Appeared in The Sunday Times on 2 November 2008
early stages of the credit crunch, most commentators denied that events in the
financial world would have an impact on the so-called real world. As it became
apparent that the two are inseparable, they moved on to ask whether the bear
market would be as bad as that in 2000-3 and the ensuing downturn as bad as
1990-92, 1979-81 or even 1973-75. Since many of today’s market participants
weren’t working at the time of these events they can’t draw on personal
experience to make a comparison. In addition, their grasp of history is often
Only as the full horror of the credit crisis and its impact on the world economy has become evident have commentators belatedly begun to ask whether there are parallels with the Great Crash of 1929 and the ensuing Great Depression. This is far from impossible and, at least in one sense, we took a step back to the 1920s this week. Only as the full horror of the credit crisis and its impact on the world economy has become evident have commentators belatedly begun to ask whether there are parallels with the Great Crash of 1929 and the ensuing Great Depression. This is far from impossible and, at least in one sense, we took a step back to the 1920s this week.
The news story of the week was Porsche’s acquisition of a 74% stake in Volkswagen, which made VW’s shares increase fourfold in a day, briefly and ludicrously making VW the largest company in the world by market value and losing a lot of money for the hedge funds that had shorted VW’s stock.
Porsche was able to do this by using so-called cash-settled options, which are the equivalent of contracts for differences, or CFDs, in Britain. Using these derivative contracts it is possible for a buyer to accumulate, anonymously, a stake in a company way beyond the size at which disclosure of a direct shareholding would be required. Under the UK’s Takeover Code, such a stake would even require a mandatory takeover bid.
Well, not much has changed. In 1923 the shares in the gloriously named Piggly Wiggly stores soared as its founder, Clarence Saunders, cornered the market.
When short sellers (yes, they were around then, too) started to drive Piggly Wiggly’s stock down, Saunders borrowed enough money to buy all they could sell. He ended up owning more than 100% of Piggly Wiggly’s stock. In so doing he had engineered “The Last Great Corner”. The share price soared as the short sellers scrambled to achieve the impossible - namely to buy stock to cover their short positions - impossible because there was only one source of stock: Saunders. They were in the position described by a traditional Wall Street ditty: “He who sells what isn’t his’n must buy it back or go to prison.”
All this was possible because the lack of disclosure rules meant Saunders could build his stake stealthily so that the short sellers could not see that they were being cornered.
In case the parallel with the events at Volkswagen isn’t clear enough, there is an even closer parallel in the corner that was engineered in 1920 in the shares of the Stutz Car Company. Stutz made performance cars that won Le Mans. When short sellers started to drive down the share price, Allan Aloysius Ryan, who controlled the company through family shareholdings, borrowed the money and, through options and intermediary companies, managed to accumulate 105% of Stutz, cornering the market and sending the share price from $100 to $391 and the short sellers reeling.
You might think that this story ends with the short sellers cast down and the entrepreneurs and industrialists running real companies triumphant. But there is a sting in the tale.
Wall Street looks after its own. Trading in Stutz’s shares was suspended, the need to settle trades in Stutz and Piggly Wiggly was delayed and the exchange even declared a lower price at which short sellers could buy back stock to settle their bargains. Which brings to mind another Wall Street aphorism: “If you can’trule the waves, waive the rules.”
The combination of having borrowed money to finance their corners, the delay in settlement and a mandated price to allow shorts to settle, was ruinous for Ryan and Saunders. Ryan’s car company subsequently went bust, and Saunders was bankrupted and lost control of Piggly Wiggly.
There are many sayings about history: that those who don’t study history are forced to repeat it, or Mark Twain’s observation that history doesn’t repeat itself but it does rhyme. You might like to bear in mind these events next time someone says we can’t be going back to the 1930s.
- Terry Smith is chief executive of Tullett Prebon
© The Times