The credit boom is still on schedule to collapse in early 2006, taking the economy and the stock market down with it. What's more, the stock market is starting to see that scenario as increasingly likely.

Many expected 2005 to be the year when the economy turned in a robust performance, finally putting the destabilizing factors of the past five years -- overpriced assets, erratic demand, whipsawing consumer confidence and a gaping trade deficit -- in the rearview mirror.

But for the economy to escape those things, it has to ditch its addiction to easy money in the very near future. And there is no sign of that happening as we approach the middle of this pivotal year. In fact, just the opposite has occurred. As hard as it may be to believe, nearly every key indicator shows that the dependence on credit has gotten markedly worse.

And the stock market is obtaining an increasing distaste for the credit bubble, even though it has helped shore it up since 2001. The lackluster performance of market indices -- the S&P 500 is down 4% so far -- needs to be explained.

Cold Turkey

To do that, it's worth looking at valuation. The S&P 500 is trading at 15 times forecast 2005 earnings, which is cheap compared with the price-to-earnings ratios of the past eight years. With interest rates at low levels historically, this cheap-looking P/E ratio would normally provide the basis for a ferocious and sustained move upward in stocks. The fact that the indiceshave sagged suggests that the market sniffs real trouble around the corner. It might be that investors feel that analysts have overestimated the earnings being used in the P/E ratio calculation.

But analysts always overestimate marketwide earnings, sosomething else must be spooking the market. That something is almost certainly the fear that the intoxicating fuel that has driven stocks higher in the past -- cheap credit -- will soon have to be switched off, either by the Fed or by banks that finally see the need to be more circumspect with their balance sheets.

And the market has had no shortage of credit-boom numbers toworry about of late.

The housing market has gone from nerve-wracking to downrighthorrifying. It's got to the point where there is simply no defenseleft for skyrocketing house prices.

First, even at today's very low interest rates, mortgages are eating up the biggest proportion of income since the early '90s. In the fourth quarter, mortgage payments were equivalent to 10.12% of disposable income, the highest reading since the first quarter of 1992 (and of course in many mortgage-paying households, the share will be much higher -- a fact that is lost in highly aggregated national numbers).

Here's the stunning difference between now and 1992. Backthen, the interest rate on a conventional mortgage was 8.5%. Today, it's just under 6%.

In addition, the market value of residential real estate is at a record high in relation to after-tax income, Paul Kasriel, chief economist at Northern Trust, points out. Again on a nationwide basis, the market value of real estate is close to 200% of disposable income now. That ratio's previous high was in the late '80s, when it climbed close to 160%. A ratio close to 200% cannot last more than a few months. It is the equivalent of Nasdaq trading over 5000.

Sore ARMs

One of the defenses the housing bulls always made was that once a borrower locks in a 30-year mortgage rate, higher interest rates won't hurt that borrower, because the cost of the loan is fixed. But in one of the most worrying developments of late in the lending sector, the amount of adjustable-rate mortgages, or ARMs, has soared.

In mid-April, ARMs made up 35% of mortgage activity, according to the Mortgage Bankers' Association. Two years earlier, the share was half that. It might make sense to take out an ARM when interest rates are expected to fall, as the cost of the loan would fall if rates dropped. However, rates have risen since last year and they are more likely to rise than decline from now on. So why are more ARMs being extended to borrowers?

Because they offer a lower interest rate, at least initially, compared with a fixed-rate mortgage. In other words, to save a few bucks now, borrowers are taking on more interest rate risk just as interest rates are going against them. That shows just how unaffordable mortgages are right now to most people, and second, it shows that the blind speculative fervor of the last eight years is still a force to be reckoned with.

Considering the low level of interest rates, there hasn't been marked improvements in the health of the credit industry so far this year. Indeed, there are signs of stress. The large credit card lender MBNA ( KRB) missed the market's first-quarter earnings forecast because its borrowers are paying down loans more quickly than expected. Again, that shows that borrowers are balking at higher rates, but it also shows two other worrying trends. First, other credit card companies are likely charging lower rates than MBNA and taking away business. But that's foolishness, not competitiveness, at this point in the credit cycle. This is not the time to be takingshare by driving down rates.

Second, it suggests that the borrowers are still borrowing on their homes' equity to pay down more expensive credit card debt. But when house prices cool off in the very near future, the luxury of cheap home-secured credit won't exist.

Given how sensitive the credit market is to changes in rates,there doesn't have to be a big catalyst to floor the U.S. economy. The Fed will of course try to forestall the inevitable by pushing the theory that the economy can grow its way out of its overleveraged state. But the only way the Fed thinks the economy can sustain its growth is by keeping rates low. What that does, however, is blow more air into the credit bubble, making the ultimate crunch much worse.

When the history books get written, the corporate crooks of the '90s will have a certain lasting notoriety -- and deservedly so. But the villain of our era will most certainly be the man who created and then sustained the biggest bubble the U.S. economy has ever had to deal with -- Detox's old friend, Fed Chairman Alan Greenspan.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to peter.eavis@thestreet.com.

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