I have a craftsman air compressor, motor wont shut off and trying to let it fill is like watching water boil on medium heat. I have found if I apply pressure to the top of the motor that the tank fills pretty normally. So I looked at the metal pipe from the motor to the tank and it leaks air from that pipe. After taking a closer look, I can pop the metal pipe in / out of the valve. That dont seem normal to me either, I would think it would be a flanged pipe held down by a bolt. Maybe it broke? I don't know what this part is so I cant find out any info on a fix.
I am not sure I totally understand the set up you have. but it does sound like you are pumping air into the atmosphere rather than the tank. I think you have found the problem, but I have a hard time imagining the exact set up. Take the model number down to your Sears store and the parts department should be able to tell you how it should be.