We won’t do any equity deals in the art market,” the banker told me. “That’s not a straightforward business like lending against the collateral of pieces of art.” He gave a small, bankerly shudder and changed the subject.

That intrigued me. Was it the natural risk aversion of someone who takes deposits from the public or was it something else he knew?

Art is the least securitised of the major asset classes. You can get real property ownership and loans against that property, sliced, diced, repackaged and re-re-packaged in hundreds of ways. Credit derivatives in their ever more abstracted forms now have an ethereal relationship with the original flows of principal and interest. Securities dealers will offer you equity options tailored to idiosyncratic company and sector strategies. But paintings, sculptures and other art objects still tend to be owned outright by one person or institution.

Not always, though. The securitisation of other asset classes has forced owners of debt and equity to more carefully characterise and quantify risks and rewards. Otherwise, they couldn’t sell what’s been sliced and diced. So learning about the way partial or conditional ownership of equity interests in art objects works can illuminate some of the dynamics of the art market. Given that a larger fraction of rich people’s net worth is tied up in art, that’s knowledge worth having.

In the distant past, that is to say more than 10 years ago, this sort of thing was of interest only to art dealers, who were not, hard as it is to believe now, the princes of society. I recently asked a friend of mine who knows a lot more about art than many market participants why he had not become an art dealer, rather than a Wall Streeter. “My father warned me away from that,” he said. “Decent people didn’t become art dealers in those days; it was sort of a sleazy business. People sold their art because they went bankrupt or got divorced or died.”

Now, of course, as one dealer friend of mine puts it, “Every housewife is an art dealer.”

The most significant change, though, is in the blurring of the lines between dealers and collectors. Abigail Asher, a partner in the Guggenheim Asher consultancy, says: “It’s really only been since the turn of the century that collectors were willing to flip their art, trade it soon after they bought it. Not even during the late 1980s or even the 1990s did you see much of that.”

The leader was arguably Charles Saatchi, now known more widely as a collector and entrepreneur than as an advertising man. His willingness to put his capital, and marketing expertise, on the line to support, and promote contemporary artists, became a model for future collector-dealers. Soap, the Conservative party and Damien Hirst – apparently all could be worked with the same skill set.

The auction house sales are the most visible places to see the changing dynamics of art ownership. They used to be where the dealers acquired inventory for resale to collectors. It wasn’t that “retail” buyers couldn’t walk in and bid; but they were intimidated by the risk. Also, until the auction house antitrust scandal of the 1990s, dealers almost openly formed “rings”, or syndicates, to bid on works. “That’s not done now, at least not openly,” says one major buyer. “When the auction houses came under a microscope after the scandal, that stopped it. Now a dealer might buy a painting and then ask other dealers if they want to buy half shares or quarter shares, but they don’t do that in the [sale] room, like they did.”

“Syndicating ownership is one way to support the market,” says one private dealer. “The Swiss dealers did it before others. It’s a way to support the market, so people don’t have a fire sale when they’re short of cash. It’s a banker’s mentality. Often, especially with European dealers, there’s only one owner of record. It makes it possible to wait longer before you have to sell a piece and the more patience you have, or can afford, the more money you can make.”

The richest dealers can afford to hold inventory for a long time without using syndication to reduce their risks. There are times when those who have the cash can rule, but in the art world, this is not one of those times. Everyone, or at least everyone who is rich, seems to have the cash. What they lack is the art, or, from the dealers’ point of view, the inventory.

That is why the auction houses have been, and can be, so aggressive in offering guarantees of minimum prices to consignors of art. Mitchell Zuckerman, the president of Sothebys’ Financial Services, the finance arm of the auction house, says: “In a rising market (like the present one) you could make the argument that guarantees should be less desirable, but if you count them up, there are more consignors asking for them.” The existence of guarantees, but not the levels, are disclosed with small symbols next to the illustrations in the catalogues.

Guarantees are marketing tools for the auction houses. “Because it’s harder to get pictures for the contemporary sales, the war between the auction houses is harder there,” says Asher Edelman, a prominent New York dealer. The relative quality of works offered for sale swings back and forth among all the auction houses, but particularly between Christie’s and Sotheby’s, depending in part on which offers higher guarantees.

In the buzz after sales, you hear talk among the trade about how particular works were “b.i.’d” , or bought in, with the assumption that guaranteed works that do not sell represent gigantic losses to the auction houses. This is naïve. “I can’t think of any year in which we had a net loss on guarantee activity, says Zuckerman. We’ve always been successful on a net basis.” That includes some tough years in the art trade.

While Sotheby’s, as a public company, says more about its finances than the other houses, nobody breaks out the profitability of guarantees. If they did, the consignors might hesitate longer before asking for them. In return for giving the guarantees, which are generally set slightly below the low end of the estimated selling price you see in the catalogues, the auction houses receive a cut of the proceeds above the guarantee. The percentage is negotiated with each consignment, rather than on a standard, disclosed scale. Typically, the auction house would receive, say 30 per cent of the hammer price above the guarantee level for the first tens of thousands, hundreds of thousands, or millions, then 20 per cent above that initial level.

This can be a good business, as a minute or two with a pencil and a list of sale results will tell you. For example, while Christie’s, as a private company, does not discuss its guarantee business, one could make some educated guesses about the profitability of some recent guarantees. In the November New York contemporary sale, a Clyfford Still picture from 1947 (above) did carry a guarantee. It was estimated at $5m to $7m. Stills just don’t come up very often; many, if not most, are in museums or with collectors who won’t sell. A bidding frenzy whirled round the picture, which was sold for a hammer price of $19m. It would seem reasonable to infer that this particular guarantee contract was a profitable one for Christie’s. I asked afterwards why the guarantee was set at the level it was; a Christie’s expert told me that it was calculated on the basis of the last auction result for a Still. It was, of course, the consignor’s choice to take a guarantee, or take their chances.

Not every guarantee works out that well, of course, which is why the auction houses are ready to share the business. Some guarantees of consignments are laid off on dealers, collectors, or collector/dealers who are willing to take the risk for the potential reward. Among the better known third party guarantors are dealers such as Robert Mnuchin and Acquavella Galleries, and collectors such as Peter Brant.

“I think third party guarantees were more significant a year or two ago,” says Edelman. “The auction houses are feeling more comfortable with the market now, so the percentage would be down.” Zuckerman of Sotheby’s says: “Sometimes somebody approaches us and offers a guarantee, or we approach people who are knowledgeable about a market (in a particular artist’s work).”

This could be interpreted as a fairly straight business, a simple calculation of risk appetite against reward. One dealer who has done third party guarantees says: “This has nothing to do with manipulation. You take on a risk for a price. The sale takes place in an open auction.” The favourable economics support this interpretation.

There are dissenters. One prominent lender against art collateral contends: “This will end soon, because there is an inherent conflict when you have parties who are in the trade, or who are somehow insiders, guaranteeing the properties.”

This might arguably be more the case when the auction houses themselves take on the guarantee. As our art lender (among many others) points out: “They can promote some lots over others. They can have a pre-sale where they set up the top 20 lots and try to synch up the lots with the collectors. (The auction house) is betting on something over which they have a lot of control.”

Art is a far more significant asset class, it’s traded with greater frequency, and there is a higher levels of financial expertise being applied to the market. All this along with the greater transparency of the business, suggest that the financial structure of the art market will become more elaborate and more regulated.

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