Imagination. I tend to first identify the character's roles and mechanical reasons for being in the story, and then build them around that functionality, flesh them out in a particular way that's important, ascribe to them certain traits that'd make sense for their role.
It's a mix, really. I usually start with the basic idea of the story, just a few sentences. From that I identify a very broad sketch of the main characters, again just a sentence or two. Then I flesh out the protagonist with traits from myself or people I know, and write a one page biography of him. Then I'll build the other characters in relation to the protagonist, and let the details of the plot come from the way these characters interact.
Everybody have fun tonight. Everybody Wang Chung tonight.