A broken market

Imagine it’s still 2000: during the bubble, before Spitzer. The market’s white-hot,

and IPOs from hyped young companies are hugely in demand. The broker-dealers

deliberately underprice the IPOs they get, guaranteeing mark-to-market profits

for their favoured customers – the ones who can get in at the IPO price.

That’s bad enough, and in fact is more or less what happened in the US stock

market a few years ago. It also meant that virtually every bank on Wall Street

ended up paying a lot of money out in settlements, and many high-profile executives

were fined, lost their jobs, or worse.

But let’s say it didn’t stop there. Let’s say that the deliberate underpricing

applied not only to IPOs but to secondary offerings as well: that broker-dealers

would sell stock in Google, say, for $20 a share even when it’s already trading

in the secondary market at $185.

And that’s just the beginning. Broker-dealers also quite explicitly sell access

to their offerings for cash: you give me money now, and I’ll make sure that

you’re able to get in on the ground floor in the future.

And the much-prized access to IPOs and secondary offerings is based only partly

on the basic market relationship of how much money the investor has and how

much they trade with the broker-dealer. A lot of other factors come into play,

such as who you know, what your surname is, and whether you have managed to

gain a good reputation in the market already. In fact, it’s reached the point

at which investors wanting in on those offerings end up employing other people,

with good names, to represent them – just so that they can get the necessary

access to the broker-dealers. It’s a whole second level of intermediation: the

broker-dealers are the intermediaries between the issuers and the investors,

while there are also "consultants" who intermediate between the investors

and the broker-dealers.

But wait: there’s more. Let’s say that there’s a small open liquid market but

that there’s a much larger behind-the-scenes market, with opaque prices, where

the broker-dealers put together trades between buyers and sellers without ever

having to disclose how much is being paid. What’s more, the broker-dealers feel

so threatened by the open market that they quite explicitly try to place their

IPOs only with investors who won’t ever try to take profits by selling in public.

Much better that their investors, if and when they do want to sell, come back

to the original broker-dealer, and place the property for sale privately, giving

the broker-dealer another chance to make money as well as giving them valuable

proprietary information that is not available to the rest of the market.

In this market, the most revered investors are buy-and-hold funds which never

(OK, which almost never) sell their holdings. These super-investors make their

holdings public, and all the broker-dealers want to sell to them. The problem

is that the super-investors rarely if ever buy in the IPO market: they prefer

to sit back and use their enormous leverage behind the scenes, often acquiring

from smaller investors at prices well below market. One broker-dealer, in an

attempt to get an issuer into one of the super-investors’ portfolios, has even

told his normal investors that they have to give the lion’s share of whatever

they buy in the IPO market directly to a super-investor. No gift, no deal, and

the investor gets nothing at all.

You get the picture? So now a magazine runs an exposé

about all this, and a major blogger responds

with this:

"So [this stuff] sells and a lot of people want to buy it. Great. But

so what? And, er, isn’t people wanting to buy [this stuff] a good thing

for [issuers]?"

Well, I’ve given it away now. The market I’m talking about is the art market,

the broker-dealers are the galleries, who are both brokers (trading privately

in the secondary market) and dealers (offering new works of art for sale). The

issuers, of course, are the artists, the investors are the collectors, the super-investors

are the museums, and the small open market is that provided by the auction houses.

The New York Magazine piece is shocking, and one of the most shocking

things about it is that it really doesn’t tell us anything we didn’t already

know. We’ve all become so used to the situation in the art world that it’s impossible

to shock us any more, even when we learn that galleries are selling paintings

to favoured collectors at just 10% of the price they would receive at auction;

even when we learn that a collector who spends more than $1 million a year on

contemporary art had to "invest" $75,000 in the Project Worldwide

gallery just in order to be able to be allowed to buy the art it was showing.

(And still he wasn’t able to, in practice: the paintings he’s now suing over

went to Jeanne Greenberg Rohatyn instead.)

What’s more, the galleries are quite shameless about their own behaviour: as

the article says, "dealers often rejoice, and collectors despair, that

the art world is the last big unregulated business in America." It’s so

clubby that even a budget of $1 million a year isn’t enough to give you real

clout: for that you need to be spending, um, real money. Like $300

million money.

The system as it stands doesn’t just benefit the galleries at the expense of

the collectors. It also benefits the galleries at the expense of the artists

(who could get much more money for their works than they get from their galleries),

and, more broadly, it benefits the established art-world names at the expense

of smaller players and newcomers. It creates enormous barriers to entry, especially

for anybody who might be interested in collecting art, and it creates a general

atmosphere of distrust and resentment which makes the art world one of the bitchiest

and most unpleasant arenas that anybody could ever consider getting involved


It used to be the case that someone with a great eye and limited funds could

amass an impressive art collection just by buying early in artists’ careers.

Today, collectors buy the work of great artists at low prices the whole time.

But those prices are only available to the richest and most established collectors:

Charles Saatchi, say, could snap up that Elizabeth Peyton from Gavin Brown for

$50,000 (that’s what they were priced at, at her last show there), but you

sure couldn’t. You will need to wait – and wait – and wait

– and eventually something will come up for auction, and there will be

such a frenzy for such a rare piece that it will go for half a million or more.

Which is just as artificial a number as that original pricetag.

Upshot: If you’re thinking about collecting contemporary art, don’t. You might

be OK if you limit yourself to multiples – just remember that prints on

paper have to be kept away from daylight. In general, however, the art market

is a high-stakes game played among sophisticated insiders, and you

weren’t invited.

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10 Responses to A broken market

  1. geoff says:

    I agree with your point Felix, but don’t see how this differs from a great many other parts of the world that deal with money with lots of zeros behind it ($ not YTL).

    Doesn’t the same situation exist loans issued to countries? with after-hours trading networks? and whatever the market is that deals with intra-company trading outside of the public floors? and banks and the rate you can get on deposits for being a preferred customer (read lots of cash)? real-esate deals? political deals? restaurant reservations?

    this is one of the founding principles of capitalism isn’t it? if not then it is at least the founding principle of the lunch meeting.

    what are you objecting to- the existance of the preferred member system or that you weren’t invited? or is it that in the art market the fact that the emporer has no clothes just to painfully obvious?

  2. Felix says:

    Absolutely not, Geoff. In all of the other cases you cite, except for restaurant reservations, there are regulatory bodies which exist to level the playing field, and trying to get a special deal is illegal.

  3. Todd W. says:

    Financial markets in the Western world are highly regulated yes, but to say this is a world-wide phenomenon would be overstating it. Plus, there are plenty of loopholes, under-the-table practices, etc. even within the regulated structure that to think financial markets are clear of this sort of dealing strikes me a idealistic or naive.

    Plus, none of this takes into account the wildly subjective nature of price-setting – or maybe it hinges on it exclusively. Most offerings in the market are unique items likely to only accumlate a handful of sale prices over their lifetimes, so there is not enough “action” to render the market rational or transparent. Hence, what will regulation bring to the table that will render this situation more friendly to the “small investor”?

  4. Felix says:

    Todd, all financial markets, to my knowledge, are regulated to *some* degree or other. Some regulations are good, some are bad, some have bigger loopholes than others. But there’s nearly always at lest the *pretense* of a level playing field. I don’t think I ever even hinted that financial markets were free of this kind of dealing: I simply pointed out that most of what goes on in the art world would be highly illegal in most of the financial world, yet is open and legal in the art world.

    That said, I’m not necessarily advocating regulation, either. My main point, insofar as there was one, was basically just that your “small investor” can not and should not expect anything like fair treatment at the hands of the gallery system.

  5. laodan says:

    Thanks for this great post.

    You conclude:

    “That said, I’m not necessarily advocating regulation, either. My main point, insofar as there was one, was basically just that your “small investor” can not and should not expect anything like fair treatment at the hands of the gallery system.”

    That’s all well but it only concerns investments and that means capital. Since when should we expect investments to be moral? Since when did the logic of capital search for something else as making more bucks?

    I understand and I agree with you that the only available limitation to the workings of the logic of capital is regulation by the State. But what concerns me even more is the product. What is the art market playing with? Is it really art and does it matter?

    The “art bureaucratic word machine” that writes and speaks the language of authority about the arts, has been corrupted by the gold of the investors and they say “whatever” about the “whatever” of visual art creations. They make bucks and the investors make even more bucks that’s the game nowadays.

    Where does that leave art and is this question still of any interest?

    I guess for me yes and my answer could be “art is dead” but I can’t satisfy myself with such a banality for, as far as one can look back in history, visual art has always had a societal functionality in the societies where it was produced and it appears that societies needed this functionality to establish their stability and their survival…

    I have nevertheless to recognize that the investors and the “art bureaucratic word machine” have destroyed this functionality during “late modernity”. So then my conclusion would be that late modern art works are not related any longer with any societal functionality and as such they are mechandises without any artistic value. Time will recognize this as it has always done in the past and it will thus erase those merchandises from human memory and in consequence their financial value will evaporate.

    But what about the artist?

    – Not benefitting any longer from the functionality of visual arts are our societies not bound to dissolve?

    – If art has no more functionality in our societies then why should artists continue to create?

    On the first question the future shall give us the answer and on the second question, as an artist, I can tell you that those of us who care about the question “what is art” don’t care a dam about what capital buys.

  6. George says:

    I came a little late to this party but maybe have something to add.

    While I agree that a potential bubble exists in the art market, the debatable business practices you are pointing out are more likely a side effect of a bubble mentality rather than a root cause.

    A bubble occurs in a market when the buyers feel “sure” that the price will trade higher in the future. This diminishes fear, the perception of risk, and encourages speculation or greed. A study of market behavior will show that once a true bubble has been unleashed it will continue until it breaks, with catastrophic results.

    The bubble mentality is a psychological condition not a financial condition. Prudent investment behavior and the assessment of value become distorted and resistant to outside intervention for an extended period before a sudden reversion to the mean. This implies that although some regulation may be necessary, even desirable it does not necessarily follow that such regulation will reduce speculation. It is possible that it may add fuel to the fire and increase speculation before the market collapses.

    I hardly find it surprising that after the millennium crash in the US stock markets that we find ourselves in the midst of an expansionary market for art (collectibles) Historically this has been the case. Money leaves one market and moves to another, witness the current strength in commodities and related equity issues along with the precious metals and art. This is a well known pattern so it should be no surprise that those with the largest financial resources are using them to good advantage.

    As an artist I find all this frightening and distasteful. I would suggest that curatorial standards are becoming skewed in order to maintain the current market momentum. Is this market manipulation? Perhaps, but the old adage, “let the buyer beware” seems appropriately applied to connoisseurship here. Price is always relative to perceived value. A great painting bought for a million dollars may turn out to be a great value over the long term but like any speculation may decrease in value over the short term.

    I have no advice for the collectors other than sooner or later this house of cards is going to collapse. For a true collector this will be a buying opportunity, for the speculator, that’s the breaks.

  7. simian says:

    I don’t know much about the art market but came across this article which seemed interesting and on-topic:


    Anticipating Artistic Success (or, How to Beat the Art Market): Lessons from History


    University of Chicago


    The recent history of modern art provides clues as to how important artists can be identified before their work becomes generally known. Advanced art has been dominated by conceptual innovators since the late 1950s, and the importance of formal art education in the training of leading artists has also increased during this period. A few schools have been particularly prominent. Auction market records reveal that during the past five decades the Yale School of Art has produced a series of graduates who have achieved great success commercially as well as critically. Recognizing Yale’s role can allow collectors to identify important artists before they become widely recognized, and therefore before their early innovative work rises in value.

  8. piper says:

    i recommend a book called “making modernism: picasso and the creation of the market for 20th century art.” it seems to reason that just about anyone with some creativity can create their own collectors and essentially their own market of art.

  9. piper says:

    it seems painters fear sometimes that they sell “x” paintings over a period of time for $200-$2000 and one day they will be valued at much greater prices and they had to live in squaller to “give it away” so it could exist for someone to “invest” in and they never saw a penny from any sales that happen after the first. there’s also the idea that an artist who sells paintings for low prices isn’t a valuable artist. although if they “make” collectors and validate an importance of their work alligning it with the history of art to existing collectors over time then there exists a formula similar to the impressionists’.

  10. David Sucher says:

    For those worried about the bug-a-boo of “regulation.” Certainly it can be ill-conceived or there can be too much of it.

    Bujt just consider the very first (to my knowledge) regulations:

    Ô prohibition of counterfeit currency

    Ô honest weights & measures.

    Regulations they are. But consider how the market simply could not exist without them.

    Sometimes people need a referee to step in and enforce rules.

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