What's interesting is that the clients had low framerates. If the problem was for example something incredibly CPU intensive server side (such as perhaps flowing water or sorting) I don't think the clients would behave the way they did. In that case you would have quite responsive clients but a very laggy environment where everything takes long time to complete.
I don't know what was going on.... the clients were laggy - It took me several minutes to get into the options menu to turn all my graphics settings down to minimal.... which I found really surprising.
But the environment was definitely laggy.... That's why the water took such a long time to clear - because it was only dropping one block every few seconds. If that lag was just client based, we'd have seen it drop dramatically each frame we saw, and if we logged out and back in again, it would have dropped since we were on last. But it wasn't.
I tried to connect MiniObsi's account on my other PC, to have someone in a non-lag zone in case we needed to tp someone out of the lag zone - but even though she was not in the lag zone, and was moving freely, her client ended up crashing out with some sort of lack of memory error (and she's been on the server before without that happening)
It first started when Bazz joined the server (in his lot, which is in the same area) and instantly everyone on the server had huge lag. I was miles away (at the sand village) and the mobs around me weren't moving at all. Zombies standing in full sunlight burning, but not moving was my first clue something was wrong - because I was able to walk around fine - it didn't seem laggy other than the mobs not moving. Then it had been sunrise, and it was bouncing back to night and forward to sunrise again. I think Admiral commented that all his machines stopped working. Then I tried to mine something and basically nothing happened. We thought the server needed restarting but as soon as Bazz left the server, it went back to normal. So we figured it was something to do with him.
He came back on and managed to get out of the lag zone and wasn't laggy any more - so then we figured it must be the area, not him..... so then I used the myst books to travel to that area, was instantly lagged when I got there and had to get teleported out. We weren't sure if it was Bazz's place or OJ's, but we worked that out by walking there from spawn and from T0ur0k's place (south?) to work out where the lag started. Going from spawn - both places loaded at once and it lagged. Coming from the other way Bazz's place loaded fine, but once OJ's place started to load, it lagged.
But then for a while I was standing at spawn without OJ's place in my view distance, with the 3 others online all within the lag zone, and I was able to move around fine with no lag - but the environment was laggy - mobs were not moving, the sunrise was bouncing and those players in the lag zone were all moving around laggy.
So it seemed that while someone was in the laggy chunks, the whole server experienced lag - though perhaps not to the same degree as those in the laggy chunk.