Porsche Goes For a Joyride

There will be plenty of books written about this period of economic history, but perhaps the most interesting will be the one that tackles the Porsche-Volkswagen drama. This story does not get much attention in the United States, but that's a shame. It involves a sexy auto manufacturer that operates more like a hedge fund, exotic international financial trickery, the suicide of a German billionaire, and a European industrialist's decades-long quest for world, er, auto-sector domination.

The story really begins in the 1930s, when automotive engineer Ferdinand Porsche founded the Porsche AG company and--at the request of Adolf Hitler, who wanted to motorize Germany and create a "peoples' car"--designed the first Volkswagen model. Today, the Porsche company remains tightly controlled by Ferdinand's descendants, while Volkswagen has gone on to become one of Europe's largest publicly-traded auto companies.

For the past couple years, Porsche has worked to take over Volkswagen. This is strange because, in terms of volume, Volkswagen is about 50 times larger than Porsche. It is, says BusinessWeek, "truly the case of the goldfish swallowing the whale."

Or at least trying to. Over time, Porsche bought up about 50 percent of Volkswagen's common stock. Because of arcane laws that give corporate veto power to the government of Lower Saxony, where Volkswagen is headquartered, Porsche needs to own at least 75 percent of the company (or perhaps more, depending on whether the company can successfully change the law) before it can force an acquisition.

By the end of last year, it looked like Porsche wasn't going to succeed in its quest. Hedge funds and other investors began to bet against Volkswagen stock, expecting that once Porsche gave up its quixotic adventure, the price would plummet. Traders sold VW short -- meaning they borrowed shares for a nominal fee, immediately sold them, then hoped to buy them back at a cheaper price after the reckoning.

Then Porsche revealed its dastardly checkmate: It had secretly amassed enough options to control 75 percent of VW shares. Suddenly, it didn't seem as if there were enough shares to go around. Investors scrambled to buy back the shorted shares they had just sold, worrying that when the music stopped, they'd be left without anything to return to their lenders. The furious activity sent the price of VW stock sky-high -- it briefly became the most valuable company in the world, and on the close of Oct. 27 it was the globe's second-largest company, behind Exxon Mobil but ahead of GE, Microsoft and Walmart.

And Porsche briefly became a hedge fund, and a very good one at that. Last year it earned about a billion euros selling autos, but nearly 5.5 billion euros on its VW stock options. And since finance is often a zero-sum game, that meant many others lost a fortune -- including German billionaire Adolf Merckle, who "lost hundreds of millions of euros when he was caught in a brief but ferocious speculative riptide linked to a campaign by Porsche, the sports car manufacturer, to seize control of Volkswagen," according to the New York Times. Merckle threw himself in front of a train the following week.

The story gets more byzantine the more you probe its depths. It now looks as if Porsche won't be able to take over Volkswagen, in part because the government of Lower Saxony has succeeded in blocking it, and in part because Porsche's finances aren't quite healthy enough for it to exercise all its options on VW stock. Meanwhile the global auto market has driven off a cliff, Opel and Fiat are trying to become Europe's largest automaker, and Ferdinand Porsche's heirs are sniping at each others' heels.

There are a lot of parallels with the broader global economic woes -- the over-reliance on complicated derivatives, the swift reversal of investor fortunes, the collapse in consumer demand. It could be kindling for the Bonfire of the Vanities of our times.