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To answer #1. The reason why they would borrow out shares is because they think the price will go up. In a scenario where they borrow 100 shares at $10.00 per share they lose $1,000.00 right away. However if when the stock is returned the price is $15.00 per share they now have a stock value of $1500.00.

I guess brokers don't have 'rational expectations' if they are aware there is a practice of short selling - and hedge funds profit from it. Why brokers and investors would knowingly retain stocks with potentially declining prices (and with a sector directly benefiting from it) seems strange. Why be invested in that stock, in the first place. Most people want their net worth to rise.

I understand people bet on just about anything -- rises, declines, static outcomes -- but the overall economy doesn't advance if bets ("investments") are routinely made for losses. I know, the argument is made that bets on market pull-backs are merely a smart form of "diversification" that makes one's position stronger. To that, I say -- listen to yourself right now. Did you sleep through your class on Moral Hazard? Seek out advancing sectors and avoid loss-ridden ones.