Veterans of the Federal Reserve’s crisis-era policy teams told an Atlanta Fed conference on Monday that incoming Chair Kevin Warsh should place greater emphasis on rules for deploying the central bank’s asset portfolio than on simply cutting its headline size.
The Fed’s balance sheet currently stands at about $6.7 trillion, much of it invested in U.S. Treasury securities and mortgage-backed securities. That footprint has drawn criticism from some lawmakers who view the accumulation of government securities as undue Fed influence in financial markets. Kevin Warsh, who has been confirmed by the U.S. Senate to a four-year term as chair and is expected to be sworn in on Friday, has linked the balance sheet to prior inflationary pressures and market distortion and has made shrinking it part of a promised “regime change.”
Still, the balance sheet is roughly $2 trillion smaller than its peak three years ago. Several former Fed officials said trimming the total assets would matter less, in practical terms, than altering the mix of holdings - moving away from longer-dated securities and toward short-term Treasury bills that better align with the balance sheet’s primary supply of overnight bank reserves.
"The size of the balance sheet ... has become a bit of an optical political football," said Jeremy Stein, a Harvard University economics professor who served as a Fed governor from 2012 to 2014 while the central bank was conducting its quantitative easing bond purchases. Stein spoke at the Atlanta Fed financial markets conference on Monday and cautioned that Warsh may feel pressured to show progress by reducing size even if a change in composition would be more economically relevant. "Kevin has got himself a bit in the position of having to shrink that just to show some progress. It’ll be a test of his communication whether he can move the conversation away from that."
Stein emphasized that shifting toward shorter maturities could better match the balance sheet’s operational role in providing reserves to the banking system. That point echoes broader discussion among policymakers about funding mix - not only how much the Fed holds, but what it holds and why.
Warsh’s approach to the balance sheet has evolved. As a Fed governor from 2006 to 2011, he supported the initial use of quantitative easing during the 2007-2009 financial crisis, when the policy rate was already at zero and the Fed purchased longer-dated securities to help hold down borrowing costs. Over time, however, he grew concerned that the continuing, effectively open-ended purchases gave the Fed too large a presence in financial markets. He renewed those criticisms after the balance sheet swelled once more in response to the COVID-19 pandemic.
Yet several former officials noted constraints the Fed faces if it tries to pare assets aggressively. One constraint is that the balance sheet’s size is influenced by bank demand for reserves - a factor not entirely under the Fed’s control. Policymakers have been debating regulatory changes to lower reserve requirements, but how aggressively they might pursue such changes remains uncertain.
Former Chicago Fed President Charles Evans, speaking at the same event, noted the contrast with the Fed’s balance sheet when he took office. "When I was appointed to my job in 2007, shortly after Warsh joined the Fed board, the Fed’s balance sheet was just about $800 billion," Evans said. He argued that hoping to return to that level is unrealistic today because the balance sheet is more tightly linked to bank liquidity needs and is a key lever the Fed uses to manage its short-term policy rate.
Evans also questioned the feasibility of Warsh’s suggested reduction targets. Warsh had written in a 2025 Wall Street Journal article that the balance sheet might be drawn down by perhaps $2.5 trillion. "I have my doubts," Evans said, adding that the regulatory and other proposals floated to make a lower balance sheet feasible are "ambitious, substantial, Manhattan Project-like initiatives."
Recent developments underline the operational pressures on reserves. Officials said the Fed’s balance sheet began to grow again slowly as banks sought more reserves. That trend became visible last autumn when short-term rates rose, signaling that reserves were becoming scarce.
For Warsh and the Fed going forward, several former officials urged clearer articulation of principles governing asset purchases - what the Fed buys and why - and better communication with markets, elected officials and the public. Randall Kroszner, a former Fed governor who is now an economics professor at the University of Chicago Booth School of Business and an external member of the Bank of England’s Financial Policy Committee, pointed to the BoE’s 2022 intervention to stabilize the UK government debt market as an example where clarity on intent mattered.
Kroszner said policymakers in the UK were explicit that their purchases were intended to keep markets functioning and would be short-lived - a distinction he argued the Fed has not always made as clearly. During the COVID-19 pandemic the Fed restarted asset purchases to keep the Treasury market functioning properly, then the program evolved to include explicit monetary policy aims of supporting the economy, and it continued to include mortgage-backed securities even after the housing market had stabilized.
"The Fed did exactly the right thing by intervening with incredible force to buy lots and lots of government securities," Kroszner said. "But it then became very difficult to slow down ... because it didn’t clearly articulate" what it was doing. "It didn’t want to be perceived as pulling back on monetary policy ... I think it’s much better to have things articulated in advance."
The former officials’ remarks at the Atlanta Fed conference underscore that the debate over the Fed’s balance sheet is not solely about a headline figure. It encompasses operational realities such as banks’ demand for reserves, the choice between long-term and short-term securities, the central bank’s role in market functioning, and the communications challenge of explaining those roles to the public and policymakers.
Summary
Former Fed policymakers advised incoming Chair Kevin Warsh to emphasize guidance on how the Fed will use its balance sheet and to consider changing its composition toward short-term bills rather than concentrating on headline reductions. They highlighted constraints tied to bank reserve demand and stressed the need for clear communication about the purpose and duration of any asset purchases.
Key points
- The Fed’s balance sheet stands near $6.7 trillion, down roughly $2 trillion from its peak three years ago, with significant holdings of Treasuries and mortgage-backed securities.
- Shifting the composition of assets toward short-term Treasury bills could better match the balance sheet’s operational role of supplying overnight bank reserves.
- Policymakers face limits on how much they can reduce the balance sheet because its size is influenced by bank demand for reserves and would likely require major regulatory changes to lower reserve requirements.
Risks and uncertainties
- Uncertainty about the feasibility of Warsh’s suggested reduction targets - including a proposed $2.5 trillion drawdown - given the regulatory and operational changes that would be required; this affects banking liquidity and short-term funding markets.
- The balance sheet has become politically charged, which could complicate the Fed’s communications and policy implementation; implications extend to Treasury and mortgage-backed securities markets.
Tags: fed, balance-sheet, reserves, treasuries, mortgages