First, some good news. I was checking the short interest on several stocks. Now that the presidential election is in the bag, short sellers have started backing out big time. We have not seen such skillful manipulation of the markets since the days of Joseph Kennedy's legendary stock manipulations.
Unfortunately, short sellers pulling back from the market does not restore stability. The short interest has dropped from the stocks I follow from around 80% to a more reasonable 7%. Wary investors now know that the street know that short sellers can essentially double the number of shares floating on the market of any stock at any given moment. This means, short sellers have a greater effect on a stock than the performance of the company.
As our communication technology gives us the ability to trade stocks in real time. There is zero value to shorting. The argument that shorting makes the market more efficient is moot because you can't get more inefficient than instantaneous.
On the down side, Patrick Byrne has a piece on how naked short selling destroyed an alternative energy company called VeraSun.
Alternative Energy is precisely the industry that requires mechanisms of shared equity financing to survive. Alternative energy requires huge upfront investments of capital. Since the price of energy fluctuates, alternative energy firms have a balance sheet that slams back and forth. Naked short sellers can use this volatility to destroy any publicly traded alternative energy company in down quarters (which are inevitable).
The practice of short selling allows the big oil cartels to collude with any rogue on Wall Street to wipe such firms out of existence.
The regulations that allow people to sell stock they do not own sits among the lamest regulation ever conceived.