Kevin Warsh's real Fed 'regime change' may happen deep inside Wall Street's plumbing

Kevin Warsh, then U.S. President Donald Trump's nominee for Chair of the Federal Reserve, delivers an opening statement during his Senate Committee on Banking, Housing, and Urban Affairs confirmation hearing in the Dirksen Senate Office Building on April 21, 2026 in Washington, DC. Andrew Harnik | Getty Images Incoming Federal Reserve Chair Kevin Warsh's talk about "regime change" at the central bank has generated speculation about everything from interest rates to major personnel changes to fundamental alterations in the way it operates and communicates. But what that eventually might look like is subtler though perhaps more consequential – a rethink of how the Fed manages the financial plumbing in the U.S. economy and the mammoth balance sheet it has built through some 18 years of crisis fighting. Interviews with former Fed officials and economists, along with a growing library of research, suggest Warsh could guide the Fed to a smaller role in day-to-day financial markets, while also setting clearer rules for how and when it should intervene. Simply stated, the debate centers on whether the Fed should continue using its balance sheet as a regular tool for influencing financial conditions and supporting markets — as it has through much of the post-financial crisis era — or reserve it for periods of market dysfunction and more pernicious economic stress. Rewriting the Fed playbook The debate over the $6.8 trillion balance sheet is technical in nature and tucked away from the more common discussions about Fed policy. But the stakes are substantial. Since the financial crisis that exploded in 2008, the Fed has aggressively used its holdings of Treasurys and mortgage-backed securities to stabilize markets and influence broader financial conditions. Prior to the crisis, the Fed had a minuscule balance sheet relatively speaking – about $800 billion – but expanded it at one point to about $9 trillion. The Fed's asset holdings now equate to about 23% of the U.S. economy, or some seven times where they were pre-financial crisis. Any effort to change the system could have wide ramifications, potentially impacting Treasury yields, mortgage rates and other interest-sensitive areas of the economy, while influencing the way policymakers respond to future crises. "It's a debate we're going to be seeing later this year. But one thing that's encouraging about all of this is that nobody, including Kevin Warsh, is arguing that any of this could be done rapidly," said Lou Crandall, chief economist at Wrightson ICAP and a longtime Fed watcher. "It's got to be done carefully, and some of the changes … would probably take time to implement," he added. "Everyone's looking at this as a medium-term project rather than part of the day-one agenda." Warsh called the balance sheet, in a Wall Steet Journal op-ed piece last year, "bloated" and said it could be reduced while at the same time allowing the Fed to lower interest rates. What 'regime change' might entail While Warsh has spoken in broad strokes about shrinking the Fed's footprint, Wall Street already is gaming out what a new operating framework could look like. Among the more provocative ideas comes from TS Lombard's chief U.S. economist, Steve Blitz, who argues that a Warsh Fed could place greater weight on the overnight repo market — the short-term funding system that underpins the Treasury's market function — rather than relying solely on the federal funds rate — which banks charge each other for overnight lending — as the key transmission mechanism for policy. "The repo rate becomes the policy rate," Blitz said in a client note. In practice, that could create an unusual dynamic: Warsh might be able to satisfy Trump's push for lower interest rates while still maintaining tighter underlying financing conditions as policymakers grapple with persistent inflation pressures. watch now However, he's likely to run into quick opposition from his fellow policymakers, some of whom are skeptical of both the Fed's ability to significantly reduce its holdings and the benefits this might provide. "I think shrinking the balance sheet is the wrong objective, and many of the proposals to meet this objective would undermine bank resilience, impede money market functioning, and, ultimately, threaten financial stability," Fed Governor Michael Barr said in a speech last week. "Some would actually increase the Fed's footprint in financial markets." Barr's thesis essentially is that looking merely at the size of the balance sheet is too narrow – that other issues, such as how it is comprised with respect to duration and composition also matter. Neglecting those issues, he asserts, could have "perverse" consequences such as increased volatility and even the possibility of more interventions from the Fed. At the same time, he said, lowering reserve requirements for banks could destabilize the system. Understanding how it works The balance sheet mechanics regarding reserves are straightforward. When