Many foreign companies have suspended operations. Their staffs are staying off the streets, and others are refusing to come in to replace those rotating out. "We have contractors there doing nothing because of the security situation," says Will Geddes, managing director of the London-based security firm ICP Group Ltd. "There are companies that we're having to hunker down with until we feel comfortable to move them [around]." Even major news organizations are finding it difficult to staff the story: "We just can't find senior correspondents who will come to Iraq now," says the bureau chief for one major American newspaper.

Iraqis suffer most. In the same week the American hostages were taken and killed, at least 300 Iraqis died from terrorist attacks. Some 45 Iraqi translators working for the American military have been killed in Baghdad. The most recent case occurred last Monday, when a woman was gunned down in her car in the afternoon. Terrorists also killed a top official of the state-owned Northern Oil Co. last week, while two moderate Sunni sheiks were kidnapped and killed in Baghdad.

The U.S. military is doing its best to hit back. A week ago a U.S. missile destroyed a car in Baghdad carrying Sheik Abu al-Shawmi, Tawhid and Jihad's spiritual leader, according to the cleric's father. Other airstrikes have targeted suspected Zarqawi safe houses in Fallujah. But none of that has had any noticeable impact on the terrorists' operations. Last Friday six Egyptian employees of the mobile telephone company Iraqna were kidnapped. Analysts talk about the need for a major assault on the insurgent stronghold of Fallujah, but that is said to be unlikely before the U.S. presidential election in November. The last such offensive, in April, resulted in numerous American casualties.

U.S. officials insist the climate of fear has not stalled rebuilding. "It's utterly, utterly untrue that we've abandoned reconstruction," says Col. Jeffrey Phillips, deputy director of the Project and Contracting Office at the U.S. Embassy in Baghdad. "I wouldn't say it's put on hold," Phillips said. "I would say certain projects are put on hold, what they call the 'out years,' but we're still pressing ahead with projects closer to hand." Priority is given to projects where security is established. "If you build it up and they blow it up, it doesn't take the two of us to figure out it's counterproductive."

U.S. officials deny speculation that many embassy staffers have been leaving Iraq recently. However, the State Department has had a hard time staffing the embassy in Baghdad, which is only at 50 to 60 percent of authorized strength, one official says, despite pay bonuses of 50 percent and more. "The only thing that will get people there is money," says an official in Washington.

That's what brought James, a young U.S. computer technician, to Iraq 12 months ago. Sitting in a house in Mansour, guarded by two dozen Kurdish guerrillas, or peshmerga, he's now considering his options. As the technical director for an Internet start-up, James provided the expertise that helped his Iraqi partner build the venture into a company employing 70 Iraqis. But now many of their clients have fled, and James is unable to visit others when they have a problem. He hasn't gone out on a service call in a couple of months. His Iraqi staff do his shopping; if he needs a doctor or barber, it's a house call. When he went home for a vacation in August, he was shocked to discover that even walking around the block was exhausting. He now uses a dance videogame to stay in shape.

"I get 10 e-mails a day from friends and family asking, 'Why don't you leave?' says James. The firm's other American expert has done just that. James says that if he evacuates now, the company will probably collapse. "I don't want to leave them in the lurch, but if things stay the way they are, I'll get out by December." That seems a long way off, but he and many other jittery expats sense that things will get worse in Iraq before they get better. And just about everyone is asking himself, Is it worth the risk?