Lyndon Baines Johnson

The Wolfsburg Corner

The Economist:

Porsche breaks the hedge funds | Squeezy money | The Economist: GREAT cornering and eye-popping acceleration make Porsche’s cars popular.... Now its clients are discovering that the carmaker itself has an unexpected talent for cornering markets. In a few tumultuous days it is thought to have made a cool €6 billion-12 billion ($7.5 billion-15 billion) on the share price of Volkswagen (VW)—a coup that has roiled the world’s financial markets.

Porsche’s gambit was as old as finance itself. For about three years it had been steadily increasing its stake in VW.... Its buying had driven up the price of VW’s shares to above the level at which it would make any economic sense for Porsche to buy VW. Seeing this, hedge funds sold shares in VW that they did not own. One strategy was a bet that VW’s share price would fall. Some also bought shares in Porsche, in a wager that shares of both would converge.

The risks of short selling should have been apparent to the brightest hedge-fund managers in Mayfair and Greenwich because of widespread suspicion that Porsche, a dab hand in currency-derivatives markets, was also mucking about with options on VW stock. Adam Jonas of Morgan Stanley warned clients on October 8th of the danger of playing “billionaire’s poker” by betting against Porsche. Max Warburton of Alliance Bernstein said Porsche could make billions by squeezing short-sellers of VW’s shares.

At the time Porsche dismissed these musings as a “fairy-tale”. But on October 26th it executed a handbrake turn, saying that it owned nearly 43% of VW’s shares outright and had derivative contracts on nearly 32% more. That meant it had tied up almost all of the freely available shares (the rest are held by the state government and index funds). Hedge funds quickly did the maths, concluding that they could be caught in an “infinite squeeze” in which they were forced to buy shares at any price.

Their frenzied buying sent VW’s share price soaring.... After languishing below €200 last year, it jumped to more than €1,005 at one point on October 28th, briefly making VW the world’s most valuable company....

Hedge funds that take bad bets may garner little sympathy, but the VW saga does more than punish a few “locusts”. On October 28th shares in Morgan Stanley, Goldman Sachs and Société Générale wobbled on worries (denied by all) that they might also be exposed to VW. If the losses are big enough to cause the failure of even a few hedge funds, that would spell more pain for the battered banking system. Other casualties include buyers of passive funds that track the German market who will end up with a disproportionate stake in VW within their portfolios. With VW’s share price falling again, those who sell now will lock in a loss.

The greatest damage is to the reputation of Germany’s capital markets, where regulators are now belatedly investigating what went on. Allowing acquirers to build large secret stakes in bid targets does nothing for confidence. Even Porsche may come to rue its coup. “They may struggle to sell 911s to hedge-fund managers for years and years to come,” says one investor.