The market is not working properly: it's not, to use the term of art, clearing. Buyers look at what sellers (domain-squatters) are offering, say "well screw that for a game of toy soldiers!" and buy a substitute good (a green-field domain name). The sellers are at fault here: they're not willing to lower prices, and as a result, buyers don't go to them, but instead resort to substitute goods.
As other replies note, the market for domain names has some unique features - but I also think that it's important to note that you're wrong when you say that it's "working properly."
As other replies note, the market for domain names has some unique features - but I also think that it's important to note that you're wrong when you say that it's "working properly."