Platform:To understand why there's a credit bubble, how it's inflating the price of stocks and what it will mean when it bursts, let's consider the recent acquisition of Avaya, a large telecommunications equipment maker, by two private equity firms, Texas Pacific Group and Silver Lake Partners, writes Steve Pearlstein.

Avaya is expected to post revenue of about $5.4 billion this year. It has virtually no debt and has $825 million in the bank. Operating earnings - profit before counting things like interest payments, taxes, depreciation and amortisation - are expected to reach $700 million. And if that's correct, it means the price being paid for Avaya, $8.2 billion, is 12 times operating profit, making it one of this season's richest deals.

What's driving such high valuations is cheap debt, and plenty of it. We don't know yet how the all-cash purchase of Avaya will be financed, but if it follows the pattern of other recent buyouts, the new owners will take on at least $6 billion in debt.

Given the junk-bond rating that has already been assigned to the deal, that is likely to work out to an average interest rate of about 8 per cent, along with the obligation to pay back 1 per cent of principal every year. Add it all together and the new, improved Avaya will have to pay about $540 million more a year in debt service than it does now.

Can the company handle that? Well, consider that only three years ago, Standard & Poor's calculated that operating profits for companies involved in leveraged buyouts were typically 3.4 times debt service. Last year the number fell to 2.4. So far this year, it is 1.7.

And the Avaya deal? It's 1.3 to 1, which, if you think about it, isn't much of a cushion if revenue suddenly falls or expenses rise more than expected. Nor would there be much cash left over for the company to increase its investment in research or pay for new plant and equipment.

In other words, a deal like this would never get financed in normal times. Bank lenders and bondholders would demand that the new owners use more of their own money and take on less debt. Or they would demand interest rates so high that the company, as presently configured, wouldn't be able to generate enough cash to cover debt service. Either way, the buyers would never have agreed to pay $8.2 billion.

But these are not normal times, and overpriced and over-leveraged deals like Avaya have been getting financed in record numbers. Back in 2004, about $275 billion in loans were issued for such highly leveraged transactions. By last year, that had risen to $490 billion. And in just the first five months of 2007, that record was broken.

At some point sanity will be restored, triggered by any number of events. A high-profile acquisition could collapse because the new owners could not secure financing. Or a deal could blow up after it is discovered that there's really not enough cash to meet the debt payments. Or interest rates could suddenly rise from their current low level, threatening the viability of recently acquired companies and making it unlikely that the new owners will be able to sell for anything close to what they paid.

In fact, over the past several weeks, all those things have begun to happen.

On the bond market, yields on the benchmark 10-year treasury bill have increased from just under 4.5 per cent to more than 5.25 per cent - a three-quarters-of-a-point jump without any action by the Federal Reserve.

And just last week, William Gross, one of the country's leading bond investors, recanted on his prediction that interest rates were headed down, warning instead that yields on 10-year treasuries could reach 6.5 per cent over the next several years.

Syndicated loans used to finance the recent purchases of the Minneapolis Star Tribune, Linens 'n Things and Freescale, a semiconductor maker, are trading at significant discounts only months after the deals were closed, after the companies reported disappointing earnings or cash flow.

Meanwhile, the Wall Street Journal reported that after a period in which lenders were throwing money at leveraged buyouts with few if any conditions, several private-equity buyers are having more trouble financing their deals.

It is impossible to predict when the magic moment will be reached and everyone finally realises that the prices being paid for these companies, and the debt taken on to support the acquisitions, are unsustainable. When that happens, it won't be pretty.

Across the board, stock prices and company valuations will fall. Banks will announce painful write-offs, some hedge funds will close their doors, and private-equity funds will report disappointing returns. Some companies will be forced into bankruptcy or restructuring.

But the damage won't be limited to Wall Street and its investors.

For if we've learned one thing in the past 20 years, it is that what happens on financial markets, in booms and in busts, can have a big impact on the rest of the economy.