Kraft durch (Schaden)freude

October 29, 2008 12:53 PM

Short sellingis basically the practice of selling borrowed shares, with the intention of purchasing them back later at a lower price. It amounts to a placing a bet on the share value dropping, is a favoured move of hedge funds, and has been recently blamed for much of the current economic mayhem. However, when last Sunday Porsche tersely announced that, in addition to its 44% of Volkswagen's shares, it had secured 31% through cash-settled call options, the invisible hand of the market gave those short-sellers an atomic wedgie: Since the German state of Lower Saxony holds just over 20% of VW, Porsche's disclosure meant that, in fact, there were only 5% of VW's shares left on the market, whereas traders were shorting for about 13% of those shares. This set off the "Mother of All Short Squeezes".

Traders scrambled to buy those few shares to cover their short positions, sending the share price of VW upwards to ridiculous heights, and completely distorting the German blue-chip index DAX.

Today, Porsche eased the pressure on the short-sellers by releasing 5% of VW's shares. Coincidentally, this also probably bagged them enough billions (never mind street cred) to finance their whole takeover operation. Suddenly, even hedge fund managers are clamouring for more disclosure and regulation in the markets. They aren't meeting much sympathy.

posted by Skeptic (98 comments total)

ha ha ha ha ha ha ha
ha ha ha ha ha ha ha
ha he ha ha ha ha ha
ha ha ha HA ha ha ha
ha ha ho ha ha ha ha
ha ha ha ha ha ha ha

/wipes tear from eye...
posted by GuyZero at 12:57 PM on October 29, 2008 [17 favorites has favorites]

Porshe is up 31% on the expectation that they'll profit immensely from the short squeeze.
posted by delmoi at 1:02 PM on October 29, 2008 [1 favorite has favorites]

That was great. An atomic assblast.
posted by unSane at 1:04 PM on October 29, 2008 [1 favorite has favorites]

What GuyZero said.

Awesome post.
posted by No Robots at 1:11 PM on October 29, 2008

As I watched this unfold over the last 2 days I was imagining the sheer panic the shorties must have been feeling...and laughing.
posted by rocket88 at 1:13 PM on October 29, 2008

Can a single share be sold short multiple times?
posted by smackfu at 1:13 PM on October 29, 2008

Speaking to reporters at a hastily called press conference, a representative for Porsche SE explained the nature of their long-term master plan.
"Basically, we did it for the lulz," he admitted, before adding "David Einhorn can go to hell for all I care. We're riding this unicorn all the way to the bank"
posted by atrazine at 1:13 PM on October 29, 2008 [34 favorites has favorites]

Yeah, I was really laughing when I heard about this first time.
posted by Catfry at 1:14 PM on October 29, 2008

Porschchadenfreude
posted by weapons-grade pandemonium at 1:17 PM on October 29, 2008 [1 favorite has favorites]

"The regulator needs to investigate,'' Piers Hillier, head of European equities at WestLB Mellon Asset Management, told Bloomberg. "The bigger question has to be why they have not done so already. Porsche's stake-building process is at best obscure."

Unlike the asset-building processes of firms like yours, huh? Sorry pal, what's good for the goose etc.
posted by xbonesgt at 1:18 PM on October 29, 2008 [1 favorite has favorites]

Shorting is a legitimate investment strategy, there's nothing good or bad about it.
The problem here was purely non-disclosure of the float. 5% float is ridiculous and you'll get distorted share prices no matter what.
posted by bhnyc at 1:21 PM on October 29, 2008

I love how everyone is laughing at short sellers, but no one criticizes the operation of a market in which a company can acquire 31% of a public company and keep it a secret. The purpose of the exchanges is to promote transparency. The fact that Porsche was able to do this gives me no confidence whatsoever that the prices on the German equity markets in any way correspond to actual value.
posted by Pastabagel at 1:22 PM on October 29, 2008 [8 favorites has favorites]

> Porsche's stake-building process is at best obscure.

They were buying a company. To own it.

It might be a difficult concept for people whose wealth is built on disbursed predictions against the potentiality of assets which are held by unrelated firms, leveraged against those unrelated firms' own payments towards the well-being, or lack of same, of companies in which they have no stake. So I'll reiterate:

They were buying a company. To own it.
posted by ardgedee at 1:24 PM on October 29, 2008 [26 favorites has favorites]

Interesting parallel to The Stutz Motor Car Company.
posted by preparat at 1:24 PM on October 29, 2008 [1 favorite has favorites]

The government must immediately allocate money to purchase VW shares for distribution to the hedge funds that have been caught in these short positions. Failure to do so could spell the end of the economy as we know it!
posted by spacewrench at 1:25 PM on October 29, 2008 [2 favorites has favorites]

Can a single share be sold short multiple times?

smackfu brings up an interesting point: how is this even possible?
posted by ZenMasterThis at 1:26 PM on October 29, 2008

I don't think I've ever said this before, but hooray for Porsche! I knew something strange must have happened when I heard about the VW price going up about 50% in ONE DAY. I mean, it's not like they suddenly started selling economical, durable, user-fixable automobiles or something like that.
posted by Mister_A at 1:30 PM on October 29, 2008

This is a fantastic post and an delightful bit of schadenfreude. As an interesting aside, one of the hedgies who got squeezed was David Einhorn, was one of the first to call out Lehman Brothers on their precarious position. Word is that Lehman's CFO was forced out thanks to several confrontations was Einhorn.

Also, can somebody explain to me how Porsche's cash-settled options gave them control of 31.5% of the shares? I thought that the definition of cash-settled was that at the exercise of the options there are no shares transferred, only the cash equivalent.
posted by There's No I In Meme at 1:31 PM on October 29, 2008 [1 favorite has favorites]

Today I leveraged my domestic assets to purchase a CrunchWrap Supreme at my local investment office (aka Taco Bell). Sadly the value has evaporated, and all I have left is an empty wrapper.
posted by blue_beetle at 1:32 PM on October 29, 2008 [5 favorites has favorites]

What happens is called naked short selling.

If you are interesting in understanding how naked short selling, there is an excellent video explaining it at:

www.businessjive.com .

Excellent post.
posted by procrastination at 1:34 PM on October 29, 2008 [5 favorites has favorites]

Can a single share be sold short multiple times?

smackfu brings up an interesting point: how is this even possible?
posted by ZenMasterThis at 4:26 PM on October 29

Considering that no one knew that Porsche was buying up the float, they probably thought those shares were out on the market. It isn't the shorts fault. You could just as easily ask Porsche how they were buying stock that was already committed in an on-the-books short sale transaction, but of course it doesn't work that way.

More to the point, it only happens in the context of information asymmetry - we know how many shorts are out there, but we apparently have no idea how many longs are out there there are until they feel generous enough to let the public know. If the market was transparent, people would have realized this and the price would have adjusted accordingly.

It seems bizarre that you can hide a long but you can't hide a short.
posted by Pastabagel at 1:34 PM on October 29, 2008 [3 favorites has favorites]

Shorting is a legitimate investment strategy, there's nothing good or bad about it.

It may be a legitimate strategy, but an investment? Isn't it rather the opposite?

Investing isn't the same as betting.

What Porsche has done was indeed quite underhand, but it was apparently legal and only underlines that the rules need to be tightened. And the hedge funds will like that even less than Porsche's drive-by short squeeze.
posted by Skeptic at 1:34 PM on October 29, 2008

smackfu brings up an interesting point: how is this even possible?

I believe, but I'm not sure that porshe bought options rather then actual shares. So say you own 100 shares of VW. An option is a contract that gives the buyer the right to buy the shares at a certain price. So, if VW's price is currently $60 a share, you can sell someone the right to buy it for like $80 a share in a couple months. If the price goes to $100, then that person will get a good deal buying it for $80.

If on the other hand the price does not get to $80, then the option will expire and you get free money.

So porshe bought all these options, but everyone else still had all their shares, which they I guess could loan out? Or they might own shares on margin accounts, in which case their brokerages can loan out the shares on margin. Or something like that, actually I'm not sure.

There's also naked shorting where you sell the shares without bothering to borrow them, in which case you have to settle (buy back the shares) in 3 days.

That's my guess, I'm not totally clear myself.
posted by delmoi at 1:34 PM on October 29, 2008 [1 favorite has favorites]

I heard a Marketplace segment by Robert Reich the other day that made this interesting point:

Pardon me for asking, but if a company is too big to fail, maybe -- just maybe -- it's too big, period.
[...]
We seem to have forgotten that the original purpose of antitrust law was also to prevent companies from becoming too powerful. Too powerful in that so many other companies depended on them, so many jobs turned on them and so many consumers or investors or depositors needed them, that the economy as a whole would be endangered if they failed.
[...]
So we're ending up with even bigger giants, with even more power over the economy and politics, subsidized by taxpayers and guaranteed never to fail because they're just -- too big!

So while economies of scale are a lovely thing, is there an upper limit of which we should be afraid?
posted by pointless_incessant_barking at 1:34 PM on October 29, 2008 [9 favorites has favorites]

Today I leveraged my domestic assets to purchase a CrunchWrap Supreme at my local investment office (aka Taco Bell). Sadly the value has evaporated, and all I have left is an empty wrapper.

Wait a few hours, and you'll see a return on your investment in the form of liquid assets.
posted by Faint of Butt at 1:36 PM on October 29, 2008 [30 favorites has favorites]

You know who else liked short selling?
posted by cjorgensen at 1:40 PM on October 29, 2008 [2 favorites has favorites]

Great post. I saw some mainstream news coverage of this, but needed the background!
posted by bystander at 1:47 PM on October 29, 2008

you know who else liked Volkswagen?
posted by bonaldi at 1:47 PM on October 29, 2008 [4 favorites has favorites]

Generally when buying a call option the counterparty is holding the stock and pocketing the premium, and will have to sell the stock to you at the agreed strike price before (or, for European-style options, ON) the expiration date.

So in the VW case we could also have had naked call writers selling VW calls to Porsche w/o owning the underlying. Now that Porsche wants its shares, the naked call writes have to go buy them.
posted by troy at 1:49 PM on October 29, 2008 [1 favorite has favorites]

You know who else liked short selling?

Here's a list of the top intra-monthly peak-to-trough drops:

October-29 10-Oct-29 29-Oct-29 19 -33.69%
October-87 5-Oct-87 19-Oct-87 14 -31.47%
September-31 1-Sep-31 30-Sep-31 29 -30.24%
October-08 1-Oct-08 27-Oct-08 26 -26.88%
May-32 6-May-32 31-May-32 25 -26.60%
March-38 1-Mar-38 31-Mar-38 30 -25.83%
May-40 3-May-40 21-May-40 18 -24.59%

March '38 was the Anschluss. May '40 was the fall of France.
posted by troy at 1:55 PM on October 29, 2008 [1 favorite has favorites]

> you know who else liked Volkswagen?

Ferdinand Porsche.
posted by ardgedee at 1:58 PM on October 29, 2008

One of the links might mention this, but I read that during the rise, Volkswagen was the world's most valuable company (based on market value), briefly topping Exxon. Insane stuff...
posted by inigo2 at 2:00 PM on October 29, 2008

And here I was thinking Germans were famous for regulations and bureaucrats.
posted by up in the old hotel at 2:04 PM on October 29, 2008 [1 favorite has favorites]

Only an idiot shorts a stock with 5% float. Who was doing this?

Goldman Sachs and Morgan Stanley.

That explains it.
posted by Ironmouth at 2:04 PM on October 29, 2008 [1 favorite has favorites]

And here I thought VW stock had shot up because everyone was having babies just to justify a Routan purchase.
posted by empyrean at 2:06 PM on October 29, 2008 [2 favorites has favorites]

Pardon me for asking, but if a company is too big to fail, maybe -- just maybe -- it's too big, period.
[...]
We seem to have forgotten that the original purpose of antitrust law was also to prevent companies from becoming too powerful.

Robert Reich unleashes my latent Milton Friedman like no one else. That was never the purpose of antitrust law. The purpose was to prevent the consolidation of market power. What the hell does "too powerful" mean anyway? Who decides? Microsoft was too powerful in the non-existent browser market, but Apple isn't too powerful in the music distribution market? Lehman was too powerful? What about Goldman Sachs? I guess with a current and a former Treasury Secretary and a New Jersey governor (who co-authored the LTCM bailout) among their alumni, they aren't too powerful?

Antitrust regulation, like all regulation, is essentially a call for lobbying. And regulation is a market like anything else. Companies with deeper pockets can spend to get regulation they want. Companies that fail to spend on lobbying can be certain of getting regulation to turn against them.
posted by Pastabagel at 2:07 PM on October 29, 2008 [5 favorites has favorites]

More to the point, it only happens in the context of information asymmetry - we know how many shorts are out there, but we apparently have no idea how many longs are out there there are until they feel generous enough to let the public know. If the market was transparent, people would have realized this and the price would have adjusted accordingly.

It seems bizarre that you can hide a long but you can't hide a short.

This isn't correct. Everyone knew exactly how many longs and shorts there were. This is always the case. What they didn't know is which anonymous entities were long and short and to what extent.
posted by JackFlash at 2:23 PM on October 29, 2008 [1 favorite has favorites]

Only an idiot shorts a stock with 5% float. Who was doing this?

That's the whole point of the issue. Everyone thought there was a ~40% float. Turns out to only have been 5% because Porsche isn't required to disclose their position in calls. Whoops.
posted by GuyZero at 2:23 PM on October 29, 2008 [2 favorites has favorites]

Does this mean that some day VW's will be reliable after 70k on the odometer? I hope so, because I like them.
posted by mecran01 at 2:24 PM on October 29, 2008 [1 favorite has favorites]

Ahhh ..."information asymmetry"

Such as
-when morgage customers suddenly get whacked with a balloon payment that was buried on p19 of the fine print,

-or when subprime debt paper gets palmed into a deck of CDAs when no-one's looking, and the bond-raters go "A-OK!",

-or when Porsche legally (in Germany) takes control of more VW stock, causing said short squeeze.

What goes around...
posted by Artful Codger at 2:32 PM on October 29, 2008 [3 favorites has favorites]

Today I leveraged my domestic assets to purchase a CrunchWrap Supreme at my local investment office (aka Taco Bell). Sadly the value has evaporated, and all I have left is an empty wrapper.

Wait a few hours, and you'll see a return on your investment in the form of liquid assets.

posted by Faint of Butt at 4:36 PM on October 29 [14 favorites -] Favorite added! [!]

I'm sorry, I don't do this much, really, but that may be the single most eponysterical post ever.
posted by The Bellman at 2:48 PM on October 29, 2008 [1 favorite has favorites]

Oh and also, fantastic post Skeptic.
posted by The Bellman at 2:51 PM on October 29, 2008

The Bellman, you realize the original joke was about Taco Bell, right?

This is starting to get creeponysterical.
posted by qvantamon at 2:52 PM on October 29, 2008 [2 favorites has favorites]

>...the original purpose of antitrust law...

I know nothing about antitrust law in Germany, but I am halfway through an antitrust law class in the US.

The first antitrust law cases did indeed condemn companies that were too big simply because of their size. We can see now that, in the time of the Standard Oil case, we thought that large companies necessarily restricted competition, so we accordingly broke them up. We did this even when it would benefit the smaller companies at the expense of consumers (by losing economies of scale, etc).

The court moved from size alone to a two-part test that measured market power and whether that power had in fact been abused. Each of these measurements has its own line of cases trying to figure out the best yardstick to use.

Though antitrust jurisprudence has tried out many different theories about exactly when a company has crossed the line, its real underlying motive is to preserve the benefits of competition. The most basic form of the economic question is whether output has decreased and prices have increased to monopoly levels. Market power plays an important role in this determination, but it is not enough on its own to prove a violation of the Sherman Act or Clayton Act (See the Aluminum Company of America or "Alcoa" case).

That said, it's a safe bet to assume that any company that gains enough market power has a big incentive to abuse it to maintain that power and raise prices. The tension here is that while we don't want to punish firms simply because they were successful enough to reach a certain size, it is only companies that attain that size that have the ability to abuse their market power.
posted by Grimp0teuthis at 2:56 PM on October 29, 2008 [4 favorites has favorites]

Schadenfreude? So I made $30k today instead of $70k...

So what is that Guy haha-ing about again?
posted by Zambrano at 3:21 PM on October 29, 2008

Thanks for this great post- I was trying to parse this in the German papers today, with little luck thanks to my crummy Deutsche.

I'm still a little confused (bear with me here, I'm a little slow on these things, and for some reason it's been hard for me to get my head around short selling. I'm trying to understand what caused the "crisis." If the 13% of shorted shares included some of the stock bought be Porsche, why was that a problem? Why wouldn't those shares be open for shorting before Porsche bought them, and why couldn't the short transaction take place as the stock rose?

Glad for any clarification.
posted by foxy_hedgehog at 3:54 PM on October 29, 2008

Investing isn't the same as betting

It's all betting that something will increase in value. I guess you are talking about time frames- 10 years is investing and daytrading is gambling. In the current market I think it's a bad bet to invest long term.
posted by bhnyc at 3:54 PM on October 29, 2008

This was fucking brilliant manuerving by Porsche.

The classic way to stop the shorts from destroying your market cap is to release enough good news to start a buying frenzy. Porsche realizes that they've got cash *and* they already know where 64 percent of the outstanding shares were.

So they take the cash, buy calls on 31% outstanding -- then casually mention that they now control 75% of the stock, and Lower Saxony 20%, at least until those options expire. And suddenly, the 13% of the stock that was shorted was chasing the 5% that was left.

Too bad, so sad. The funny thing is that 5% they released? I'll bet they used the options, bought them at before squeeze price, and sold them onto the market at after squeeze prices.

Thus, they now have enough money to go ahead and exercise the rest of the calls, ending up with 70% of the stock in hand *and* the cash they started with.

And, as a bonus, they utterly screwed a few dozen hedge funds, as least some of them who were shorting stock they didn't have locates on.

Nelson Muntz, white courtesy phone, please.
posted by eriko at 3:59 PM on October 29, 2008 [10 favorites has favorites]

Hedge fund managers call for regulation of anyone smarter than they are? Thanks, but no thanks.
posted by rodgerd at 4:02 PM on October 29, 2008 [3 favorites has favorites]

foxy_hedgehog: When the person you have to buy the stock off in order to close out the short position also happens to be the same person that lent you the stock in the first place, because there aren't any other sellers, then they get to set whatever price they like and you get to pay.

The hedgies thought they were shorting shares borrowed from the open float, whereas in fact they were borrowing them from Porche, who had set up the whole thing to bilk them out of their cash. This would be illegal in most markets in the world & is probably mostly illegal in DE, but Porsche found a loophole in the regs & drove a 911 through it.
posted by pharm at 4:09 PM on October 29, 2008 [2 favorites has favorites]

See also, this ftalphaville post which talks about the report from the analyst who worked all this out a couple of weeks ago whilst on a cycling holiday in France. There's more from his report in the FTAlphaville Markets Live chat from the 17th October.
posted by pharm at 4:15 PM on October 29, 2008 [1 favorite has favorites]

eriko: Of course, Porche has completely f*cked the reputation of the DE market in the process. This sort of thing isn't supposed to be allowed, surely?
posted by pharm at 4:26 PM on October 29, 2008

Porsche. Sigh.
posted by pharm at 4:31 PM on October 29, 2008

pharm: No, naked short selling is not supposed to be allowed. I just watched this whole thing linked above, and am now kind of terrified. It's worth the time.

Also, I'm not sure Porsche is the culprit you're looking for here.
posted by rusty at 4:38 PM on October 29, 2008

Rusty: As I understand things, no naked short selling was involved (or if it was, it's a side issue). The shorts were not naked: they had borrowed the stock on the open market (from Porsche probably).

What's not supposed to be allowed is building up a controlling stake in a listed company (by whatever means) without making that fact public. The fact that Porsche appears to have found a legal way around the .de rules on this doesn't stop it being deeply shady practice.
posted by pharm at 4:53 PM on October 29, 2008

Naked shorts has nothing to do with it. Shorts, naked or otherwise, have to eventually be covered by buying back the stock that you originally borrowed in order to sell. You can wait indefinitely to cover your short, but if you see the stock suddenly rise in price, you have to cover quickly because each rise in price increases your loss. If all the short sellers rush to the exits at once to buy back their stock, they compete against each other and can drive up the price to extreme levels in what is called a short squeeze. A short squeeze doesn't require naked short selling.

Also, the issue is not transparency of the number of longs and shorts. Everyone knows how many shares are long and short. The hedge funds were betting against the longs and counting on taking easy money from all of the poor schmucks who were long when the price went down. What they didn't realize was that there weren't a bunch of schmucks out there that would sell at a cheap price to them in a panic. There was only Porsche and they weren't selling going to sell cheap. When the hedge funds realized they couldn't easily find shares to buy back, that's when the short squeeze started.
posted by JackFlash at 5:07 PM on October 29, 2008 [2 favorites has favorites]

So just for my curiosity, what happens if you are unable to buy the shares to cover your short position?
posted by ntartifex at 5:15 PM on October 29, 2008

I think I saw this episode on the Undersea World of Jacques Cousteau! It's the one where a school of barracuda exploring a bunch of crevices to chow down on the cute little fishies find out too late that the tunnels have all led to a big cave with a fucking huge shark in it.
posted by seanmpuckett at 5:17 PM on October 29, 2008 [2 favorites has favorites]

pharm / JackFlash: I see what you're saying. No, naked shorting doesn't necessarily have anything to do with it.
posted by rusty at 5:25 PM on October 29, 2008

Super post.

I learn so much about capital markets through our community so thanks everybody. The finance threads here are supportive with plenty of members willing to go out of their way to help impart understanding.

Maybe we could do that for other subjects too (or discuss is again after next week...)
posted by Samuel Farrow at 5:38 PM on October 29, 2008

So just for my curiosity, what happens if you are unable to buy the shares to cover your short position?

You can always buy shares, the only question is price. Thus the astronomical rise in VW's price.
posted by GuyZero at 5:39 PM on October 29, 2008

Also, VW made up 27% of the Börse? WTF? That's like the Nortel-era TSE. Last I check I think Germany had a more robust economy than that, though I could be wrong.
posted by GuyZero at 5:41 PM on October 29, 2008

With apologies to Format & J-5:

Ve know somesing (you don't know)
And if ve don’t share then ve don’t grow
Holger Härt vil set ze hedge funds on fire
posted by anthill at 6:04 PM on October 29, 2008 [1 favorite has favorites]

I wonder if Porsche confirmed delivery of all outstanding orders to hedge fund managers before issuing their disclosure.
posted by b1tr0t at 6:26 PM on October 29, 2008

I learn so much about capital markets through our community so thanks everybody.

I'm not saying this is a crap post (I haven't read all the comments yet), but there is a lot of bogus information posted to MeFi finance threads, just like everywhere else. Don't use MeFi as your only source of information!
posted by b1tr0t at 6:28 PM on October 29, 2008

So just for my curiosity, what happens if you are unable to buy the shares to cover your short position?

You have to just keep raising your bid offer until you can induce someone to sell. That's why in a short squeeze, the price can go up 100% or more in one day. You can be wiped out trying to cover.

If you delay buying for too long, and the price goes against you, your broker may issue a margin call requiring you to either deposit more money to cover the short and/or start forcibly sell off your other stocks in the account. It can get really ugly.
posted by JackFlash at 6:37 PM on October 29, 2008

I've read some comments about the German market rules here and elsewhere. Perhaps it's a good idea to understand the rules before you put millions of dollars in to a foreign market?
posted by markr at 6:41 PM on October 29, 2008

So just for my curiosity, what happens if you are unable to buy the shares to cover your short position?

You have to just keep raising your bid offer until you can induce someone to sell. That's why in a short squeeze, the price can go up 100% or more in one day. You can be wiped out trying to cover.

If you delay buying for too long, and the price goes against you, your broker may issue a margin call requiring you to either deposit more money to cover the short and/or start forcibly sell off your other stocks in the account. It can get really ugly.

You are also responsible for all dividends paid out on the shares you've shorted until you can close, and interest on your margin.

How much of the value of a short squeeze is a bubble vs permanent gain? Can they leverage it to acquire other companies in stock transactions and permanently inflate the value of VW? How badly can they screw over the short sellers and the brokers that the short sellers borrowed securities from?
posted by BrotherCaine at 6:49 PM on October 29, 2008

It can get really ugly.

I've always understood that to be the real problem with shoting to make money: orthodox share trading leaves a worst-case scenario that is "I lost all the money I invested." Shorting leaves you open to unlimited losses.
posted by rodgerd at 6:52 PM on October 29, 2008

Somebody said that naked shorting had nothing to do with this.

Porsche already held 44% of VW shares. It then contracted to obtain another 31% of the shares via call options. Those contracts are binding; they bind people to sell VW shares to Porsche at a specified price. After those contracts go, Porsche will hold 44+31=75% of VW.

Lower Saxony holds 20% of VW shares. Presumably they're not lending them out to be shorted. 75% + 20% = 95% of outstanding shares are now accounted for. That means that 5% of VW shares are out there floating.

Short sellers have presumably borrowed stock which they have then sold. If they sold the shares without borrowing the stock first, those shorts are naked and can be subject to a fail to deliver. 13% of VW's outstanding shares were short. 95% are already accounted for and not shortable. Therefore, 95+13% = 107% of VW's shares are accounted for.

However, only 100% of VW's shares actually exist. The binding contracts regarding the other 7% have to be fulfilled, but they can't be, because someone's not going to be able to get their hands on the shares to deliver them on the delivery date. This is referred to as a "failure to deliver." The possibility of failure to deliver is a counter-party risk, the kind that made Warren Buffett call derivatives a weapon of mass destruction.

Pastabagel is right when he points out that Porsche's secret maneuvers on the derivatives market, as well as any naked shorting that may have gone on, distort the price-discovery process, the process that is probably the only decent justification for allowing this kind of market-based trading in assets to go on in the first place.
posted by ikkyu2 at 7:06 PM on October 29, 2008 [4 favorites has favorites]

However, only 100% of VW's shares actually exist. The binding contracts regarding the other 7% have to be fulfilled, but they can't be, because someone's not going to be able to get their hands on the shares to deliver them on the delivery date. This is referred to as a "failure to deliver." The possibility of failure to deliver is a counter-party risk, the kind that made Warren Buffett call derivatives a weapon of mass destruction.

Close but not entirely accurate.

You forget that all these shorts aren't going to delever simultaneously. As some hedge funds are forced to return the shares I'm sure the investment banks will more than happily sell the shares to the next round of hedge funds seeing as they're going to be screwing them to the wall and get insane prices for them.
posted by Talez at 7:23 PM on October 29, 2008 [1 favorite has favorites]

CHRIST I JUST DONT UNDERSTAND THIS BULLSHIT

On the oither hand I just made 40k US flippig websites
posted by Sparx at 7:45 PM on October 29, 2008

there's irony and then there is bad spelling
posted by Sparx at 7:51 PM on October 29, 2008

From reading around, it sounds like the math only works if the shorters were borrowing the shares from Porsche. They didn't know that, but it's scary.
posted by smackfu at 7:53 PM on October 29, 2008

Short sellers have presumably borrowed stock which they have then sold. If they sold the shares without borrowing the stock first, those shorts are naked and can be subject to a fail to deliver. 13% of VW's outstanding shares were short. 95% are already accounted for and not shortable. Therefore, 95+13% = 107% of VW's shares are accounted for.


This does not necessarily require naked shorts.

As you said, Porsche originally had 44% and Lower Saxony 20% for a total of 64%. This leaves a float of 36%. The short sellers take 13% of these shares and sell them to Porsche (unwittingly). Porsche and LS now control 77% of shares and the float is now down to 23%. Porsche then buys another 18% of the float which gives them 95% and leaving 5% for the float. When all is done, Porsche controls 95%, the float is 5% and the shorts are still stuck holding a 13% share debt. At no time were the shorts naked. The key to the transactions is that the shorts were borrowing shares from the float and then selling them to Porsche. They just didn't realize this.

When short selling, the short seller owes a debt of shares, even though 100% of the shares are held in other owners hands. This is always the case because the short seller doesn't own any shares. 100% are owned by someone else. No naked shorts are involved.
posted by JackFlash at 8:06 PM on October 29, 2008

This is a fantastic example of history repeating itself (from a pretty good financial blog)

Also if you look at Porsche's P&L you realize that
1) A huge sum of their earnings have come from financial bets rather then actually, you know - building cars
2) They currently have drawn down their revolving credit lines - not to use themselves, but to make loans to others
3) If Porsche had wanted to actually buy VW for the cheapest price possible they would have used some mechanism other then how they created this short squeeze. One of the things this short squeeze does (assuming the VW price is somewhat sticky above a rational market value) is allow Porsche to book big gains on their position as profits through their P&L.

German industrial companies pretending to be hedge funds don't have a good track record. Might I point you in the direction of Metallgesellschaft
posted by JPD at 8:21 PM on October 29, 2008 [2 favorites has favorites]

Also, while I think what Porsche has done is a bit...sleazy - you have to be amused that they did it by abusing the same loophole that the TCI/Atticus' of the world have used to attack other DAX members.
posted by JPD at 8:23 PM on October 29, 2008

Therefore, 95+13% = 107% of VW's shares are accounted for.

This is not the way you account for shares. Short sellers never own any shares. 100% are always owned by someone else. A short sale is simply a paper obligation to buy some shares from the 100% of owners at some time in the future. It doesn't increase or decrease the number of shares.

In fact, it is theoretically possible that the short seller buys the shares back from the person they originally borrowed them from. Remember, after a short sale, neither the original owner nor the short seller actually has physical possession of the shares -- they've been sold to someone else. The short seller can theoretically buy from the original owner -- who now only has a paper claim to shares but no actual shares. The short seller's paper debt of shares and the original owner's paper claim to shares cancel out when the short seller pays the original owner.
posted by JackFlash at 8:35 PM on October 29, 2008

Thanks for this thread Skeptic and commenters (particularly JackFlash), great reading :)
posted by onalark at 9:25 PM on October 29, 2008

JackFlash, that still doesn't make sense to me. At the point in your narrative where Porsche buys (options on?) another 18% of shares, they've bought them from someone, yes? (Many someones, perhaps, but each share came from somewhere.) And that someone has either (a) also promised them to the short sellers at a future market price, which I assume would be fraudulent; or (b) has not promised them to the short sellers, in which case the short sellers are naked. No? Is there a third option?
posted by hattifattener at 12:33 AM on October 30, 2008

It doesn't just hurt shorts, it can affect funds that are into VW for the long haul. From the FT:

This whirligig has hurt hedge funds shorting VW. But it has also hurt long-only fund managers that avoided VW. By not owning VW, their performance relative to indices has suffered by as much as 3 percentage points – and with that their fees.

posted by PenDevil at 1:08 AM on October 30, 2008

Oops... rather "that are NOT into VW"
posted by PenDevil at 1:19 AM on October 30, 2008

Every Friday, a bunch of tough guys get together on the outskirts of town and have knife fights for cash prizes. During the week they swagger around town in fancy clothes, sneering at low-paid schlubs and drinking champagne from the bottle. Then one Friday, a whole lot of them get seriously injured. They rush to the emergency room and demand priority treatment.

"What did you expect, tough guys?" asks the nurse. "You have knife fights every Friday night! Of course you were going to get hurt one day!"

"Yeah, but you should have seen the angle that this one guy was holding his elbow at!"
posted by No-sword at 2:58 AM on October 30, 2008 [3 favorites has favorites]

What's not supposed to be allowed is building up a controlling stake in a listed company (by whatever means) without making that fact public.

If I'm massively shorting a large company that I know has over 50% of the shares out of play, you'd better bet I'd be watching the options market. Porsche bought options on 31% of the outstanding shares. You'd think this might make a little blip in the options markets?

I'm *not* about to cry for the Hedgies. They do everything in secret, and they scream for the right to do everything in secret. Porsche played the game by the rules the Hedge Funds wanted.

They're just pissed off because Porsche played them, rather than the other way around.
posted by eriko at 4:27 AM on October 30, 2008

Someone at Porsche is gonna get a fat and well earned bonus this year...
posted by Fupped Duck at 6:04 AM on October 30, 2008

Wait, so the practice of selling something you don't own can turn around and burn you? Who could have ever imagined such a thing!?!? No rational market model could possibly have allowed such a possibility! The human mind simply cannot conceptualize it!

...so yeah, boo-fucking-hoo. I guess skydiving into an active volcano wasn't such a great idea after all...
posted by aramaic at 6:34 AM on October 30, 2008

procrastination: I checked out the link you posted. It's informative, but what's odd about that presentation is that it's largely anonymous: no speaker identification, no way to evaluate context/slant/bias. It turns out the domain is registered to a guy from overstock.com -- the same people who complained strongly about naked short selling driving down their stock price in this article, which is cited in the presentation on slide 53 -- despite the fact that overstock is never identified by name in the presentation.

I'm always suspicious when people try to "educate" you without identifiying their own goals and issues...
posted by ubermuffin at 7:59 AM on October 30, 2008

JackFlash, that still doesn't make sense to me. At the point in your narrative where Porsche buys (options on?) another 18% of shares, they've bought them from someone, yes? (Many someones, perhaps, but each share came from somewhere.) And that someone has either (a) also promised them to the short sellers at a future market price, which I assume would be fraudulent; or (b) has not promised them to the short sellers, in which case the short sellers are naked. No? Is there a third option?

Shares are not promised to short sellers. Short sellers borrow shares from someone else and promise to pay them back later.

In the first step, Porsche/LS controls 64% and everyone else owns 36% (called the float). The float consists of public, uncommitted owners. The short sellers then take 13% of the float leaving 23%. These 13% are borrowed, not naked shares. They got them from the 36% of public, uncommitted owners. The shorts sell their 13% to Porsche giving them 77%. Porsche then buys (or options) 18% more from the remaining 23% of public, uncommitted owners. So Porsche has 95%, 5% are still owned by the public, but the short sellers still owe 13% back to the people they borrowed from.

Perhaps the confusion is the definition of naked short. Owing shares does not constitute a naked short. That is true of every short, naked or not. A naked short is selling shares before they actually borrowed them or selling shares that are not actually available. In this case they actually did borrow them from the 36% available from public owners. That's not naked.
posted by JackFlash at 8:59 AM on October 30, 2008

Hedgies crying about information asymmetries and regulatory loopholes. Boo-fucking-hoo. I don't recall any outcry from them when they were using these exact same tools to make massive profits. Don't come running for help when someone beats you at your own game, you fucking whiners. Reminds me of all of those Lloyds Names who went crying to the government in the late 80s and early 90s. 'I didn't know I could lose on an investment. I thought it was a license to print money.' GIRFUY.
posted by Jakey at 9:48 AM on October 30, 2008

eriko: The suspicion is that Porsche has been quietly building their shadow stake in VW for at least two years, whilst milking the hedgies all the time. There wouldn't have been any single option price / volume spike. By spreading the options across a number of banks, they ensured that no one institution had the whole picture, so although the total option interest in VW would have been known, the fact that Porsche was behind most of it wasn't.

Now, I like a good hedge fund schadenfreude story as much as the next man, but this kind of behaviour just destroys trust in the markets, which at the end of the day is bad for everyone, not just hedge funds that found themselves holding the short end of the stick this week. If you can't trust the prices quoted on the market to reflect market participants true assessment of a company's worth, because a single big player is busily gaming the system, then why would you invest anything at all, whether short or long?
posted by pharm at 9:48 AM on October 30, 2008

(There are no stupid questions, right?....) So let me get this straight A is long B comes along and says to A, hey I'd like to be short loan me your shares, B immediately resells them to C. Now C is the real long, the real owner and A & B have a "bet" (my own little terminology for financial shenanigans that have no relationship to actual ownership) about the value of VW (say).

This hardly seems substantially more legitimate than naked shorting. Naked shorting just cuts out the middle man. When B "naked shorts" he's basically saying to A forget about C let's just go straight to the "bet" we would have had in the first place.

I suppose that strictly speaking for this to be a "bet" it would need to have some sort of cash settlement rather than share delivery. I mean I can go to the bar and find some guy and say hey I will pay you the difference between MSFT in the paper today and in a week from now. Why bother to actually buy the stock?

I'm not sure if a pure bet / cash settlement is worse or better. There would be no short squeeze because the shorts wouldn't actually be buying any stock. On the other hand the consequences of that are that basically non-participants would be creating a metamarket, we're going to be sort of waiting on the edge of our seats to see what price the real market sets so we can settle our bet.

Ugly...
posted by Wood at 11:28 AM on October 30, 2008 [1 favorite has favorites]

If you can't trust the prices quoted on the market to reflect market participants true assessment of a company's worth, because a single big player is busily gaming the system, then why would you invest anything at all, whether short or long?

Well, before we go after Porsche, we ought to be shutting down equity firms, VC firms, and a host of other market participants, all of who do exactly what you're railing against.
posted by rodgerd at 11:31 AM on October 30, 2008

Thanks, JackFlash, that makes sense. I'd been under the impression that in order for the short sellers not to be naked they'd have to have already contracted with a fourth party to sell them some shares at the future market price. (Or equivalent bookkeeping within a brokerage, I guess.) Though I suppose when the float goes to zero then the notion of market price becomes ill-defined.

If you can't trust the prices quoted on the market to reflect market participants true assessment of a company's worth, because a single big player is busily gaming the system,

Presumably Porsche is willing to sell at some price, say for argument a trillion euros per share. If that's how much the short sellers need to pay to buy the shares to cover their obligations, then how is that not a case of the market reflecting market participants' assessment of the company's worth?
posted by hattifattener at 12:04 PM on October 30, 2008

Theoretically, if you could perform a hostile take-over and gain control of 100% of the markets, anyone caught shorting would owe you an infinite amount of money, no?
posted by ShadowCrash at 12:34 PM on October 30, 2008

Hattifattener: if the hedgies had known that Porsche controlled 70%+ of VW stock they would never have entered into the shorts in the first place. I'm pretty sure that what Porsche did is verboten on both the UK and US markets, but don't quote me on that: I'm certainly not an expert on exchange regulations!

Odds are that when all this is blown over, the price of VW stock on the open market is going to fall through the floor, since the outlook for all car manufacturers is pretty poor at the moment.
posted by pharm at 1:06 PM on October 30, 2008

Odds are that when all this is blown over, the price of VW stock on the open market is going to fall through the floor, since the outlook for all car manufacturers is pretty poor at the moment.

Or perhaps not.
posted by Skeptic at 2:04 PM on October 30, 2008

Theoretically, if you could perform a hostile take-over and gain control of 100% of the markets, anyone caught shorting would owe you an infinite amount of money, no?

In all practically? No. As the stock price shoots up as a company starts buying more and more stock it would trigger a margin call at some point and you'd either be forced to front up more collateral or close your position.
posted by Talez at 5:58 PM on October 30, 2008

Why do short sellers not hedge with call options?
posted by BrotherCaine at 6:12 AM on October 31, 2008