They sell dreams, the property developers of the Costa Blanca, of ornate villas set between fiery red mountains and the azure sea.

Little Moorish palaces surrounded by manicured lawns, perfect for the about-to-retire British couple wanting to escape grey skies and taxes on everything. God's waiting room in the sun – with golf thrown in.

Peter – not his real name – had his dream. Five years ago, he and his wife sold their bungalow in south-west England for £270,000.

They used half of the proceeds to buy a house in Britain for their two sons, and reserved half for their palace, a house in a new development called the Albatera Golf and Country Club, 20 minutes by motorway from Alicante.

The Spanish developers, San Jose Inversiones, called the house design an Amapola. They had lots of designs: Tulipans, Rositas and Marbellas – a tower here, a balcony there, whatever the customer desired.

"It was right on the golf course with the mountains in the background," says Peter. "The club was to have a swimming pool and a bar; and if we wanted to go to the beach, it was only half an hour away."

Peter, who worked for a brewery before retirement, had it all worked out. He would rise in the morning, greet the mountains and set off for a round of golf.

His wife, a keep-fit instructor, would offer private classes to other residents to supplement their pension. They handed over £82,000 as a deposit and waited for the club to be built. It never was.

Today, the Albatera Golf and Country Club consists of a few show homes, a row of apartments and nothing else. It was pitched as a new La Manga – an upmarket resort combining golf with some 1,100 homes and two hotels. That is now mere hubris.

Peter, who doesn't want his identity known because he still hopes to get his money back, hasn't seen his deposit since 2003. In May, San Jose was placed into administration, another casualty of Spain's imploding property market.

The company had failed to secure full planning permission for Albatera and other sites. Then the bank stopped lending.

San Jose claims it has assets of some £300 million, but says it needs a loan of more than £20 million to get things moving again.

In the meantime, Peter and his wife live in an apartment, waiting for their money. They and some 1,500 other buyers must wait to see if the company can be rescued.

"I wish I'd never bloody come," he says. "I wish I was still in England, in my bungalow, with the way of life, and the friends I had there."

Thousands of British buyers are in the same boat. They surrendered deposits for homes often bought off-plan (unbuilt, from the architects' drawings).

Now prices are falling, buyers are disappearing and developers, starved of loans by Spanish banks nervous about international financial instability, are going bust. Along the Costas, developments lie half-finished, without water and electricity, and without any prospect of being sold.

For Spain's notoriously corrupt and capricious planning regime, which gave birth to the developments now disfiguring virtually all the country's Mediterranean coastline, the chickens are coming home to roost.

Houses built on the nod of corrupt mayors are being refused retrospective planning permission by regional administrations under pressure from the green lobby. Many properties, new and not-so-new, are blighted by illegality and are the effectively worthless; others have simply been demolished.

Scan the websites used by current or potential British expatriates and you will find people desperate for advice about how to reclaim deposits that they will, in many cases, never see again – and all at the wrong end of life, when lost savings cannot be recouped.

Even the biggest Spanish firms are going under. Last week, Martinsa-Fadesa, a major and respected player, filed for bankruptcy.

Gwilym Rhys-Jones is a financial investigator based on the Costa del Sol, and a longtime observer of the Spanish property scene. He says that even large, well-known builders were accepting deposits for off-plan developments that had no planning permission.

"These things are no more than pipe dreams, but there was such a ready supply of British and north European buyers that all they had to do was show them a pretty drawing and they were falling over themselves to buy them."

Drive along the coast south of Alicante and the results of the Spanish property bubble are there to see: serried ranks of exquisitely tasteless, often empty, villas advancing in close order up isolated, parched hillsides. Many have been built in locations totally unsuitable for housing: by the sides of dual carriageways, away from shops and amenities – anywhere that developers could find a landowner willing to sell.

Property has driven the Spanish economy like no other in the European Union. Last year, housing investment accounted for a tenth of GDP and 13 per cent of private sector jobs. More than four million dwellings have been built in the last decade, a boom fuelled partly by an influx of British retirees (some three-quarters of a million Britons now reside in Spain). Britain's Royal Institute of Chartered Surveyors says the number of homes built last year would be excessive even given steady market conditions, never mind a downturn.

But it's on the Costas where the developers are really hurting. La Axarquia is part of Malaga province, a constellation of 29 coastal and inland councils. Ask about the number of illegally built properties in La Axarquia and the official figure will be about 10,000. Local environmentalists put that at more than 20,000.

"In Marbella, the local council is calling on the regional authorities to retrospectively authorise illegally built properties because otherwise mortgages cannot be raised on them," says Mr Rhys-Jones. "In other words, they want to draw a line under the old era."

However, he does not believe the property industry will be cleaned up any time soon. "In my town of Estepona, the mayor was elected in May on an anti-corruption ticket. He is now awaiting trial, charged with money laundering, and influence-peddling relating to planning permission."

Housebuilding was popular with ordinary Spaniards, struggling to match the living standards of their more developed partners in the EU. Unfettered building was a vote-winner with local electorates because of the money it injected. Smallholdings, worth next to nothing as agricultural land, suddenly took on great value. Helping it all in recent years was the pound's strength against the euro, making Spain an attractive destination for elderly British couples wanting to maximise their pensions.

Now, the pound has dropped and the developers are finding fewer takers from the UK. The result is an enormous glut. Prices are falling relentlessly on the Costas, destroying the hopes of Britons who bought properties as investments.

Tina Reeves, who has worked as an estate agent in Spain for the last 18 years, says tortuous planning laws are part of the problem. "Licences granted by local councils to developers are being rescinded by the regional authorities," she explains. "It's not the fault of the developers, it's the fault of local councils granting licences and not passing it by the region. Also, not many Spanish banks are lending at the moment. They are getting uptight because even they don't know whether anything is legal any more."

Drive inland, a few miles from the Costa Blanca resort of Torrevieja, and you come to the village of San Miguel. As recently as 25 years ago it was an isolated spot, accessible only by a potholed road. Now it is thriving, partly thanks to an influx of expatriates such as Margaret and her friend Melvyn, both from south Yorkshire.

Margaret moved to Spain a decade ago. She feels sorry for people like Peter, but says they are often victims of their own naivety. "People leave their brains at Gatwick. You wouldn't part with your money that easily in the UK, but when they get here, they do. Spanish people will not sign unless everything is in order.

"They bring these people out from England on short breaks and show them a new-build property or a plan and tell them, 'This is your dream' – and it is a dream. The amount of building has gone mad. There is hardly a patch of coastline not built on. When we came here, you would have detached properties with a bit of land. Now it's apartments and houses crammed together."

The value of Margaret's pension has dropped with the pound – the rising euro means she is worse off by the equivalent of a weekly shop – but she says he and her husband would never return to Britain. "I wouldn't go back. I don't think I could afford to live there, to be honest."

Melvyn, a former environmental health officer, is very pro-Spanish. However, he warns: "Corruption is commonplace. They bring you out here and show you a patch of land with a view and it looks beautiful. But when you hand over money you have saved all your life, you find they've built another house a few yards away and there's no view."

A few miles away, Peter is sitting in his apartment, musing on the last few years.

"If we went back I think we would say, 'Well, we lived in Spain for two years. It was an experience. There were a lot of good things and a lot of bad.' "

His wife appears more accepting of misfortune.

"I had the image of running private keep-fit," she says wistfully. "You looked out and the mountains were right on top of you. I loved the idea of that."

As a kind of remedy, the couple have been offered an apartment being built at another site. But "it's not what we wanted", says Peter, the stress telling in his voice.

His dream of golf in the morning and a mountain view at sunset is likely to remain just that.