Money isn't conserved in the same way that matter is. Right now the market cap of gamestop is $22B, which is calculated by multiplying the share price times the number of outstanding shares. If some news comes out over the weekend that causes people to value the stock lower, we could see the first trade at $33/share instead of $330/share. $20B of money just disappears. It never really existed in the first place.

It depends.

If a hedge fund went bankrupt, the cash will go to investors who may be risk averse.

If the hedge fund survives it will have significant losses and probably be cagey about deploying a lot of capital again too quickly because it just stared into the face of death.

In the case of individual investors selling off everything, they might be scared because everything is crashing.

There's no rule that says the money will come back to the market quickly. It depends on investor sentiment. Often things have a V-shaped recovery and things are more or less "fine". We had a few of those over the past few years.

But put it to you this way, if this statement of yours:

It has to go somewhere, and so it will come back into securities in probably a few weeks or max, months. The value represented isn’t exactly disappearing it’s still in the ‘system’.

...was correct, then we wouldn't have crashes. But we do. When fear takes over the money doesn't just come back into the market quickly. And then even if it could, it doesn't because second order effects take over. Small businesses close en masse, etc, which magnifies the downturn until it snowballs into a legitimate recession.

I'm not saying a crash will happen because of this. I'm saying it very realistically can happen.

It only becomes a big deal when the government steps in to "assist" in any way beyond providing copious liquidity.

Downdrafts and even crashes are called corrections for a reason. They eliminate the weak holders and cause the remainder to carefully evaluate their positions. In the absence of interference, they will be over quickly.

They are a disaster for retail investors on margin. I've never understood why the SEC doesn't gradually increase margin requirements across the board when the market starts to get overheated. (But not once it tops!!)

Well sure, I'd definitely rather short Gamestop and watch my short thesis get delegitimized in real time than literally run from a hungry tiger.

Except humans have been apex predators for a long long time.

It seems like a reduction in short-selling will probably help the market be healthier.

Companies shorting 130% of a stock doesn't help the market.

Been ten years since I was last in it, but a lot of large investment firms (before automated trading was prevalent in the older large institutions) don't have people responding to the market ad hoc. Trades are executed infrequently (weekly, if not monthly) and are approved upfront during trade planning meetings to define the qualifying parameters for a particular order.