FirstFed’s shares soar as ‘short’ bets backfire on bears

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The bears on FirstFed Financial Corp. may have outsmarted themselves: By heavily betting on the stock to drop, they’ve created a situation where just the opposite is happening.

The Los Angeles-based mortgage lender’s shares were up $3.14, or 26%, to $15.14 at about 11:30 a.m. PDT today, in what looks like a classic ‘short squeeze.’

Here’s the setup for today’s move: The number of shares of FirstFed that were sold ‘short’ -- stock borrowed (usually from a brokerage) and sold, in a bet that the share price would drop -- rocketed in the first two weeks of August, from 8.7 million to a record 12.6 million, according to New York Stock Exchange data.

Yet the number of FirstFed shares outstanding is just 13.6 million.

So the bears, it seems, have borrowed and sold 93% of all FirstFed shares. And if we remove from the outstanding total the shares locked up by company insiders, short sellers have borrowed and sold more shares than actually are available in the market.

Sound strange? This appears to be a gross case of ‘naked’ shorting: Some traders have been selling shares that they didn’t actually have in hand. With naked short sales, the same shares could, in effect, be sold multiple times by different traders, who never actually have control of the stock.

Naked shorting is what the Securities and Exchange Commission outlawed in the case of 19 big bank and brokerage stocks from mid-July to Aug. 12 in an effort to stop the meltdown in financial shares in general.

The SEC also has said it plans to propose a market-wide rule against naked shorting, which under current rules may or may not be illegal, depending on the circumstances.

But that apparently didn’t stop some bearish traders who were confident that FirstFed shares would decline further this month as the company continues to struggle with a large number of loan defaults.

‘I think we may have a group of short sellers who aren’t too worried about the rules,’ FirstFed CEO Babette Heimbuch told my colleague E. Scott Reckard today. ‘I always figured that is why we have so many rumors spread about us. These shorts are in illegally and need the stock to move fast so they can get out, so they spread lies to make it happen.’

The goal of a short sale is to sell a stock today at, say, $20, and buy it back later (to replace the loaned shares) at a lower price. If the price indeed drops, the short seller’s profit is the difference between the sale price and the repurchase price.

But if the stock price rises instead of falls, short sellers lose. That can send them rushing into the market to buy new shares to replace the loaned stock.

It looks like that’s what’s happening today with FirstFed, after analyst Fred Cannon at Keefe, Bruyette & Woods Inc. noted the extraordinarily high shorting of the stock in a report he published late Wednesday.

The shorts are being ‘squeezed’ as they try to find shares to close out their positions. Knowing how much the shorts need the stock now, investors who hold FirstFed can drive a hard bargain before they’ll sell.

Heimbuch said she wished the SEC would look into the crush of short selling in FirstFed, ‘but I imagine we are too small for them to worry about.’

An SEC spokesman in Washington declined to comment.