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For a brief moment last Tuesday, Volkswagen (VW) became the most valuable company in the world. Panic buying by hedge funds to cover their short selling of VW caused the German car maker’s price to skyrocket to €1,005 (RM4,543) a share.

At this price, VW was valued at €296 billion (RM1.3 trillion), slightly higher than US oil giant Exxon’s market capitalisation of US$359 billion (RM1.3 trillion) and more than that of all American and European car makers combined.

VW ended last Tuesday at €945 (RM4,272) a share. The following day, it tumbled by more than 45% to close at €517 (RM2,337). Despite the fall, Wednesday’s price was more than double the previous Friday’s close of €210 (RM949). By any yardstick, this price performance over four trading days was a remarkable roller coaster.

Short selling involves investors – pessimistic about a company’s outlook – selling shares that they do not own in the expectation of buying the shares before the delivery date at a lower price and pocketing the profit from the price differential.

VW’s share price fiasco spotlights three major issues. First, it underscores the destructive potential of financial engineering activity. Financial engineering via share options and short selling helped boost the German auto giant’s share price sky high, a development divorced from actual reality.

Tuesday’s panic buying in VW shares was prompted by iconic sports car maker Porsche announcing it had acquired 31.5% of VW through cash-settled options; that is the option would be settled through cash rather than cash. Combined with an existing stake of 42.6%, this brought Porsche’s shareholding in the German car maker to 74.1%.

And with Germany’s Lower Saxony state accounting for another 20.2% of equity, this left VW with a free float of 5.7%. News of a minuscule free float coupled with knowledge that about nearly 13% of VW had been shorted meant there was a scarcity of shares available for trading; a realisation that prompted short sellers to bid up the German car maker’s share price to stratospheric levels.

News reports suggest the magnitude of losses by fund managers who had short-sold VW shares is estimated to be as high as €30 billion (RM135.6 billion).

Additionally, share options have another hidden, and potentially lethal, potential. In countries like Germany, investors aren’t legally required to disclose their holdings of share options. This enables an investor to mount a takeover of a company by stealth.

Second, VW’s hyperventilating share price also calls into question the utility of stock markets in determining a company’s valuation. That VW’s share price last week was determined solely by speculative activity rather than corporate profits and earnings outlook undermines the claim that a listing status provides a superior means of pricing a company’s shares.

Third, frenzied buying of VW shares last week calls into question the appropriate role of stock markets in an economy.

As John Horvath notes in an article titled Casino Economy, nowadays stock markets have become nothing more than glamorised betting shops that are increasingly divorced from economic realities. Well-established companies have been led to ruin, not because their products or services were bad, but because of speculative movements of their share prices.

Doug Henwood, editor of Left Business Observer, notes the marginal role of stock markets in financing corporate activity. Since 1952, corporations have funded 95% of their cost of expansions internally, primarily through retained earnings. And because companies are increasingly controlled by stockholders and managers, the bulk of corporate profits tend to be spent on dividends.

In his indictment on stock markets, Henwood wrote "throughout the late 1980s and early 1990s, the stock market rewarded firms announcing write-offs and mass firings – a bulimic strategy of management – since the cost cutting was seen as contributing rather quickly to profits. Firms and economies can’t get richer by starving themselves, but stockmarket investors can get richer when companies they own go hungry – at least in the short term," he says.

Wall Street has been described by a cynic as a street with a river at one end and a graveyard at the other. Unfortunately, as VW’s experience shows, the phenomenon of Wall Street has been replicated across the Atlantic and further afield.

Opinions expressed in this article are the personal views of the writer and should not be attributed to any organisation she is connected with. She can be contacted at schoo@noordinsopiee.com