The disturbance formed near the Turks Islands at the end of August and intensified with extraordinary speed. By September 1, it reached hurricane strength near Andros Island in the Bahamas. A Cuban military pilot, Captain Leonard Povey, flew his open-cockpit Curtiss Hawk biplane north of Havana to investigate, but wisely chose not to enter the storm. His proposal for an aerial hurricane patrol went unheeded until 1943, when the first hurricane hunter flights began near Galveston, Texas. Weather Bureau advisories on the morning of Labor Day predicted the storm would pass through the Florida Straits. By early afternoon, hurricane warnings were issued, and Fred Ghent of the Florida Emergency Relief Administration requested a special train to evacuate the veterans' work camps in the Upper Keys. The train left Miami at 4:25 p.m., but a drawbridge delay, track obstructions, poor visibility, and the need to reverse the locomotive cost precious hours.

Three work camps housed 695 veterans on payroll in the Upper Keys, part of a federal program to keep unemployed World War I veterans occupied and away from Washington, where Bonus March protests had embarrassed the government. The camps, established by Harry Hopkins's Federal Emergency Relief Administration, put the men to work building the Overseas Highway. The veterans lived in flimsy barracks on islands barely above sea level during the height of hurricane season. Time Magazine and The New York Times had published sensational stories portraying the men as drifters and troublemakers. Just days before the storm, on August 15, Hopkins announced the camps would be closed. Veteran Albert C. Keith, editor of the camp newspaper, wrote to both President Roosevelt and Eleanor Roosevelt arguing the program was rehabilitating men for civilian life. His letters arrived in Washington the week the hurricane struck.

The storm surge that swept over the Upper Keys reached extraordinary heights, submerging the low-lying islands entirely. The town of Islamorada was obliterated. On Long Key, the hurricane destroyed a fishing camp, a hotel, the railroad, and virtually all vegetation. Ernest Hemingway, who weathered the storm at his home in Key West, later visited Indian Key by boat and reported that not a blade of grass remained. The eleven-car evacuation train at Islamorada was tossed from the rails by the surge. Only the locomotive and tender stayed upright. Remarkably, everyone aboard survived. The Danish motorship Leise Maersk was carried over the keys and grounded four miles from its anchorage. Miles of the Overseas Railroad were ripped away, and two miles of steel rail washed ashore at Cape Sable on the mainland. The storm surge between Lower and Upper Matecumbe Key scoured away the fill connecting the islands, restoring a natural channel that Flagler's engineers had closed decades earlier.

The final count was devastating: 485 dead, including 257 veterans and 228 civilians. Bodies were scattered across the Keys and decomposed rapidly in the subtropical heat. Public health officials ordered cremations at dozens of sites throughout the Matecumbe Keys. In Miami, 109 bodies were buried with military honors at Woodlawn Park Cemetery. Hemingway wrote a furious article for The New Masses titled "Who Killed the Vets?" accusing the government of callous negligence. A joint investigation by the Veterans Administration and FERA produced a report that exonerated everyone involved, calling the disaster an "act of God." The Greater Miami Ministerial Association called it a whitewash. A more thorough VA investigation by David Kennamer produced 2,168 pages of exhibits and cited three FERA officials as negligent, but his findings were suppressed. They remained buried for decades, likely to avoid embarrassing the Roosevelt administration in an election year.

A memorial stands at mile marker 82 in Islamorada, near where the post office once stood. Designed by the Federal Art Project and built from native Keys limestone by the Works Progress Administration, it was unveiled on November 14, 1937. Its frieze depicts palm trees bending in hurricane winds, and a ceramic-tile crypt holds the commingled ashes and bones of approximately 300 victims. President Roosevelt sent a telegram to the dedication expressing personal sorrow. Local residents hold ceremonies at the monument every Labor Day and Memorial Day. In 2006, a small island off Lower Matecumbe Key near the site of Camp 3 was officially named Veterans Key. In 2023, memorial markers for 166 veterans lost in the storm were placed at South Florida National Cemetery. The railroad was never rebuilt. Instead, its surviving bridges and roadbed became the foundation for the Overseas Highway, completed in 1938, the road that carries traffic through the Keys to this day.