An algo did it to Volkswagen AG. It wasn’t the algo of some evil stock-market manipulator, but of the company itself, a devious secret piece of software, a “defeat device,” as the EPA called it, purposefully coded by the company’s engineers and part of the software that governs its 4-cylinder turbodiesel engines in Volkswagen and Audi cars from the model years 2009 through 2015.
It was designed so that these cars, about 482,000 of them, which the company touted as “clean diesels,” would violate US law and deceive consumers with impunity.
But Volkswagen, the world’s largest automaker in the first half of 2015, had the bad luck of getting caught. The scandal broke Friday afternoon, when the EPA and the California Air Resources Board (CARB) revealed that the vehicle control systems contained code – the “defeat device” – that shut down the emission control system during regular driving, but turned it back on as soon as the algo noticed that the car was plugged into an emissions testing machine.
The purpose of the algo was to conceal emissions of nitrogen oxide, which contributes to the creation of ozone and smog that can trigger severe health problems, such as respiratory diseases, and premature death. Emission of nitrogen oxide is one of the big issues of diesel engines. The EPA found that during normal driving, the vehicles emitted up to 40 times the allowable levels.
How did the EPA find out? Bureaucratic excellence? Hardly. The Detroit News:
The VW emissions issue came to the attention of EPA in 2014 after independent analysis by researchers at West Virginia University, working with the International Council on Clean Transportation, a non-governmental organization, raised questions about emissions levels.
Motive? Disabling the emission controls likely improved acceleration and fuel economy, and the engines might run less hot and thus be more durable.
The scandal metastasized from “alleged” to “publicly admitted” on Sunday when Volkswagen AG CEO Martin Winterkorn said in a statement that the Board “takes these findings very seriously.” Findings, not allegations. Here’s his mea culpa:
I personally am deeply sorry that we have broken the trust of our customers and the public. We will cooperate fully with the responsible agencies, with transparency and urgency, to clearly, openly, and completely establish all of the facts of this case. Volkswagen has ordered an external investigation of this matter.
That “external investigation” is the coming Winterkorn whitewash, according to my hunch. He added with dripping irony, “We do not and will not tolerate violations of any kind of our internal rules or of the law,” after having admitted to having violated US law since model year 2009 (which came out in 2008).
“This matter has first priority for me, personally, and for our entire Board of Management,” he said.
I bet! Earlier this year, he’d survived a fierce power struggle with Ferdinand Piëch, chairman of Volkswagen’s supervisory board and an offspring of the Porsche family that has dominated the company. In the end, Piëch was forced out. Winterkorn triumphed.
But now he’s in trouble: Either he knew about the scam, in which case he is up to his nostrils in it, though he will forever deny it; or he didn’t know about it, in which case he has lost control of what’s going on at the company.
The EPA, CARB, and the Justice Department are working together on this investigation. It could get expensive: the Justice Department could hit Volkswagen with up to $37,500 in fines for each car sold, or about $18 billion in total.
The company has ordered dealers to halt sales of model-year 2015 and 2016 cars equipped with this type of turbodiesel, along with used cars with those engines. But these cars make up about 20% to 25% of Volkswagen’s already struggling sales in the US.
Within the first two hours of trading in Frankfurt today, Volkswagen shares plunged 23%, when bottom fishers jumped into the fray. The shares closed at €132.20, down 19% for the day. In early April, before German stocks began their trip toward a bear market, Volkswagen shares were trading at €253, now having crashed 48% in five months.
How long did the company think it could keep this secret algo secret? Or the more pressing question: why did it take regulators so long to catch that fraud? We might never know the answer.
In addition to the problems Volkswagen has had in the US, it is now at risk of becoming a pariah. And it will have to persuade consumers to buy diesels that, with all their emission controls enabled, suddenly offer degraded performance, fuel economy, and durability.
The recall will undo that algo. And those folks who bought these cars some time ago and get that recall done may have a rude awakening.
For Volkswagen, it’s going to be a tough marketing job. And redesigning these diesels in all haste to where they don’t disappoint finicky American consumers is going to be a tough engineering job.
But here is the thing: This isn’t a faulty product, a design flaw, or even gross negligence. And it will be hard for Winterkorn to blame some low-level rogue coder, like banks have blamed rogue traders for their scams. This defeat device is a design, carefully planned and expertly executed – so well that it remained a secret for at least seven model years.
Daimler and BMW, which also sell diesels in the US, are denying that they’ve done the same thing.
Which leads to the broader issue of other algos hidden deep inside financial, commercial, and consumer products that have been designed to deceive and defraud. As the Volkswagen case shows, these things are just too easy to do and devilishly hard to detect. They might fleece customers and businesses for years. And many of them will never be found.
This time, regulators took down one of the largest companies out there. But smaller outfits might never get that kind of professional scrutiny. And they might get away with it, their owners laughing all the way to the bank in this era of the secret algo.
When it comes to German stocks, American investors are on the hook. Read… German Stocks Crush Dream of Central-Bank Omnipotence