6 ms·

A “short squeeze” sounds innocuous enough...

224 points by jdnier 18y ago

"One of the most masterful hacks of the financial system in history."

jdnier 18y ago
Ivan Krstić was the security lead for the One Laptop Per Child project. Here's his completely unrelated retelling of the downfall of Adolf Merckle, one of the world’s richest men, who committed suicide yesterday by throwing himself under a train. Merckle is actually ancillary to the story; it's really more about how Porsche perpetrated "one of the most masterful hacks of the financial system in history." It's fascinating!
mynameishere 18y ago
The key phrase is "infinite squeeze" which is a condition where shorts are forced to buy at any price determined by owners, http://www.economist.com/displaystory.cfm?story_id=12523898&fsrc=nwl http://www.economist.com/displaystory.cfm?story_id=12523898&... ...this is the worst possible condition of a financial market, in which a class of investors can literally dictate prices without limit (IIRC, German authorities stepped in at some point to prevent catastrophe).
- Rod 18y ago
  And since (theoretically) there's no upper bound on the price of a stock, then (theoretically) there's no upper bound on the losses one can incur when engaging in short-selling practises either. Porsche is an evil genius of Finance. Their predatory trading practises have become legendary. Some more links on this: http://www.nuclearphynance.com/Show%20Post.aspx?PostIDKey=122828 http://www.nuclearphynance.com/Show%20Post.aspx?PostIDKey=12... http://ftalphaville.ft.com/blog/2008/10/27/17465/the-disreputable-market-in-volkswagen/ http://ftalphaville.ft.com/blog/2008/10/27/17465/the-disrepu... http://www.bloomberg.com/apps/news?pid=20601087&sid=aAe7ia0t3kDs&refer=home http://www.bloomberg.com/apps/news?pid=20601087&sid=aAe7...
  - sokoloff 18y ago
    Amusing quote from the first link: "Porsche exhibiting their excellent cornering ability"
- sam_in_nyc 18y ago
  What happens in the case of an "infinite squeeze" where the party who owes stock to another cannot pay it back? Is this a risk the lender has to deal with, that they may not ever see the stock they lent out again because the party they lent it to squandered it? Seems to me in the "short squeeze" situation the value of the stock cannot be infinite -- it is bound by the terms of the contract to which the shares were lent out.
  - newt0311 18y ago
    Probably similar to a bankruptcy case though the ins and outs of securities regulations would likely muddy the waters considerably.
  - patio11 18y ago
    You will forfeit whatever you posted for collateral. For a retailer investor, that might mean a margin call causing you to liquidate what you held with your brokerage. There are safety requirements (imposed by the government and your brokerage) to make sure you cover the liability. But when you're talking about billion dollar bets, you probably didn't fully secure it. Nope, you put your reputation up for collateral instead -- "You can trust us to say this billion dollar chunk of stock will be returned on time to the very minute because we have NEVER FAILED TO DO SO, EVER". You really need that capital bit to be true because, if not, you'll never be permitted to do this again by your counterparties. If that happens, say goodbye to your hedge fund -- actually securing the size of bets you are making is murderously expensive. Do you understand why this means you're willing to pay literally any price to satisfy the short according to schedule? If you don't, your firm is finished as a going concern. This is the same reason why no fund family will allow their money market funds to break the buck. They'll invariably kick in their own money to keep it solvent because the alternative means ruin. (The Reserve, which broke the buck earlier in the financial crisis and was not able to kick in funds from other sources, is probably finished, even though the FDIC is now insuring money market funds.)
    - sam_in_nyc 18y ago
      Very informative. It comes down to reputation.
- deleted 18y ago
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tptacek 18y ago
It ends with a bit of a thud, but I had no idea Ivan Krstic was this good a writer. Really great pacing.
sh1mmer 18y ago
This is a brilliantly clear explanation.
- 1gor 18y ago
  Perhaps the author should also made it clear that Porsche took advantage of poor securities laws in Germany rather than showed any 'financial genius'. In US and UK there are explicit regulations forbidding secretly building a stake in a company. This 'hack' is illegal here just like insider trading is.
  - swombat 18y ago
    Indeed - and it should be illegal. The lack of transparency means that hedge funds will now think twice before investing in a company that's based in that jurisdiction.
    - markessien 18y ago
      Not before "investing". Before speculating on the shares of companies in the region. The investors are only the people who purchase the stock as sold from the company - and those people have nothing to lose by this affair.
      - eli 18y ago
        I don't quite follow. Isn't buying shares de facto "investing" ? (You may have a point on the shorting of shares, but that serves a purpose too; to devalue overpriced assets)
        potatolicious 18y ago
        I think he's making a distinction between "classical" investment and Wall Street-style investment (for lack of better terms). There's an ideal that an investor puts money into a business that he thinks has potential to succeed (e.g. VC funding), and reaps his rewards through the success of the business. Then there are others who invest purely as stock price speculation, and is generally disinterested in the actual goings-on of the business beyond what is likely to impact short-term stock price.
sam_in_nyc 18y ago
Question: how is it that nobody knew how much VW Porche owned? Is there no way to see who owns a certain stock, or what stock a company owns?
- svjunkie 18y ago
  I'm sure disclosure laws vary by country, but in the U.S. companies must provide this information to the SEC (via form 13-F and others). On an unrelated note, I believe a better suited word in this case is "innocuous," not "inconspicuous."
- dabeeeenster 18y ago
  You get different brokers to buy it on your behalf bit by bit, anonymously. From there it depends on the laws of the country you are operating within. Companies often do this when selling stock too, so as to not draw attention to themselves or their positions.
  - swombat 18y ago
    Except that, in the US and UK, that's illegal. In Germany, though, where this happened, it's not. That's not a good thing for Germany.
    - dabeeeenster 18y ago
      It's only illegal for companies though, right? If individuals do it they don't need to declare anything do they?
      - Harkins 18y ago
        I've poked through FEC data (lots is available free online via FTP) and seen releases indicating when an individual owns mroe than 5% of a public company. I understand that to be the reporting threshold but could be wrong. Remember, in the US legal system, companies are people. And the legal system is reluctant to create laws restricting only corporate behavior.
nihilocrat 18y ago
He really should have just resigned and tried to leave with a bit of real money to have a comfortable (you know, by normal-people standards) retirement. It's sad to see heinously rich people kill themselves over money.
- gsmaverick 18y ago
  Most of these super rich have built their reputations on being successful, and when the cornerstone of their reputation is suddenly crushed they are overcome really quickly. So it's not so much about the money as it is the self-esteem and reputation.
Guatejon 18y ago
"On paper, Porsche made between €30-40 billion in the affair. Once all is said and done, the actual profit is closer to some €6-12 billion. To put those numbers in perspective, Porsche’s revenue for the whole year of 2006 was a bit over €7 billion." Just shows how out of whack the whole economy is in that Porsche could make more money for their shareholders by playing financial games then actually manufacturing products.
- eru 18y ago
  It came at a risk, though.
  - run4yourlives 18y ago
    So would normal profits from products though. They're in the automotive industry after all.
    - eru 18y ago
      But that's their normal business risk.

224 points by jdnier 18y ago

"One of the most masterful hacks of the financial system in history."

Ivan Krstić was the security lead for the One Laptop Per Child project. Here's his completely unrelated retelling of the downfall of Adolf Merckle, one of the world’s richest men, who committed suicide yesterday by throwing himself under a train. Merckle is actually ancillary to the story; it's really more about how Porsche perpetrated "one of the most masterful hacks of the financial system in history." It's fascinating!

mynameishere 18y ago

The key phrase is "infinite squeeze" which is a condition where shorts are forced to buy at any price determined by owners, http://www.economist.com/displaystory.cfm?story_id=12523898&fsrc=nwl http://www.economist.com/displaystory.cfm?story_id=12523898&... ...this is the worst possible condition of a financial market, in which a class of investors can literally dictate prices without limit (IIRC, German authorities stepped in at some point to prevent catastrophe).

Rod 18y ago
And since (theoretically) there's no upper bound on the price of a stock, then (theoretically) there's no upper bound on the losses one can incur when engaging in short-selling practises either. Porsche is an evil genius of Finance. Their predatory trading practises have become legendary. Some more links on this: http://www.nuclearphynance.com/Show%20Post.aspx?PostIDKey=122828 http://www.nuclearphynance.com/Show%20Post.aspx?PostIDKey=12... http://ftalphaville.ft.com/blog/2008/10/27/17465/the-disreputable-market-in-volkswagen/ http://ftalphaville.ft.com/blog/2008/10/27/17465/the-disrepu... http://www.bloomberg.com/apps/news?pid=20601087&sid=aAe7ia0t3kDs&refer=home http://www.bloomberg.com/apps/news?pid=20601087&sid=aAe7...
- sokoloff 18y ago
  Amusing quote from the first link: "Porsche exhibiting their excellent cornering ability"
sam_in_nyc 18y ago
What happens in the case of an "infinite squeeze" where the party who owes stock to another cannot pay it back? Is this a risk the lender has to deal with, that they may not ever see the stock they lent out again because the party they lent it to squandered it? Seems to me in the "short squeeze" situation the value of the stock cannot be infinite -- it is bound by the terms of the contract to which the shares were lent out.
- newt0311 18y ago
  Probably similar to a bankruptcy case though the ins and outs of securities regulations would likely muddy the waters considerably.
- patio11 18y ago
  You will forfeit whatever you posted for collateral. For a retailer investor, that might mean a margin call causing you to liquidate what you held with your brokerage. There are safety requirements (imposed by the government and your brokerage) to make sure you cover the liability. But when you're talking about billion dollar bets, you probably didn't fully secure it. Nope, you put your reputation up for collateral instead -- "You can trust us to say this billion dollar chunk of stock will be returned on time to the very minute because we have NEVER FAILED TO DO SO, EVER". You really need that capital bit to be true because, if not, you'll never be permitted to do this again by your counterparties. If that happens, say goodbye to your hedge fund -- actually securing the size of bets you are making is murderously expensive. Do you understand why this means you're willing to pay literally any price to satisfy the short according to schedule? If you don't, your firm is finished as a going concern. This is the same reason why no fund family will allow their money market funds to break the buck. They'll invariably kick in their own money to keep it solvent because the alternative means ruin. (The Reserve, which broke the buck earlier in the financial crisis and was not able to kick in funds from other sources, is probably finished, even though the FDIC is now insuring money market funds.)
  - sam_in_nyc 18y ago
    Very informative. It comes down to reputation.
deleted 18y ago
[deleted]

deleted 18y ago

[deleted]

tptacek 18y ago

It ends with a bit of a thud, but I had no idea Ivan Krstic was this good a writer. Really great pacing.

sh1mmer 18y ago

This is a brilliantly clear explanation.

1gor 18y ago
Perhaps the author should also made it clear that Porsche took advantage of poor securities laws in Germany rather than showed any 'financial genius'. In US and UK there are explicit regulations forbidding secretly building a stake in a company. This 'hack' is illegal here just like insider trading is.
- swombat 18y ago
  Indeed - and it should be illegal. The lack of transparency means that hedge funds will now think twice before investing in a company that's based in that jurisdiction.
  - markessien 18y ago
    Not before "investing". Before speculating on the shares of companies in the region. The investors are only the people who purchase the stock as sold from the company - and those people have nothing to lose by this affair.
    - eli 18y ago
      I don't quite follow. Isn't buying shares de facto "investing" ? (You may have a point on the shorting of shares, but that serves a purpose too; to devalue overpriced assets)
      - potatolicious 18y ago
        I think he's making a distinction between "classical" investment and Wall Street-style investment (for lack of better terms). There's an ideal that an investor puts money into a business that he thinks has potential to succeed (e.g. VC funding), and reaps his rewards through the success of the business. Then there are others who invest purely as stock price speculation, and is generally disinterested in the actual goings-on of the business beyond what is likely to impact short-term stock price.

sam_in_nyc 18y ago

Question: how is it that nobody knew how much VW Porche owned? Is there no way to see who owns a certain stock, or what stock a company owns?

svjunkie 18y ago
I'm sure disclosure laws vary by country, but in the U.S. companies must provide this information to the SEC (via form 13-F and others). On an unrelated note, I believe a better suited word in this case is "innocuous," not "inconspicuous."
dabeeeenster 18y ago
You get different brokers to buy it on your behalf bit by bit, anonymously. From there it depends on the laws of the country you are operating within. Companies often do this when selling stock too, so as to not draw attention to themselves or their positions.
- swombat 18y ago
  Except that, in the US and UK, that's illegal. In Germany, though, where this happened, it's not. That's not a good thing for Germany.
  - dabeeeenster 18y ago
    It's only illegal for companies though, right? If individuals do it they don't need to declare anything do they?
    - Harkins 18y ago
      I've poked through FEC data (lots is available free online via FTP) and seen releases indicating when an individual owns mroe than 5% of a public company. I understand that to be the reporting threshold but could be wrong. Remember, in the US legal system, companies are people. And the legal system is reluctant to create laws restricting only corporate behavior.

nihilocrat 18y ago

He really should have just resigned and tried to leave with a bit of real money to have a comfortable (you know, by normal-people standards) retirement. It's sad to see heinously rich people kill themselves over money.

gsmaverick 18y ago
Most of these super rich have built their reputations on being successful, and when the cornerstone of their reputation is suddenly crushed they are overcome really quickly. So it's not so much about the money as it is the self-esteem and reputation.

Guatejon 18y ago

"On paper, Porsche made between €30-40 billion in the affair. Once all is said and done, the actual profit is closer to some €6-12 billion. To put those numbers in perspective, Porsche’s revenue for the whole year of 2006 was a bit over €7 billion." Just shows how out of whack the whole economy is in that Porsche could make more money for their shareholders by playing financial games then actually manufacturing products.

eru 18y ago
It came at a risk, though.
- run4yourlives 18y ago
  So would normal profits from products though. They're in the automotive industry after all.
  - eru 18y ago
    But that's their normal business risk.