It depends on what you mean by sellling short

CJR has just a torrent of good bits out there today.

• OMG, the guys you see in the news everyday? idiots. 
• If you're having trouble solving the crisis of the uninsured crisis - blame the victims!

but the WSJ piece on Morgan Stanley is such a great illustration of the toxic effects of the Credit Default Swap. CJR just hits the high points, but even in those you see the tendrils of the CDS bursting through.

They're talking about short selling - hell, everybody is.
We keep hearing corp execs whine about short-sellers. They've managed to get regulation in place to prevent some of it

Not that it will help.

Short selling is this:

• Company X is selling its stock at $3, and I belive it's going to tank.
• I go to someone holding stock in Company X and say "Can I borrow 100 of your stock shares for 24 hours?"
• An investor loans me the stock. (I owe an investor 100 shares of Company X)
• Then I sell those 100 shares for $2.50 bucks each. (I have $250 bucks and still owe an investor 100 shares)
• It's a bargain! People snap them up.
• Then - my premonition comes true - and Company X's stock price falls to $2.
• I snap up 100 shares at $2 a pop. (I have 100 shares with $50 left over)
• I give the investor back their 100 shares and keep the $50.

Money for nothing.

Well, almost. If the price didn't drop - I still owe the investor back their shares. Having sold at $2, I have to buy 100 shares at $3 a pop. I lose $100.
If the stock goes up in value - I'm really screwed.

The new regs stopped something called naked short selling - which is shorting a stock without having closed the deal to borrow shares first. This shorthands the up-front transaction.

• I sell 100 shares of company X for $2.50 - and having agreed to the transaction, I'm asked to provide the shares.
• I don't - but I say "I'll get you those shares as soon as I can."
• At some later time, I get those shares and get them to the buyer.
• If I can't- the buyer can walk and no money changes hands.

Assuming everyone's behaving themselves - this is a fast way to get a trade done.
When people aren't behaving themesleves - it can be a way to screw with the market.

For example:

• I loudly announce to the world I'm shorting 2,000 shares of Company X!
• Investors get the impression something is wrong at Company X and begin selling.
• I get buyers for the shares I offer, but since I'm doing a naked short - I tell the buyers to wait until I get them.
• They wait, the shares keep dropping and I fail to deliver the shares.
• The buyers walk - no money changes hands - but my naked short just helped Company X's stock lose value.

This is evil - and rightly regulated.

Stopping the naked short forces short sellers to risk their money - which will engage their natural aversion to losing money. Yes, they can still take positions that screw people. But since they can get screwed by going short on healthy companies, the market will eat the fools and the smart investors will make money on companies that are overvalued.

Then there's the Credit Default Swap. This is the nuclear weapon of short selling.

A high value bond transaction is insured up to its full value by someone who does not hold the bond.

I pay a small premium for a CDS on a billon dollar bond that I think will fail. It's not my bond and (absent my buying a CDS) it failing would normally not affect me.

Since I did pay for a CDS (say $10 million annually) if it fails, I get a billion dollars.

That's just sick.

Let's say that premium is paid out in installments over the year (by quarter, let's say) and I buy the CDS on the billion dollar loser right before it tanks.

I've paid $2.5 millon dollars in CDS premium - and now somebody owes me $1 billion US.

Really sick.

Yes, if the loser bond manages to stay afloat, I keep paying CDS premium (and wasting money) - but I can stop paying - cancel the CDS - at any time.

My risk is nowhere near the $1 billion I stand to get paid if the bond fails and I can (and probably would) start shorting the bond issuer's stock to help make that company fail.

Meaning - if I feel Company X not looking so good, the normal course of action would be to get out of their stock with caution.
Now, with the CDS - I buy CDS's against bonds they've issued - then LOUDLY shout to the heavens that I have to short Company X because I understand their forthcoming balance sheet is going to suck.

I don't just bail out anymore - I take out insurance and try to damage as much as I can on the way out.

That's unbelievably sick.

And that kind of betting is why this mess we're in is so massive.