Kevin Warsh is about to take over the Federal Reserve with a clear mission: unwind years of aggressive central bank expansion that left the institution holding roughly $6.7 trillion in assets. But the incoming Fed chief is walking into a minefield of technical constraints and outright skepticism from his own colleagues.
The Fed's portfolio exploded from $800 billion before 2008 to a peak of nearly $9 trillion in 2022, ballooning each time the central bank intervened during economic upheaval. Three years of reduction brought it back down, but the Fed started growing its holdings again last December after stress rippled through critical funding markets. Warsh sees the bloated balance sheet as a core problem that benefited financial asset holders far more than ordinary workers.
"If we cut rates, a broader number of people will benefit from it versus quantitative easing, which tends to move through financial assets first," Warsh said during his confirmation hearing. He has long viewed the Fed's enlarged footprint as too convenient a tool for stimulus outside genuine crises.
The practical obstacles are formidable. Shrinking the Fed's holdings risks pushing up mortgage rates and longer-term borrowing costs across the economy. More dangerously, extracting too much cash from the banking system too fast could trigger another money market seizure like the one in 2019 that forced an emergency Fed reversal.
"If we're talking about a significant decrease in the balance sheet in the near term, that seems incompatible with potentially reducing interest rates," Roy Henriksson, head of investment risk at GMO, told Axios. The math does not favor doing both simultaneously.
Warsh appears to grasp these hazards. At his confirmation hearing, he stressed moving "slowly and deliberately," noting it took 18 years to build the balance sheet to its current size. Former Chicago Fed president Charles Evans echoed that caution, calling proposals to shrink the balance sheet by reducing banks' reserve holdings "ambitious, substantial, Manhattan Project-like initiatives" that he doubted would work.
The central complication is the Fed's own liabilities. Banks park enormous amounts of cash, called reserves, at the Fed. Draining those reserves to shrink the balance sheet is theoretically possible through regulatory changes, but Roberto Perli, who oversees the Fed's market operations, warned that miscalculation could destabilize the repo market and the Treasury market itself.
At least one Fed governor is already in open opposition. Michael Barr said last week that shrinking the balance sheet is "the wrong objective," arguing that attempts to do so "would undermine bank resilience, impede money market functioning, and ultimately threaten financial stability." He added that some proposals would paradoxically require more frequent Fed market intervention, not less.
Charles Evans captured the broader skepticism bluntly: "Any longing for the good old days of $800 billion is just completely unrealistic."
Author James Rodriguez: "Warsh is inheriting a Fed that has painted itself into a corner with its own tools. Good intentions on balance sheet reform are one thing. Actually pulling it off without breaking something is another."
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