Even during the Senate hearings, Warsh stuck to his guns: the Fed should have a smaller balance sheet.
By Wolf Richter for WOLF STREET.
The Department of Justice announced this morning in an X post by US Attorney Jeanine Pirro that it would end its investigation into the construction cost overruns of the Federal Reserve buildings in Washington DC, and that it asked the Inspector General for the Federal Reserve to “scrutinize the building cost overruns.”
“I expect a comprehensive report in short order and am confident the outcome will assist in resolving, once and for all, the questions that led this office to issue subpoenas,” she wrote in the post.
And she said: “I have directed my office to close our investigation as the IG undertakes this inquiry. Note well, however, that I will not hesitate to restart a criminal investigation should the facts warrant doing so.”
Powell already asked the IG last July to scrutinize the building cost overruns, and that work has continued.
The DOJ investigation blocked the confirmation by the Senate Banking Committee of Kevin Warsh, nominated by Trump to succeed Powell as Fed chair, because retiring Senator Thom Tillis (R.NC) had vowed he would not support any Fed nominee as long as the DOJ’s investigation into Powell was going on. Republicans have only a 13-11 majority, and all 11 Democrats have also vowed to oppose any nomination until the investigation ends.
At the hearings on Tuesday, Tillis said during his time slot to grill Warsh: “Let’s get rid of the investigation so that I can support your confirmation.” And now he can.
Powell was the architect of mega-QE from March 2020 through early 2022, even as inflation began raging in early 2021 – “the most reckless Fed ever” is what I called it at the time for that reason. And he was the architect just before covid of the “ample reserves regime” that prescribed a relatively bloated balance sheet even when there is no crisis. These policies, among other effects, distorted and destroyed the housing market as they caused home prices to explode from mid-2020 through mid-2022, after already surging for years.
Warsh and Bennet, who picked Warsh as one of the candidates, have publicly opposed these policies. Bessent did so in an essay last September which blasted the Fed for QE, its “perverse incentives” for fiscal “irresponsibility,” the Fed’s “wealth effect” policies, its failure to deal with inflation, and so on ( my discussion of his essay). And Warsh has done so for many years.
When Warsh was a governor on the Federal Reserve Board under Bernanke, he supported QE-1 to get the Financial Crisis under control. But Bernanke pushed for QE-2 despite a recovering economy and roaring markets, and against substantial opposition from some members on the FOMC, including Warsh and Thomas Hoenig. Bernanke persevered and announced QE-2 in November 2010. In response, Warsh quit in March 2011 and Hoenig retired later in 2011. Warsh explained all this and why he quit in a speech in 2018.
Even during the selection process, and this week during the Senate confirmation hearings, Warsh stuck to his guns: the Fed should have a smaller balance sheet than it has now. He has also been an inflation hawk – and he thinks reducing the balance sheet will make it easier to keep a lid on inflation. His hostility to “money printing” appears to be etched in stone, and Bessent is with him on this.
During the Senate hearings, Warsh called for a “regime change” at the Fed – a change of the policy regime he explained, not the presidents of the regional Federal reserve banks. This might include the “ample reserves regime” that Powell concocted.
Powell’s term as Fed chair expires on May 15. His separate term as a governor of the Federal Reserve Board of Governors expires in January 2028. In the past, when the Fed chair term expired, Fed chairs also resigned from their governor slots and departed the Fed entirely, thereby making room for a new governor – in this case Warsh.
But at the last FOMC press conference, Powell had said that he would stay on as “chair pro tempore” until a new Fed chair was confirmed, and that he had “no intention of leaving the Board until the investigation is well and truly over, with transparency and finality.” So both of these elements seem to be a step closer and on track, and Powell should start looking for some cardboard boxes to pack up his stuff, including his “ample reserves regime,” and enjoy his retirement.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the mug to find out how:
He wants QT which is fine by me, but he probably will push for lower interest rates which is not. If you want to tighten monetary policy to end the rampant speculation in the market, force Congress to curb spending, and bring inflation down, you can’t have your cake and eat it too. I want someone at the Fed who isn’t afraid to make the tough decisions irrespective of which political party is in power.
The Fed’s policy rates only affect short-term rates. Long-term rates are set by the bond market. If he gets a majority on the FOMC for QT, and they do implement it, it would mean slightly higher long-term rates… that includes most of the rates that really matter, such as mortgages and corporate bonds.
He was very hedged during the hearings about cutting the Fed’s policy rates. He sees lots of issues with that. And he won’t be in any kind of rush. You should listen to the things he said about it. But he does have the theory that a smaller balance sheet will put a lid on inflation, and that down the road — not at first — the business use of AI will trigger productivity gains that will bring down inflation. But he was also hedged about that, conceding that this is a theory and that there is no data yet. And he said that short-term, the massive investment in AI may further fuel inflation. He showed an analytical balanced approach to the whole issue.
Powell enlarged the Fed’s balance sheet 2020-2022 because interest rates were at zero so that tool was not available. Deep fears that the country would fall into an even worse economic slump did, in my view, justify the money injections. Given also that inflation was in great part caused by broken supply chains, Powell’s inclination to see it as “temporary “ was, to a reasonable extent, justified. It was indeed temporary (at least the massive peak) but what length of time is temporary as opposed to persistent is in the eyes of the beholder.
IMO, the use of the Fed balance sheet was justified because there were no other tools. PPP was riddled with inefficiencies and a good deal of fraud, and caused the deficit to explode.
The only thing that caused the deficit to explode was idiotic VAST PROFLIGATE OVERSPENDING by Congress which is an issue totally beyond any control by the Federal Reserve.
Powell’s QE was only justified if your #1 priority is to inflate asset prices out the wazoo without rhyme or reason, including the home price explosion that is now causing such big problems, and if you don’t mind 10% consumer price inflation. Lots of people benefited from that (including the higher prices which cause corporate profits to explode), and from their eyes, QE was justified. But when inflation headed toward 10%, even Powell pulled the ripcord on QE and started QT.
In March 2020, the Treasury market was locking up due to the basis trade going awry. And that was a big issue. But the Fed could have dealt with it by offering lots of repos – that’s its classic tool to deal with bond market freeze-ups, such as during 9-11. Then after a week or two, when the dust settles, the repos get paid back and come off the balance sheet, and the balance sheet goes back to where it was before. That’s how the Fed has dealt with every crisis until Bernanke unleashed QE. And the Fed needs to get back to that method.
Hmmmm., My gut instinct says this sounds like the prelude to austerity.
To end money printing = “austerity” 🤣
new one to me
Some sanity.
I’ve never been one to call for the return of the gold standard but the uncoupling of labor productivity and real wages began to diverge after we left it. Every new financial innovation seems to have only accelerated that uncoupling.
There were serious flaws with the gold standard but it’s time we acknowledge the various flaws in our current model, of which QE is only one part.
At this point, the Fed is an abomination that has been rewarding bad behavior and facilitating the greatest theft of real wealth that the planet has ever seen.
Looking forward to Wolf’s next Fed analysis BUT, despite “the greatest eCONomy ever” the Fed has begun expanding its balance sheet again and is now back over 6.7 trillion.
We have had feudal systems before and we know how this turns out folks.
Hedge accordingly.
We could do a LOT worse than Warsh.