I really don't have time to dig into this, work is a bet hectic. When I've got some spare time, I'll try to remember to revisit it. I'm fairly certain that this is a recursive CTE problem, so Dwain may well be your man (he loves recursive CTEs).

Just wondering, how many rows do you end up with in your working table? Taking a quick glance at your code, I'd imagine that as the number of rows increases in your source table, the number of rows in your working table must go up exponentially.