As the American economy limps through its second “recovery summer,” hobbled by trillions of dollars in bubble-era debt, politicians and regulators should take a long look at an unlikely place: Kingsbridge, a neighborhood in the northwest Bronx. In some ways, Kingsbridge’s credit-bubble experience was no different from the rest of the nation’s. As the bubble reached its greatest size in late 2006 and early 2007, the financial system—aided by dizzyingly intricate instruments and coddled by the government, which had long kept investors from facing the consequences of bad decisions—piled too much debt on Kingsbridge’s modest dwellings. As a result, the buildings’ owner abandoned them, leaving tenants to bear the brunt of somebody else’s mistakes.

Yet Kingsbridge has also become a startling exception to what’s happening in the rest of the country. A few people, acting within New York’s regulation-strangled rental real-estate market, have produced a solution that harnesses the power of the marketplace to correct mistakes. They’ve pulled this off even as most of the country languishes in government-bailout purgatory. Washington should heed the lesson of Kingsbridge. If it doesn’t, we’re likely to spend another half-decade haunted by the bad debt of the past.

Kingsbridge, a mostly black and Hispanic hardscrabble neighborhood, is different from Las Vegas, Miami, and other go-go symbols of the mid-2000s credit bubble. Sergio Cuevas, an accountant at the nearby Albert Einstein College of Medicine, has lived in Kingsbridge for nearly three decades, in a brightly cluttered, rent-regulated two-bedroom apartment that he has shared with his two children since their mother died. “The baby got shot right over there,” he says, gesturing out the window to the spot where a stray bullet wounded a three-year-old girl his mother was babysitting in 1993. Shootings are less frequent now, and the crime rate in general is lower. But this is still the northwest Bronx, nearly an hour from midtown Manhattan by subway. The median household income is just $29,000, and according to NYU’s Furman Center for Real Estate and Urban Policy, nearly a third of Kingsbridge’s households earn under $19,000 a year.

Five years ago, though, a California-based real-estate firm called Milbank announced that this humble reality represented instant opportunity. Calling the Bronx “one of the last boroughs to offer affordable rent, which would also be positioned to undergo significant gentrification,” the company decided to buy properties, mostly in Kingsbridge, and transform them into luxury buildings.....