The Auction Edition | WITI Recommends

Felix Salmon (FMS) is a friend of WITI, finance writer (subscribe to his excellent Axios Capital newsletter), podcaster, and five-time WITI contributor (Wine Happiness, Pop Art, Sacklers, Wine Caves, and Brezels).

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Felix here. In mid-November, hedge fund billionaire Ken Griffin bought a 1787 copy of the Constitution at Sotheby’s and promised to lend it to the Crystal Bridges museum in Arkansas.

Why is this interesting?

Putting aside the crypto angle, which has been covered elsewhere, Griffin’s victory sheds some light on contemporary auction dynamics in general.

Griffin’s aim was exactly the same as that of the underbidder: To buy the Constitution and then lend it to a museum. There might have been a difference in exactly which museum was going to receive the donation, but that hardly explains the ferocity of the bidding war between the two sides. Griffin paid well over $40 million not to ensure the Constitution would find its way into a museum—that was always a given whether he won or lost—but to be the person who got to lend it to a museum.

Griffin held two big strategic advantages in this fight. First, he knew exactly who he was bidding against, and also knew exactly what their maximum bid was because they published that number on their website. That made it easy for him to work out exactly how much to bid such that they couldn’t muster a larger bid. In general, advertising your maximum bid to rival bidders is a suboptimal bidding strategy.

Second, he knew the tricks of the trade—including the power of the pre-negotiated irrevocable bid. Long before the Nic Cage memes took off, Sotheby’s had to secure the lot for itself, rather than see the business lost to archrival Christie’s. In order to do that, Sotheby’s guaranteed the seller, the Dorothy Tapper Goldman Foundation, that it would receive a certain minimum sum from the sale.

That guarantee created a serious financial risk for Sotheby’s. If no bidder materialized at or above the reserve price on the lot, then Sotheby’s would find itself in possession of a 234-year-old piece of paper that it never particularly wanted to own, and that would very publicly have failed to sell at auction. That object would be hard to sell, and meanwhile, Sotheby’s would be out somewhere in the region of $15 million.

Sotheby’s, therefore, found a “third-party guarantor” in the person of Ken Griffin. Griffin committed to bidding at least a certain amount for the copy of the constitution, in return for a share of the upside if the document ended up selling for far more than the guaranteed amount. Importantly, Griffin was entitled to his share of the upside whether or not he ended up winning the auction.

There’s an interesting twist to this particular tale, though: Artnet’s Katya Kazakina reports that Sotheby’s received the guarantee from Griffin after the ConstitutionDAO (decentralized autonomous organization) had amassed a significant war chest. On its face, that doesn’t make a lot of sense. If the DAO was certain to bid, Sotheby’s could be sure of selling to them and didn’t need to worry about getting stuck with the object.

The problem was: If the DAO came in very visibly and credibly promising to outbid anybody with less than $40 million to spend, for an item that was only estimated at $15 million to $20 million, then there was a real risk no one else would bother to bid at all. In theory, anybody could just come in and bid $39 million for the lulz, safe in the knowledge that the DAO would outbid them. But in practice, given the layers of vetting you need to go through in order to be able to bid at that level, Sotheby’s couldn’t count on such a thing. In order to guarantee some kind of a bidding war, the auction house was willing to give significant upside to Griffin. He, after all, could credibly want to buy the Constitution for at or near the amount the DAO was willing to pay, and therefore couldn’t be easily accused of working in cahoots with the seller—or Sotheby’s itself—to merely drive the price up.

Another reason Griffin was happy to bid against the DAO is that he was going to get more value out of winning the auction than the DAO was.

Griffin has acquired a valuable object, which has a lot of utility to him. He has now been identified as an American patriot willing to put many millions of dollars into buying and preserving a copy of the Constitution. He can borrow money against that copy on a non-recourse basis (which means no bank can come after any of his assets other than the object itself); he can donate it to a non-profit and take a tax deduction for doing so; he can lend it to a museum and thereby curry favor with its billionaire founders. Plus, of course, he might in theory be able to sell it at a future date for a significant profit. Little if any of that utility was available to the crypto collective that Griffin was bidding against.

This was also never a fair fight. One side had a war chest of over $45 million and was willing to spend every penny. The other side was an individual so rich that dropping $45 million—or even $145 million—on a single object would make no discernible difference to his lifestyle or his wealth. It’s easy to see why such individuals are such coveted clients of the auction houses, and why Sotheby’s might be happy to treat Griffin generously in any given transaction.

Finally, this whole affair says interesting things about the trustworthiness of auction prices. In an art world that’s notorious for opacity and mendacity, published auction prices are the closest thing there is to a gold standard—an unfudgeable and indelible record of how much someone really paid for a certain work at a certain time. And yet, once third-party guarantees get involved, headlines soon follow using words like “murky” and “mysterious”.

It’s easy to see why. When the DAO bid $40 million, they were committing to pay a total amount of $46.2 million. And yet they got outbid by someone paying $3 million less than that amount.

For anybody using auction prices as a guide to the maximum amount that a bidder was willing to pay in a certain saleroom on a certain day, the $43.2 million figure is decidedly misleading. After all, the DAO bid more than that themselves.

And while $43.2 million is definitely the final net cost to Griffin, in another sense it doesn’t represent the true net cost he was willing to pay.

Think about it this way: If Griffin had stopped bidding after the DAO’s $40 million bid, the DAO would have won the auction, the final recorded price would have been $46.2 million, and Sotheby’s would have written Griffin a check for somewhere in the region of $4 million. The second after the DAO made that bid, Griffin was $4 million in the black. By putting in an extra bid at the $41 million level, he swung all the way to $43.2 million in the red. The cost of that final bid, to Griffin, was the magnitude of the swing — some $47.2 million.

Historically speaking, Christie’s would have reported the price paid by Griffin as $47.4 million; any side dealings involving irrevocable bids and third-party guarantees were considered a separate, confidential matter. Today, however, both Sotheby’s and Christie’s subtract the amount payable to the guarantor from the gross price payable by the winning bidder, when the guarantor wins the work. In this case, that means Sotheby’s reported the final price paid not as $47.4 million but rather as $43.2 million.

Of course, it’s impossible to convey all that subtlety in a single reported number. Sotheby’s has a simple binary choice: It can record the final price paid as $47.4 million, or it can record the final price paid as $43.2 million. Neither number fully represents the “truth” — because auctions aren’t nearly as clean and simple as many art-world observers would like to believe. (FMS)

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Noah (NRB) & Colin (CJN) & Felix (FS)

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