There are two ways to get naked. You can run out in the street with no shorts, or you can run out in the street and drop the shorts.
In the debate on naked shorts, most people are concentrating on cases when a shorter sells shares without bothering to locate shares to sell. The second way of going naked happens when a person loans shares to a short then goes out and sells the same shares.
Now that there is a number of hedgefunds with strategies that hold short positions for long durations, the second path of going naked is probably more prevalent than the first.
Both of these practices have the effect of creating phantom shorts. The practice of selling things often manifests as Failure to Deliver. In an FtD, the person buying the share of a stock doesn't get the product purchased. The brokerages just shuffle paper around and try to look innocent when questioned.
Failure to Delivery is just a symptom of the problem. The serious problem is that the undisciplined shorting that allows multiple investors simultaneously hold the same share creates phantom stock. The phantom stock adds to the stock floating on the market and effectively diminishes the market value of a company.
One possible solution to the ill effects of undisciplined shorting is to demand discipline.
In a disciplined shorting regimen, the investor would lend the stock to a short trader that the short trader can sell on the market. This stock would then be replaced by a promissory note who promises to replace the stock with a given set of conditions. Note, the investor no longer has the stock. He has a promissory note from the trader. The investor could not sell the promissory note as stock as the promissory note is not stock. The investor could not vote in corporate elections as the investor doesn't own the stock anymore.
It is important for people to remember. The second an investor lends shares to a short, they are no longer an investor owning a piece of a company. They are a speculator playing a funny money game of chicken with a short seller. The share lends should share the risk of the speculative game.
If the short seller falls into financial difficulties, then the investor who loaned the shares in lieu of a promissory note should stand in line with the rest of the trader's creditors. This system makes sense because, when an investor loans stock to a trader, they are no longer an investor in the company at hand. By lending the stock to the trader, they are an investor in the trader.
If the investor needs to liquidate, they could sell the promissory note. The price of the note is likely to be somewhere between the face value of the note and the current market price of the stock.
The goal of disciplined investing is to make sure everyone knows what they have at each point in a transaction. Discipline shorting prevents anyone from trading something that they don't own (creating FtDs or phantom float).
One interesting aspect of disciplined investing is that it would effectively put time limits on short positions as the people lending stock are unlikely to lend stock for longer durations. For that matter, you would probably want to structure the market so that the people lending stock could set an outer buyback date.
A disciplined short structure might make it difficult for hedge funds looking to take large long duration short positions as part of their hedge formula. But, guess what? There is absolutely nothing in the laws of universal karma that says we need to structure our market for the needs of people who are seeking to avoid the risks that the rest of society must bear.