Last spring, I was reporting a piece on the energy “shortage” (oil was soaring above $100 a barrel) and put in a call to Robert Barbera, a Wall Street economist. Barbera is a favorite of financial writers, thanks to his gift for pithiness and his willingness to be unorthodox. Sure enough, he deviated from the prevailing view and told me that high prices would themselves cure the problem. Thanks to $4-a-gallon gas, people were driving less and oil companies were drilling for more supply. In fact, Barbera said, he could see those trends in his own backyard.

“Right,” I said disbelievingly, well aware that Barbera lives in a Connecticut suburb. “You can see Exxon’s oil fields from your kitchen.”

But it turned out to be true, more or less. Barbera has a knack for popping up, Zelig-like, at momentous events that other economists merely model. Writing about the Federal Reserve in his new book, The Cost of Capitalism: ­Understanding Market Mayhem and Stabilizing Our Economic Future, for instance, Barbera recalls working as an aide to Senator Paul Tsongas in 1980, when Tsongas took on then-Fed chairman Paul Volcker. As for having first-hand experience with failed investment banks, well, Barbera once was chief economist for not only E.F. Hutton & Co. but also Lehman Brothers Inc.

So when I spoke to him a year ago, I wasn’t too surprised to learn that Barbera had a stake in a hunting club in Western Pennsylvania, which turned out to be the center of a drilling boom where gas leases had soared from $2 an acre to more than $1,000. The invisible hand is working, he assured me: Get ready for the price to crack.

In The Cost of Capitalism, Barbera trains his sights on the free market’s greatest failure since the 1930s. The result is a punchy and relevant book on our present distress that has, at its core, one very big and useful idea.

I must disclose that Barbera and I have become professionally chummy over the years; I should also say that The Cost of Capitalism reads as though it were written in haste (perhaps because I’m taking much longer to write my own book). It contains one serious error, which is to install Andrew Mellon atop the Federal Reserve during the Great Depression. The dour and famously conservative Mellon was, of course, Treasury secretary.

Error, though, is very much a part of Barbera’s thesis. Markets make them, and so do economists. Two of the worst he recounts are from recent Fed history: First, there was Alan Greenspan’s forecast of a large and enduring budget surplus in 2001, which eased the passage of the Bush tax cuts. (By the time the cuts were in place, the surplus was history.) Second, as recently as July—which is to say, after six straight months of job losses—the Ben Bernanke-led Fed predicted an economic expansion for the remainder of 2008 and beyond.

Barbera’s explanation for such bloopers could level a stack of PhD dissertations: “We simply don’t have models that forecast history before it happens,” he notes. Forecasting, rather, is mostly the art of projecting the recent past onto the future. We are now getting close to his big idea.

What happens when the economy prospers is that people expect more prosperity. They lower their guard and stop worrying about risk, especially in financial markets—where, after all, risk is priced. Barbera encapsulates this process in two precepts: (1) A long period of healthy growth encourages people to take bigger risks, and (2) when many people assume more risk, even a small disappointment can have devastating consequences.

He credits these insights to Hyman Minsky, the quirky economist who was Barbera’s mentor and who plays the role of his alter ego in the book. Minsky was a student of the free-market iconoclast Joseph Schumpeter. But where Schumpeter celebrated “creative destruction”—the power of capitalism to reinvent itself through failure—Minsky saw economic and market cycles as potentially destabilizing. Thus, Barbera quotes Minsky’s claim that “whenever full employment is achieved and sustained, businessmen and bankers, heartened by success, tend to accept larger doses of debt financing.” With debt comes deleveraging and home foreclosures.

Barbera’s idea is to point out that every recent economic crisis has been unleashed by this very cycle. So why, he wonders, has the Fed rigidly refused to pay it heed? Greenspan and Bernanke have both argued that the Fed’s job is to monitor inflation, not to “prick” asset bubbles. The formula that serves as the Fed’s guide in setting interest rates does not even take financial markets into account.

Economic growth on Main Street once did spur cycles of inflation and recession; we suffered a nasty one in 1982. But that was your parents’ recession. The days when the fate of the economy hung on the outcome of UAW wage talks are over. Since the mid-1980s, inflation has been quiescent. Rather, it has been the U.S. and Japanese stock markets, followed by junk bonds, too-easy loans to developing nations, dotcom mania, and then mortgage mania—financial bubbles all—that have triggered meltdowns.

Barbera’s remedy: When asset bubbles start to build, the Fed should raise rates. The notion that the Fed should worry about systemic risk only after a crisis hits is madness.

Barbera is modest about his profession’s abilities, wary of too much government intervention. He frequently pauses to remind us that the market model is still the best we have. Where policymakers erred was in following purists in the dogmatic credo that markets are never mistaken and never warrant governmental action. Belief in the invisible hand, Barbera writes, gave way to belief in the “infallible hand.” That was the biggest bubble of all.