There are about five questions here, as the duly elected representative of the intelligent people I’ll answer with a broad brush. Depending on the lender and the loan, the amount the bank loses in a forclosure can result in a judgement that will haunt the borrower but that is not usually the case and usually the bank eats it and it wrecks the borrowers credit for years. In a short, you negotiate with the bank to sell for less than what you owe and the bank forgives the loss, your credit takes a smaller hit but right now you pay income tax on the amount of the forgiveness (this tax may change with legislation now in the works). Think of it in terms of a divorce, in a forclosure she comes home and finds you with the maid in bed, throws your clothes out the window and never talks to you again. In a short, you sit at the table and divide up your stuff, she doesn’t like you all that much but tolerates you and doesn’t say too many bad things about you to friends and neighbors.

For the most part in either a foreclosure or a short sale, you don’t owe the bank, hence it’s popularity. When the tax rule changes, the short sale will gain popularity over forclosure. Will it hurt the economy, a little, but what you have to look at is most of the country isn’t in a bubble market, just a handful of states, the impact will not be felt equally all over the nation. Did hurricane Katrina hurt the economy? A little, but it probably didn’t hurt you too much. Does Iraq hurt the economy? A little, but it probably didn’t hurt you too much. Will the bursting R/E bubble hurt some guy in Montana or Texas? A little, but it’s gonna hurt like hell in Southern California, this is our hurricane, except mother nature didn’t deal us a bad car, greed brought it on so don’t expect any benefit concert or 5th graders having a bake sale.