(FORTUNE Magazine) – Thus far, 2002 has produced no shortage of unusual spectacles: Chelsea Clinton's glam Versace makeover, models and economists mingling at the World Economic Forum in New York City, and Virgin Records paying Mariah Carey $28 million not to sing, to name a few. Alas, those topics are the province of other magazines. Luckily, the business world has proved scandal-rich as well; 2002 is rapidly becoming the year of the epic bankruptcy.

Three big blowups in as many weeks--Kmart, Global Crossing, and Enron (okay, this one technically took place in the last weeks of 2001, but you get the point)--rank among the largest U.S. corporate bankruptcies in history (see table). Banks are cracking down on cash-starved firms, companies are struggling to pay debt issued three years ago, and wary investors have a bad case of Enronitis. That puts teetering sectors like telecom, retail, and steel in peril. And the trend is building: Last year 257 publicly traded companies filed for Chapter 11, up from 176 companies in 2000. "We may be coming close to a peak in the bankruptcy cycle," says Henry Miller, a vice chairman for global restructuring at investment bank Dresdner Kleinwort Wasserstein, "but we're not there yet." In fact in late January, McLeod USA (an emerging telecom) filed for Chapter 11 protection.

Why the bankruptcy boom now? A confluence of factors managed to make an iffy economy a breeding ground for Chapter 11 filings. The first culprit is a late-'90s binge that is turning into a wicked hangover. Back then banks and brokerage firms couldn't throw loans at startups or issue high-yield debt fast enough. In 1998 alone, Wall Street issued more than $141 billion of junk bonds, causing that market to jump to around $600 billion in 2001--more than three times its size a decade earlier. Investors lapped up the deals: After all, debt defaults--in which firms are unable to make principal or interest payments--had dipped as low as 1.6% in 1996, from 1991's record 10%. "Investors figured [junk] was a pretty good place to put their money," says Martin Fridson, a chief high-yield strategist at Merrill Lynch.

Whoops. Just as investors in DrKoop.com got burned, so did anyone who bought the really junky junk. Weak business models buckled under the weight of a crumbling economy (did someone say telecom?), and companies like Winstar, Warnaco, and Sunbeam found themselves unable to meet interest payments. Last year companies defaulted on $64 billion, or 9.8% of outstanding debt. It didn't help that historically there's a three-year lag between periods of heavy junk issuance and heavy defaults. This cycle was no different.

With J.P. Morgan Chase and Citigroup on the line for billions in loans to Enron alone, many banks are now trying to ratchet down their exposure to risk. "Previously the banks would have relaxed a loan covenant for a period of time or not forced a draconian solution if a company couldn't make a payment," notes Miller. Not anymore. A Federal Reserve survey of banks in October showed that 51% said they were tightening lending standards and none were easing. Kmart, for example, came out of its dismal Christmas only to get slapped by insurers and lenders unwilling to cut the troubled retailer even an inch of slack. "There are companies that could live to fight another day if they could only get their credit lines extended," says Fridson. They can't, which is why defaults are forecast to hit 8% this year. (Yes, that's down slightly from last year's telecom-startup-inflated figure.) Junk-bond issuance, meanwhile, has tumbled 41% over the past three years.

The bankruptcy boom is bleak news for stock and bond holders, but it's a bargain hunter's paradise. "During the great speculative excess of the 1990s, companies sold tons of debt that you can now buy at a 25% yield or better," says Marty Whitman, the legendary manager of Third Avenue Value fund. He spent January snapping up Kmart bonds for 53 cents on the dollar, on the bet that the failed company's assets--inventory and real estate--will be worth more than that if the company is liquidated or profitably reorganized. Should that happen, bond holders would be first in line to be paid (stockholders typically end up empty-handed). Other breeds of vulture investors are angling to gain outright control of a company after the reorganization. "We're seeing the beginning of the great takeover game," predicts Whitman. And whatever lies in store for Big K, he adds, "at these prices, I'm going to do okay." Too bad the same can't be said for the original investors.

Feedback? first@fortunemail.com