Financial Reform and the Art Market

Daniel Grant has a very good article on the impact of current financial legislation pending in Congress and how it could impact the art market in general,  and auction houses in particular.  As auction houses routinely assist bidders with financing packages, they too could be impacted by these potential laws.  Of course it all depends on how they are intrepreted as well.

Grant reports

The terms of the auction houses' loans and advances, as well as the rate of interest charged to borrowers, are not publicly disclosed. These companies seek to keep confidential their arrangements with clients. Their continued ability to maintain that secrecy may be threatened by the legislation, although it is not entirely clear.

Kip Wainscott, a partner in the Washington, D.C., office of the St. Louis-based law firm Bryan Cave, stated that based on his review of the House and Senate bills, auction houses would be regulated by the Consumer Financial Protection Bureau established by the law. "To the extent that auction houses make loans, and use traditional borrower-lender functions like interest and collateral, it would seem that the spirit of the bills aims to include them," he said. This consumer bureau would write rules for the industry that may affect what has become standard practice in the auction field, such as requirements for increased disclosure.

The major auction houses sometimes wear two hats. The first is as a third-party seller of objects on behalf of consignors. The second is as a lender to prospective buyers. The two may come into conflict. As a seller, the auction house's duty is to maintain a level playing field and create a transparent process of buying and selling. As a lender, however, the auction house has a financial stake in the item up for sale. While the auction house indicates its interest in a particular lot with some symbol—for instance, a small triangle—many bidders may not be aware of what that symbol means, and the amount of the auction house's financial stake in the object is not made public at all.

In March 2010, Sotheby's quarterly report revealed that its loan portfolio amounted to $167.8 million. Earnings—based on annual interest rates of prime plus three or four points for these typically one-year loans, collateralized by the artwork purchased—amounted to 2% of overall revenues and 8% of the auction house's net income. In 2009, Sotheby's total revenues were $2.8 billion, of which $9 million resulted from loans. "Making loans is not a large part of its business," said Kristine Koerber, an analyst at JMP Securities in San Francisco.

Neither Christie's nor Sotheby's would comment on the legislation, although a spokesman for Christie's acknowledged that "we are following the process, but it is not clear yet what might come of it."

Economists are divided on the wisdom of subjecting auction houses to a new layer of consumer protection regulation. George Akerlof, a 2001 Nobel Prize winner in economics and a professor of economics at the University of California at Berkeley, said, "I hope the law wouldn't apply to them. Auction houses haven't been a problem for the economy." On the other hand, New York University economist William Baumol stated, "There has been scandal in the auction world, and the public has been endangered. Some degree of regulation would be important."

Art financing companies also might be subject to new rules. At present, "the usury laws that protect ordinary citizens don't apply to us, because our borrowers are considered highly sophisticated," said Christopher Krecke, co-owner of Art Finance Partners. He added that his company's average loan is $1.5 million to $2 million and that the typical borrower has a net worth of $40 million to $50 million. As a result, the rates the company can charge and the transaction structures it may set up are not covered by state usury laws.

To read the full article in MAD click HERE.