There is one other frequently cited connection between the art market and auction house guarantees that ought to be addressed. That’s the common refrain published recently that 2016 auctions will be down because guarantees have been removed by and large from the marketplace.

That kind of post hoc propter hoc thinking is central to the confusion over guarantees. Rather than the market falling because of auction house restraint, it is the prospect of weak market that causes guarantors to pull back.

This isn’t intellectual speculation or argumentation. We have some pretty straightforward evidence from Sotheby’s former CEO Bill Ruprecht. Here’s what Ruprecht said to the New York Times in the aftermath of the Fall 2008 art market crash caused by the wider global credit crisis:

“We’re preparing for a different market. We are out of the guarantee business at least for a while. It’s too hard to predict what tomorrow looks like.”

Ruprecht said that late 2008 when it was obvious the art market was going to be very, very different for some time to come. But that wasn’t the first time Ruprecht swore off guarantees in 2008. The story of that year offers some interesting insight into how guarantees function and whether they “inflate” the market.

The story of Sotheby’s ill-fated attempt to be cautious at the peak of the last art market cycle begins not in 2008 but November of 2007. Sotheby’s Impressionist and Modern Evening sale that Fall had several heavily guaranteed properties. Here’s Carol Vogel narrating the impactful moment:

Sotheby’s had invested heavily in a van Gogh painting, “The Fields (Wheat Fields),” by giving the sellers a guarantee — a sum promised regardless of the outcome of the sale. One in a series of sun-dappled wheat fields he painted in Auvers-sur-Oise, it was completed just weeks before van Gogh died in 1890. But it became one of the evening’s most expensive casualties. When the painting appeared on the turntable, the overflowing audience at Sotheby’s became eerily silent. Not a hand went up. Tobias Meyer, the evening’s auctioneer, stopped the bidding at $25 million, well under its $28 million low estimate.

So much for the guarantee inflating the price. It also failed to inflate the broader evening sale. The hiccup surprised a jittery stock market and Sotheby’s shares fell precipitously. The day after the sale, the stock was down 35%. It has never recovered the price that it achieved a few weeks before that sale.

Naturally, Sotheby’s and Ruprecht were spooked by the market reaction. In his February earnings call for investors and, again, in May of 2008, Ruprecht made it clear that Sotheby’s was reducing its risk exposure by reducing its guarantee book. Nevermind that in 2007, Sotheby’s had done very well by guaranteeing property.

The United States had already enter a recession in December of 2007 and most CEOs were battening down the hatches for the coming rough ride. (If they only knew!) Here’s Ruprecht from the May 2008 earnings call:

We have been operating in an environment of pretty uncertain economic times over the last nine months. So, at the end of last year we focused very keenly on managing our risks and limiting our exposures to guarantees by taking on fewer deals where we could have exposed our balance sheet to material losses. As risk in the world tend to travel together, we tampered some of our opportunities which led to lower margins where it meant that we could meaningfully shift risk-away from Sotheby’s. Those are short-term issues which we expect will affect 2008 to some extent but the level of financial market turbulence that we see and seems to be impacting anybody associated with our business does appear to be diminishing.

The art market remained unexpectedly buoyant through the Summer of 2008. The price of oil and other commodities remained high. Those getting rich on natural resources were eager to bolster their cultural standing. The US, at the time, was a net exporter of art. Sotheby’s caution on guarantees was giving its rival an edge. Worse, the lack of guarantees was cutting into Sotheby’s revenues while Christie’s hammered away. Here’s how Ruprecht explained his weaker results in early 2008:

They really are a reflection of how we’ve chosen to manage risk and not expose ourselves to significant losses. The vast majority of our best customers who continue to be active with us every year are very active again here in our business year-to-date through early May.  […] A traditional competitor has approximately $80 million more in guarantees than we in this 10-day period.

Instead of sticking to his sensible strategy, the success of London’s June 2008 sales convinced Ruprecht the market’s outlook was still strong. His specialists had buyers for a number of works. With guarantees in hand, they went out in search of items on their clients’ wish lists.

This turned out to be a terrible head fake on the market’s part. Throughout the Summer, Sotheby’s was guaranteeing works for its Fall sales. The initial indicators were good. After all, in mid-September, Sotheby’s was holding Damien Hirst’s Beautiful Inside My Head Forever sale. Not only were early indications good that the appetite for art remained strong, the sale itself was an overwhelming success.

Too bad that Lehman Brothers and AIG were ripping a hole in the bottom of global credit markets even as Oliver Barker hammered down lot after lot of Hirst’s greatest hits. Sotheby’s limped through an Autumn of sales that were surprisingly strong considering the panic surrounding them. But they were not strong enough to meet the levels works had been guaranteed at. If only guarantees could be relied upon to put a collar on falling markets.

They can’t. No guarantee can make another bidder bid. To our point here, the guarantees are written when the auction house believes there are buyers who will more for the works than the guarantees. Otherwise, there would be no point to a guarantee.

When the auction house specialists don’t see demand, they have a harder time persuading the bean counters to open the guarantee purse. With third party guarantees, its even harder.

Lest you think the guarantee game has changed meaningfully in the last eight years. Let’s hear from some astute observers today. In December, Georgina Adam raised the question of guarantees with Artvest’s Michael Plummer. Pay attention to the causation here.

“If the art market does cool and become more selective, in 2016 it will be more difficult for auction houses to make as many guarantees as they have in 2014 and 2015,” notes Plummer, “because it becomes a much riskier bet on their part to find the right price level in a market that is moving sideways rather than mostly up.”

If the market intermediaries don’t see the market going up, they don’t offer guarantees. That’s the opposite of what you’re being told.

In Down Economy, Sotheby’s and Christies’s Crash Back to Earth  (The New York Times)

At Sotheby’s Art Auction, Buyers Were Not Impressed  (The New York Times)

Sotheby’s Q1 2008 Earnings Call Transcript (Seeking Alpha)

What lies in store for the art market in 2016?  (FT.com)