Photo: Heiaken on flickr
We have half joked about this on Friday after a ton of the Facebook traded around its IPO price of $38 and no doubt many of the shares came back to the Street. Oliver Stone couldn’t write a better script.Far fetched and unlikely as it is, but imagine a scenario where the leads of the Facebook IPO take down so much stock trying to protect the $38 syndicate price it puts them at risk. The markets panic as FB breaks syndicate price sending the stock into freefall. The Fed is then forced to step in and provide liquidity to these financial institutions and take Facebook stock as collateral.
Morgan Stanley’s market cap is more than double the entire size of the Facebook IPO so we wouldn’t lose any sleep contemplating such a scenario. The “green shoe” also protects the underwriters who support the syndicate price. The Chicago Tribune writes,
Had Morgan Stanley bought all of the shares traded around $38 in the final 20 minutes of the day, it would have spent nearly $2 billion. The “green shoe” overallotment, which can be used to support Facebook’s stock, is 63 million shares. At $38 per share, that amounts to $2.4 billion in firepower.
We’re not the only one thinking about the potential for a future Hollywood screenplay.
Craig Pirrong, a professor of finance at the University of Houston, writes about this very scenario over at Seeking Alpha. Note he’s also careful to point out the fantastic nature of such a scenario and adds some historical perspective and spice to the story,
On to Morgan Stanley. It is evident that the underwriters, of whom MS was the leader, bought large quantities of stock to support the $38 issue price. The exact total amount, and the amount bought by any of the underwriters, is not known, but it could represent billions of dollars. The underwriters can’t afford to grant free puts for very long, so it is quite possible that Facebook will trade below the issue price, thereby imposing losses on the underwriters.
This experience triggered my historical reflexes, and I thought about the experience of another legendary underwriter, Jay Cooke. There are some superficial similarities between Cooke and MS. I don’t take them too seriously, but one can hear echoes.
Cooke was the lead underwriter of another innovative entity with a dicey revenue model: The Northern Pacific Railway, of which Cornelius Vanderbilt said “you can’t build a railroad from nowhere to nowhere.” Jay Cooke & Company underwrote sales of the railroad’s bonds, and ended up taking ownership of large quantities of them, in anticipation of selling them, and selling them particularly to Europe. But it proved unable to market the bonds, due in large part to economic shocks emanating from Europe. There were several bank failures in Europe in Vienna that spread to other European countries. Moreover, there was a monetary shock emanating in Germany, namely, that country’s decision to cease minting silver coins, that had averse consequences for the U.S. Furthermore, Germany demanded a large reparation from France in the aftermath of the Franco-Prussian War, which was also financially destabilizing.
Once Cooke & Company’s depositors became concerned about the company’s inability to market the bonds, a run commenced, and the firm suspended and went into bankruptcy. This sparked a broader financial panic in the U.S.- the Panic of 1873.
So, in both 1873 and 2012, a big investment bank takes a large position in a company with a highly speculative revenue model, against the background of financial crisis in Europe.
We saw what happened in 1873. We will see what will happen in 2012. Almost certainly the outcomes will be quite different, because even if MS took a multi-billion dollar stake in Facebook, this is not a bet-the-company investment in the way that Cooke’s foray into the NPRR was. It may cause some discomfort for MS and its shareholders, but likely nothing more than that.
And of course, the biggest difference between 1873 and 2012 is that there was no Fed in 1873. Again, I do not consider it at all likely that Morgan Stanley would be mortally harmed even if Facebook stock falls well below $38, but if it were, the post-Lehman-we’re-not-going-to-let-that-happen-again-Fed would no doubt ride to the rescue. This raises the question: Would it take Facebook shares as collateral?
This seems like a highly speculative question, and perhaps even an idle one, but in these times one cannot rule out anything, no matter how fantastical it appears.
Can you imagine the political backlash of such a scenario? The Fed effectively minting and printing billionaires? At least it’s another way to get QE more directly into the hands of consumers.