Kevin Warsh, the nominee to become the next chair of the Federal Reserve, has voiced a clear preference for substantially reducing the central bank's large holdings of Treasuries and mortgage securities. But analysts and market participants say the financial mechanics and policy framework built around a balance sheet swollen by crisis-era purchasing make any significant and rapid reduction difficult to execute without disrupting markets and complicating interest-rate management.
Warsh, who previously served as a Fed governor from 2006 to 2011, has argued that the central bank's enlarged portfolio distorts financial conditions. In a November opinion piece in the Wall Street Journal, he wrote that "the Fed's bloated balance sheet, designed to support the biggest firms in a bygone crisis era, can be reduced significantly," and suggested proceeds could be repurposed "in the form of lower interest rates to support households and small and medium-sized businesses."
Those prescriptions come against the backdrop of a multi-year campaign by the Fed to unwind assets amassed during the COVID-19 pandemic. Purchases of Treasury and mortgage-backed securities at the start of the health crisis were intended to stabilize markets and later served as a form of stimulus. The scale of crisis buying doubled the Fed's holdings to a roughly $9 trillion peak in the summer of 2022. A subsequent quantitative tightening, or QT, program brought total holdings down to about $6.6 trillion by late 2025.
However, in December the Fed resumed growing its holdings through technical purchases of Treasury bills. Officials said the move was aimed at ensuring sufficient liquidity in the financial system so they could maintain firm control over the federal funds rate target range. Since then, the balance sheet has been viewed as a standard instrument in the Fed's policy toolbox, particularly valuable when short-term policy rates may need to be cut close to zero in acute downturns.
Part of the challenge in significantly shrinking the balance sheet stems from how the Fed now manages interest rates in a system flush with bank reserves. Market infrastructure and bank behavior have adapted to higher reserve levels. Joe Abate, a U.S. rates strategist at SMBC Capital Markets, noted that while Warsh "may want a smaller balance sheet and smaller Fed footprint in financial markets," actually cutting the balance sheet size sharply is effectively a "nonstarter" because banks prefer the current level of reserves.
Abate pointed to evidence that when reserves in the banking system decline toward roughly $3 trillion, money market rates become notably more volatile. That turbulence can undermine the Fed's ability to steer short-term interest rates, placing a practical floor beneath how far holdings can be reduced without risking market instability.
Beyond immediate market mechanics, any major reconfiguration of the Fed's balance sheet policy would require broad agreement among Fed officials. Many policymakers have accepted the balance sheet as an official element of monetary policy and may resist substantial reengineering of that toolkit.
Analysts outline a handful of paths that could, over time, reduce the need for such a large Fed footprint, but they emphasize these would be gradual and cautious.
One option would be to alter regulatory rules that influence how banks manage liquidity. Loosening some of the regulatory burden surrounding liquidity management could reduce banks' incentives to hold very large reserve balances.
Another approach is to make standing liquidity facilities more attractive. Enhancing the appeal of the Discount Window or ongoing standing repo operations could give banks alternative sources of liquidity, lowering the demand for reserves held on Fed balance sheets and enabling a smaller central bank presence over time.
David Beckworth, a senior research fellow at the Mercatus Center at George Mason University, suggested Warsh could use the Fed's periodic framework review to revisit how the balance sheet is deployed. Beckworth also flagged the possibility of coordination between the Fed and the Treasury to swap securities as a way to alter the composition or size of Fed holdings without immediately draining liquidity from the system.
Even proponents of change urge a gradual course. "The Fed's like a ship that slowly turns, that's probably a good thing, because you don't want to be so disruptive to the financial system," Beckworth said, encapsulating a widely shared view that incremental adjustments are preferable to abrupt moves.
Evercore ISI analysts likewise expect any actions on the balance sheet under a Warsh chairmanship to be measured. The research firm said it anticipates Warsh will be "more pragmatic than many expect," pledging no abrupt alterations to balance-sheet policy and pursuing a Fed-Treasury accord to frame closer cooperation. The analysts added that markets would likely interpret such an accord as giving Treasury Secretary [Scott] Bessent a de facto soft veto over aggressive QT plans, a stance they said Warsh would welcome.
In short, while Warsh has articulated a policy preference to significantly pare back the Fed's holdings, financial plumbing, reserve dynamics and the institutional consensus around the balance sheet as a policy instrument suggest that accomplishing that goal would be slow and operationally complex. Any substantial contraction could tighten financial conditions, complicating a chair who may favor lower short-term borrowing costs in the near term. For these reasons, market participants and analysts expect a cautious, incremental approach rather than a rapid retreat from the size and role of the Fed's balance sheet.