Did Naked Shorting Regs Come From Dividend/Tax Issue?

This is actually fairly complex. It starts with he fact that there is a possibility that the GSEs may reduce or suspend dividends because of their losses, which is pretty straightforward: No profit, no dividend.

However, it ends up creating some complex tax and cash flow issues for traders that could have triggered rampant short selling of the stocks.

In order to to a normal "non-naked" short sale, you have to borrow a stock, pay a fee to the owner, and you sell that stock now with the promise that you will buy later and return to the lender.

Most of the shares so lent are held in brokerage margin accounts where the original purchaser of the stock would borrow money from the brokerage to cover some of the purchase price of the shares, which increases the upside and downside possibilities of the stock (if you put 25% down on purchasing a stock, and the stock makes 25%, you make 100% profit, as opposed to 25% if you paid 100% down).

However, dividends create an incentive not to keep stocks in margin accounts. The buyer does not get dividends, but instead gets payments-in-lieu of dividends, which are treated as ordinary income, and taxed more heavily.

So as an corporation cuts, or eliminates, its dividend, as Fannie Mae and Freddy Mac seem likely to do (see first 'graph), people are more likely to put their shares in margin accounts, which makes more shares available for people to short, and hence, makes it easier more people to short the stock.

The SEC does not want this to cascade into a death-spiral for the 2nd and 3rd largest borrowers in the world, so they issued an emergency rule to restrict short selling.

Everything clear?

Good. Because I'm still confused as hell.