California bank stocks surge as bears back off in a hurry

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The ‘shorts’ are on the run again today, particularly in stocks of some small California banks.

Financial issues that had been brutalized for the last six weeks are up sharply for a second day, in a rally that has all the earmarks of a short-covering panic.

The day’s winners include many California community banks that have been heavily shorted in recent months by bearish traders. In a short sale, a trader borrows stock and sells it, hoping the price will drop so he can replace the borrowed shares later with stock bought at a lower price.

That strategy has worked well for much of this year with financial stocks as the companies’ earnings have withered amid rising loan losses.

The problem for short sellers is that, once a heavily shorted stock begins to rebound, the turn can trigger a rush to close out those bearish bets. As shorts jump in to buy, they become each other’s worst enemies, driving prices higher.

Panicked buying? Look at Pasadena-based East West Bancorp, which was up $1.05, or 12.1%, to $9.72 at about 10 a.m. PDT, after soaring as high as $13 early in the session. The stock rose 16% on Wednesday.

Struggling mortgage lender Downey Financial, based in Newport Beach, has gained 86 cents, or 39%, to $3.08 after rocketing 66% on Wednesday. Downey shares, which closed at $1.28 on Monday, spiked as high as $3.80 early today.

Other big gainers among California community banks include L.A.-based Cathay General, up 14% so far today, and San Francisco-based UCBH Holdings, parent of United Commercial Bank, which is up nearly 10%.

Threats by the Securities and Exchange Commission this week to crack down on what it labels abusive short selling may be giving some short sellers another reason to close out their bets.