Working Papers

Why the Federal Reserve Failed to See the Financial Crisis of 2008

The Role of "Macroeconomics" as a Sense making and Cultural Frame


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 a serious economic meltdown was underway even after the collapse of Lehman Brothers on September 15, 2008. 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 sense-making to explain how this happened. The Federal Reserve’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 2008, demonstrating that the framework provided by macroeconomics dominated FOMC conversations throughout this period. The topic models also suggest 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 sense-making and the role of economics in policymaking more generally.