Serious Money: The economist Hyman Minsky, who passed away more than a decade ago, would almost certainly enjoy the ongoing turmoil in the world's financial markets, writes Charlie Fell.

The theories he espoused in two books and numerous articles were largely ignored during his lifetime but have recently been resurrected to explain the deepening crisis in the US mortgage market.

Leveraged investors are learning that capital gains come and go while debt must either be paid off in full or restructured in bankruptcy.

The origins of recent market turmoil are easy to identify. The Greenspan Fed reduced interest rates to decade lows in the wake of the collapse of "new" economy stocks in 2000 and cheap credit was afforded to borrowers for far too long. Meanwhile, Asian central banks' seemingly insatiable appetite for dollars kept long-term interest rates lower than justified by economic fundamentals.

The consequent drop in mortgage rates boosted housing demand while the small differential between short-term deposit rates and the cost of credit afforded to long-term borrowers encouraged the banking industry to take greater risks.

A classic debt-fuelled bubble, as described by the works of Minsky, began in earnest.

Minsky's theories differentiate between three types of borrower - hedge, speculative and ponzi.

The first has the ability to pay both interest and principal; the second can meet interest payments but relies on refinancing to meet maturing principal repayments; while the last depends on a continued rise in asset prices to stay afloat.

The economist noted that long periods of stability breed instability as the mix of borrowers shifts progressively from hedge to ponzi. The reckless abandon of both borrowers and lenders ends in an economic downturn that paves the way for the next recovery and expansion.

The theories of the under- appreciated economist are certainly applicable to the US housing woes. Rising prices attracted borrowers of every sort and the banking industry was more than happy to lend in its hunt to boost profitability.

Financial innovation compounded the situation as lenders were separated from a mortgage's ultimate outcome. "Condo-flippers" became commonplace, as did the availability of so-called "ninja" loans - no income, no job and no assets. The share of outstanding mortgages attributable to subprime loans soared to double-digit levels.

It is now clear that the US is suffering from a severe recession in the housing sector.

The bull market cheerleaders on Wall Street, who confidently declared just months ago that a bottom to the housing slowdown was close at hand and that spillover effects to the broader economy would be contained, have been proved wrong.

The trickle of news concerning subprime losses among financial institutions from China to Germany has precipitated seizures in the credit markets and central banks have been forced to act.

The Federal Reserve, which only a matter of weeks ago said it was more concerned with inflation risks than threats to growth, lowered the rate at which it makes emergency loans to financial institutions by half a percentage point.

The actions by Ben Bernanke and his compatriots at the Fed have soothed investors' nerves. An interest rate cut of 25 basis points at the monetary policy meeting on September 18th is fully incorporated in market prices, with a further reduction of the same expected in October.

Unfortunately, such measures, if taken, cannot solve the crisis, given the more than $500 billion (€366.2 billion) in adjustable-rate mortgages that are on course to be re-priced upward by roughly three percentage points during the first six months of next year.

Additionally, easier monetary policy sends a bad message to financial markets that reckless abandon in financial matters is acceptable. It is never right to engage in reckless pursuits and expect to be bailed out when the environment gets rough. The words of Benjamin Franklin spring to mind when he said: "Experience is a dear school but fools will learn in no other."

George Bush has also entered the fray with promises of bail- outs for responsible borrowers, but he seems to be unaware that America's time as the world's financial superpower has come and gone. Corruption and fraud at companies such as Enron and WorldCom following the demise of the 1990s "new era", combined with the regulation that followed, has seen a decline in New York's market share to London and elsewhere.

Its housing market collapse and the opaque financial instruments that were spawned will reinforce the trend. Minsky's moment has arrived and the age of America is over - sell dollar assets.