WHEN ARIEL SHARON moved into a new apartment in the Moslem quarter of Jersusalem's Old City last month, he focussed public attention on a little-known Israeli yeshiva called Ateret Cohanim. This religious school -- backed largely with money raised in the United States -- is seeking to settle Jews in the Arab quarter of the Old City in anticipation of the coming of the Messiah.

During the last several years, Ateret Cohanim has established numerous outposts in the Moslem quarter of the Old City, altering the equilibrium there between Arab and Jew. Through an affiliated organization known as the Jerusalem Reclamation Project, the yeshiva has begun to purchase Arab real estate with the intention of turning the Old City (including Moslem and Christian holy places) into a Jewish domain, the prelude, group members believe, to the Messianic Age and the Redemption of Mankind.

The prelude to the Redemption, however, may be an increase in the daily level of violence between Israelis and Palestinians. Ehud Sprinzak, a professor at Hebrew University who studies extremist Israeli groups, says Jewish settlement in the Arab Old City could explode into intercommunal violence on the scale and fury of Belfast. "The yeshivas shouldn't be there," says Sprinzak. Communal violence will increase, he warns, as the Jewish presence there grows.

"The struggle over real estate" is the heart of the conflict between Israel and the Palestinians, says Sam Lehman-Wilzig, assistant director of the Institute for Public Communications at Bar Ilan University. "Much of the Land of Israel was not conquered, it was bought from Arabs between 1904 and 1948. It was cash on the barrel head. Slowly but surely, the land moved from Arab to Jewish hands. What's happening in the Old City is in keeping with the Zionist tradition."

Because there are no laws prohibiting Jews from buying property in Arab East Jerusalem, there is little the municipality of Jerusalem or the Israeli government can do. "We don't have apartheid in Israel," says Nachum Barnea, the editor of the liberal political weekly Koteret Rashit. "Jews, and Arabs for that matter, can live where they want." He contends that Jerusalem Mayor Teddy Kollek "wants to keep the city ghettoized with people living in their separate religious and ethnic enclaves, but he doesn't have the power to hold the mosaic together anymore."

Between 1936 and 1978, no Jews lived in the Old City's densely populated Moslem quarter -- a winding labyrinth of dank, cobblestone streets crowded with outdoor markets and teeming with barefoot children, donkeys laden with produce, and caravans of Western tourists hunting for bargains.

The Jewish resettlement of the Old City began on the first night of Hanukkah in 1978, when eight young Orthodox Jews established a yeshiva in the Moslem quarter called Ateret Cohanim, or the Priestly Crown. The yeshiva students came to the Old City to prepare for the last battle -- the struggle between good and evil that will precede the End of Days and the Redemption of Mankind. They studied the ancient priestly texts and prepared for the coming of the Messiah and the rebuilding of the Second Temple, which was destroyed by the Romans in 70 A.D. Many of the students believed that a crucial step toward the Messianic Age would come with the removal of the Dome of the Rock Mosque, which now sits atop the ruins of the Second Temple.

The founder of Ateret Cohanim was an army veteran and yeshiva student named Matityuhu Hacohen. A disciple of the rabbi who helped found the Gush Emunim settlement movement, Hacohen decided to take the Gush Emunin philosophy a step further. Why not carry Gush Emunim's holy crusade to settle and build up Judea and Samaria into East Jerusalem itself? If Judea and Samaria were the heart of the ancient Land of Israel, Hacohen reasoned, then Jerusalem and the Temple were its soul. How could the Messiah come to Jerusalem if Jerusalem wasn't a holy Jewish city, the kind of city described by the Prophet Isaiah?

"Hacohen became a regular fixture in the halls of the Knesset, lobbying for Jewish settlement in the Old City," says Yisrael Medad, aide to Geula Cohen, head of the right-wing Tehiya Party. According to Medad, Hacohen forged particularly close relationships with then Agriculture Minister Sharon.

To help finance their dream, Hacohen and his American colleagues founded in the early 1980s the Jerusalem Reclamation Project as an arm of the Ateret Cohanim yeshiva. Its goal is to buy the estimated 1,100 properties in the Moslem quarter.

"We will not employ fanaticism to embrace {our} vision," says an internal Ateret Cohanim document. "That is why it is a difficult goal to carry out -- because we must move carefully and cautiously . . . every piece of property we buy cements our ties to the heart of Jerusalem. Every new {Jewish} family that moves into a redeemed house means an Arab family of larger numbers has willingly consented to move . . . ."

But as Jews began to expand their presence among the 20,000 Arabs in the Moslem quarter, tensions flared. The opening of three new yeshivas several years ago further strained relations. Shuvu Banim, a mystical congregation that studies the teachings of Nachman of Bratslav, a 19th-century Hasidic mystic, has been a particular source of problems. Some of the Shuvu Banim students have been accused of arson and other strong-arm tactics to drive out their Arab neighbors, according to reports in the Hebrew press. (Ateret Cohanim officials have condemned Shuvu Banim's violent behavior towards its Arab neighbors.)

Meanwhile, a handful of Jewish extremist groups began to agitate for the right to pray on the Temple Mount, the site of the Second Temple where the Dome of the Rock now stands. More ominously, Israeli police during the last few years uncovered several plots by Jewish extremists to blow up the Dome of the Rock Mosque. Even students at Ateret Cohanim have become embroiled in violent clashes with local Arabs. In 1982, for example, students began to tunnel under the Temple Mount in search of a chamber where King Solomon is thought to have hidden many of the gold vessels used in the First Temple. Arab guards at the Dome of the Rock heard the digging, A riot ensued, and the Israeli police later sealed the tunnel.

An Ateret Cohanim official says that the group currently owns more than 70 buildings in the Moslem quarter, worth an estimated $10 million. The property includes their yeshiva, the building that houses Yeshiva Shuvu Banim, several dormitories, a museum, and more than 50 apartment units. Much of the property acquired by Ateret Cohanim had belonged to Jews who lived in the Moslem quarter before they were driven out by pogroms in 1929 and 1936. Ateret Cohanim officials estimate that the cost to purchase the rest of the buildings in the Moslem quarter is $100 million, with another $100 million for renovations.

Ateret Cohanim uses Christian Arab middlemen to purchase property in the Moslem quarter in order to disguise the fact that Jews are the buyers. Both Jordan and the PLO have made it a capital crime to sell property to Jews.

"We were afraid of publicity," explains Louis Bloom, the English-born public relations director for Ateret Cohanim. "We thought the PLO would come in and start a bidding war. But the PLO has been broke since the Lebanon War."

Bloom says Ateret Cohanim is negotiating for 12 additional buildings, and has a large waiting list of yeshiva students and families who are ready to move into the Moslem quarter. "The only thing stopping us now is money," he says. "But I think that within 10 years we will have made . . . Jerusalem Jewish again forever.

""We pay {the Arabs} well above market value," Bloom says. "They are very glad to leave the Old City, and with the money they can go to Europe and open up a little business. You can get more out of Arabs by being nice. If there were another way to get them out we would use it, but we think {Rabbi Meir} Kahane's way is a disaster."

Ateret Cohanim raises most of its money in America. In 1984, it set up American Friends of Ateret Cohanim, a tax-exempt, not-for-profit organization incorporated in New York State. Prior to that, Ateret Cohanim had money passed to it through PEF Israel Endowment Funds, Inc., a tax-exempt public charity corporation in New York. The American Friends of Ateret Cohanim is given free office space on Manhattan's Fifth Avenue by the Genesis Foundation, a New York City-based, tax-exempt, religious charity that promotes "Jewish awareness."

According to Ateret Cohanim officials, most of the money collected by the American Friends of Ateret Cohanim goes to the Jerusalem Reclamation Project, whose primary purpose is to purchase Arab property in East Jerusalem. Originally, Bloom says, Ateret Cohanim wanted to register the Jerusalem Reclamation Project in the United States as a tax-exempt foundation but was advised that the IRS wouldn't grant tax-exempt status to an organization that buys and renovates real estate.

Sources close to Ateret Cohanim say that in addition to contributions from American Jews, the group has collected money from wealthy Christian Evangelicals in America -- who view the Jews' return to Israel as the prelude to the Second Coming of Christ. Among the largest American Jewish contributors, according to Bloom, are two Florida doctors. One, Dr. Irving Moscowitz of Miami, recently purchased the 52-room Shepard Hotel, formerly owned by the Mufti of Jerusalem, for "considerably more than $1 million," according to Moscowitz. "I am doing everything I possibly can to help reclaim Jerusalem for the Jewish people," he explained in a telephone interview last week.

Last May 27, the Friends of Ateret Cohanim held its first annual fundraising dinner for the Jerusalem Reclamation Project in Manhattan at the Hilton Hotel. More than 500 people attended, paying $180 each. Israel's U.N. ambassador, Benjamin Netanyahu, was the keynote speaker. In a recent interview Netanyahu said, "I support the idea that Jews can live anywhere in the Land of Israel."

Ateret Cohanim isn't a fringe group in Israel. It enjoys wide support from conservative political parties, and even some grants from the government. Among Ateret Cohanim's most ardent supporters is Avraham Shapira, the Ashkenazi Chief Rabbi of Israel. "I appeal to all those who are so able to give a helping hand {to Ateret Cohanim} in this sacred burden . . . and restore the light on the Torah to within the Old City of Jerusalem," wrote Shapira in a letter of greeting to Ateret Cohanim.

Rafi Davara, an aide to Mayor Kollek, says that although the Jerusalem municipality strenuously opposes more Jews moving into the Moslem quarter, legally there is little they can do to stop it. "Four or five times when we heard that Ateret Cohanim was negotiating with Arab property owners in the Old City, we went in and put pressure on the Arabs not to sell," says Davara. "We can slow Ateret Cohanim down, but we can't stop them."

Even the national government is paralyzed. Amnon Rubinstein, who resigned as Minister of Communications last May, said he met with Foreign Minister Shimon Peres last year to complain that the expansion of Jews in the Muslim quarter promotes social tension and will ultimately undermine the city's international character. "What can I do?" Rubinstein recalls Peres asking. "Give me a formula!"

Most Israelis, however, believe Jews should be allowed to settle in the Moslem quarter. In a poll published last February in the Hebrew-language daily Maariv, 62.1 percent of the respondents approved of Jewish settlement in the Moslem quarter. The changes that have already taken place in the occupied West Bank may be a sign of what's ahead in the Moslem Quarter of Jerusalem. Twenty years after occupation, more than 50 percent of the West Bank is in Jewish hands, carved into a network of roadways and electrical grids for 120 settlements housing some 60,000 people.

Meanwhile, stone by stone and house by house, the members of Ateret Cohanim are quietly working to transform the Old City into what they hope will become the pride of Jews everywhere -- a holy city in service of the Third Temple. But while Ateret Cohanim burns bright with religious passion, its Arab neighbors burn with hatred and contempt.

Robert Friedman, a 1987 Alicia Patterson Fellow, is a freelance writer in New York.