You can always offer less than the asking price on a short sale, the bank can always refuse it, and they usually do. What I've seen happen time and time again is that the bank will "accept" an offer on a short sale, and then hold the earnest money for 3-6 months, only to find a reason not to sell the property to the potential buyer, and then return the earnest money.
In these cases, what the banks are doing is taking the buyers money, buying short term Treasuries typically paying 3/4% interest, booking that "profit" and then returning the earnest money. You may think that 3/4% isn't alot of money for banks to do this, but when they have a seemingly unlimited supply of homes with interested buyers, it translates into a huge, untapped revenue stream for the right banks that can scale up to automate the process and drive a nice revenue stream from it.
Believe it or not, this is exactly what's happening. I won't say the names of the banks doing this (to shield FR from any potential liability) but if you look at the biggest TARP recipients and the "too big to fail" banks you'll have a real good idea who they are.
Does the current mortgage holder have to pick up the difference or does it just result in a loss to the bank?
Loss to the bank, and the bank can issue a 1099 to the mortgage holder for the difference as it's technically considered income under IRS rules.
You are very correct in that the banks and homeowners don’t want to drop the prices of the homes. Many are still thinking there is a way to keep the market propped up. No one wants to accept a loss.
It's not keeping the market propped up, it's keeping the BANKS propped up. They're keeping the full value of those homes on their books, it's an accounting trick to make their balance sheets (assets v. liabilities) look better. Sooner or later, they're going to have to take the loss and that's when the banking industry in this country is in real trouble -- as if it isn't already.
Thanks for the info on what the banks do with the earnest money. When I am ready to act, I’ll take that into consideration and request a short escrow period.