It really is a pity capitalism can’t devote
as much ingenuity on a cure for cancer as it does on trying to make money or as
much resources on getting rid of world poverty as it does on gambling. But it’s
a laugh when they get it horribly wrong.
Hedge funds are a bunch of locusts who add
nothing to the sum total of human happiness. One of the ways they make money is
by short selling. Short selling is betting that shares, or other pieces of
paper, will go down in price. The hedge fund borrows the shares from an
institution for a fee, for example £80 for 8. They sell the shares – that they
don’t own! If they’re right and the shares go down they can buy them back later
for £64, give the institution 10 shares back and keep £16. Easy peasy.
The reader may very well ask the question:
why should an institution lend its assets to a hedge fund whose intention is to
sell them short? It’s a good question. The short answer is: that’s capitalism
for you.
Shorting is now so standard that they don’t
even need a human brain to set the deal up. They can programme a bank of
computers to do the job. After all, for the past couple of weeks almost all
shares have been going down. So short selling has been money for old rope.
Except…except when it goes wrong. Nobody
told the computers that Volkswagen was being stalked for takeover by Porsche. Porsche
made the announcement on Sunday. When a predator goes in for the kill, the remaining
shares in the firm being taken over usually go up in price since the stalker
needs to get enough shares to bid for overall control.
The computers were programmed on the basis
that VW shares, like all shares in car companies, were likely to go down and
the hedge funds could help them on their way. Then the news came out about
Porsche’s takeover bid. All the hedge funds realised that VW shares were going
to go up and they’d have to ‘cover their positions.’ (Don’t forget they didn’t
actually own the VW shares they were short selling.) All the capitalists who
were merrily selling VW short now had to buy. Panic stations. This situation is
called a short squeeze.
On Monday October 28 VW shares suddenly
surged by 147%. At one point VW was more highly valued for its shares than
ExxonMobil, Wal-Mart, Microsoft or General Electric. Total share price was £280bn.
Shares were trading at one point at £800, more than five times what they were
supposed to be worth the previous Friday. Analyst Max Warburton called it, “The
biggest short squeeze in history,” adding that, since the institutions who had
lent the hedgies VW shares could name their price, “It is a short squeeze to
infinity.”
Like any bad loser, the hedge fund managers
are crying foul at Porsche. Porsche, after all, stands to make pots of money on
their VW holdings at the hedge funds’ expense. And, boy, have they lost! £8-12bn
by some estimates, others guess £24bn. “This was supposed to be a very low risk
trade, and it’s a nuclear bomb which has gone off in people’s faces,” said one.
Bob McKee, chief economist at Independent
Strategy, commented, “We are either seeing hedge funds closing down, or
investors are trying to redeem their investments. In addition the returns on their
investments are now really appalling – some aren’t making any money for their
clients.” The Bank of England echoes his pessimism. Hedge funds look to be the next
victims of the credit crunch. And – be honest – would anyone but the rich who
invest in them and the managers who run them really notice?
