and unlikely to be influential. The second section, 'Reality-Based Economics', recounts the much less widely advertised history of opposition to free-market simplifications and abstractions and the extent to which that ideology simply ignored the irrational elements of economic behaviour. The third section, 'The Great Crunch' covers the crisis itself, relating the progress of events to the points covered in the first two sections. A concluding chapter - originally written in 2009 - then offers Cassidy's thoughts on what has been learned. This is extended by an Afterword, which appears to have been added to the paperback edition of this book, and brings the story up to the middle of 2010.
Cassidy is a fluent writer, and the book is aimed at the intelligent general reader with no specialist knowledge. 'How Markets Fail' is free from obvious bias (indeed, most of the obvious villains of the tale do a fine job of condemning themselves out of their own mouths). As a one-volume introduction to the subject it can scarcely be bettered, though the interested reader may feel inclined to supplement his or her knowledge in detail by reading any of a number of other excellent studies that have emerged in the last two years - for example, Nouriel Roubini's 'Crisis Economics', John Quiggin's 'Zombie Economics' and Ha-Joon Chang's '23 Things They Don't Tell You About Capitalism'.
As Cassidy's Conclusion and Afterword make clear, it is far from certain that the necessary lessons from the crisis have been learned at the highest levels of government. But it is now inexcusable for anyone to be ignorant of these matters. Cassidy's book is a public service as well as a fine read.