Home History of Financial Crises The Volkswagen Short Squeeze (2008)

The Volkswagen Short Squeeze (2008)

by internationalbanker

 

Less than a month into 2021, the world watched in amazement as the stock price of the then-troubled American brick-and-mortar video-game and consumer-electronics retailer GameStop skyrocketed after countless traders, mainly from the popular Reddit sub-forum wallstreetbets, bought up the company’s shares in droves.

What’s more, they did this in defiance of major hedge funds on Wall Street that had already deemed GameStop to be overvalued and shorted the stock, meaning that they borrowed stock in order to sell it in the hope that its price would fall, after which they would buy the stock at the lower price and thus secure a sizeable profit. But by driving up the price instead, the Reddit traders inflicted a “short squeeze” on the hedge funds, whereby they would have to purchase the stock at a much higher price and thus incur billions of dollars of losses.

The entire episode harkens back to the days of October 2008, when Porsche inflicted a similar short squeeze on Volkswagen (VW), its fellow automaker and occasional but long-running business partner. Indeed, right in the midst of the global financial crisis (GFC), when following the collapse of Lehman Brothers investors were panic selling across the world and markets were tanking, the “mother of all short squeezes” arose, as one analyst at the time put it.

The Volkswagen-Porsche Short Squeeze happened in the middle of the global financial crisis.

By 2006, Porsche had announced that it wanted to boost its shareholdings of VW and did so by acquiring substantially more stock in the company, which, in turn, began pushing the share price higher. As the price continued to rise throughout 2007, many hedge funds held the view that VW stock had become overvalued and increased their short positions in the troubled carmaker, which had amassed substantial debt by that time. And as the global financial crisis unfolded, of course, VW only suffered further as the demand for new cars collapsed. This made VW an even more enticing candidate for short selling, as its stock was widely expected to plummet.

By March 2008, Porsche owned 31 percent of Volkswagen and confirmed at the time that it was not looking to increase its holdings to 75 percent, as was widely rumoured. “The speculation of going to 75 percent overlooks the realities of the shareholder structure of VW,” Porsche said. “In view of the fact that Lower Saxony as second largest shareholder owns 20 percent of VW, the probability of acquiring the necessary shares in freefloat is extremely low.”

Nonetheless, it became apparent over the ensuing six months that Porsche had decided to up its interest in its rival, which it revealed, to widespread astonishment, on October 26. “Due to the dramatic distortions on the financial markets Porsche Automobil Holding SE, Stuttgart, has decided over the weekend to disclose its holdings in shares and hedging positions related to the takeover of Volkswagen AG, Wolfsburg,” Porsche’s press release noted. “At the end of last week Porsche SE held 42.6 percent of the Volkswagen ordinary shares and in addition 31.5 percent in so called cash settled options relating to Volkswagen ordinary shares to hedge against price risks, representing a total of 74.1 percent.”

As such, Porsche suddenly had the potential to control 74.1 percent of VW. Combined with Lower Saxony’s 20-percent holding, moreover, this meant that the amount of VW shares available to buy on the open market suddenly plunged to less than 6 percent. According to Porsche, however, it was not attempting to acquire VW fully. But it did acknowledge that it had decided to make this announcement “after it became clear that there are by far more short positions in the market than expected”.

Indeed, for those who had shorted the stock, this was a nightmare scenario. A successful short sell required them to borrow shares, sell them in the open market, hopefully buy them back at a lower price and return them to the initial lender, thus locking in a profit on the price drop in the process. But with around 12 percent of VW’s outstanding shares sold short, it was impossible for every short seller to buy back their required shares and close out their positions. As such, a massive imbalance between supply and demand for VW stock emerged.

“The disclosure should give so called short sellers—meaning financial institutions which have betted or are still betting on a falling share price in Volkswagen—the opportunity to settle their relevant positions without rush and without facing major risks,” Porsche stated at the time. But the opposite occurred. By Sunday, October 26, the news was circulating that less than 6 percent of VW voting stock was available in the market.

Panic among short sellers set in, and the supply-demand imbalance triggered a monumental short squeeze that drove its share price up from €210.85 to more than €1,000 in less than two days. Indeed, Volkswagen became the world’s largest company by market value on October 28—albeit, very briefly. Short sellers still trying to close out their positions ended up paying up to €1,005 per share, which in turn put VW’s voting stock at a hefty €296 billion, exceeding the $343-billion market capitalisation commanded by the world’s incumbent top company at the time, ExxonMobil.

German financial-services regulator BaFin (Federal Financial Supervisory Authority) announced on the same day that it was examining the VW stock-price activity for evidence of insider trading or market manipulation. Porsche issued a blanket denial of the latter. “We vehemently reject the accusation of share price manipulation,” a Porsche spokesman stated. “The ones responsible are those that speculated with huge sums of money on a falling Volkswagen share price.”

That said, the following day saw Porsche unload around 5 percent of its VW holdings to the suffering short sellers. Nonetheless, much of the damage had been done. After VW’s share-price peak on the 28th, its stock plunged by 58 percent in just four days as the short squeeze loosened to some degree; a month later, it was down by 70 percent from its peak. But it did not prevent painful losses from being incurred by those short sellers who ended up having to close out their positions at stratospheric price levels.

“Someone must have been very desperate to get a hold of the stock, so there will be a big surprise at some point who will have all these losses—because someone must have lost a lot of money,” Christian Schick, head of portfolio management in Germany for Fortis Investments, observed at the time.

Ultimately, those hedge funds that had shorted VW stock ended up losing an estimated $30 billion from their trades. “I have had hedge fund managers literally in tears on the phone,” said one London-based analyst on the 29th, whilst other hedge-fund managers reportedly compared the Porsche disclosure to a “nuclear bomb going off in our faces”, describing the resulting losses as “a bloodbath”.

But Porsche was able to make huge sums of money, which is even more startling given how badly the automotive industry was doing at the time. Reports emerged of angry traders raging at what they perceived to be a Blitzkrieg attack by Porsche on the financial system, seemingly allowed by German regulators, which permitted it to secretly accumulate VW stock options without having to declare its hand.

“It was one of the most painful days in my career,” Arndt Ellinghorst, who worked at Credit Suisse, told the Financial Times 10 years later. “The pain among investors was unparalleled versus any other market scenario I have encountered.”

 

Further Viewing

Here is a video of the original GameStop (GME) technical analysis provided by Keith Patrick Gill (Reddit username DeepFuckingValue) who turned $53,000 (US) into nearly $50 million.

 

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