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Saturday, November 8, 2008

Family Kidnaped by Ninjas

Friday, November 7, 2008

Can this Mess be Fixed?

A lot of people have been asking and wondering, what will work? What can prevent a massive recession? What can prevent a depression? How are our policy makers and political leaders going to ‘fix’ this mess?

The answer is actually a simple one and was very carefully and neatly articulated in the 1920’s.

The Original:

“Es gibt keinen Weg, den finalen Kollaps eines Booms durch Kreditexpansion zu vermeiden. Die Frage ist nur ob die Krise früher durch freiwillige Aufgabe der Kreditexpansion kommen soll, oder später zusammen mit einer finalen und totalen Katastrophe des Währungssystems kommen soll.” - Ludwig von Mises

The Translation:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” –Ludwig von Mises

Well, we all know which route was chosen for us. One more final, massive, desperate push in credit expansion should just about do it…

Those of you that have never read Ludwig von Mises, I highly recommend you do.

Mises figured out in the 1920’s what our current economic leaders still haven’t figured out. He enraged all the communists and socialists, proving mathematically that non-factor-market (NFM) socialism could never work. This was called the economic calculation problem. All statist regimes face this problem to varying degrees including our own mixed economy. The evidence is plain to see in our history of booms, bubbles and busts.

Market interference via tax policies, subsidies, tariffs, regulation and ridiculous fiscal and monetary policy result in the constant misallocation of scarce resources because they distort market prices and market signals.

Zero Rate World, the Age of Free Money: We're Doomed

Global ZIRP. This is going to be a disaster.

In a zero rate world there is NO incentive to save. NONE.
In a zero rate world the incentive is to borrow, leverage and spend.

Kind of like what we have been doing.
That didn't work out so well.

So how can more of the same be a fix? If cheap and easy credit got us into this mess how can the absolute extreme version of cheap and easy credit get us out? How can ZIRP save the day?

This neo-Keynesian claptrap has got to stop. Quantitative easing doesn't work. It's probably time for heterdox monetary policy.

Otherwise we're all doomed.

Zero Rate World May Lie Ahead as King, Trichet Cut (Update3):The age of free money may be at hand.

As major central banks slash interest rates with unexpected speed, benchmark borrowing costs are now below core inflation for the first time since the early 1980s, and policy makers are signaling they will go deeper.

Yesterday's cuts by the Bank of England and European Central Bank, which came with the Federal Reserve and Bank of Japan on the cusp of zero rates, are a bid to shock life back into their recessionary economies and strained money markets. It may be an uphill battle as consumers and businesses show greater interest in saving than spending, and banks hoard capital rather than lend it.

“It's the race to zero,” said Stewart Robertson, an economist at Aviva Investors Ltd. in London, which manages about $230 billion. “There's no obstacle to more rate cuts.”

Thursday, November 6, 2008

Who Needs Vegas, When You Can Gamble with Your 401k?

ECB Cuts But Nobody Buys

After the Bank of England (BoE) cut by 1.5%, this cut of 0.50% is seen as a little bit of a disappointment.

Equities futures did a feeble pop and drop and are now languishing again at overnight lows. Considering the magnitude of the cuts, (the Swiss tossed in a surprise 50 basis point cut of their own for good measure) this is deeply worrying.

Equities are clearly going to go cliff diving now. Let it Bounce, So We Can Short Again still stands. I got my first set of shorts off yesterday as the S&P 500 (ES DEC08) couldn’t get back above the 1000 mark in early trade. I’m adding here since it is clear now that absolutely nothing can inspire buyers…

ECB Cuts Interest Rate by Half Point to Counter Economic Slump: “The European Central Bank lowered interest rates for the second time in less than a month to counter the euro region's worst economic slump in 15 years.

ECB policy makers meeting in Frankfurt reduced the benchmark lending rate by half a percentage point to 3.25 percent, as predicted by all but one of 55 economists in a Bloomberg News survey. The ECB cut the rate by the same amount when it joined a globally coordinated move on Oct. 8 in response to the deepening financial crisis. The Bank of England today lowered its key rate by 1.5 percentage points to 3 percent and Switzerland's central bank lowered rates in an unscheduled move.

Economists predict the ECB will continue to reduce borrowing costs at the most aggressive pace in its 10-year history, taking its key rate to 2.5 percent by April as growth slows around the world. The economy of the 15 nations sharing the euro is probably already in a recession and will stagnate in 2009, the European Commission said this week.

“The dimension of the crisis requires forceful action,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “The ECB is more focused on the risks to growth.”

ECB President Jean-Claude Trichet will hold a press conference at 2:30 p.m. to explain today's decision.

`Door Open'

Trichet will “probably leave the door open for further rate cuts,” said Holger Schmieding, chief European economist at Bank of America Corp. in London. He will “likely warn that the euro economy will not grow at all in late 2008 and early 2009 and recover only haltingly thereafter.”

Economic growth in the euro area will slump to just 0.1 percent next year, the worst performance since 1993, the Brussels- based European Commission forecast on Nov. 3. It said the economy, which contracted in the three months through June, will probably continue to shrink in the third and fourth quarters.

Europe's manufacturing and service industries contracted at a record pace in October while executive and consumer confidence has slumped to a 15-year low. Manufacturing orders in Germany, Europe's largest economy, dropped by a record 8 percent in September, the government said today.

The crisis that started with the U.S. housing slump and drove Lehman Brothers into bankruptcy caused the biggest global stock sell-off in 70 years. Banks in Europe remain reluctant to lend to each other even after the ECB flooded them with cash and governments announced rescue packages to prevent banking failures.

`Behind The Curve'

“Interest rates have to be appropriate for the economic environment,” ECB council member Axel Weber said Oct. 30. “If the economy cools, then rates have to come down rapidly so one doesn't risk falling behind the curve.”

The Federal Reserve last week cut its benchmark to 1 percent from 1.5 percent and signaled it's ready to take rates to the lowest level on record. China and Japan have also reduced rates, and Australia this week slashed borrowing costs by three quarters of a percentage point.

The ECB raised rates as recently as July, saying Europe's economic fundamentals were sound and inflation was a bigger threat than weaker growth. Since then, oil prices have more than halved from a peak of $147 a barrel.

Inflation slowed to 3.2 percent in October after reaching a 16-year high of 4 percent in July. Still, the ECB aims to keep the rate below 2 percent. Trichet has stressed the need for moderate pay increases, saying there's a risk of a wage-price spiral as workers seek compensation for the higher cost of living.

Lowering interest rates too much also risks re-fueling the excessive borrowing that led to today's problems, ECB Executive Board member Lorenzo Bini Smaghi said on Oct 31.

“The present crisis is partially due to interest rates that remained at low levels for too long,” he said. “At that time, rates were lowered too much in order to stimulate growth. We need to avoid repeating the same mistakes.””

Bank of England, Huge Panic Cut

The market was expecting 1% at most. This cut smells of absolute panic. The market is taking this as a bad bad sign.

This is the largest single cut I’ve ever seen from the Bank of England.

Just another Step Closer to ZIRP, Liquidity Trap, Lost Decade.

Global ZIRP should be interesting though. I mean how is that going to work if money is practically free on a global scale?

Bank of England Cuts Key Rate by 1.5 Percentage Points to 3%: “The Bank of England unexpectedly cut the benchmark interest rate by 1.5 percentage points as policy makers tried to contain the damage caused by a recession.

The nine-member Monetary Policy Committee, led by Governor Mervyn King, slashed the bank rate to 3 percent. The move was predicted by none of the 60 economists in a Bloomberg News survey.”

Bank of England MPC Comments on November Rate Change (Text): “The following is the text of the Bank of England Monetary Policy Committee comments following the November rate decision:

The Bank of England's Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 1.5 percentage points to 3%.

The past two months have seen a substantial downward shift in the prospects for inflation in the United Kingdom. There has been a very marked deterioration in the outlook for economic activity at home and abroad. Moreover, commodity prices have fallen sharply.

Since mid-September, the global banking system has experienced its most serious disruption for almost a century. While the measures taken on bank capital, funding and liquidity in several countries, including our own, have begun to ease the situation, the availability of credit to households and businesses is likely to remain restricted for some time. As a consequence, money and credit conditions have tightened sharply. Equity prices have fallen substantially in many countries.

In the United Kingdom, output fell sharply in the third quarter. Business surveys and reports by the Bank's regional Agents point to continued severe contraction in the near term. Consumer spending has faltered in the face of a squeeze on household budgets and tighter credit. Residential investment has fallen sharply and the prospects for business investment have weakened. Economic conditions have also deteriorated in the UK's main export markets.

CPI inflation rose to 5.2% in September. The substantial rise since the beginning of the year largely reflects the impact of higher energy and food prices. But commodity prices have fallen sharply since mid-summer, with oil prices down by more than a half. Inflation should consequently soon drop back sharply, as the contribution from retail energy and food prices declines, notwithstanding the fall in sterling. Pay growth has remained subdued. And measures of inflation expectations have fallen back.

Since the beginning of the year, the Committee has set Bank Rate to balance two risks to the inflation outlook. The downside risk was that a sharp slowdown in the economy, associated with weak real income growth and the tightening in the supply of credit, pulled inflation materially below the target. The upside risk was that above-target inflation persisted for a sustained period because of elevated inflation expectations. In recent weeks, the risks to inflation have shifted decisively to the downside. As a consequence, the Committee has revised down its projected outlook for inflation which, at prevailing market interest rates, contains a substantial risk of undershooting the inflation target. At its November meeting, the Committee therefore judged that a significant reduction in Bank Rate was necessary now in order to meet the 2% target for CPI inflation in the medium term, and accordingly lowered Bank Rate by 1.5 percentage points to 3.0%.

The Committee's latest inflation and output projections will appear in the Inflation Report to be published on Wednesday 12 November.

The minutes of the meeting will be published at 9.30am on Wednesday 19 November.”

Wednesday, November 5, 2008

Those Nigerians Sure Are Quick

Those Nigerians sure are quick to adapt… (I'm just guessing this is an adaptation of the classic Nigerian e-mail scam.)

Fed Warns Consumers About Pitches on Phony U.S. Lending Program: “The U.S. Federal Reserve cautioned consumers against fraudulent solicitations claiming access to a nonexistent federal consumer loan program.

Individuals are being told brokers can tap into a Fed effort providing “sizable secured loans to consumers,” the Fed said in a statement today. Consumers are then encouraged to deposit large sums of money, described as a security deposit, to get their loan, the bank said.

“The Federal Reserve is advising consumers that it has no involvement in these solicitations and does not directly sponsor consumer lending programs,” the statement said.

The central bank has done an unprecedented amount of lending in multiple attempts to stem the financial crisis since September. It extended a $122.8 billion credit line to American International Group Inc., the largest U.S. insurance company. The Fed also bought commercial paper valued at $145.7 billion in an effort to support money markets and issued a record $110.7 billion in direct loans to commercial banks as of Oct. 29.

Investors should “verify the legitimacy” of potential business partners, the Fed said. Questions can be addressed to the Federal Reserve's help center at 1-888-851-1920 or”

For $50 cash I can show you how to access the discount window directly…

Tuesday, November 4, 2008

Let It Bounce, So We Can Short Again

The S&P 500 has finally strung together two consecutive up days in the month of October. Volume has rapidly declined as prices approached resistance round the 985 area and the declining 20 day EMA (blue line).

Ultimately a bounce to resistance around the 1050 – 1070 area is possible.

The Nasdaq Composite has put in five straight up days on rapidly decreasing volume. Futures are up pre-market, so that could result in the sixth day. Prices are at resistance around 1782 and the declining 20 day EMA (blue line).

Ultimately a bounce to resistance around 1900 is possible where the declining 50 day EMA (red line) should come into play as well.

An Obama win might be the catalyst as the world feels a brief, naive rush of relief, change and hope.

I think the economic data; especially the borrowing needs of the treasury on Wednesday and Non-Farm Payrolls on Friday will bring those hopes crashing back to earth.

I will be using this opportunity to get rid of my last longs from the panic days earlier in the month.

Let it bounce, so I can get heavily short again above 1000 on the S&P 500.

Monday, November 3, 2008

Stimulus: The Germans Do It Differently

“History shows that economic stimulus packages aren't a panacea. Taking into account what we know now, the measures will alleviate the looming recession but won't stop it.” -Joerg Kraemer, Commerzbank AG

Germany Plans Stimulus Program to Boost Economy (Update1): “The German government plans a two-year program of investments and incentives to provide a 50 billion- euro ($64-billion) boost to the slowing economy hit by the freeze in global credit markets.

“Measures to safeguard companies' financing and liquidity are provided by funding investments worth slightly more than 20 billion euros,” according to a joint paper by the economy and finance ministries obtained by Bloomberg News. They “will encourage investments and orders by companies, private households and municipalities totaling about 50 billion euros.”

Chancellor Angela Merkel said yesterday the government will enact “broad” measures to bolster the economy. The government has so far been divided on whether to offer tax cuts or boost spending, and the Cabinet will discuss the package on Nov. 5.”

The U.S. government recently implemented their own stimulus package which I covered in Fact Sheet: The Bush Stimulus Package:

“My Comments

1. The tax rebates won’t be spent on consumption. They will be hoarded and used to make last ditch debt servicing payments. The rebates are barely the equivalent of a single month’s mortgage payment for a couple. These rebates will simply buy some time. A month or two. They will not stimulate the consumer.

2. Businesses are expecting a slowing economy. They will not purchase new equipment with wild enthusiasm just because they can deduct more of the cost. The primary driver of a business purchase decision is definitely not the tax implications. If a new machine is not needed, it is not still purchased because of some tax advantage. The tax break will likely only have a small affect on businesses purchases. Positive economic effects would be marginal and temporary. For example, it may push up by a quarter or two purchases that were planned for later. Naturally, this then results in weak business demand later.

3. Bottom Line: The average Joe six pack is a baby boomer quickly running out of time. His single largest asset, his primary residence, is deflating rapidly. This single largest asset is also the primary collateral for his single largest liability. His balance sheet is rapidly deflating as all his assets, from his home to his equity portfolio, all simultaneously deflate while his debt outstanding may actually still be increasing. His debt servicing costs not dropping, despite aggressive rate cuts, and may actually be rising. It has also become damn near impossible to refinance certain mortgages as easy credit evaporates. On top of that, Joe six pack should now be seriously concerned about his job security. So when a cheque for $300 to $1500 arrives in the mail, Joe six pack is not going to spend it on a $200 steak dinner or a new computer or on a vacation. Got it?”

Well, it all came to pass, EXACTLY as predicted. I tackled stimulus packages again in Stimulus: Does It Even Work? where I use the Japanese experience with a credit, equity and real estate bubble as an example:

“In the end it all didn’t work. The agony was prolonged and is now referred to as the Lost Decade in Japan.

Sparked by low interest rates, Japans average home value more than doubled from the early 1980's to 1990 (sound familiar?). Now, over 16 years after prices peaked, home values are still declining and are nearing the average price of 1980.

The situation in Japan then and America now are eerily similar. I would argue that America is actually worse off. The ABSOLUTE lack of personal savings is really going to hurt the team here.”

The question then is why, after so much evidence to the contrary are the Germans now trying to make a stimulus package of their own work? The Germans actually admit that they don’t expect the traditional stimulus package to work:

“A broad-based, economic stimulus program financed through debt would only burn taxpayers' money. After a couple of years, at the latest, middle-income people would have to pay for it through higher taxes.”

What then are they up to?

“Possible stimulus measures include a two-year tax break on purchases of cars with lower-than-normal carbon-dioxide emissions, greater tax relief on household repairs and funds for improving the energy efficiency of buildings, according to the document.”

Notice the absolute FOCUS on energy efficiency? The Germans are planning for the long run. They clearly view the current collapse of crude prices as a temporary phenomenon. When crude prices do another moonshot, to new highs, the Germans expect to be prepared. Americans, having spent their stimulus checks on new Plasma screen TVs and filling up their giant SUVs will get pwned. AGAIN.

The Germans do it differently.

Germans Teach the LOCUST Funds a Lesson

It all started with Volkswagen Short Squeeze, Hedgies Hurting. Slowly word is spreading on the actual damage as facts and figures come to light.

A favorite theory is that the German government and Porsche engineered this mother of all short squeeze to teach the LOCUST funds a lesson.

Eventually VW will fall back to earth as the last few hedgies are carried out bloodied and tattered on their battle worn shields...

Porsche and VW share row: how Germany got revenge on the hedge fund 'locusts': “Gordon Rayner discovers how financial predators became the prey in the audacious multi-billion takeover of VW by Porsche.

With its jaws gaping, poised to swallow its prey, Damien Hirst's tiger shark in formaldehyde takes pride of place in the $700 million art collection of the hedge fund manager Steven A Cohen.
Until now, it had served as a symbol of the killer instincts which made Mr Cohen and his fund SAC Capital one of the biggest predators in the world's financial markets, earning him a personal fortune estimated at $8 billion.

"I liked the whole fear factor," he said cheerily when explaining what had attracted him to the Hirst shark which he bought for $8 million four years ago.

The fear factor is something Mr Cohen, and around 100 other hedge fund managers, are experiencing, like never before, as SAC Capital and others collectively lost a staggering £24 billion with a doomed gamble on Volkswagen shares, according to the Wall Street Journal.

The biters have been well and truly bitten, and in a week full of ironies it was Porsche, manufacturer of the hedge fund managers' transport of choice, which was to blame.

While "hedgies" bet on VW shares falling because of the global economic downturn, regarded by some as "the safest play in town", Porsche had been secretly building up a 74.1 per cent stake in VW through intermediaries.

When Porsche showed its hand, it sent the VW share price rocketing and exposed the hedge funds to breathtaking losses.

"I have had hedge fund managers literally in tears on the phone," said one London-based analyst yesterday. Others likened the Porsche disclosure to a "nuclear bomb going off in our faces", describing the resulting losses as "a bloodbath".

For many impartial observers, the biggest single loss in the history of hedge funds will be nothing less than just desserts for the "vulture capitalists" who were blamed, perhaps unfairly, for helping bring about the demise of HBOS through their controversial practice of short selling.

Together with Connecticut-based Mr Cohen, who recently shrugged off a $100,000 restoration of the Hirst shark as an "inconsequential" expense, this week's losers include David Einhorn, the poker-playing president of the American fund Greenlight Capital, who helped drive down the value of Lehman Brothers shares before the investment bank collapsed this summer.

In London, Odey Asset Management, managed by Crispin Odey, who paid himself £28 million this year, also took a substantial hit.

Many fund managers believe they are victims of a stitch-up orchestrated by the German government and Porsche.

The German establishment has never tried to hide its contempt for them, with a leading politician referring to hedge fund managers as "locusts". One trader went as far as describing this week's events as "payback".

Certainly, Porsche's secretive empire-building would have been illegal in the UK, which has much stricter rules on disclosure. But do the fund managers have a case?

The root of the hedge funds' demise lies, appropriately perhaps, in the murky practice of short selling, in which traders seek to make huge sums by betting on the share price of a company falling.

Traders agree to sell shares in a company (in this case VW) to a third party at a fixed price and by a certain date, then wait for the price to fall before buying the shares and handing them on to the third party.

The difference between the agreed sale price and the price at which the trader buys the shares is profit. But if the share goes up, traders are exposed to potentially limitless losses.

Shorting in financial shares has been temporarily banned, but it remains legal in other sectors of the market.

Hedge funds believed they were on safe ground by short selling VW shares, which they saw as overvalued when all car manufacturers are feeling the squeeze.

What none of them knew was that Porsche had quietly been adding to its 42.6 per cent stake in VW by taking out options to buy VW shares owned by a number of German banks.

Germany's somewhat eclectic financial regulations did not require Porsche to disclose this, and so none of the hedge fund managers had a clue what Porsche was up to.

That all changed with spectacular consequences when the sports car manufacturer suddenly issued an announcement, in German, just after 3pm on Sunday declaring that it either owned or had the option to own 74.1 per cent of VW.

With the state of Lower Saxony owning another 20.1 per cent, this meant that just 5.8 per cent of VW shares were available to buy.

But hedge fund managers had promised to sell to third parties a total of 12 per cent of VW's shares, and 12 into 5.8 doesn't go.

One London-based fund manager saw the news when he flicked through financial websites on his BlackBerry during a Sunday afternoon walk.

"I ran like a madman back to my house," he said. "I assumed the numbers were wrong. I called my broker and couldn't get through.

"But when I finally did speak to him, and he told me he'd had a dozen panicked calls already, I knew it was true."

Across the capital, and in financial centres across the world, brokers rushed to their offices to work out just how big a hit their clients were about to take.

Throughout Sunday afternoon, their phones rang off the hook as traders called them begging for help, undisguised panic in their voices.

Hours before the markets opened here on Monday morning, hedge fund offices in "hedge fund alley'' in Mayfair were already buzzing with activity as traders went through the numbers over and over again, unable to do anything more meaningful until the German stock exchange opened at 8am.

"We knew there would be a bloodbath as soon as the market opened," said the trader. "We knew the price would rocket, widening the exposure of lots of hedge funds – they would be offering their daughters in return for the stock, just to get out of it."

The scramble for shares meant that shareholders could name their price, and VW stock went from 210 euros to more than 1,000 euros in two days, making VW, at one point on Tuesday, the world's most valuable company at £240 billion.

Meanwhile, the fund managers who hadn't managed to buy enough shares to settle their accounts watched with horror as their losses spiralled out of control. Some of the bigger funds are thought to have lost as much as £4 billion.

And as the price of those precious shares quadrupled, Porsche made a paper profit of more than £100 billion, dwarfing the money it makes from selling cars.

Across the world, traders raged at what they saw as a thinly disguised sting operation by Porsche and the German financial establishment. In almost any other country, Porsche would have been forced to declare its hand, rather than secretly building up share options through third parties. The hedge funds are demanding an investigation.

Christian Strenger, a board member of Germany's biggest fund manager DWS, said the German government needed to address the "untransparent" regulations, while Mike Warburton, an analyst at the City firm Sanford Bernstein, described the situation as "arguably an embarrassment for all European capital markets".

Bafin, Germany's financial regulator, insists no rules have been broken.

So should we lose any sleep over the fact that hedge funds have lost their shirts, or should we all indulge in a spot of schadenfreude? The answer, as we should know after months of financial turmoil, is that we are all, ultimately, likely to be losers.

Hedge funds will have to sell shares in other companies to make up for their losses on VW, which is likely to drive down those shares and contribute to the continuing turmoil on the stock market, further damaging the value of pension funds.

Several banks which are thought to have acted as counterparties to Porsche, in effect placing "covering bets" in case VW's share price went down, will also be losers.

Rumours about such exposure led to a 17.5 per cent drop in Societe Generale shares at one point on Tuesday, while Morgan Stanley was down 11 per cent and Goldman Sachs down by 8 per cent.

After a month in which Gordon Brown and other political leaders have called for an overhaul of global financial regulation, the Porsche affair has rammed home the point that, now as never before, the world needs a new financial policeman to make sure everyone plays by the same rules.”

Porsche crashes into controversy in the ultimate 'short squeeze': “For old-timers, the "short squeeze" at the Stutz Motor Company is a favourite from financial folklore.

Combining legendary status - the cars won races such as Le Mans - with speed, reliability and beauty, they were the object of every ambitious young man's desire. But the emergence of mass production competitors at the end of the First World War spelt trouble for Stutz and financiers knew it. The smart money bet that the stock would fall.

Alan A Ryan, who controlled the company through family holdings, secretly started buying stock, often through options and opaque holding companies until, in 1920, he announced he controlled 105pc of Stutz.

When Ryan declared he would settle with the shorts at his price, the whole financial system reeled: as well as the trapped traders, a raft of brokers and intermediaries in the middle of the trade faced bankruptcy too.

Eventually, the New York Stock Exchange intervened, setting the settlement price itself. Ryan ended up buying an expensive 100pc of a declining car company and went bust. Financiers thought they'd never see the trick attempted again.

Extraordinarily, the plot - or the first part at least - was last week almost replayed at Volkswagen. Shortly after 3pm on Sunday afternoon, Porsche, the German maker of the iconic 911 sports car, revealed it had secretly bought 31.5pc of VW through a series of cash-settled options with a range of investment banks.

Added to its known holding of 42.6pc, the options handed Porsche control of nearly 75pc of its bigger rival.

The news shot through the global hedge fund industry. With shares in VW trading far above the company's fair value and a recession hitting every other car manufacturer, traders had bet millions of euros that the stock would fall.

But the statement screamed the opposite. With nearly 20pc of the share register held by the state of Lower Saxony and another estimated 6pc held by index trackers, traders calculated a cornered market.

As one said: "With over 100pc of the stock tied up and nearly 13pc shorted, the correct price of any available stock was infinity. It was the ultimate squeeze."

The stock lurched violently, punishing the rest of the DAX index of Germany's leading companies. Hedge funds were estimated to have taken a €30bn hit, with the investment banks sustaining heavy losses, too.

The German regulator belatedly agreed in the face of the turmoil that there could be a case of market manipulation to answer.
Even so, this weekend the reputations not just of Porsche and its advisers, but of regulators and corporate Germany as a whole, are badly damaged.

Sources close to Porsche insist that the company never intended to cause the rumpus and has acted entirely within the rules.

Other observers disagreed. "This is the culmination of long-held plans to take over VW. Porsche engineered the squeeze as one of the most brilliantly conceived wealth transfers ever: they've got the hedge funds positioned to pay for Porsche's acquisition of VW. The only thing they underestimated was the scale of the fallout," said an insider.

So how has a sports car maker become an options trader? Will Porsche now buy VW, or has it crashed on the last corner? And even if not, will traders ever buy another Porsche again?

The development of Porsche from car maker to financial engineer has been driven by an extraordinary combination of powerful ambitions.

The first is that of Ferdinand Piech, 74, grandson of Ferdinand Porsche, who founded Porsche and also designed the iconic VW Beetle, Adolf Hitler's "Car for the People".

Confusingly Piech, who now controls 50pc of Porsche's equity and 100pc of its voting rights, spent most of his career at VW where he is head of the supervisory board.

After getting a degree in engineering in the 1960s Piech started his career at Porsche and then moved to Audi in1972. In 1993 he became chairman and chief executive of VW until his retirement in 2002 to the supervisory board.

One insider said: "Piech considers VW his life's work and Porsche his family name. He passionately wants to see the two combined before he dies."

His ambition has been matched only by that of the indomitable Wendelin Wiedeking, chief executive of Porsche since 1991.

Mr Wiedeking, reportedly the best paid director in Europe with a paypacket of €72.6m (£56.7m) last year, made Porsche into the most efficient private company in the automobile industry, winning international plaudits.

In addition, unlike the stereotypical German corporate boss, he gained a reputation for being a maverick and anti-establishment.

In his book Anders ist Besser (Different is better) and his autobiography, he laid out his Machiavellian philosophy which revealed a pride in breaking rules, winding up other business leaders and a pleasure in the unconventional. The theme of David and Goliath is one of his favourites, while he shows a withering lack of respect for politicians.

However, despite punching above its weight, Porsche in recent years has fallen behind its rivals, particularly hampered by a lack of access to research and development and technological expertise.

Mr Wiedeking eyed VW's vast R&D capabilities enviously and started hatching a plan to get shared access to it via owning a stake.

One insider said: "Wiedeking's designs on VW were motivated by industrial logic. But the way to pay for it came from Holger Harter."

Mr Harter, Porsche's innovative chief financial officer, started looking at the financial markets as a way of boosting the company's income. He started a radical overhaul of Porsche's treasury operations which he described in 2002 as a "vital milestone" for the company.

Harter's taste and talent for options trading started attracting attention. As early as 2003, Max Warburton, an analyst at Bernstein, had already coined the phrase "a hedge fund with a car showroom" in describing Porsche. Meanwhile Porsche set its sights on taking over the whole of VW. Ostensibly, it seemed an impossible task since the so-called "VW Law" sets the threshold for enforcing a so-called domination agreement at 80pc control, rather than 75pc, which is common for German companies.

Lower Saxony's 20pc stake gave it the power to veto any domination agreement. This was not just an historic holding but one of vital political importance to the state whose stated aim has been to protect its VW workers. In September 2005, Porsche announced it had bought a 20pc stake in VW.

Even then, analysts like Mr Warburton reckoned the amount was probably far more. No one could tell because in buying options, Porsche gained the right to own stock without having to declare it. This suited Porsche perfectly, not least because it could deflect much of the direct anger from Lower Saxony's trade unions who vowed to fight any hint of a change of control.

A year later, pre-tax profits in the year to July 2007 had soared from €2.1bn the year before to €5.9bn, with €3.6bn coming from earnings on stock options trades - more than three times the amount made on selling cars.

Porsche kept buying shares, this time crucially with the knowledge that the vital VW Law was being reviewed and expected to be withdrawn within the next few years.

As one analyst said: "To Piech and Wiedeking buying VW finally looked possible. They needed to buy 75pc of the company and sit tight for the law to change, whereupon Lower Saxony could no longer object. Mr Harter got to work."

Attention from his options trading was distracted by ferocious rows between Mr Piech and his cousin, Wolfgang Porsche, who is head of Porsche's supervisory board, about how a takeover of VW would work.

Meanwhile, VW's shares were attracting real hedge fund investors as well as Porsche. The unusual double class of shares offered the chance of an easy arbitrageur to bet on the spread between the ordinary and preference shares.

The onslaught of the financial crisis, in particular the meltdown among the American carmakers, meant VW attracted even more hedge funds who believed that the stock, which was far higher than others in the sector, was bound to fall.

The emergence of the hedge funds in big numbers presented Harter with a new ambitious financial engineering opportunity. For each VW share they shorted, hedge funds needed to borrow a real one as collateral. By allowing the banks that held their current stake to lend shares, Porsche was already earning incremental income this way.

Secretly, Mr Harter had instructed six investment banks to each buy options on 4.99pc of VW shares to bring Porsche's stake up from 35pc to the magic 75pc level. Now he allowed the banks to lend this stock too to make even more money from the hedge funds. It has been speculated that, as the hedge funds piled in, he foresaw the opportunity of cornering the short-sellers, therefore being able to name his price to settle and force billions out of them, but there is no evidence of this.

In hindsight, hedge funds should have realised something was going on behind the scenes because of the steady share price, but instead they blindly piled in, short-selling 13pc of VW's market value.

Again, Mr Warburton was first to unearth the truth. Three weeks ago, in a note called "Fruit Machine: A Possible Explanation for VW's Inexorable Rise", Mr Warburton said he believed Porsche had now bought options on as much as 75pc of VW; that the daily volume that was being traded in VW was in fact just short-sellers, who were then borrowing stock from Porsche or its banks, and that Porsche was making money out of the transactions.

Stung at being caught out in its clever game, Porsche dismissed Mr Warburton's views as "fairy tales".

Even so, the questions wouldn't go away. Last Sunday, perhaps with a nudge from regulators demanding clarity, Porsche admitted its secret: the company had in recent months lined up six investment banks, buying through each of them options to buy 4.99pc of VW shares. The company said they are "cash-settled" options, meaning that when exercised the banks have to deliver the value of the shares in cash rather than the shares themselves, as in normal options. The cash generated by the options is then used to buy the physical shares if Porsche wanted to.

While Porsche ponders its next move in silence, the extent of the damage of its move is beginning to emerge.

The squeeze on hedge funds was the most visible pain. But behind the scenes, Porsche's six banks are thought to have taken a big knock too. In addition, Merrill Lynch, Porsche's adviser, is being boycotted by hedge funds in protest. The jokes that have already been made about traders now boycotting the cars themselves are not far from the truth.

The volatility also damaged other German stocks and in turn the index trackers.

But the greatest damage is to the reputation of Germany's capital markets where regulators are now belatedly investigating what went on. As one commentator said: "In any other country this would be illegal. And this isn't some small firm, it's Germany's biggest. It's a return to the wild west."

Mr Warburton says the key lies with the VW Law: "If it goes, Porsche can move in and buy its 75pc and take control of VW. If the law stays, we're probably in for a long stalemate of political lobbying."

Financial Ninja Favs: October

In case you missed them, here are YOUR favorite Financial Ninja posts for the month of October:

1) Really Scary Fed Charts: OCT, Now Crazy Scary
2) Politics Before and After a Crash, Depression
3) Bernanke Bailouts Not Working, Banks Hoarding
4) Volkswagen Short Squeeze, Hedgies Hurting
5) Closer to ZIRP, Liquidity Trap, Lost Decade

The most popular posts were about the Fed in general and interest rate policy heading towards ZIRP.

Homeless made it into the top 10 posts for the month, the first time one of my joke posts has done so.

October was a record month for many reasons in many ways. Unique visitors hit 72k, and pages views exceeded 120k as credit markets seized up and equity markets imploded.

Incoming Site Traffic:

1) Dollar Collapse
2) The Kirk Report
3) Naked Capitalism
4) Financial Armageddon
5) Afraid to Trade

These are the top 5 blogs referring traffic to The Financial Ninja for the month. All are excellent sources of financial insight and are on my daily must read list.

Sunday, November 2, 2008

Where's My Bailout?

[ Hat Tip: Evil Speculator ]

"Where's my bailout? ... Because all Americans should be protected from their own stupidity."