At a bargain-basement auction of foreclosed homes held on Jan. 29 in a New York City Sheraton hotel,

one of the music tracks that played as bidders prepared to pounce on distressed properties was James

Brown's "Living in America." It was either a major planning blunder or a brilliant thematic choice. Either

way, the song's lyrics ("everybody's working overtime ...") were a strangely fitting sound track to a new

American reality: while corporate profits rise and economic growth returns, the housing market is only

getting worse.

The latest figures from the Case-Shiller home-price index, showing a fifth straight month of price

decreases — including major drops in cities such as Boston, Washington, Las Vegas and Dallas — have

economists worried that we may be headed for a double dip in the housing market this year, which could

restrain the economic growth we're finally starting to see. And 2011 was supposed to be the year housing

recovered; now, analysts are betting on anything from a 5% to 20% price decline.

A rising number of foreclosures, tied to persistently high unemployment, is smothering housing's rebound.

According to the Mortgage Bankers Association, there are already 4.5 million homes in some stage of

foreclosure. Some experts believe an additional 1.5 million may be added to the pile this year. With that

kind of distressed inventory on the market, it could take four to five years for prices to come back up,

according to Capital Economics senior U.S. economist Paul Dales. What's particularly troubling is that data suggests a good number of those properties belong to

lower-income, higher-risk borrowers who had already gotten a break on their mortgage payments via

federal programs designed to reduce defaults. November data (the latest available) on these so-called

modified loans showed that 45% of them had been canceled, meaning that the borrowers very likely

redefaulted, even after the payments had been adjusted.

This is yet another example of the bifurcated nature of America's economic "recovery." The Fed can keep

interest rates low to encourage lending, and the government can dole out tax breaks to encourage

spending, but as Dales points out, "If you don't have a job, you aren't going to be able to pay your

mortgage." Indeed, the biggest factor in mortgage defaults is unemployment — and as we all know by

now, the unemployment rate is still unnaturally high for this point in a recovery, especially among

vulnerable groups like minorities and those without college degrees.

Unfortunately, the trouble in the mortgage market contributes to the trouble with job creation. "Lower

home prices don't help jobs, because they constrain consumer spending," notes Yale economist and

housing expert Robert Shiller. Job growth is tied to spending, because without more expected sales,

companies won't hire. But people whose homes are decreasing in value won't spend; it's the wealth

effect in reverse. So the poor housing market is holding back everything. Shiller, who just returned from

the World Economic Forum in Davos, Switzerland, believes that the world leaders and policymakers who

were there "don't really realize the extent of the suffering that's occurring. They are too insulated. But it's

a vicious cycle that can make people feel worthless."

Don't get too comfortable if you live in an area that hasn't suffered big price cuts, because the problem

could spread in the coming months. The latest numbers indicate that the lower end of the housing market

is seeing the sharpest declines. But those declines could well drag down the value of higher-priced

properties. Given that U.S. households still keep about a quarter of their wealth in property, the

implications for consumer spending are sobering. "More than keeping interest rates low, the best thing

that Washington could do for the housing market is to try and create some jobs — quickly," says Dales.

In lieu of that, policymakers might also get more creative about how mortgages are structured. In his

2008 book, The Subprime Solution, Shiller suggested a drastic fix to the current problem — a

continuously changing mortgage balance that would be reset periodically based on both home prices and

unemployment. Thus, mortgages would reflect ongoing economic reality, and banks would have to keep

lending. Meanwhile, to help banks cope with the risk involved, a market would be created to let them

trade home-price futures, rather than splicing and dicing baskets of high-risk mortgages and then passing

the risk on to investors. (A small market of this kind already exists at the Chicago Mercantile Exchange.)

"We need to be creative. It's all about democratizing finance and bringing more of the benefits of it to

individual consumers," says Shiller. These and other housing-market reform ideas were deemed too

radical when the crisis began. As it is now, they might not be radical enough.

— With reporting by Mackenzie Schmidt / New York