BOOKS 
How Markets Fail
By John Cassidy
Allen Lane £25, 400 pages
FT Bookshop price: £20
Halfway through John Cassidy’s new book, How Markets Fail, there is a revealing anecdote about Morgan Stanley. Back in the mid-1990s, Cassidy asked officials at this once-mighty US bank how they recruited economists, only to be told that Morgan Stanley avoided hiring anybody straight from university.
“We insist on at least a three-to-four-year cleansing process to neutralise the brainwashing that takes place on those graduate programmes,” Stephen Roach, the firm’s chief economist is quoted as saying, noting that academic economists appeared to have become dangerously divorced from reality.
In future, Roach, or anyone else, might simply disperse copies of Cassidy’s book to accelerate that intellectual “cleansing”. How Markets Fail is not just a sobering account of the recent financial disasters, it is also a thoroughly readable history of how the modern economics profession has developed over the past century – and lost its way.
More specifically, Cassidy, an eloquent British writer who now lives in America and writes for The New Yorker, does not believe that recent calamities should be blamed on the heads of just a few bankers or politicians, such as Dick Fuld or Henry Paulson. Instead, he argues that the central culprit is an idea – the uncritical adoption of unworkable and “utopian” free-market concepts, as developed by the economics profession during the past century and championed by men such as Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006.
Cassidy sets out to demonstrate this by essentially telling two, interwoven stories: first, the history of modern economics, and second, the recent credit crunch, in terms of how it was shaped by this flawed set of economics ideas. In truth, this two-pronged device is sometimes confusing for readers. Cassidy himself admits that his book is really several books, all at once.
However, this approach sets the book apart from most of the other credit crunch works now hitting the bookshelves, which tend to focus on colourful individuals and contain minimal analysis. Cassidy, who knows his stuff exceedingly well, is a good enough writer to have produced a very compelling and persuasive work.
His intellectual thread starts with Adam Smith, the 18th-century Scot who is hailed by many as the father of free-market economics. The narrative then covers numerous other economists, both well-known (Paul Samuelson, Robert Lucas, Milton Friedman, John Maynard Keynes and Hyman Minsky) and more obscure (John von Neumann, Gérard Debreu or Francis Bator). From that dizzying kaleidoscope, Cassidy develops his central theme: that the core fallacy of dogmatic free-market ideals was the presumption that humans are rational, self-interested economic actors, whose behaviour can be modelled with mathematical precision.
After all, as Cassidy writes, markets can only work if there is good information – just as the human body can only function with oxygen. And while information flows freely in some areas of business – the trade of tomatoes, say – it is not true in many others such as, crucially, finance. Moreover, human beings are not robots: disciplines such as neuropsychology indicate that we employ different parts of our brain in different situations, and find it hard to do complicated sums. Action that appears rational for individuals can collectively produce irrational outcomes, especially when feedback loops kick in.
This leaves Cassidy to conclude that the academic world needs to embrace something he calls “reality-based economics”, or analysis based on the idea that humans are, well, human. Meanwhile governments need to recognise that free-market principles work some of the time, but not always – and step in when there is a market failure, or where information flows are poor. This is essentially a manifesto, in other words, for a pragmatic, flexible type of policy-making. And as such it certainly sounds sensible, even unremarkable given that western governments have all been forced into such pragmatism in the past year.
Yet, one needs only to scan the middle sections of Cassidy’s lively account to get a stark reminder that the concept of government intervention was considered heresy in America, and parts of the UK, just four years ago, when men such as Greenspan ruled the intellectual roost. Even today there is a temptation to keep painting economic choices in black and white. Or, as Cassidy notes: “In Washington in particular, the debates on healthcare and financial reform might lead you to believe that the only choice is between liberty and socialism: either you are for free markets or rapid government intervention. This is absurd.”
In that respect Cassidy’s book is to be strongly applauded. Not just because it is highly readable but, most importantly, because it tries to paint a more subtle picture at a time when too many people are still seeking simplistic stories and villains to blame.
Gillian Tett is an FT assistant editor and author of ‘Fool’s Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe’ (Little, Brown)
