RealtyTrac reports that the third quarter of 2010 set a new historical record, marking the largest foreclosure activity ever – with foreclosures exceeding 100,000.

And though these foreclosure numbers are horrendous, we can expect a drop in foreclosures in the fourth quarter, resulting from the freeze instituted by banks across the country. Our guess is this will somehow be manipulated as good news that the mainstream media can run with. We can picture the headlines now: “Foreclosures down 90% in 4th quarter 2010.”

This may sound good if you’re a politician trying to convince the masses that your policies are working.

But the flip side to the coin is that sales of foreclosed homes are actually about 1/3 of the existing real estate market. RealtyTrac reports (via Zero Hedge):

“…if the documentation issue cannot be quickly resolved and expands to more lenders we could see a chilling effect on the overall housing market as sales of pre-foreclosure and foreclosed properties, which account for nearly one-third of all sales, dry up and the shadow inventory of distressed properties grows — causing more uncertainty about home prices.”

Since Wells Fargo and others have essentially halted the sale of all foreclosed or pre-foreclosed properties, this 1/3 of the entire real estate market is going to report a big fat zero (or close to it) for the fourth quarter.

Tyler Durden of Zero Hedge says that such an effect would mean “a complete housing market collapse.”

While we have been writing about Wave Two of the real estate collapse for almost a year, it would have been nearly impossible to predict the underlying mortgage transfer systems had so many problems that banks would be forced to actually stop the foreclosure process across the nation, affecting hundreds of thousands of homeowners, as well as potential home buyers.

We may now very well see an accelerated and more severe collapse of the residential housing market than anyone predicted.

Dan Denning at Whiskey and Gunpowder discusses what’s at stake:

“…if borrowers challenge foreclosure proceedings, and if banks (as they have already begun to do) halt foreclosure proceedings nationwide, the process of establishing a market-clearing price in the U.S. house market is frozen. Buyers can’t buy and sellers can’t sell if the ownership of the underlying collateral — the house itself — is in doubt. What sane person would enter a market like this with prices effectively having completely broken down?

As if that’s not bad enough — and it’s nearly as bad as it gets — don’t forget that that there is a whole universe of financial instruments whose value derives from the underlying collateral. Mortgage backed securities…collateralised debt obligations…the value of any instrument whose value is derived from the underlying asset is now suddenly in doubt.

It’s hard to understate what this could mean for financial markets. It could mean another capital crisis in the financial world. It would make 2008 look quaint.”

The mortgage fiasco is just one of several elements ailing the U.S. economy. Add to that the problems facing the US dollar, a dying American consumer, rising unemployment, and personal debt defaults to the equation, and we have a very serious problem on our hands – one that could make the Great Depression look like a cake walk.