That is a bad situation.

As you've already said its very unlikely that you'll now be able to turn your z-visa into the residence permit so I would suggest that you tell the school you are leaving. This is likely to provoke one of the following responses from the school

1. It may prompt them to take action, although I'm not sure at this stage what they really can do so be suspicious of any promises they make. Remember you are the one bearing the risk by continuing to stay illegally so don't let them continue to fob you off by saying it'll all be ok, we'll sort it tomorrow, blah, blah, blah

2. They'll threaten you with the fine and the difficulties down the line should you walk away. You may just have to bite the bullet and accept the fine and any further ramifications. It would be better to do that now as waiting will only increase the fine and consequences of staying illegally in china.

You should also report the situation to the SAFEA and once you're safely away from the school post the names of these scammers so that others don't get lured into the same trap.

Just to confirm, did you give them your passport? If you did this could place you in an even worse situation.

I can't say exactly what might happen if you wish to reapply for the z-visa and then residence permit. There is lots of talk of a 'blacklist' existing for teachers who run out on contracts, etc. but no one really knows if it exists, also I'd imagine most schools inc. yours would be less inclined to report teachers to the authorities as they themselves are breaking the law. I also know plenty of people who have had visa trouble at one place, left the country (at which point they were taken to oneside by the customs officials for overstaying their visa) but who then reentered with the proper documents a few weeks later no questions asked........