The hopes of recovery continue to be dashed by the reality of the nation’s sagging housing market. Home prices fell sharply in the first quarter of 2011, the largest drop in three years. What you see is that the homebuyer’s tax credit propped up the market slightly (although not enough to increase prices; prices have fallen for 57 straight months), and the removal of that tax credit has moved prices on their normal trajectory. And this is largely due to the glut of foreclosed properties in the system.

While most economists expected sales to decline after tax credits expired, the drag on the market has been greater than many anticipated. “We expected December and January to be bad” as the market reeled from the after-effects of the tax credit, said Stan Humphries, Zillow’s chief economist. But monthly declines for February and March were “really staggering,” he said. They indicate “a reflection of the true underlying demand, which is now apparent because most of the tax credit is out of the system, and it’s being completely overwhelmed by supply.” [...]

Prices are decelerating in large part because the many foreclosed properties that often sell at a discount force other sellers to lower their prices. Mortgage companies Fannie Mae and Freddie Mac have sold more than 94,000 foreclosed homes during the first quarter, a new high that represented a 23% increase from the previous quarter. More could be on the way: They held another 218,000 properties at the end of March, a 33% increase from a year ago.

This supply of foreclosed properties will continue to rise. Housing site Zillow estimates that 28% of all homeowners are underwater, owing more on their properties than they are worth. This represents a 22% increase from a year ago. It’s a vicious cycle: foreclosure sales lead to lower home prices and values, which lead to more underwater homes, which lead to more foreclosures. Add 9% unemployment to that and it’s hard to see a recovery in housing. And since prices remain above their historical level in real dollars, it’s not advisable to prop up the market any further.

Perhaps the scariest part of this are the truly distressed areas. 85% of all mortgages in Las Vegas are underwater; 73% in Reno; 68% in Phoenix; 60% in Tampa.

This is killing the economy, and it’s why HAMP should be held out for particular scorn. The design of HAMP simply kicked the can down the road. It was never designed to be a durable solution for the housing market. And we’re seeing the results: four years after the housing crash, prices keep dropping, distressed properties keep popping up on the market, and people keep losing their homes.

It also shows how the homebuyer’s tax credit was a useless giveaway to people wealthy enough to buy homes, which did nothing to alter the fundamentals of the housing market.