I wish people would stop making this out to be more than it is.
The financial markets are built on confidence and trust. Counter-party risk is very real.
What many people do not know is that mid-2007 they changed the criteria to short a stock. Previously, you could only short on an uptick. Now, that requirement is gone.
Using a combination of naked shorts and shorting on DOWN ticks you can quickly create a huge run on a stock. This spooks counter-parties, big time, especially in crisis of uncertainty and rumors.
Spooked counter-parties then stop dealing with the targeted stock. Credit lines disappear or become more costly. Partners break ties and look elsewhere. Clients pull out.
Essentially, the short attack reverses the usual bad business = bad stock price. Instead bad stock price = bad business.
The SEC simply made it harder to short (they didn’t BAN anything) and reinstated the requirement to short on an uptick.
Not saying its ideal, but you can understand the idea.
whatev, they banned NAKED shorting.