Libertarian Fantasy Indeed!
He is, however, far too kind in at least one respect. It is not just that free markets can't solve all our problems. As Jack Knight and I have argued for many years* - we cannot rely on the various market mimicking decentralized solutions (Coasian bargaining, community, incentive compatible mechanisms, etc.) that libertarians peddle for much either. Why? The models that suggest otherwise tend to rely on incredibly restrictive assumptions. In some instances the underlying mechanism the models invoke operate a cross purposes. Conversely, as Tim Besley has recently argued**, the well known difficulties underscored by principle-agent models in no way sanction any wholesale reliance on decentralized solutions either. So, while Krugman makes his point on the basis of homely examples, there is good reason in theory to think his conclusions are quite general.
* See our paper in APSR (2007) and the book length version The Priority of Democracy: Political Consequences of Pragmatism (Princeton, 2011).
** See Tim Besley. Principled Agents? The Political Economy of Good Government (Oxford 2007). I recommend reading the final couple of paragraphs first, then working through the book from the beginning.