Out of Thin Air: More Techniques in Upper Class Wheeling and Dealing: An Exposition
For this essay we are indebted to the expert analysis of author, activist, and former World Bank official, Raj Patel. I will be cuttng a tiny swath out of his fascinating book, The Value of Nothing: How to Reshape Market Society and Redefine Democracy (2009).
We're going to be looking at a case study, like the three-card Monte IPO scheme in the previous "Out of Thin Air" essay, that gives the lie to what is called the Efficient Market Hypothesis. The Efficient Market Hypothesis says that prices of shares of stock reflect all available information (with the presumption that the information is truthful and accurate). Price changes are supposed to reflect incoming information that alters the value of the shares. The idea is that the market achieves perfect equilibrium in this way, and so forth.
A Tale of Two Car Companies
At the end of October 2008 Volkswagen became the world's most valuable corporation, and it managed to do this without selling a single vehicle. At this time, October 2008 the U.S. economy had hit the skids, as it were, and traders were taking a dim view of Volkswagen, and every other car manufacturer. "One way to cash your hunch in," wrote Raj Patel, "is to sell Volkswagen stock today, and buy it back when the price falls" (Patel, p.8).
This is called short-selling. First, you go to an institutional investor who owns the stock you want to "short." You borrow it for a price and promise to return all of it soon. The institutional investor is fine with this because they make money from loaning out the stock. Next, you have to sell the stock you have borrowed, and wait for the price to go down. When it does, you buy it back, making a profit. You are not only able to pay back the institutional investor, you have put money in your pocket (ibid).
Volkswagen's rival, Porsche, had started quietly buying up Volkswagen's stock with the goal of securing 75 percent of the company. Traders were selling borrowed Volkswagen stock to Porsche, who did not sell it back. This kept the value of the Volkswagen stock "artificially" high. Traders got into a panic and this led to a 'short squeeze,' as investors rushed to try to cover the bets they had made with stock they didn't own. They had bet that VW stock would fall just like every other automaker stock in an economy in recession. When that did not happen, speculators hurried to buy more of the stock before the price went any higher (ibid).
All of this speculative purchasing activity pushed the price up further, so high in fact, that Volkswagen entered the DAX 30 index of the biggest corporations in the German stock market, the 'bourse.' This fact, Volkswagen's entry into the DAX 30 bourse, triggered yet another buying spree, "driven not by stock market gamblers, but by their polar opposites --- conservative institutional investors" (ibid, pp.8-9).
"Pension funds, for instance, invest with an eye to longterm returns;" wrote Raj Patel, "they prefer a slow and certain accumulation of wealth rather than risky bets. One way to keep their portfolio on an even keel is to buy shares in nothing but blue chip corporations, ones that are guaranteed to be least susceptible to the shocks that stocks are heir to, ones that are in the top, say, thirty corporations traded in the open market" (ibid, pp.9-10).
Let's pause here for a moment and notice something.
This situation is what I like to call an ironic symmetry. What we have, here, is the herd of speculators, frenzied, all trying to get aboard the gravy train of inexplicably skyward moving Volkswagen stock (which shouldn't be happening during an economic recession in which the car companies are as hard hit as anybody else, if not under much more duress). These traders are not anything like careful or prudent in the traditional sense of those words. And yet, they have created a financial situation that puts them in unity with "their polar opposites, conservative institutional investors" who take the slow and easy approach to investing, the make sure all the I(s) are dotted and T(s) are crossed, look-under-the-hood approach to investing.
This just goes to show that the irrational and rational are two sides of the same coin, in capitalism and perhaps in life in general. Okay.
When Volkswagen joined the DAX 30, a "flock" of institutional investors automatically wanted in. They bought shares at whatever price they could buy them. The result was that the price per share lept and bounded in such a way that on paper, Volkswagen was worth $386 billion, making it more valuable, briefly, than Exxon-Mobil (with a book value of $343 billion). Eventually the air was let out of the balloon, the rules on the DAX 30 were changed, the Volkswagen share price settled down, and in 2009 Volkswagen bought Porsche (ibid, p.10).
And so it would appear that Porsche's scheme to do a leveraged buyout of Volkswagen, not only failed, but backfired.
And so it goes.
Thanks for reading.
Patel, Raj. The Value of Nothing: How to Redefine Market Society and Redefine Democracy. Picador Books, 2009. pp.8-10