So when the contract is agreed, no one has bought or sold anything.
Since no one in his right mind would agree to a forward contract selling a stock he owns at below the current market price, a short contract makes no sense unless you plan to acquire the stock at a lower price at a date at or near the contract delivery date.
The securities rules require you to borrow the stock at the current price (really, you get a loan on the margin & pay interest to the stock holder for the loan). Your profit is the expected difference between your negotiated sale price and the (lower) actual price at the contract expiration, minus any interest and other transaction costs.
a) In some ways it's not much different than buying an out-of-the money put option.
b) if these were OTC short contracts negotiated with Goldman, I assume the counterparties were not ordinary investors but other big fish;
The real issue is whether Goldman was making use of insider knowledge of other financial institution's bad positions to make the short contracts, e.g. knowing Citi's mortgage backed securities were junk before anyone else did.
I think a short sale is a sale of borrowed stock which you must some day return to the owner. It is not like a put or call which are options and can be allowed to expire. You have to cover a short at some time in the future, at least theoretically. In the meantime there is a charge for borrowing the stock.
In the case of a short, your losses are theoretically unlimited since you are on the hook for any increase in price of the stock after you sell it and before you cover.