Just Finished Reading: How Markets Fail – The Logic of Economic Calamities by John Cassidy (FP: 2009) [361pp] 

I have long had a poor opinion of Economics as a study and Economists as a profession. Through various downturns and the odd crisis over the decades they seem either completely bemused or dangerously overconfident about any event or trend we’re living through at that time. Reading up on the topic in recent years I’m beginning to realise why they all too often seem not to understand what’s going on – because they don’t. 

Such complete lack of understanding was on full display during the 2007/2008 financial crisis that almost tipped the world into a Depression more reminiscent of the post-1929 Wallstreet Crash. Only Herculean (and VERY expensive) intervention by governments across the world – at least this complete irony was a delight in the face of ‘free market fundamentalists’ who harp on about governments being an impediment to economic activity rather than its saviour – saved us from mass unemployment and soup kitchens throughout the world (and, no doubt MUCH worse). But why did it happen? How did we manage to miss any signs of upcoming collapse and why didn’t the ‘market’ “self-correct” as it's ‘supposed’ to? 

I’d probably blame Adam Smith. His idea of the ‘invisible hand’ that guides sellers to buyers and always gets the best price for everything has a lot to answer for. Market fundamentalists don’t just think that the free market is the best way to organising our economic life, they don’t even think that it's the only way – they believe, in their heart of hearts, as an act of unquestioned Faith, that the market is PERFECT. They believe, against all logic, against all reason and against actual historical fact, that bubbles, crashes and Depressions simply don’t happen. The reason they ‘seem’ to happen is twofold – firstly that people don’t understand what they’re seeing and that government interference is throwing sand in the wheels of the economy. If only they got out of the way and let the market self-correct everything would be fine. Sure, businesses and banks would fail. Sure, people would be out of work and maybe a handful of them would starve. Sure, there would be a modicum of social angst, unrest and handwringing but in the end, months, years or maybe decades down the line, once the dust had settled and the bodies had been buried, everything would be fine and the stock market would rise again, bigger, better and healthier than before once the deadwood and the brush had been removed and set on fire. 

Except, of course, the real world isn’t like that – at all. Now I have no issue with the idea that models of the world, or of the human activity in it – Economics – are a simplified, and often very simplified, version of reality. But, along with the idea of perfect markets we need to add in the idea of rational people who operate with perfect knowledge regarding what they’re buying and what they’re paying for it. Now, with less than two seconds thought I think we’d all agree that people are rather less than fully rational most of the time and we most certainly do not operate with anything close to perfect knowledge about anything – including ourselves. It's a bit like coming up with an equation to explain a natural phenomenon but it only works for spherical chickens in a vacuum. The answer might very well be ‘elegant’ and it might even work – at least sometimes – but it won’t be a very good reflection of the real-world. It shouldn’t surprise anyone that economists working with this level of ‘theory’ can’t really explain why a non-perfect market in which irrational people often make irrational decisions with inadequate knowledge sometimes does strange and dangerous things – like bubbles, depressions and crashes. 

I think we all remember the 2007/2008 financial turmoil and the years long aftereffects. Different countries reacted in different ways but, generally, this involved bailouts of banks and other institutions that were considered ‘too big to fail’, austerity measures and much else besides. What we saw precious little of was people held to account – almost anywhere – and fundamental changes to the way banks, financial institutions and the market itself was allowed to function. The conditions that led to the crash/crisis (or whatever you want to call it) still, by and large, exist. There is little in place to stop it happening again. 

I’ve been trying to wrap my head around and understand Economics from around 2010 (for obvious reasons). This book has greatly aided that quest. I can completely understand why it became book of the year in the Economist on publication. The author really knows his stuff and had interviewed the ‘people in the room’ who were at the very centre of things as they unfolded in the money markets and in government – especially the US Federal Reserve. I thought the result was not only very informative – he spends the first half of the book explain how we got here going back to Adam Smith himself – but also very even handed. There is/was certainly enough blame to go around, not only in the banks and financial institutions who created, traded and then defaulted on countless toxic loans but also in government (who helped enable things) and the bodies entrusted to oversee and regulate things. If you’ve ever wondered exactly what happened in the run-up to the financial disaster we all lived through and want to understand exactly why it happened, then this is most definitely the book for you. It’s not an easy read though. Despite an almost complete lack of equations this is still fairly dense and technical in places. It's not the kind of thing you can skim read to get the gist. Concentration and thought is required – at least from time to time. A basic knowledge of economic thought will help but the author does go through quite a lot between the covers. Highly recommended.