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Even by the heady standards of one of Europe's fastest growing economies, the Estonian housing firm Nova Haus was on a roll. Launched in 2004, with initial funding of just $13,000, it grew so fast that by 2006 it boasted 120 workers and a $2.5 million profit. In 2007 Nova Haus even took home the Estonian government's award for Developer of the Year. "It was crazy how easy it was," recalls Hegert Lepik, 28, a lanky economics graduate and father of two who helped found the company. "I kept asking myself: How is this possible? It almost didn't seem real." In one sense, it wasn't. Less than a year after Lepik and his fellow managers were honored for their entrepreneurial smarts, the company filed for bankruptcy — a victim of the property industry's implosion. Over coffee in an empty restaurant in the heart of Estonia's capital, Tallinn, Lepik laments that he's had to sell his house and two cars, and is contemplating going back to school to improve his English. The situation, he says, is "awful."

And the misery is only just beginning. The former Soviet Baltic republics of Estonia, Latvia and Lithuania had the highest growth rates in Europe until recently. But, hit by the global credit crunch and economic downturn, the Baltics are now leading Europe into recession. By some estimates, Estonia's economy may already be shrinking. "There's an Estonian saying: Every party ends in tears," says Maris Lauri, an economist at Hansabank, a subsidiary of Sweden's Swedbank.

Eastern Europe avoided the first wave of banking problems caused by the sub-prime mess, but as the global economy slows and credit dries up, there's plenty to cry about. Many of the region's capitals borrowed heavily to fuel the boom, and those bills are coming due. On Oct. 26, the International Monetary Fund (IMF) announced a $16.5 billion bailout for Ukraine, to prevent a run on its banks and shore up its currency. Three days later, the IMF agreed with the World Bank and the European Union on a $25 billion rescue package to restore confidence in Hungary, which had seen its currency plunge in recent weeks. The IMF and European leaders are also worried that, if postcommunist economies collapse, the region could return to the kind of political turmoil it has only recently shaken off.

During Eastern Europe's good times, few countries partied quite as hard as the tiny Baltic states. The end of communist rule and the liberalization of their economies, together with the promise of joining the E.U. (which all three did in 2004), drove dizzying growth. Rapidly rising wages and property prices fueled the exuberance. In cities like Tallinn, families borrowed to buy their own homes for the first time. Flashy cars bumped along cobblestone streets, while high-end restaurants catered to the new moneyed class, serving mojito cocktails and champagne for lunch. "It was like New York City in the 1980s," says Imre Kose, chef de cuisine at Vertigo, one of the city's trendiest restaurants. "Everything was on credit and everything was materialistic. It was amazing."

Much of the growth was financed by cheap money, as Swedish and Finnish banks competed for customers in Europe's fastest growing region. Entrepreneur Lepik recalls firing off an e-mail loan application in 2006 with a "very basic" business plan, and getting approval in less than a week. Private debt across the Baltics rose from nearly zero to Western levels as consumers became hooked on credit. Home buyers and businesses took out mortgages in foreign currencies, which had the effect of worsening already severe current-account deficits. In a peculiarly Estonian twist, companies in the tech-savvy country began offering high-interest short-term loans by mobile phone. Borrowers could text the company their requests and have money transferred into their bank accounts almost instantly, albeit at usurious interest rates of up to 800% a month.

But when property prices began to fall last year, people like Lepik, who had grown accustomed to making 50% a year on their real estate investments, suddenly struggled to sell. As the banks that helped finance the boom clamped down on credit, dozens of companies went bust. Land on the outskirts of Tallinn that had cost $0.50 per square meter in 2000, and peaked at $90 per square meter in 2006, now fetches just $20.

The pain in property and construction has spread. Estonia's stock index is down 60% in the past year. Tourist numbers have fallen. A third of restaurants in Tallinn's old city center are expected to close in the next few months. It doesn't help that a diplomatic spat between Estonia and Russia, which erupted last year following Estonia's decision to relocate a Russian war memorial, has resulted in a 30% drop in exports through Estonia's ports. Combine all that bad news and it's little wonder that Estonia's unemployment rate, just 4.7% in 2007, is predicted to hit 9% next year. "Everyone is worried about what will happen," says Aivar Hundimagi, deputy editor of a business paper that has shed nearly 20% of its staff since last year. Black banners for a lecture series recently appeared in Tallinn asking: IS THERE LIFE AFTER CAPITALISM?

That's a question being raised in other parts of Eastern Europe these days, too. By one estimate, net banking flows into the region, most of them originating in Western Europe, will fall from $219 billion in 2007 to just $74 billion next year. Sweden's Swedbank, which not long ago earned a fifth of its profits from the Baltic region, has seen its stock price halve in the past year over fears of exposure to bad loans, and on Oct. 27 it announced a $1.5 billion rights issue to bolster its finances. Two days later Austria's Erste Bank turned to the state for $3.5 billion, in part because of problems with its banking operations in Eastern Europe. In addition to Ukraine and Hungary, which holds high levels of debt in foreign currencies, Bulgaria, Romania and the Baltic states have all been cited as potential candidates for rescue packages down the road. No bank operating in the region is immune. "This is a systemic crisis where everything gets sold," says Simon Maughan, an analyst at brokerage MF Global in London. "It doesn't matter whether you are less exposed to Hungary and more exposed to Poland. Eventually it's going to catch up with everybody."

Beyond seeking short-term bailouts, governments need to find ways to pay off their foreign debt — by increasing exports, reducing imports, or both. They also need to cut spending drastically: Hungary is looking at up to $1.4 billion in cuts in order to qualify for the IMF bailout.

Such drastic belt-tightening could trigger protests and political opposition; ruling parties will find winning re-election a lot harder. Since the end of communism, the region has introduced some of the world's most business-friendly policies, including, in Estonia, axing corporate taxes. Such policies are unlikely to disappear immediately. "If anything, we will strengthen them, to improve education and encourage innovation," says Juhan Parts, Estonia's Minister of Economic Affairs and Communications. Whether he feels that way several months from now will depend on just how low Estonia and its neighbors sink. — With reporting by Adam Smith/London

• ANDREW PURVIS / TALLINN
• The Baltics enjoyed years of stunning growth. But now they're waking up to the grim reality of a downturn that's hitting Eastern Europe particularly hard