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Bubble Alert: Are Third-Party Guarantors Inflating the Art Market? UPDATE

UPDATE: More on this here.

Whenever an artwork sells at auction for more than any previous work has fetched (as with Munch‘s “The Scream” and Bacon‘s “Three Studies of Lucian Freud), the pundits pile on, decrying the questionable taste of megabucks buyers and the self-centered values of the 1%. They enjoy a frisson of schadenfreude at the prospect that the art-market bubble may soon burst.

Edvard Munch, "The Scream," 19TK Sold at Sotheby's in 20TK for $TK million Photo by Lee Rosenbaum

Edvard Munch, “The Scream,” 1895
Sold at Sotheby’s in 2012 for $20 million
Photo by Lee Rosenbaum

Until now, I haven’t joined the chorus: Dissenting from the detractors, I admired both of the above-mentioned record-smashing works (particularly the Munch) and defended the right of the rich to pay what it takes to acquire art that they covet (while also, in many cases, deploying their wealth in support of worthy philanthropic projects). I even believed the auction houses’ story that the creation of new wealth and the globalization of the art market made it unlikely that the boom would end any time soon.

But given the major role played by third-party guarantees and irrevocable bids at this month’s major modern and contemporary art auctions, I now think that the bubble-pundits may be on to something.

In response to my queries, Sotheby’s told me that 14 of the 63 lots in its May 12 contemporary sale were protected by an “irrevocable bid”—an amount that a third party (not the auction house or seller) promises to pay at the auction, at a level that insures that the work will sell. (The irrevocable bidder also may continue to bid above the promised amount.)

Sotheby’s said that there were five additional works in the May 12 sale with guarantees, some of which [I’m still checking this] may have been partly financed by third parties. (A guarantee is a prearranged amount that a consignor is guaranteed to receive from the auction house and/or third party, even if the bidding doesn’t reach that value. Guarantors benefit financially if the lot sells successfully and can suffer a loss of it doesn’t.)

Christie’s told me that at its May 13 contemporary sale, 17 of the 83 lots were protected by third-party guarantees. (Unlike Sotheby’s, Christie’s doesn’t use the term, “irrevocable bid.”)

Christie’s also told me that at its May 11 “Looking Forward to the Past” sale (combining modern and contemporary works), 13 of the 35 lots had third-party guarantees. The world record-setter—Picasso‘s $179.37-million “Les Femmes d’Alger (Version ‘O’),” 1955—was not included on that list, even though the auctioneer had announced at the start of the sale that “a party with a financial interest may be bidding” on it. (I have requested clarification on this from Christie’s and will update if and when I learn more.)

Picasso, "Les Femmes d’Alger (Version ‘O’)," 1955, unevenly lit at Christie's presale exhibition Sold May 11 for $179.37 million Photo by Lee Rosenbaum

Picasso, “Les Femmes d’Alger (Version ‘O’),” 1955, dramatically but unevenly lit at Christie’s presale exhibition
Sold on May 11 for $179.37 million
Photo by Lee Rosenbaum

Why do third-party guarantees matter?

Typically, those who offer third-party guarantees or irrevocable bids are major dealers or megabucks collector/investors who may prefer not to win the bidding but who have much to lose if the auction market goes south for works similar to those that they own. Through their anonymous “third-party” interventions, they are, in effect, bolstering the market for their own holdings and keeping the bubble from bursting. At Christie’s (but not Sotheby’s), these third parties still receive a fee from the auction house for assuming risk if they are the winning bidders.

As I’ve previously mentioned, this makes for an uneven playing field, because the net cost to a third-party guarantor who is a successful bidder at Christie’s (and collects a fee from the auction house) is less than it would be for a normal bidder.

What’s more, Christie’s implicitly recognizes in its own catalogue’s “Important Notices and Explanation of Cataloguing Practice” that abuses related to third-party guarantees may occur:

Third party guarantors are required by us to disclose to their clients their financial interest in any lots they are guaranteeing. However, for the avoidance of any doubt, if you are advised by or bidding through an agent on a lot identified as being subject to a third-party guarantee, you should always ask your agent to confirm whether or not he or she has a financial interest in relation to the lot.

At Sotheby’s, there could be a similar potential conflict-of-interest issue if third-party guarantors or irrevocable bidders advise clients to bid on works in which they have an undisclosed financial interest. Irrevocable bidders at Sotheby’s (unlike third-party guarantors at Christie’s) are compensated only if the bidding exceeds the level of the irrevocable bid and another bidder buys the lot. In other words, an irrevocable bidder at Sotheby’s doesn’t get what amounts to a partial rebate (a fee from the auction house) if he wins the bidding.

The third-party gambits fall apart if normal bidders fall away, either because they’re tired of being gamed by the insiders or because general economic conditions are worsening. (Think 2008.) There was clearly robust interest for the record-breaking Picasso. But competitive bidding appeared to be slim-to-nil on other important works in the recent sales—a possible warning sign.

In his comments during his May 11 conference call with securities analysts, Tad Smith, Sotheby’s new president and CEO, suggested that he intends to rely more on third-party irrevocable bids and guarantees in the future:

Of course, there are also guarantees that we have made on consignments that do not perform in auctions the way we would have hoped, with the result being that our company finds the lots on our balance sheet.

We will inevitably make mistakes from time to time. Nevertheless, we are committed to making every effort to hedge these risks through partners [emphasis added] to ensure that our shareholders’ money is well deployed to generate a return.

If this doesn’t signal a move towards bubble territory, I don’t know what does.

Which brings us back to the flamboyant, tits-and-ass Picasso, which (in my view) has plenty of eye-candy wall power but not much connoisseur allure. It’s “a so-so Picasso,” sniffed Adam Gopnik of the New Yorker.

Christie’s catalogue featured a two-page spread juxtaposing its star lot with a universally lauded masterpiece—the Museum of Modern Art’s 1907 “Les Demoiselles d’Avignon.”

This attempt at gilt-by-association merely made the 1955 “femmes” look foolish:

Each to his own masterpiece, I suppose.

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