Sunday, December 20, 2009

How Markets Fail

Two weeks ago The Economist published a list of their four best finance books of 2009 and two of them piqued my interest, Too Big To Fail by Andrew Ross Sorkin and How Markets Fail by John Cassidy. Both books have been getting rave reviews in the financial press so I ordered them on Amazon and finished How Markets Fail early this morning. Boy was I disappointed. I hope Too Big To Fail is better because I just slogged through 350 pages of some of the most tedious writing I've come across this year. At the outset of the book Mr. Cassidy states he didn't want it to read like a text book, but I'm afraid this is exactly what he's done. This is not to say the book has no value because I did learn a lot from it, but it would appeal to a much broader audience if it didn't drag on for so long.

How Markets Fail is divided into three sections: the history of Utopian economics, the history of realistic economics and the inflation of the housing bubble and its implosion. In the history of Utopian economics, Mr. Cassidy gives a brief, but detailed chronology of free-market economic theory dating back to Adam Smith and culminating with the Chicago School led by Milton Friedman. The second part of the book is the history of realistic economics and how this branch of economic thinking refutes some, but not all of the doctrines of the supply-siders. John Maynard Keynes, behavioral finance and Hyman Minsky are all highlighted in this section and this is where Cassidy falls short. He devotes a chapter to Minsky when he should have extrapolated more about him because at the end of the book, Minsky turns out to to be dead on with his theory of meshing both the free-market and Keynesian schools of thought. The final 150 pages is devoted to the 2008-2009 real estate crash and this has been overdone by too many authors, so let's get back to Minsky.

As Cassidy writes: "Minsky advanced the view that free market capitalism is inherently unstable, and that the primary source of this instability is the irresponsible actions of bankers, traders, and other financial types. Should government fail to regulate the financial sector effectively, Minsky warned, it would be subject to periodic blowups, some of which could plunge the entire economy into lengthy recessions.". I first heard about Hyman Minsky in an interview on CNBC with Paul McCulley, the Chief Investment Officer at PIMCO, and had no idea about why he was so enthusiastic about him. This is partly to do to the fact that Minsky is not a very well know economist, but he is getting there. Like Mr. Cassidy summarizes: "Perhaps the biggest lesson we have learned is one Hyman Minsky taught us as far back as the 1980's: Wall Street needs taming. On an individual level, banks, investment banks and other financial companies provide essential services. Taken together, however, their self-interested actions have created and amplified economic disturbances, largely through the use of leverage and excessive accumulation of risk.".

In fact, Cassidy blames the Great Recession of 2008 on Alan Greenspan and his free market cronies because: "The notion of financial markets as rational and self-correcting mechanisms is an invention of the past forty years.". In the conclusion of How Markets Fail, Cassidy pontificates: "If Ronald Reagan, instead of appointing Greenspan to the Fed in 1987, had talked Paul Volker into staying another four or eight years, things would have turned out differently...When historians come to write about the 'Greenspan Bubbles,' they will do so with good cause: more than any other individual, the former Fed chairman is responsible for letting the hogs run wild." How Markets Fail hits the bullseye in citing Greenspan and the supply-siders for the Panic of 2008 and also whetted my appetite for more information about Minsky, but never really sated me, so next on the docket is something more substantial. There should be a place for a book like this, like in the hands of hardcore economics students, but for the average investor, you should really skip this one.