If you were of a nervous disposition, you might be thinking that judgment day is nigh for the British economy, after all the excess, easy money and booming house prices of recent years.

America looks like it is already in recession, one that threatens rapidly to become the biggest slump since the 1920s. The collapse a week ago of the country's fifth-largest investment bank, Bear Stearns, signalled that the crisis sweeping the world's credit markets had taken a decisive turn for the worse.

The wobbles in the HBOS share price last week, although based on groundless rumours, are a sign of how frayed nerves have become.

Certainly, those hoping that the drying up of global money markets last August, which brought down Northern Rock in September, would be just a passing phase are sorely disappointed.

In the budget the Treasury said the credit crunch would probably last until summer 2009, although no one can know for sure. As a result, Alistair Darling had to mark down another £20bn of borrowing to cover an expected shortfall in tax revenues. That means both of Labour's cherished fiscal rules are likely to go out the window.

The credit problems have endured because the banking system had got more pumped up with reckless lending and ever more creative and incomprehensible "assets" than even the worst pessimist had feared. As a result, the unwinding of all this, or "deleveraging", is taking longer and proving more painful than had been thought.

Banks are keeping their money for themselves and winding in risky lending that only a year ago they were revelling in. That is where the impact spills out of the credit markets and into the real economy - and that is where the pain is being felt. "There is a lot of credit rationing going on. Indeed, the credit markets are pricing in Armageddon," says Richard Batty, a strategist at Standard Life Investments. He says this is showing up in the US mortgage market, where interest rates on the long-term mortgages beloved of Americans have pushed up above 6%, even though the Federal Reserve has been slashing short-term rates, bringing them last week down to 2.25%. Small wonder that experts in the US predict another 10-15% off house prices there in the next year, adding to the 15% drop seen over the past year. A 25-30% house price fall in two years counts as a crash in anyone's book.

The question is, of course, how bad can it get in Britain? We've already seen that lending to first-time buyers has slumped by a third since last summer while first-time buyer numbers have dropped to a record low. Lending to buy-to-let landlords is drying up too. After a decade that has seen house prices triple, banks are finally realising that lending up to 100% and more of a property that could soon be worth less than its purchase price is not terribly clever.

In the case of many of those now infamous inner-city new-build blocks beloved of landlords, purchase prices have long been above the true value of the properties, with developers making false claims about the potential rents in order to shift them to gullible investors. From the current perspective, the idea that house prices in Britain, which are already sliding, can just drift sideways after such a boom is optimistic to say the least.

Some have long argued, however, that house prices are well supported in Britain because there is not much new housing being built and the population is expanding. We need a trigger such as rising unemployment to push prices down, because that hits demand hard, they say. Figures last week showed that employment has hit another record high, although it fell for the first time in six years in the financial services sector - a sign of the pain being felt in the City. But what is happening now is that strong demand for somewhere to live is manifesting itself in strong rises in rents, rather than house prices.

Make no mistake, there is a demand shock happening in the housing market caused by the credit crunch.

Remember that economics textbooks define demand as "a need or want backed by the ability to buy". It is this ability to buy that has been hit. Ask any estate agent where are his or her first-time buyers - the traditional prop of the market - and they will tell you that they have disappeared. Likewise would-be landlords. Both these groups have suffered a slamming of the door to the world of easy credit unless they have a very sizeable deposit.

Add to that a growing realisation that house prices are extremely high by almost any measure and you have a change in sentiment among buyers. That sentiment could prove long-lasting and so prices could fall sharply, although probably not as sharply as in the US. However, US house prices doubled over the last decade, rather than tripled, so UK values have potentially further to fall.

Commercial property prices are already in freefall and down 10-15% since the autumn. Legal & General forecast last week that they are likely to fall as much again, especially if the credit crunch continues unabated. It wasn't so long ago that investment experts were telling us that commercial property was a good bet - safe as houses.

For the housing market, much will depend on how far the Bank of England cuts interest rates. The City thinks rates will come down by 0.75 points or more by the end of this year. That is not much, because the Bank remains concerned about inflation from rising food and energy prices. It will provide some relief to homeowners on variable rates but may not make money any more available to new buyers.

This credit crunch is more about the availability of money than its price. If you accept that a fall in house prices is likely, the question becomes: then what? Will consumer spending, on which the economy has depended for years, also collapse? Quite possibly, although the Bank has argued for some time that the link between house prices and consumer spending is less clear than you may think.

Resilient

Robert Barrie, chief European economist at Credit Suisse, takes the view that though some sort of economic slowdown is likely, one should hesitate before assuming everything is going to hell in a handcart.

For a start, he argues, retail spending has held up well, in spite of the weak credit and housing conditions. Rate cuts will help consumers, he says, as will the fact that shops are cutting their prices on almost everything but food, thereby making consumers' incomes go further.

"We don't want to argue that things can't go wrong in the UK economy or that this is likely to be anything other than a difficult year," Barrie says. "However, it seems to us - against the record of the past 10 years and the behaviour of the economy at the start of this year - that sentiment may again be unduly pessimistic."

A document on the Treasury's website issued at the time of the budget argues that the UK has the most resilient of the world's major economies because of its flexible and competitive nature and the strength of its policy-making framework. You may argue that they would say that, wouldn't they? But the document does highlight data showing the UK economy has had remarkably stable growth and inflation over the past decade or more. Growth has been twice as stable as that in the US over the past decade. Barrie argues that should mean a recession here is twice as unlikely as in the US.

One thing's for sure: with consumer debts at record levels and house prices way too high, that resilience will face its sternest test yet over the next 12 months. Judgment day may be nigh.