November 02, 2008


ALTHOUGH I AM NOT an automobile enthusiast, I must say that if I ever find myself in the position to purchase a luxury automobile, I'll give strong consideration to buying one of Porsche AG's fine machines. After this crazy week -- in which parent firm Porsche SE pulled off one of the most audacious, clever, astounding, fantastic maneuvers to take place in high finance in the past half-century -- it is the least I can do.

You see, Porsche SE pulled off the financial equivalent of The Play this week, and did it in such stunning fashion that it has become the talk of the business world. It was such an incredible move that it deserves to be talked about as if Porsche had amazingly outmaneuvered its rivals, ran the ball in for a touchdown despite the enemy's band being on the field, and then knocked over the trombone player. "THE BULLS!" one can imagine Joe Starkey saying. "THE BULLS! THE BULLS HAVE WON! Oh, my God! The most amazing, sensational, dramatic, heart-rending... exciting, thrilling finish in the history of finance!"

So what did Porsche do? Well, you should know that shares of Volkswagen AG, the German automaker, had been subjected to a rash of short-selling before this past week. This was because hedge funds, rightly believing the world's auto industry would suffer setbacks as a result of the global economic downturn, found Volkswagen a tempting target for their machinations.

Now, when one "shorts" a stock, one borrows shares of a company and then sells them, with the proviso he has to eventually buy the shares back. The idea is that a speculator can buy back the shares for less than what he received when he borrowed and sold them, with the difference being his profit.. The practice adds liquidity to the market -- it makes it easier for everyone to buy shares -- but at the same time people can't stand it. That's because when people short a stock, the borrowed shares are immediately sold, helping push down the price of the stock, creating losses among traditional (or "long") investors who just want their stocks to go up. As such, traditional investors view short sellers as rotten scheming bastards who should have their heads impaled on pikes.

Anyway, all these hedge funds had shorted Volkswagen shares, figuring the company was going to be in for a rough ride. However, as all the hedgies went after the company, Porsche secretly arranged to buy call options on Volkswagen shares with several German banks. Porsche, which already owned 42 pc of Volkswagen, then innocently announced it had arranged to boost its stake in Volkswagen to 75 pc. As 20 pc of VW is owned by a German state government, it effectively meant that only 5 pc of Volkswagen's shares were on the market -- and the hedgies had sold 12 pc of the firm's shares short.


The end result was that Porsche had cornered the market in Volkswagen shares, leaving the hedge funds exposed to incredible losses. The share price skyrocketed from 200 euros to 1,000 euros as the hedge funds desperately tried to close out their positions. When all was said and done, the hedge funds lost the equivalent of THIRTY EIGHT BILLION DOLLARS.

The Rant would sum up its reaction in one word: wow.

Of course, the cleverness of this scheme has led the hedge funds in London and elsewhere to cry foul, and demand the German authorities conduct an investigation. Heh. Good luck with that. In the meantime, the rest of us can indulge in heaping helpings of schadenfreude, as more than 100 hedge funds may have lost money in the whole affair. Not only will the rotten investors in such vehicles get burned, the funds' managers could get burned as well.

That's because hedge funds usually calculate their famed 20 pc shares of the profit against a "high-water mark," meaning that any future losses make it that much more difficult to book huge gains. Plus, since those profits are often invested back into the funds, they could really lose out when all is said and done. And although I am traditionally sympathetic to the idea that a rising tide lifts all boats, I'm not exactly discouraged at the idea that when the tide goes out, all the fancy yachts are getting pulled out with it.

Posted by Benjamin Kepple at November 2, 2008 01:29 AM | TrackBack
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