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"Naked" short selling is not.

Short selling confuses the hell out of me but here is the way it works:

With normal short selling, the investor borrowers X number of shares and then agrees to sell that number of shares to someone at $X per share at some point in the future.

IOW:

XYZ stock is trading at $10/share.
I agree to sell 5 shares to underpants at $10/share 6 months from now and underpants locks in that price by paying a fee per share.
As I don't own those shares, I have to have someway of getting access to them so I, for a fee, borrow them from someone else.
What I am hoping is that XYZ drops in price below $10 (+ my borrowing fee) so when underpants buys the shares I make money.
What underpants is hoping is that XYZ goes up so he can buy XYZ for $10 when it is trading at $15

Naked short sales are the same except that I don't have/didn't borrow the 5 shares of XYZ. What happens if I can't buy the 5 shares to deliver to underpants?

Now, 5 shares is not a huge deal but imagine if it was 100,000 shares involving hundreds (or thousands) of traders. This creates issues of

Fraud - in our example, a 10 basis point fee per share is $0.01/share, across a 100,000 share= $1000. If I offer this to 500 people and they bite and I don't deliver (but have already been paid) that is $500,000 gone *poof*.

Market manipulation - If I short sold XYZ at $10 and the price skyrocketed (legitimately) to $100/share, I am going to get my clock cleaned. So I might conspire with others like me to spread "news" that might cause the share price to drop.

Market volitivity - normal short selling (my borrowing shares) is recorded and the volume is built into the share price. With naked short selling, there is really no easy way to see how many shorts are out there so that is not built into the share price. When people come thundering it to cover their short sales, this can create artificial swings in share value.

I hope this made some sense. I really don't fully understand it myself which is why I run away from these types of transactions.