One of the great ironies of finance, a banker friend likes to remind me, is that no institution wants to lend money to someone who really needs it. Between 2010 and 2022, as excess liquidity sloshed through the system, ultra-high-net-worth individuals borrowed billions and billions of dollars against their assets. For many art collectors, that meant leveraging their art—sometimes to make money in other asset classes, sometimes to buy more art. Starting two years ago, those conditions have reversed, draining the art market of billions.
Art-backed loans have been a fixation in the financial world for more than a decade. Alternative-asset giant Carlyle tried to get into the game, and Sotheby’s Financial Services—which recently sold a $700 million portfolio of art-related loans as an asset-backed security—has attracted attention from investors for its unique position within the auction house. But the dominant player in this field has been Bank of America, which used its clout with its rich clients to create a massive art loan book of $10 billion by offering exceedingly low rates—at least while they lasted.
For years, this was a dual benefit for banks and their clients, especially for high-net-worth individuals looking to do what another banker described to me as balance sheet arbitrage. In short: Most wealthy people have the bulk of their net worth in semi-illiquid assets, like company stock, real estate, and equities held in family trusts. So when someone comes to you with an investment opportunity, but you don’t want to trigger a major taxable event to free up some cash, you have to get creative.
Enter your banker with an arbitrage opportunity. Instead of selling your assets to make a short- or even medium-term investment, your banker will happily make you a loan. The financial math is simple. As long as the return from the investment is higher than the cost of the loan, you’re making money. Also, you don’t have to sell any assets, whatever they may be. Banks love these loans because the borrowers don’t really need the cash, which means they’re low risk for everyone involved. If the bank can see what you’re really worth, and they can perfect the collateral you offer for the loan—i.e., they gain legal control over your money or property—they can offer you a very good rate.
This is especially important to the art world because for those dozen years, from about 2010 to 2022, the art market was goosed with billions of dollars—I’ve seen estimates of $17 billion-$20 billion—in art loans that were built on this exact principle. These loans were also used for lifestyle goals. Don’t want to exercise your Goldman options but still want a glow-up? Your banker can help get you into that Hinckley picnic boat or acquire another Vilhelm Hammershoi for the beach house.
Art Arbitrage
Earlier this month, I wrote about Jacob King’s provocative theory that today’s art market doldrums can be attributed, in part, to the years-long glut of collectors rushing into the secondary market with an “investment mindset,” driving up prices to unsustainably high levels and thus choking off new activity. But as I was reminded by a savvy money manager, who reached out after reading my column, much of the slowdown can also be attributed to the fact that art loans have gotten much more expensive.
Interest rates are a crucial input for the art market ecosystem, of course, because many of the most successful long-term collectors are art rich but cash poor. Fine art, after all, is one of the most illiquid assets in the world.
Before Jay Powell started jacking up interest rates, private bankers—especially those managing collectors’ non-art assets—were lending against up to 50 percent of the value of the investors’ art holdings. That means if you had $20 million in art in your house or storage, you could get $10 million in cash to invest in other things. That might sound reckless, but it’s more prudent to diversify your holdings, especially if you’re merely art rich.
That same bank probably had a number of different investment opportunities it wanted to sell you on. The bank made money; you made money; and your portfolio generated income, as well as being balanced against the risk of the art market falling. If the bank was managing your investments, they felt much safer making the art loans because they knew the money was in something as (or more) valuable than the art. And they could keep an eye on it.
In exchange for all of that confidence, the bank was willing to lend at very low rates, sometimes as little as 75 to 150 basis points above the discount window. For much of the period from 2010 to 2022, the Fed was operating under a Zero Interest Rate Policy that meant money was essentially free to these banks. Collectors were paying 1.5 percent or less to borrow and invest.
Anyway, most borrowers put the money in a range of financial or alternative investments that generated much higher returns than fine art. But a few enterprising art collectors recognized there was an arbitrage opportunity available only to them. As we’ve discussed, the art market is clannish and exclusionary. You cannot simply buy art because you have the money; you have to add value. Established art buyers with recognized and admired collections move to the head of the line at any gallery. The dealer wants to sell to someone whose name and reputation will advance the visibility and status of the artist.
For much of the ZIRP era, it was easy for well-respected collectors to get primary market works from the most sought-after new talents at prices below market value. If you could borrow $1 million against your art holdings at 1.5 percent annual interest and buy a dozen or more primary market paintings, and then quietly flip them for double or triple the price, why wouldn’t you? Especially if it was only costing you $15,000 a year in interest payments to make that million or more.
This has always been one of the dirty secrets of the art world. Everyone loudly condemns speculators—people who flip art for short-term profit—but the speculators are usually people with the most access to art, meaning the most respected collectors. And they’re abetted by the very galleries who control the markets of the artists everyone is speculating in!
There were not a lot of people playing this game. Nevertheless, it ended when dealers raised primary prices and the Fed raised rates. In both cases, the spread collapsed, eliminating the arbitrage opportunity.
Priced to Perfection
In 2022, the Fed began raising the rate it charges banks, eventually topping out where we are today, at 533 basis points. That drove the Secure Overnight Financing Rate, the benchmark that loans are calculated from, up to the same level; banks also raised the extra fees they charged from 57-150 basis points up to 300-500 basis points. Today, the total cost to art market borrowers ranges from 8.33 percent to as high as 10 percent. At that level, these loans are no longer cheap.
That doesn’t mean everyone is running for the exits. Remember, few of the people who are borrowing against fine art need the money. They’re simply reallocating their investments. Often these loans are combined with a margin loan against equity holdings. And the art market may be down, but the equity market is definitely not. So it isn’t very hard to move money from one part of the balance sheet to another. One banker wondered aloud if the $10 billion art loan book at Bank of America had dropped closer to $8 billion over the last 18 months.
The BofA book has declined rapidly, in part, because art loans don’t have a long duration. They’re short-term loans by definition, because the art market is illiquid and it is difficult to mark the collateral to market. With auction volumes down nearly 50 percent from the 2022 peak, art valuations are also down. That means the collateral is getting reduced and the loans are being called in.
Since these borrowers have only a small percentage of their net worth in art and their portfolios are still strong, paying down the art loans or credit lines used to buy art isn’t a disruptive event. But it does mean the collector has less money to spend on art right now—which is probably a good thing because, as most wealth managers will tell their clients, now isn’t a great time to buy art. One person in the advisory business who deals with collectors and artists recently told me, “Investment opportunity in art is at the lowest it ever was.” The big-money buyers have walked away, which makes it even riskier to buy art at this price level. The last thing you should do at a time like this is borrow against art to buy more art.
It’s also a lousy time to sell art, but that might not be why we’re not seeing some of this art liquidated. The truth of the matter is that collectors are still collectors. The value of art isn’t in the financial gains; it’s in what they call psychic income: the status and satisfaction one gets from owning art, which isn’t easy to measure but is a significant driver in the market. Art, after all, is often the last asset buyers acquire—after the house, the beach house, the boat, and, for some, the plane. And because buying art is so personal and connected to the collector’s sense of status, it’s often the last thing they sell, too. (Just ask Ron Perelman.) It’s very hard to explain to your friends at the private club why you’re dumping your art even in the worst of times.
