Failing the Test of Time: The 2008 Mortgage Crisis as a Case of Analogical Lock-In

• In Event: 149 - Regular Session. Economic Sociology: Herds, Runs, Bubbles: Social Influences in Financial Markets

Abstract

This paper examines the long-term consequences of using analogies to existing phenomena, e.g. ‘mortgage-backed securities are like bonds’, to help facilitate the diffusion of innovations. Using a historical case study, this paper examines how an analogy affects the innovation’s trajectory after the innovation has been adopted. I introduce the notion of analogical lock-in to explain decision-makers’ inability to update their beliefs about the validity of the accepted analogy when faced with evidence that the analogy is no longer valid. The paper presents qualitative evidence that analogical lock-in can occur even if the decision-makers evaluate the analogy in keeping with the best-case-scenario criteria set out by analogical reasoning scholars. Drawing on a combination of interview, archival, and industry trade manual data, I document the role played by the ‘mortgage-backed securities as bonds’ analogy in the diffusion and evolution of mortgage-backed securities (MBS) from 1968 to 2008. Specifically, I find that analogical lock-in can lead to negative consequences unanticipated by the decision makers. My research also highlights the interaction between persistence of the analogy and the technical tools used to bridge the gap between the innovation and the existing phenomenon the analogy compares the innovation to. This finding suggests that technological and analogical lock-ins are mutually reinforcing.

Author

• Natalya Vinokurova, The Wharton School