Contagion and Sunspots Surrounding Speculative Home Equity Lending Losses

15 Pages Posted: 21 Jan 2009

Date Written: January 21, 2009


Subprime mortgages, HELOCs, supply-side restrictions, fraud and misrepresentation have been postulated as causes of the "housing bubble" in the U.S. in the early- to mid-2000s, and the subsequent crash and mortgage crisis. In this paper, I offer a theoretical demand-side explanation instead. Utilizing a sunspot model of housing demand and home equity lending, I show how agent preferences generate sunspot equilibria which cause housing prices to be excessively volatile, and how this results in home equity lending losses. I also suggest how the Fed's dramatic reductions, then increases in interest rates during the early- to mid-2000s, could have played a role in increasing housing price volatility. In addition, I examine financial contagion (cross-country spillovers of housing price volatility). Finally, I suggest how tax policy could be used to eliminate sunspots in housing markets and possibly avert future mortgage crises.

Keywords: housing bubble, sunspots, mortgage crisis

JEL Classification: D84, G18

Suggested Citation

Lim, William Wui-Ling, Contagion and Sunspots Surrounding Speculative Home Equity Lending Losses (January 21, 2009). Available at SSRN: or

William Wui-Ling Lim (Contact Author)

York University ( email )

4700 Keele Street
Toronto, Ontario M3J1P3

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