In one Harvard University study performed in 2001, amnesiacs reported having dreamed about things that happened the previous day. Trouble was they didn't recognize the dream reflected their own experiences. In the study, amnesiacs played the block-stacking videogame Tetris for several hours each day. After they'd slept, they reported seeing large blocks falling and rotating, just like in Tetris, when falling asleep and in dreams. And because they were amnesiacs, they couldn't explain why they'd seen these blocks since they had no waking memory of playing the game. Does this mean that dreaming is a cure for amnesia? Not exactly, but it could mean that dreams aren't drawing from declarative memory at all, but from implicit memories.
Implicit memory, also known as non-declarative or unconscious memory, is just that -- memories that are not part of our waking consciousness but are there, nonetheless. Under the umbrella of implicit memory are procedural and semantic memories. Procedural memories include things like knowing how to ride a bicycle. You know how to do this, but you don't literally think "sit on the bike and put your feet on the pedals." You just hop on and ride. Semantic memories are more abstract, and live in the neocortex region of the brain. You saw an example of these abstract semantic memories in the dreams of the amnesiacs. While the participants could remember blocks falling, they didn't see themselves in a room sitting at a computer and actually playing the game. We also know that amnesiacs retain their implicit memories. That's why, after an injury, an amnesiac may not know his wife's name, but does remember how to flush a toilet.
This all leads to the theory that while we sleep, the brain goes over the millions of bits of information we take in each day in order to file everything away into the proper spaces. Dreams, some theorize, are what happen while this is going on. Work stress may play out in your dreams very clearly at times because your brain is giving it more weight than, say, the hot dog you ate for lunch. However, it's also possible for you to dream about the hot dog. Or maybe the hot dog is in your dream about your work stress. If it's true that the hippocampus is not responsible for dreams, and the answer lies in the neocortex and your implicit memories, then that also explains why your dreams can be very abstract at times.
At this stage, there really is no final answer as to how the brain transforms reality into dreams. But it's likely that it's tied to how we process our memories. As more studies of the brain, sleep and dreams are performed, perhaps our understanding of how our brain manages information will become clearer.