Kevin Warsh’s real Fed ‘regime change’ may happen deep inside Wall Street’s plumbing
Kevin Warsh, then-President Donald Trump’s nominee for Federal Reserve Chairman, delivers an opening statement at the Senate Banking, Housing and Urban Affairs Committee confirmation hearing at the Dirksen Senate Office Building in Washington, DC, on April 21, 2026.
Andrew Harnik | Getty Images
New Federal Reserve Chairman Kevin Warsh’s talk about “regime change” at the central bank has sparked speculation about everything from interest rates to major personnel changes to fundamental shifts in the way it operates and communicates.
But what that will ultimately look like is more subtle but perhaps more important: a rethinking of how the Fed manages the financial apparatus of the U.S. economy and the massive balance sheet it has built over nearly 18 years of fighting the crisis.
Interviews with former Fed officials and economists, as well as a growing library of research, suggest Warsh could steer the Fed toward a smaller role in day-to-day financial markets while also setting clearer rules for how and when it should intervene.
Simply put, the debate centers on whether the Fed should continue to use its balance sheet as a regular tool to influence financial conditions and support markets—as it has done throughout much of the post-financial crisis period—or reserve it for periods of market dysfunction and more damaging economic stress.
Rewriting the Fed’s playbook
debate over 6.8 trillion dollar balance sheet is technical in nature and removed from the more widespread discussions of Fed policy. But the risks are quite high.
Since the financial crisis erupted in 2008, the Fed has aggressively used its holdings of Treasuries and mortgage-backed securities to stabilize markets and influence broader financial conditions.
Before the crisis, the Fed had a relatively small balance sheet — about $800 billion — but at one point it expanded it to about $9 trillion. The Fed’s assets now account for about 23% of the U.S. economy, or about seven times the pre-financial crisis level.
Any effort to change the system could have broad consequences, potentially affecting Treasury yields, mortgage rates and other interest-sensitive areas of the economy and influencing the way policymakers respond to future crises.
“This is a debate we’ll see later this year. But the encouraging thing about all this is that no one, including Kevin Warsh, is arguing that any of this can be done quickly,” said Lou Crandall, chief economist at Wrightson ICAP and a longtime Fed watcher.
“This needs to be done carefully and some changes will likely take time to be implemented,” he added. “Everyone is looking at this as a medium-term project rather than part of the first day’s agenda.”
Warsh called the balance sheet Wall Street Journal column He said it was “inflated” last year and could be eased while also allowing the Fed to cut interest rates.
What might ‘regime change’ entail?
While Warsh has spoken widely about shrinking the Fed’s footprint, Wall Street is already working out what a new operating framework might look like.
Among the more provocative ideas comes Steve Blitz, chief US economist at TS Lombard; Warsh argues that the Fed could put more emphasis on the overnight repo market (the short-term funding system that supports the Treasury’s market function) as the key transmission mechanism for policy, rather than relying solely on the federal funds rate that banks charge each other for overnight lending.
“The repo rate becomes the policy rate,” Blitz said in a client note.
In practice, this can create an unusual dynamic: Warsh can satisfy Trump’s push to cut interest rates while tightening key financing conditions as policymakers grapple with persistent inflationary pressures.
However, he is likely to face swift opposition from fellow policymakers who are skeptical about the Fed’s ability to significantly reduce holdings and the benefits it could bring.
“I think shrinking the balance sheet is the wrong goal, and many proposals to achieve that goal would undermine bank resilience, hinder the functioning of the money market, and ultimately threaten financial stability,” the Fed Chairman said. Michael Barr said in a speech: last week. “Some of them will actually increase the Fed’s footprint in financial markets.”
Barr’s thesis is basically that looking only at balance sheet size is too narrow, and that other issues, such as how it is composed in terms of duration and composition, are also important. He argues that ignoring these issues could lead to “adverse” consequences, such as increased volatility and even the possibility of further intervention by the Fed. He also said that lowering banks’ required reserves could destabilize the system.
Understanding how it works
The balance sheet mechanics for reserves are simple.
When creating the balance sheet, the Fed deposits digital cash into itself and uses it to purchase assets from banks, creating reserves. This provides banks with liquidity that then theoretically flows throughout the financial system. Conversely, as the Fed shrinks its balance sheet, it no longer purchases assets and allows the proceeds of the bonds it purchases to be reinvested.
On the other side of the operation, the Fed uses its trading desk to reach its target interest rate. The central bank also has a number of other tools, such as the interest it pays on reserves, the discount window rate and, importantly, overnight reverse buyback operations that move financial flows.
The Fed operates under a system of “abundant” reserves; a vague term, essentially meaning something beyond typical but not excessive – that would be “ample.” Warsh hinted that the Fed could return to its pre-crisis “scarce” reserve policy, with the option to add more as needed.
“Reasonable people might disagree on this,” said Bill English, the former Fed chief of monetary affairs and now a professor at Yale. “The Fed could certainly go back to a system where reserves are scarce, it would work just fine. It might be a little complicated to get there. You want to do it slowly, but I think they can do it.”
After spending much of the past 18 years depending on the Fed’s balance sheet to keep operations running smoothly (and critics supporting the bull run in stocks), markets will be watching the situation closely.
“I would expect the Fed to have an open discussion about establishing a framework for future operations so the market doesn’t just assume it will trade unlimited amounts,” said Crandall, the Wrightson economist. Doing so “will allow the market to form more reasonable expectations of what will happen.”
As it stands, the Fed has never announced clear rules for when and how to use the balance sheet.
Markets have adopted the terms quantitative easing, or QE, for expansion and quantitative tightening, or QT for tapering, for balance sheet operations, but the Fed has never set clear guidance on when to use either. This is especially true when distinguishing between addressing the functioning of the financial market and supporting the dual inflation and employment objectives.
“They never established a framework for when to use QE,” former Cleveland Fed President Loretta Mester said. “I think the Fed hasn’t done a very good job over time of distinguishing and explaining when it’s using asset purchases for monetary policy reasons.”
Change message
This is where Warsh can particularly come into play.
Setting the tone for policy guidance is in the president’s wheelhouse, and Warsh may try to temper market expectations that the Fed will step up asset purchases as Wall Street starts to get nervous.
In addition, he spoke in favor of efforts undertaken by Michelle Bowman, the Fed’s vice chair for bank supervision, to loosen some banking regulations. Part of this will change the types of assets that banks can claim as reserves and use in times of crisis; This is an effort by the President of the Dallas Fed. Lorie Logan quoted in a recent speechHe said he was looking forward to “seeing how this goes.”
Logan has first-hand experience with the dynamics of balance sheet management. Before his current role, he ran the trading desk at the New York Fed, charged with executing the central bank’s open market strategy.
Logan also noted in his speech on April 2 that the Fed has other tools at its disposal to help liquidity flow, essentially using components from both Warsh and Barr’s sides of the debate.
Like others, he spoke in favor of moving slowly to solve the problem.
“I would like to emphasize that any change to the balance sheet must be gradual and carefully planned,” Logan said.
Work has begun
Inside, Fed officials are preparing to discuss.
Central bank researchers have published several papers on the subject; one of them “User’s Guide to Reducing the Federal Reserve Balance Sheet”
The document concluded that without approval in either direction, cuts of up to $2.1 trillion could be achieved through the current policy framework, with further cuts possible if the Fed changes direction towards a scarce reserve approach in banking. The article also suggests that it will take “at least a year, and possibly several years” for the process to begin.
All of these offers are likely to be on the table after Warsh takes over on Friday.
He inherited a Fed that faced not only economic challenges but also high political expectations from a president who repeatedly threatened to fire him for not fulfilling Trump’s desire to cut interest rates, regularly attacked outgoing Chairman Jerome Powell and dubbed him “Too Late.”
For all the talk of “regime change”, former officials warn against expecting a dramatic overhaul overnight when Warsh’s big ambitions are about to meet central bank reality.
Warsh will inherit a Federal Open Market Committee built on consensus, where even major policy changes often occur deliberately and only after lengthy internal debate. Political considerations are left outside the walls of the central bank, these officials say.
“I was going to FOMC meetings” [Alan] Greenspan was president, so that’s a long time. “Politics never enter this room. Political considerations never enter the discussion,” said Mester, the former president of the Cleveland Fed.
