Disclaimer: Given that I am not an attorney, I can't answer this question in any type of definitive form. The information below is for entertainment purposes only and should not be relied upon for its accuracy or its relevance to your situation.
Having said that, In California, I believe a lender can proceed with what is called a "judicial foreclosure," which allows a lender to recoup their loses by suing a home owner for the amount the lender claims they lost.
In my untrained opinion, one method to protect yourself against this process, is to obtain an appraisal of your home at the time of foreclosure. If possible, obtain three appraisals from real estate agents or from a certified home appraiser, so that you have a clear picture of what your home is worth. Make sure all appraisals are in writing.
In theory, a bank can only go after you for what they lost. Meaning, in other words, if your home has a value of $400k and you owed $420k (you'd be $20k underwater), but the bank decides to sell it for $300k, that's not your problem.
They (the lender/bank) CAN go after you for the lost $20k, but NOT FOR THE FULL $420k you owe. Again, to clarify, they can't take your home and then sue you for the full amount of your loan. Your home is still worth something at the time of foreclosure, and just because the bank decides to sell it for $300k, does not mean it is not worth $400k. Though this applies to purchase monies loans only (money lent for the purchase of your home, and sometimes for home improvements such as swimming pools, etc).
I do not believe this applies to second mortgages where you took cash out (sometimes referred to as an equity loan). If you took cash out to make home improvements, than you may be protected. If you took cash out to send your kids to college, you may owe that money to the bank, but again, that is my opinion only. It's just as likely my opinion is incorrect.
In regard to a short-sale, again, I am not an attorney, and this is not legal advice, but sometimes banks will go after a lender for money owed, especially if a borrower took out a second mortgage that was not related to purchase monies.
I don't believe the above is at all unique to your situation. Sometimes banks won't go after a home owner, period. Sometimes they will. It all depends and it's impossible to predict.
I believe you should perform the following steps: A) seek the advice of a real estate attorney as quickly as possible. That advice can be had for a few hundred dollars, and many attorneys will give you an initial consultation for free B) Seek the advice of an accountant who understands the tax implications that can be associated with forgiven debt and to assess your particular situation (you may be able to avoid these penalties) C) Seek the advice of a real estate agent to make sure that your home is valued properly, and if you're considering a short-sale, to make sure that your home is marketed correctly and that the short sale is carried out properly. D) stay away from most Internet forums. They are filled with incorrect information and information that is state specific. Many states have different laws, so what pertains in Nevada, for example, may not pertain in California. There are also lots of troublemakers and uneducated posters, who will fill your head with horrible tales of world-ending consequences.
That is not the case and you're not in a unique situation. Millions are in the same position you may be in, Therefore, many lawyers are extremely educated on this subject and can assist you from start to finish. I highly advise you to seek the knowledge of one, as again, I am NOT an attorney and the information above is not legally sound advice.
Short-sales can be tedious and complicated and it's best to seek the advice of a dedicated real estate agent. Therefore, my advice is to interview 2 or 3 agents before you make your decision.
Best regards, and again, please be aware that the advice above is not legal advice, but opinion based advice only. I do not claim to be an attorney, nor should the above be classified as advice obtained from an attorney. Please seek the advice of a real estate attorney if you have any questions pertaining to your situation.
San Francisco/ San Diego/Arizona