When Islamic State insurgents were advancing toward the capital of Iraq’s Kurdish region, Sherzad Sadraden was supposed to be fighting on the front lines.

There was just one problem: The soldier with the storied Kurdish pesh merga didn’t have a rifle. He had sold it a year earlier, when all seemed peaceful, to pay for a new house.

So Sadraden’s brother Rasho, a construction executive, did what he considered his patriotic duty. He rushed out to the local weapons bazaar, paid $1,250 for a Cuban-made AK-47 and four magazines of bullets, and gave them to his brother. “He’s using the gun right now to fight,” Sadraden said.

Washington has long looked to Kurdistan, a tolerant pro-American region of Iraq with a thriving oil economy, as representative of its grandest hopes for the country. Even as Baghdad burned in 2006 and 2007, the semiautonomous Kurdish region remained a sanctuary. These days, the Obama administration is counting on the Kurds to be the leading edge of a ground offensive to take back cities throughout northern Iraq from ruthless, well-financed and heavily armed Sunni insurgents.

The past few months, though, have exposed some deep cracks in the Kurdish success story and raised questions about the viability of an Obama administration strategy that leans heavily on the Kurds.

In August, the legendary Kurdish pesh merga soldiers ceded frontline positions to Islamic State fighters who advanced within 25 miles of Irbil, setting off a panic in the regional capital. The Kurdish troops lacked arms, ammunition and, in some cases, even fuel for their vehicles. Some complained that they had not been paid in months. It took a hurried decision by President Obama to launch airstrikes to halt the insurgents’ advance.

The pesh merga’s struggles are just one in a series of problems that have hit Iraqi Kurdistan, a proud region of Kurdish-speaking people who suffered badly under Saddam Hussein’s rule and aspire to break free of Arab-majority Iraq.

These days, the Kurdistan Regional Government is laboring through a financial collapse, spurred by budget disputes with Baghdad but made worse by the government’s mismanagement, corruption and bloated payrolls.

The crises have affected virtually every Kurd, including Sadra­den, whose company last month stopped working on a college dormitory it was building for the Ministry of Higher Education. In the glove compartment of his car, the construction executive has a check from the ministry for 699 million Iraqi dinar, or about $600,000. For now, it is un-cashable. “They told me it will be more than two months before they have the money,” he said of the ministry.

Kurdish officials blame the economic crisis on the Iraqi government, which this year stopped paying the region its share of the budget after a feud over the Kurds’ right to sign independent oil deals and the distribution of the revenue.

“The cause of the financial crisis comes back to a fundamental decision made by Baghdad to cut the budget of Kurdistan,” said Qubad Talabani, the deputy prime minister of Iraqi Kurdistan. “They’ve been threatening us since 2003. For them to actually do it has created irreparable damage to the trust between us and them.”

But Talabani acknowledged that recent years of intoxicating economic growth masked deeper problems in the government and its security forces.

“What we’ve done badly as a government is not be prepared for these crises,” he said.

Dream City

Before the crash, foreign investors, drawn to Iraqi Kurdistan’s relative stability and deep oil reserves, embarked on a spending spree. In some areas of Irbil, long considered something of a dusty backwater by more urbane Iraqis, real estate prices soared to ­Manhattan-like levels. Luxury high-rises and gated housing developments with names such as “Dream City,” “Park View” and “Future City” popped up next to crumbling concrete homes that lacked 24-hour electricity or reliable plumbing. New Mercedes-Benzes and Land Rovers fought for space on Irbil’s chaotic roads with rusting taxi cabs and broken-down pickup trucks.

Hemin Dizayee, a Kurd from Gainesville, Va., was one of many real estate developers who rushed to take advantage of the runaway growth, building a new “American Village” development modeled on the suburbs he had left behind in Northern Virginia. Prospective buyers toured the development’s winding, tree-lined streets — each named for an American state — in Dizayee’s bright red Hummer.

When his Bangladeshi laborers struggled with building American-style sidewalks and gutters, Dizayee flew in Mexican workers. Kurds, he said, were not interested in hot, dirty construction work.

Buoyed by demand from government ministers, oil companies and wealthy Kurds returning home, average home prices in American Village quadrupled from 2007 to 2012, peaking at about $620,000.

Then in August, Islamic insurgents broke through pesh merga defenses less than 30 miles from Irbil. Oil companies evacuated their workers, and the Kurdish economy — already hurt by the budget fight with Baghdad — collapsed.

Now, as the regional government shifts to a war footing, it must also attend to many of the problems that contributed to the government’s budget crisis and broader economic collapse.

Its top priority is training and equipping its pesh merga fighters. Some of the required changes are structural. For decades, pesh merga commanders have reported to Iraqi Kurdistan’s two major political parties. The arrangement would be akin to the Republican and Democratic parties in the United States fielding their own separate armies with their own chains of command.

The pesh merga — originally a guerrilla force fighting Hussein’s army in the mountains — also will need new equipment, such as radios, bulletproof vests, anti-armor weapons and armored personnel carriers. The United States and European nations have begun to fill some of those voids, but the flow of weapons has been slowed by Baghdad’s insistence that all military equipment pass through the capital for inspection, Kurdish officials said.

“We need to get away from using cellphones to communicate,” said Talabani, the deputy prime minister. “We need to get away from our guys driving their own vehicles to the front lines . . . and buying their weapons from the bazaar. We have a force that has the heart to fight. We now need to add to that heart the professionalism.”

Budget battle

The new Iraqi prime minister, Haider al-Abadi, recently promised to resume sending the Kurdish region its share of the budget — about $1 billion a month. The money will allow the government to pay its employees, many of whom have not received regular salaries for months. But Kurdish officials acknowledge that resolving the dispute with Baghdad will not fix longer-term problems that could make it difficult to pay for the war. The region’s ministries and its armed forces include thousands of Kurds who collect two or even three salaries as a reward for party loyalty. The ministries’ payrolls are also rife with ghost workers who do not exist.

“I have 7,000 employees, but I could easily work with 1,000,” said Darbaz Rasool, who heads the Ministry of Construction and Housing. The ministry is responsible for finding shelter for the more than 1 million refugees who have flooded into Iraqi Kurdistan from Islamic State-controlled areas. Many of those refugees are squatting in the concrete skeletons of hundreds of unfinished high-rises and shopping malls that symbolize the economic collapse.

To root out corruption and to better track its finances, government officials said they need a modern banking system to replace what is still a cash economy. At the Dollar Market in the shadow of Irbil’s ancient Citadel, businessmen, government bureaucrats and smugglers cart in 110-pound flour sacks full of Iraqi dinar that are changed into thousands or even millions of dollars and often shipped out of the country.

The market has evolved its own terminology. “Ten papers” equal $1,000. A wad of cash worth $10,000 is called a “book,” and $100,000 is a “block.”

Even the Kurdish Finance Ministry still tracks government expenditures using old-fashioned paper ledgers that make it hard to plan or show exactly how much money is being spent. “It is a very cumbersome system,” Talabani said. “We are simply not able to do any forecasting.”

The crises, however, have come with an upside: After years of what Kurdish officials describe as an attitude of benign neglect, the West is finally offering help.

“I am not making excuses here, but for years we have been left to our own devices,” Talabani said. “Every time a senior U.S. official comes to Kurdistan, the only thing they talk to us about is Baghdad. . . . Not once has a senior U.S. government official come to Kurdistan and said, ‘What can we do for you?’ ”

The Kurds’ new role as the West’s proxy ground force in its battle against the Islamic State has fueled optimism among many in Irbil that the U.S. government has made a long-term commitment to Iraqi Kurdistan’s stability and success.

Biner Aziz, who owns a high-end tile, marble and bathroom fixtures store, said he did not make a single sale in August. This month, revenue is down about 80 percent from last September.

But recently, Aziz hung a slab of black marble decorated with 24-karat-gold-infused paint in his shop’s main display window. The price: $5,000 per square meter. For Aziz, 35, the marble slab amounts to a big bet that the boom times will return. “I feel there is a market for this,” he said. “There will be a market for this.”