In the immediate wake of the Standard & Poors downgrade of U.S. debt one week ago, a chorus of criticism of the rating agencys decision rose from media pundits, market analysts and particularly Washington. In addressing the move, President Barack Obama declared that no matter what some agency may say, weve always been and always will be a triple-A country.
One voice that was not raised to condemn the messenger was that of Stanley Crouch. As chief investment officer at New Yorkbased Aegis Capital Corp., Crouch oversees more than $2 billion in assets with a sole focus on income generation and a reach spanning equity, fixed income and alternative strategies. An active force in the specialized financing segment of the municipal bond markets for decades, Crouch joined Aegis from Herbert J. Sims & Co. last month. Aegis seeks to aggressively expand its institutional asset management footprint.
Over the course of his career, Crouch has never been afraid to take an independent or activist stance. He is perhaps best known for spearheading novel restructurings, including a transaction last year in Adams County, Colorado, in which a bankruptcy court approved a conversion of taxable obligations to tax-exempt status and allowed for the release of previously encumbered collateral to bondholders. During the financial crisis of 2008-09 he was able to use this creativity and tenacity to great effect in completing a number of transactions that would otherwise have come to naught during a period when the credit markets were effectively shut down. Among these was the resuscitation of a large Maryland senior-living facility, using a never-before-implemented municipal bond structure.
Crouch spoke yesterday with Institutional Investor Contributing Editor Andrew Barber about why the rating change was warranted, why he believes the best strategies to regain triple-A status may be counterproductive for the broad economy and how he is adjusting his portfolio to the challenges the new environment presents.
Institutional Investor: The surprise at the S&P downgrade quickly gave way to recrimination as many argued that the analysis used to justify the rating change was flawed. You have maintained that the change was warranted. Why?
Crouch: First of all, the downgrade should have come as a surprise to no one. S&P was simply following through on the fair warning they provided in April and July. What we are talking about in a rating according to the S&P methodology specifically is the probability of default.
S&P had clearly stated that they wanted to see a $4 trillion reduction over the course of the budgetary process. Something else that people should pay attention to is that they also put a time frame on there: They wanted to see something in 90 days. Their expectations werent met within the time frame, and this, to me, is S&P reestablishing their credibility. The credit rating agencies are still removing some of the egg from their face from what happened in the 2007 to 2008 period. Dont forget that there is precedence for this with Japan, Australia, Canada, Sweden all triple-As that were downgraded. All of those except Japan eventually regained that status because they took measures to address the issues raised by the rating agencies.
Clearly, S&P is signaling what it wants the U.S. to do to get its house back in order. Should these actions be taken, or are the correct ways to fix the economy and the correct ways to fix the credit rating separate tracks?
This is a critically important question. Will S&Ps requirements to avoid a further downgrade trump potential actions the Treasury may take? David Beers [global head of sovereign ratings at S&P] seemed to position any consideration of restoration of the U.S. to triple-A status as remote. If we consider the steps, S&P is highly likely to change the outlook to stable, then to positive, before any reassignment to triple-A. This is likely a multiyear process, especially given the embedded structural impediments to meeting the criteria S&P has set forth.
The question that remains is, will the Treasury and/or Congress be at all mindful of the risk of a further downgrade? I believe it all depends on the severity and depth of the downturn we may have already entered. When relief lines exceed the length of the lines waiting for the next must-have gadget, I believe the rating of the U.S. will be one of the last things on politicians minds, particularly for those in power heading into another election cycle. Of course, its critical to keep in mind that we are 15 months away from a national election. If recent history is any guide, there will be little substantive work that gets done in Washington to fix any of this while the election season is upon us.
If we have already entered a downturn, how severe and long do you think it could be?
The issue is one of confidence, period. We are in the midst of unwinding a worldwide credit bubble. This could take another decade or longer. Sovereign debt woes, tepid employment and consumer spending, GDP slowdowns and significant equity and commodity market declines are all part of the continuing aftermath of the credit crisis. In the aggregate, people are out of money, they fear the future, and dysfunctional governments are strapped and have used almost all their bullets already a bad combination akin to a perfect storm. Its just not going to stop raining any time soon.
As an investor, how will you navigate an environment like that?
We will use perceived weakness to our advantage. Solid dividend payers exhibiting low leverage on their balance sheets will be our focus in equities, as they always are. In bonds we will continue to be very selective as we look for solid, project-based credits that are not highly leveraged and deliver essential or near-essential services. These will be made up mostly of tax-exempts, which may be on sale at very compelling levels if municipal bond funds become forced sellers, as they were in the latter part of 2008 into 2009.