In early 2021, there was a surprising event in the financial world. The stock price of GameStop, a struggling video-game and electronics retailer, soared. This unexpected surge was driven by a group of traders from the Reddit forum called wallstreetbets, who went against major hedge funds on Wall Street. These hedge funds had thought GameStop was overvalued and had bet against it, borrowing stock with the hope that its price would fall. Instead, the Reddit traders pushed the price higher, causing what’s known as a “short squeeze” and resulting in billions of dollars in losses for the hedge funds.
This incident brings to mind a similar situation in October 2008 when Porsche created a short squeeze on Volkswagen (VW) during the global financial crisis. In 2006, Porsche announced plans to increase its stake in VW, driving up the stock price. Throughout 2007, as the price continued to climb, many hedge funds believed that VW’s stock had become overvalued. Consequently, they increased their short positions, essentially betting that the troubled carmaker’s stock would decline. This situation was exacerbated by VW’s substantial debt and the worsening global financial crisis, which caused a sharp drop in demand for new cars. As a result, VW became an even more attractive target for short selling, with widespread expectations that its stock would soon experience a significant decline. As the financial crisis worsened, Porsche surprised everyone by revealing it owned over 74% of VW, causing a shortage of available shares and triggering a massive short squeeze.
By March 2008, Porsche owned 31% of Volkswagen and confirmed it wasn’t planning to increase its holdings to 75%, as rumored. However, over the next six months, Porsche increased its interest, revealing on October 26 that it held 74.1% of VW, potentially controlling the majority. This move caused a scarcity of VW shares on the open market. This move, combined with Lower Saxony’s 20% holding, significantly reduced the number of VW shares available on the market to less than 6%.
It became evident in the following six months that Porsche had chosen to increase its stake in its competitor. This revelation, made on October 26, surprised many. In response to the notable distortions in financial markets, Porsche Automobil Holding SE, based in Stuttgart, decided to disclose its holdings. According to Porsche’s press release, “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 related to Volkswagen ordinary shares to hedge against price risks, representing a total of 74.1 percent.”
For short sellers who bet on a stock’s decline, this was a nightmare. A successful bet required them to borrow shares, sell them, and buy them back at a lower price, making a profit. However, with around 12% of VW’s shares sold short, it became impossible for every short seller to buy back their required shares. This created a massive imbalance in supply and demand.
The imbalance between supply and demand led to a massive short squeeze, driving VW’s share price from €210.85 to over €1,000 in just two days. Volkswagen briefly became the world’s most valuable company on October 28. Panic among short sellers ensued, and they ended up paying exorbitant prices to close their positions.
Short sellers, facing a supply-demand crisis, experienced a significant panic that triggered a massive short squeeze. In less than two days, Volkswagen’s share price skyrocketed from €210.85 to over €1,000. Briefly, on October 28, Volkswagen became the world’s largest company by market value. Short sellers desperately attempting to exit their positions found themselves paying as much as €1,005 per share. This surge pushed VW’s voting stock to a mammoth €296 billion, surpassing the $343-billion market capitalization of the world’s leading company at the time, ExxonMobil.
Porsche claimed its disclosure was meant to help short sellers settle their positions without facing major risks, but it had the opposite effect. Panic set in among short sellers, leading to a monumental short squeeze. VW’s share price skyrocketed from €210.85 to over €1,000 in less than two days, briefly making it the world’s most valuable company. Short sellers trying to close their positions ended up paying exorbitant prices, putting VW’s voting stock at a substantial €296 billion.
German financial regulator BaFin examined the VW stock-price activity for possible insider trading or market manipulation. Porsche denied manipulation, blaming those who had speculated on a falling VW share price. 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.” The following day, Porsche sold around 5% of its VW holdings, but the damage was done. After VW’s peak on October 28, its stock plunged by 58% in four days, and a month later, it was down by 70%.
Hedge funds that had shorted VW stock suffered an estimated $30 billion in losses, causing significant distress in the financial industry. Meanwhile, Porsche made substantial profits. Despite the turmoil, Porsche’s actions were legal, and German regulators were criticized for allowing the accumulation of VW stock options without disclosure.
This incident had a lasting impact on the financial world, prompting debates on market regulations and the power dynamics between small retail investors and institutional investors. It showcased the unpredictability of financial markets and the potential consequences of short squeezes, leaving investors and analysts reflecting on the unprecedented events.
