Neil Fligstein et al — Why the Federal Reserve Failed to See the Financial Crisis of 2008: The Role of “Macroeconomics” as a Sensemaking and Cultural Frame

Groupthink.

Abstract

One of the puzzles about the financial crisis of 2008 is why the regulators were so slow to recognize the impending collapse of the financial system. In this, paper, we propose a novel account of what happened. We analyze the meeting transcripts of the Federal Reserve’s main decision-making body, the Federal Open Market Committee (FOMC), to show that they had surprisingly little recognition that there was a serious financial crisis brewing as late as December 2007. This lack of awareness was a function of the inability of the FOMC to connect the unfolding events into a narrative reflecting the links between the housing market, the subprime mortgage market, and the financial instruments being used to package the mortgages into securities. We use the idea of sensemaking to explain how this happened. The Fed’s main analytic framework for making sense of the economy, macroeconomic theory, made it difficult for them to connect the disparate events that comprised the financial crisis into a coherent whole. We use topic modeling to analyze transcripts of FOMC meetings held between 2000 and 2007, demonstrating that the framework provided by macroeconomics dominated FOMC conversations throughout this period. The topic models also show that each of the issues involved in the crisis remained a separate discussion and were never connected together. A close reading of the texts supports this argument. We conclude with implications for future such crises and for thinking about culture and sensemaking more generally.

Why the Federal Reserve Failed to See the Financial Crisis of 2008: The Role of “Macroeconomics” as a Sensemaking and Cultural Frame
Neil Fligstein Jonah Stuart Brundage Michael Schultz
Department of Sociology University of California Berkeley
February 2014