I discovered this when I prepped to paint. I went up with caulking, started injecting ... and found that a few hand-sized places were essentially painted veneer with sponge-like wood underneath. I stopped caulking immediately, realizing that I was basically trying to glue together sawdust under a thin coat of wood held together with paint.
After a lot of tapping and testing, we've found all the bad spots, so we'll replace the siding in those areas and paint them while we still have dry weather. I'm disappointed that we won't have the painting done in time to beat the incoming wet weather, but that's okay. Another dry spell will come along.
That's both dry and above freezing.
The good news is the vast majority of our siding is surprisingly sound. Yay! I'm looking forward to how the house will look when it's all done, and I'll sleep a little easier knowing that we'll be in good shape to weather the next long stretch of years. All in all, the house really is getting into really good shape. When I look back at how it was, both home and property, and how it is now, I'm amazed.
It's hard to realize how far we've come when I discover a problem like this, until I start to think about how major some of our problems were (like my office flooding) compared to what they are now (a little bit of rot that will only take a few hours to deal with.)
I think we're going to be more than okay. I think this house is turning out great.