Hey Manolo, Now These Are Some Really Green Shoes

There’s fine print, and there’s even finer print. The very finest print, is used by our banker friends on Wall Street.

The recent Facebook IPO generated a lot of money for the company and their original investors. Then there were fees for the bankers that took Facebook public. A syndicate of investment banks, lead by Morgan Stanley, earned those fees by getting Facebook a premium price for their initial stock offering. There has been some kerfuffle over technical glitches at NASDAQ that cost traders some money, and claims that all the small investors didn’t have access to the same information as the larger investors. Whatever. I have a hard time feeling sympathetic for anyone who wants to swim with sharks.

Color Me Green With Envy

But a single sentence in this Wall Street Journal report caught my attention, because it seems so counter-intuitive. I mean, how do you make money supporting the price of a falling stock?

Morgan Stanley …  made additional money through their attempts to buoy the faltering stock early on. Those efforts generated trading profits of about $125 million, according to bankers knowledgeable about the transactions.

Leave it to the bankers. They have figured out a way to structure the share offerings, with the blessings of the SEC, so that if the newly issued stock tanks they will make even more money as they ‘support the price’ in the market.  As part of the IPO process, underwriters can award themselves up to 15% additional shares called a “green shoe“. These are used to buoy the price of a new issue if it sinks below the offering price. The actual mechanics of how it works are really magic for the bankers, because it’s heads they win and tails you loose. You can click this link if you want to know the details.

Which is what happened to Facebook shares, after the initial price surge.

As the stock sank back toward $38, Morgan Stanley stepped in to buy shares the underwriters previously had sold from what is called a “green shoe”—extra shares that can be removed from the market to help prop the price of a faltering IPO.

What’s amazing to me is that Morgan Stanley actually earned (sic) about twice as much from the green shoe operation [$125 million] than they did from their fees [$68 million]. Keep in mind that their fees were paid by Facebook, while the profits from the green shoe “support” came from investors on the losing side of Morgan Staley’s trades.

As the Wikipedia explanation of Green Shoe concludes:

Cast in the most negative light, price stabilization might be seen as a means of transferring risk to a relatively naive segment of the investor population.

If you insist on swimming with the sharks, I’d suggest you take a cage along.