Diamond-the problem with that argument is that there were no firms making a market in CMKX stock. The stock traded on an unsolicited quote basis, and all trades consisted of matched retail buys and sells. Shareholders (and insiders feeding shares into the market) were making their own market-essentially operating as an ECN.
No MM had filed a 15-c-2-11, allowing "him" to make a market in the stock, and others to piggyback on him. Under those circumstances it is all but impossible to have a "naked short," as retail brokers won't tolerate a fail to deliver in a retail customer's account and can, using established NSCC proceedures, cure a fail and force delivery within a few days.
Initially a lot of promotions wanted to be a one-legged pink precisely because there were no MM's able to short into peaks in demand, giving thim the ability to feed new shares into the market on the ask side. What they found, however, that once a promotion fueled spike faded, that the shares had no bid support whatsoever, creating extreme volatility in the share price and rapid collapses. See for example MLON and NMCX.
As to the NASDAQ bubble, yep, a lot of market cap was lost from the peak of 18 trillion. However, a lot of that market cap was hypothetical. Many of the bubble stocks had razor thin floats, with the bulk of shares in various insider lock-ups or reserved for secondary offerings. There was no way that those shares could have been monitized at the bubble peak prices. Actual retail investor and fund losses from the collapse of the bubble and the long slow slide down afterwards is in the 1 to 2 trillion dollar range.
MM's no doubt made use of their exemption from locate requirements on the sell side, and their exemption from delivery requirements-allowed at the time. However, they also provided price support on the bid side, allowing people who wanted out to get out. That is, after all, how they make money. No doubt there were some abuses. On the whole, however, traders and MM's lost their ass. Track NITE's net from 2000-2004.
There are many, in fact, who argue that artificial constraints on short selling allowed the bubble to inflate. Many sell side firms saw it early on, took short positions, and got mauled when the dumb money kept piling into the market. They pulled back, removing any damping of the continuing bubble. Many of the real high fliers couldn't be shorted anyway because shares to borrow were scarce, and expensive when they could be obtained. There were NO Palm shares available to short after its much hyped IPO, allowing a mispricing of Palm against 3COM to persist for months due to the inability to arbitrage the price relationship to the proper levels.
AI
