MINNEAPOLIS -- Sung Won Sohn is bullish on banks these days. And after listening to Norwest Corp.'s chief economist lay out the reasons, it's tough to dispute his thinking.
"Things are pretty wonderful for banks," he said. "The economy is doing very well. You've got good credit quality, high loan demand, healthy margins, and an expanding asset base. There really aren't too many things to complain about."
Quoted often - and never at a loss for words - Mr. Sohn has had a 20-year tenure at Norwest that has made him the guru of midwestern economists. He worked for the Federal Reserve before arriving in Minneapolis.
Ask him about current trends, and Mr. Sohn dodges quickly to another room, returning a moment later with two thick notebooks of data, which he slaps down on a cluttered desk.
A true economist, Mr. Sohn can sound contradictory at times. "We're experiencing robust growth right now," he says, only to put in a cautionary word a moment later that growth may not be so spectacular as some - including the Federal Reserve's governors - think.
The optimism he feels about banking today is tempered by history. What goes up, Mr. Sohn says, must come down. So he cautions bankers to ride the present wave carefully because, somewhere out there, another recession and possible interest rate increases are in the making.
Q.: Where is the national economy heading?
SOHN.: As long as we don't raise interest rates much beyond the current levels, there's a good possibility that we can enjoy a moderate, sustained economic growth over the next couple years. If interest rates go up, though, I'll begin to worry. It will create a higher probability of a hard landing with a recession.
Q.: Was the latest rate hike justified?
SOHN.: The Federal Reserve has been raising interest rates on the expectation that shrinking excess capacity in the economy will create more inflation. It could be right, but it could also be wrong.
I think there may be more capacity out there than the Fed thinks. If you look at the amount of equipment purchased by business this year, it has risen rapidly. And on top of that, corporate downsizing is raising productivity.
In addition, while we have been adding jobs, the quality of those jobs is not that good. A lot of them are part-time, and a lot are low-paying service jobs. Retail sales weren't all that strong in the second quarter, so the economy may not be as strong as many believe.
Q.: Do you expect the Fed to raise rates again soon?
SOHN: We could see a hike in either November or December. But I would expect it to be a very modest one. Fed officials feel the risk is on the upside, both for inflation and economic growth. That risk, if it is not managed correctly, could lead to a boom, which could raise interest rates and inflation and lead to a bust. We are trying to avoid a boom-and-bust cycle.
I don't expect a hike right away, because of the congressional elections. Many Democrats will be running against the Federal Reserve and high interest rates, and Chairman [Alan] Greenspan wants to stay out of politics.
Q.: What are the downsides for banks in the present climate?
SOHN: The only major area of concern is investment securities. Rising interest rates have pushed bond prices down, and the margins on bonds are being squeezed. Most banks have some sort of bond losses.
Long-term bond rates are going to drop more, at least temporarily. What the financial markets are looking for is a convincing sign of an economic slowdown. We haven't seen that yet, but there are some tell-tale signs, such as lower housing starts and auto sales.
The convincing signs should come later this year and then long-term.interest rates should come down.
Q.: How are consumers reacting to the interest rate rise?
SOHN: The mortgage market has slowed significantly. Refinancing has probably dropped by 85%; home purchases are down about 10%,
That is having an impact on retail sales. In the past few years, people refinanced homes and spent the money, or they moved into a home and bought furniture and appliances. Consumer spending is still rising but at a much slower rate.
Otherwise, loan demand has been rising because of the strong economy. Most banks are putting a lot more consumer and business loans on the books. Those are some of the most profitable assets banks have.
Also, margins are remaining healthy because banks are very aggressive in raising interest rates when the Fed raises its rates. All that is boosting earnings.
Q.: Is loan quality good now?
SOHN: Yes. Loan quality is a function of economic conditions, and the economy is pretty robust. So we are seeing banks actually lowering credit standards.
Q.: Is there any danger in that?
SOHN: I think so. When the economy goes into a recession, loan quality goes with it. Historically, banks lower credit standards during good times, and they forget to tighten when the economy, deteriorates. So during bad economic times, the loan quality goes bad, and they have a problem.
Q.: Norwest is active in the Rockies. How is the region faring?
SOHN: The Rocky Mountain region has probably been the most vibrant part of the United States, in part because of the recession-depression it went through in the mid-1980s. The region had a lot of pent-up demand, so when it came out of recession, it grew rapidly.
In Colorado and other states, that catch-up phase is over. All these projects are coming to a conclusion, so construction employment is declining. Colorado is also very vulnerable to defense cutbacks. Still, the national economy should hold them up.
We are projecting [regional] growth for the rest of the year and into 1995 to be more like the national rate - in the 2.5 to 3% range.
Q.: How about the Midwest?
SOHN: If you look at the Northern Plains, you're talking about a lot of food. We are going to have record or near-record grain production because of good rain. Livestock producers are not doing quite as well. There are too many cattle out there, and beef has to compete with pork, poultry, and fish.
Overall, the economy in the Upper Midwest is pretty well diversified, so ups and downs in the national economy aren't likely to have the kind of dramatic effect you might expect. We could see growth of about 2.5 to 3%, which I think is quite healthy.