IWSF – Ch 212

Hyunjoo adjusted her glasses and spoke.

“I know, but many companies have suffered because of Big One.”

I had been spreading the word about this fact months before the Big One incident. However, very few believed me.

Except for Golden Gate, all IBs incurred losses, and hedge funds also faced significant setbacks. Thanks to this, we made over $10 billion.

“They’re aggressively trying to recover their losses, no matter what.”

Short selling is a trading technique where you sell stocks you don’t own and buy them back later to repay. We also short-sold Seosung Electronics during the L6 incident.

Short selling provides liquidity to the market, prevents overheating, and allows for hedging, among other positive functions.

Almost every country allows short selling, but the majority of individual investors are negative about it. Some even advocate for its abolition.

This is because there are many associated problems.

Short selling is an investment method used when one predicts that a stock price will fall.

Whether you short sell or not, stocks that are going to fall will drop. In this case, short selling helps rationally adjust the market.

The issue arises when stock prices fall excessively due to short selling, or when false information is spread to exaggerate a crisis and induce price drops.

Even this time, foreign brokerage firms are flooding the Korean market with negative reports.

Stock prices are often compared to a dog walking with its owner. Sometimes the dog will be ahead or behind, but ultimately, it moves with the owner. In this analogy, the owner represents the company’s actual value.

Even if short selling causes a stock price to drop excessively, it will eventually recover over time. However, during this process, individual investors with less capital and slower access to information suffer significant losses.

In fact, the biggest problem with short selling is the accessibility for individual investors.

In the U.S. and Japan, individual investors can short sell as long as they have a margin account. However, in Korea, the structure effectively makes it impossible for individual investors to engage in short selling.

Institutions and foreigners dominate individuals in terms of capital, information, and transaction fees, allowing them to utilize short selling. In contrast, individuals can only respond with buying and selling.

If OTK Company were not a foreign entity and did not have sufficient capital, we would have had to sit idly during the L6 incident as well.

“You’re seeing it; they’re flooding the market with short sales. The focus is primarily on Eunsung, and then on biotech and consumer goods.”

“Who are the leading forces?”

“Albert.”

I frowned.

“Those guys again?”

The formal name is Albert Management. They claim to be an activist fund and an investment management company, but in reality, they resemble a Vulture Fund. They target distressed companies for profit, akin to vultures tearing into carcasses, hence the name.

Their main activity involves acquiring failing businesses or distressed bonds at rock-bottom prices and reselling them at inflated prices. Up to this point, it falls within normal investment practices, so there’s nothing to criticize. However, they employ extraordinarily unconventional methods in this process.

A famous anecdote recounts how in 1996, they bought Peruvian government bonds and seized the private jet of an ex-president who had fled the country, netting five times their investment. They also purchased Congolese bonds cheaply and reclaimed poverty aid funds the Congolese government received from the international community. During Argentina’s moratorium in 2002, they bought over $2 billion in government bonds for a pittance, then sued in U.S. courts, seizing an Argentine naval ship docked in a foreign port, employing every trick in the book to recover the principal and interest, achieving returns of up to 400%.

The international community condemned such speculative behavior, but Albert remained unfazed.

What’s the problem? It’s not illegal.

In fact, it was legal. It just seemed dirty.

“What is Albert’s asset size?”

“$40 billion.”

I was taken aback.

“When did it grow so much?”

“Since its establishment, the average annual return is 16%. Recently it’s been around 20%. At this rate, investors are bound to rush in with their money.”

Since they will do anything profitable, they have recently been meddling in corporate governance reforms.

Hyun-joo said while exhaling cigarette smoke, “It seems the Korean market has been looking decent lately. Its openness relative to the size of the financial market makes it easy to invest money, and even easier to pull it out.”

The Korean stock market has often been swayed by foreign capital. Even Seosung Electronics recently plummeted 5 percent in a single day due to a Merrill Lynch report expressing concerns about oversupply in the semiconductor sector.

Although it recovered within a few days, during that time, some faced losses while others saw profits.

“Has the target been set on Eunsung Motors this time?”

“Automobile stocks are sensitive to economic conditions. Especially now, faced with difficulties and even a recall situation, it makes sense for them to be a target. Something similar happened during the financial crisis. Can you think of anything regarding short-selling auto stocks?”

It immediately came to mind. “The Volkswagen short-selling incident?”

Ellie nodded, perhaps thinking the same thing. “It was an incredibly absurd event.”

Only Taek-gyu looked confused. “What’s that?”

“It happened during the financial crisis.”

Many incidents in finance often go unnoticed by the general public. However, this was a significant event that received ample news coverage at the time. I learned about it later since I was young back then.

2008 was a tough time for automakers. Cars represent the second-largest asset after homes. With the uncertainty brought by the financial crisis, no one wanted to buy a new car, leading to a plunge in automobile sales.

Car stocks fell sharply and were expected to drop further. As a result, hedge funds targeted automobile stocks and engaged heavily in short selling.

Volkswagen was no exception. At that time, Volkswagen’s stock price had skyrocketed from 200 euros to 400 euros in a short period due to a management dispute with Porsche.

It was clear that the stock price was overvalued compared to its actual worth.

Hedge funds would certainly not miss such a good opportunity. They simultaneously unleashed short positions against Volkswagen stocks.

In about a month, they sold 12 percent of the total shares through short selling, amassing over 10 billion euros in capital used.

“What’s going on?”

“The Volkswagen stock has halved.”

“Then didn’t the hedge funds win?”

“Everyone thought so.”

Now, they just need to buy the plummeting stocks, repay the short positions, and walk away with huge profits.

But…

“Suddenly, there’s a problem.”

“What kind of problem?”

Hyun-joo said, “Porsche Holdings announced that it acquired 42.6% of Volkswagen’s shares. They also stated they would increase their stake to 50% by the end of the year and up to 74.1% by next year using call options.”

Ellie added, “20.1% of Volkswagen shares are owned by Lower Saxony, where the headquarters is located. That’s not something that will be available on the market.”

They both know the percentages exactly. People in finance love to talk like this.

I continued explaining, “Think about it. If Porsche secures 74.1% of Volkswagen shares and adds the 20.1% owned by Lower Saxony, that’s 94.2%. That means only 5.8% is circulating on the market. But the hedge funds shorted 12%.”

Taek-gyu blinked.

“So what happens now?”

“What happens is that, even if they buy all the circulating shares, a situation arises where short covering becomes impossible.”

They need to buy Volkswagen stocks and cover their short positions before Porsche increases its stake further.

After Porsche’s announcement, as soon as the market opened, hedge funds rushed to buy Volkswagen shares.

“Another problem has come up.”

Due to a sudden surge in stock prices, Volkswagen was included in the DAX30 index, which consists of major German companies. This prompted institutional investors to start buying in before the price rose further, with index funds and program trading joining in as well.

While the demand to buy was high, available shares were scarce.

Volkswagen’s stock skyrocketed by 150% in just one day, surpassing 500 euros, and the following day exceeded 1,000 euros. (The German stock market has no upper or lower limits.)

In just two days, the stock price more than quadrupled.

Market capitalization also more than quadrupled, allowing Volkswagen to leap over the then-unchallenged leader ExxonMobil to become the world’s largest company by market cap.

“Thinking about it, it’s astonishing. They didn’t develop a new product, nor did sales increase.”

Everything remained the same, but due to speculative activities, the market cap had risen fourfold.

Ultimately, when Porsche withdrew its acquisition plans, the situation calmed, but during that time, Porsche excitedly sold off its Volkswagen shares.

While other automakers struggled with declining net profits, Porsche’s net profit in 2008 increased by 50% compared to the previous year. Surely, they couldn’t have made such profits just from selling cars?

On the other hand, hedge funds that took short positions suffered astronomical losses and retreated. Among them, the fifth richest person in Germany, Adolf Merkel, committed suicide by throwing himself in front of a train.

At the time, both the government and individuals were frustrated with hedge funds’ short selling, leading to a mostly positive reaction.

“When hedge funds decide to attack, it’s hard for the market to withstand it. Regardless of everything, Golden Gate has done similar things many times.”

South Korea ranks among the world’s leading manufacturing powerhouses. Just attending CES, you’d see a plethora of Korean products. The excessive reliance on large corporations and an export-driven economy has caused various side effects, but thanks to the efforts of major firms like Seosung Electronics and Hyundai Motors, the country earns a substantial current account surplus each year and approaches the threshold of advanced nations.

However, unlike the industrious capital that excels globally, the performance of financial capital is dismal.

Hyunjoo sighed and said:

“In short, we’re making money through industry and being drained by finance.”

While it’s natural to earn dividends or capital gains from investments, not being able to properly respond to such speculative behaviors is problematic.

Ellie added a comment.

“Speculative capital has caused controversies in the Korean market more than once.”

During the IMF crisis, many domestic companies were sold off cheaply to foreign capital.

A well-known incident is the U.S. private equity fund Lone Star’s controversy with Korea Exchange Bank. Following that, the Canline Group similarly exploited HB Bank (the person who succeeded in this was RCK Brothers’ chairman, Ryu Cheol-gyun).

Tiger Fund embezzled 630 billion by competing for shares in SK Telecom, and subsequently, Sovereign attempted to seize management rights over the SK holding company, successfully embezzling another 900 billion (if this happens twice, shouldn’t we suspect the responsibility of the founder’s family and structural issues?).

Furthermore, Carl Icahn purchased shares in KT&G, interfering in management to embezzle 150 billion.

This is just the tip of the iceberg; listing all embezzlement cases would require several books.

In contrast, instances of Korean capital embezzling in foreign markets are extremely rare. One notable success story is OTK Company during Brexit, which embezzled in the UK and Japanese foreign exchange markets (although OTK Company is classified as U.S. capital).

“To speculative capital, Korea is an easy market,” said Taek-gyu, crossing his arms.

“It’s not like we’re a republic of embezzlement.”

Due to the big one, consumer sentiment has decreased, the economy has contracted, and export-heavy Korea has been hit hard. On top of this, hedge funds have poured out short sales, leading to stock market declines and rising exchange rates.

Fortunately, the company with the largest market capitalization, Seosung Electronics, has been holding its ground, but without it, the stock market’s decline would be even steeper. Even Seosung Electronics, considering the rising exchange rates, has effectively dropped by 20%.

Moreover, the culprit behind the crisis is the president, and with the change of government, neither the ruling nor opposition parties can respond effectively. Eunsung is also in disarray, facing issues with recalls and Chairman Han Min-goo’s retirement and management succession.

Knowing this, hedge funds are intentionally pulling such stunts.

The problem is that in the process, subcontractors and individual investors are suffering. As always, when those in high positions cause issues, it is the common people who bear the brunt.

By the time hedge funds withdraw after raking in huge profits, individual investors will have suffered significant losses, and component companies will likely have collapsed.

However, the government cannot directly regulate speculative capital either, due to issues like WTO or ISD (Investor-State Dispute Settlement).

In fact, in the case of Lone Star, they not only executed a “eating-and-running” scheme, but also claimed losses due to the Korean government’s delay in sale approval and filed a lawsuit for ISD. They intend to pocket compensation even after making profits.

These bastards…

In reality, the best way to deal with speculative capital is with more speculative capital. Just like Porsche issued false statements, not intending to protect anything, and blindsided the hedge funds.

After thinking for a moment, I said, ‘Is there a good way to screw these guys over?’