I'm a hedge fund accountant, and my software follows many thousands of trades including short sales. I know exactly how to account for these trades, but I have

I'm a hedge fund accountant, and my software follows many thousands of trades including short sales. I know exactly how to account for these trades, but I have no idea what's really going on. As an accountant, all I see is that someone sold 1200 XYZ shares at $23.00 each, receiving a grand total of $27,600 cash. To simplify the example, I am not subtracting any commission there. Now the funny thing is, this account didn't have any XYZ shares before the trade. Nevertheless the trade happens, and the account has -1200 XYZ shares, and $27,600 more cash than it had before. At that moment, the account has incurred a liability to buy back 1200 XYZ shares -- eventually. The account can hold this liability indefinitely, so long as it has enough total capital to reassure the brokerage that it can easily buy back the 1200 XYZ shares at any time. I've read the stories about "naked short selling," and how that's a giant scam because the seller doesn't even have to locate any shares to borrow. In this telling of the story, the seller is issuing brand new shares and selling them into the market -- in effect, counterfeiting. I spoke with a very experienced money manager about this, and that's his take. I also spoke with a friend who is very wise about markets, and he had an entirely different take. He made the point that no matter how the short sale occurs, either "naked" or "covered", in both cases the seller ends up with the liability of -1200 XYZ shares, so what's the difference? The only difference is that if the short sale is naked, the seller owes the shares to the buyer. But if the short sale is covered, the seller owes the shares to the lender. Either way it's a liability of -1200 XYZ shares, and the only difference is to whom the shares are promised. Now I'm a rational man, so it bothers the hell out of me to agree with both sides of a contradiction. So what gives? I don't know. The only other shred of evidence I have, and it's a very small shred, is the phenomenon of "Payment in Lieu of Dividends." If I have negative quantity of shares, and those shares pay a dividend, then that dividend is charged to my account as an expense. Normally, as an accountant, I see that as a simple negative dividend, which we call a "Dividend Expense." But sometimes I see those negative dividends labeled "Payment in Lieu of Dividends." I read an article once saying that the only difference is that "payment in lieu" occurs when the shares were sold short in a "naked" fashion. So maybe, just maybe, there is a real difference between the two forms of short sales, as my money manager friend asserts. The money manager asserts that naked short selling actually increases the total supply of shares, even past the official "float" of shares issued by the company! The people at the Gold Anti-Trust Action Committee (GATA) even claim that short sellers are creating this artificial counterfeit supply in the gold market. I would suggest calling their bluff and redeeming the physical gold into allocated Swiss storage -- but lo and behold, these financial instruments have no redemption contract. They're cash-settled only. How conveeeeeenient. You asked if the people lending the shares actually hope for the stock's success. Of course they do. If someone borrows 1200 XYZ shares and sells them, the lender still has an asset of 1200 XYZ shares, and clearly still wants their price to rise. The seller has a liability of -1200 XYZ shares, and clearly wants their price to fall. The buyer has an asset of 1200 XYZ shares, and clearly wants their price to rise. Note that in my example there, the total net quantity of shares in the three accounts involved is precisely 1200, both before and after the short-sale. So where is this alleged increase in supply from short-selling? Perhaps there's no increase in this case because it wasn't a naked short sale. OK fine, let's make it a naked short sale. A trader simply sells 1200 XYZ shares without either having them or bothering to borrow them. Another trader buys those 1200 XYZ shares. Now the seller has a liability of -1200 XYZ shares, and the buyer has an assert of 1200 XYZ shares. So after the short sale, the total net quantity of XYZ shares in those two accounts is precisely 0. But the net quantity was precisely 0 before the short-sale as well! So once again, where oh where is this alleged increase in supply caused by short-selling?