A lot of people know they can't afford their housing situation. Some of these people have been evicted from their homes after the bank took possession (Real Estate Owned [by the bank]) is the term for this kind of property when put up for sale. Some of these people are in the process of foreclosure, which is what banks do when mortgage holders default (miss a payment). And some of these people are trying to make a deal with their mortgage holder to sell the house for less than the outstanding debt, so they can get out of their situation, hopefully with less damage to their credit.
In general, banks lose some money on a short sale, more money if they go through the foreclosure/auction process. Typically, when properties are sold for substantially less than "market value", appraisers and lenders note that and do not include those properties in comps. However, currently in several regions, and increasingly nationally, such properties are the _only_ comps, which has the effect of reducing the "market value" of _everyone's_ houses, with cascading effects (anyone relying on a home equity line of credit is goatfucked, basically, but those people have mostly had their lines of credit taken away anyway and therefore this is less and less relevant. That is, they've already been goatfucked.).
In markets like Seattle, which typically lag the national real estate market (and did so quite strongly this time, with a whole lot of people pretending there was no bubble in Seattle), everyone is basically set to resist accepting a turn in the market. As a result, there have been a number of stories (cited in Seattle Housing Bubble, an amusing blog, and elsewhere) of banks refusing short sales, then a year later selling that property for less in a foreclosure auction. Pretty stupid. Talking to a friend recently who is a real estate geek and was for a while a mortgage broker and who himself is upside down on a condo he can't afford, I heard that at least his bank, when asked about short sales, just wanted to know where to mail the package. This article suggests there's a whole lot of variability in willingness to do short sales nationwide (we knew this) but this time, it's the _realtors_ complaining. Usually they're too busy pretending There's No Such Thing. Ha.
Edited: Further argument in the article is that short sales would help by reducing inventory and allowing prices to rise. Locally, in the relatively limited area and price range we're tracking, we're seeing 2-3 new properties a day show up on the MLS; R. is noticing signs springing up like weeds. Some of this, of course, is the time of year. But it's a little out of hand for that.