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.
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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.
Warsh would not agree that tariffs cause inflation, nor that dropping the Fed rate to 1% would cause inflation. Yes he said a lot of positive things as you point out, but the big question is whether he would bend the knee to Trump when Trump demands very low interest rates, which we all know Trump will demand. And of course Trump will have a hissy fit if Warsh does not accede to Trump’s demand.
Walsh will be a great Fed chief. Even better than Volcker. He will reduce the balance sheet and this will lead to lower interest rates. Good move to drop the DOJ investigation and move it to the IG.
Is anybody watching inflation?
5 years over the “target” and ramping up now….even pre Iran…
and people still….STILL speak of lowering rates?
If you lower rates with what is going on, when do you raise them?
Stocks all time highs….inflation ramping. Gold all time highs.
It’s been a while since I’ve heard some sensible discussion during nomination hearings.
I don’t think Powell has done a bad job, it’s not his fault Congress and the current and last president were/are addicted to spending. But slowing QT while we still have inflationary issues just felt like the wrong move.
We need a smaller fed balance sheet and fiscal debt. Higher taxes on the ultra rich – however we get there. We are past the level of inequality we saw in the gilded age, it’s time we admitted that. Fiscal and monetary tightening will put a lid on the inflation and runaway debt issues we are facing.
Although I doubt they’re advocating for that last piece, sadly our political system is bought and paid for.
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.
Yes. The people who defend Powell the most are those who benefited strongly. It’s clearly unbridled self-interest.
I’m so tired of people defending what was indefensible, even at the time. Under no circumstances, even if you’re worried about an economic slump, is printing $3 trillion in a period of a few weeks justified.
And in no circumstances is continuing to print for a year and a half, long after a recovery has began, justified.
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.
Not hard to do better than Powell. No one was worse than Bernanke. I hope Warsh follows through with the balance sheet.
You could easily argue that Greenspan was worse. He set the precedent for the Fed running to the rescue after the dotcom bubble burst, which only threw fuel on the fire of the brewing mortgage bubble. And the 2001 recession wasn’t even all that bad either.
Then when they became aware of the housing bubble in 2004, they hike rates quickly in order to stop (pop) the bubble and then Blackstone came in and took your house. But yes, we could do a lot worse than Warsh
What’s R * now? Powell handed Warsh a problem. Even Barnett gets this right. Money is too loose.
Positive real rates (≠) tight monetary stance.
https://tradingeconomics.com/commodity/crb
Why is investigating massive cost overruns such a political issue?
It shouldn’t be, but the White House designed it as a political issue from the first second. Cost-overruns are not a crime. they happen all the time in complicated big construction projects, especially during a time of lots of inflation that blew all estimates apart. And investigating cost-overruns is not the issue. The issue is that they started a criminal investigation, under the pretext that Powell lied to Congress, in order to force Powell’s policy hands. That’s the issue. That’s political from the first moment.
Warsh “ His hostility to “money printing” appears to be etched in stone, and Bessent is with him on this.”
Do you think Trump is aware of this? Trump doesn’t seem to have a problem bailing out companies. (Now Spirit)
And now Bessent considering swap lines for the UAE and other gulf countries, Argentina credit line. (Paid back), lifted Russian sanctions, etc.
I think Bessent and Warsh cave to Trump if there is a problem with bailouts and so the Fed PUT might not be dead.
And the market seems to be brushing off these so called hawks.
Just My Opinion.
The stock market is in a complete mania and doesn’t notice anything anymore.
I am starting to believe that the market will never go down substantially ever again.
If 99 cents of every new dollar of wealth created in an economy go into the pockets of the people who need that money the least, how can the stock market ever crash again? You would need mass hysteria on a ‘War of the Worlds’ scale to create enough of a panic to do it, right? Or maybe just another COVID
The only way it’ll go down and stay there is if a crisis happens and the Fed doesn’t ride in to the rescue.
No matter what you can say about “retail participation,” or “forced auto 401K deposits,” what is keeping the market propped up are people buying any dip.
People are buying any dip because they’re convinced there is no risk. They are convinced there is no risk because the Fed will bail the market out.
Something has to happen that will convince them that there is major risk for dip buyers to stop jumping in each time.
AI driven trading programs buying AI stocks…..
(NASDAQ)
maddness
Intel gained $80 billion in market cap today on NOTHING.
They beat a ridiculously low estimate. All you heard or read about today was that they beat estimates and raised revenue guidance, BLAH BLAH BLAH. I didn’t hear one person on CNBC or read one article mentioning the totally absurd valuation.
[From Intel’s website: First-quarter revenue was $13.6 billion, up 7% year-over-year (YoY).
First-quarter earnings (loss) per share (EPS) attributable to Intel was $(0.73); non-GAAP EPS attributable to Intel was $0.29.
Forecasting second-quarter 2026 revenue of $13.8 billion to $14.8 billion; expecting second-quarter EPS attributable to Intel of $0.08 and non-GAAP EPS attributable to Intel of $0.20.]
Gee, I guess that’s worth another $80 Billion!!! The semiconductors are in a bubble all by themselves now.
Our fiscal position is rapidly becoming dire, our political situation is dire. In short, unless we can find a way through this mess, inflation is going to be a huge long term consequence of these events. And the old folks who spent so much time and high interest rate suffering are going to be reminded in full of the bad times. So, while everyone is complaining house prices are too high, just consider they are paid in coupons…and everyone thinks wages are too low as well. So higher wages and stagnant asset prices are the most likely outcome.
And yet we think everything will be fairly calm, like the every growing stock market of AI. All hail the new imploded stocks list, for it shall grow large….
Powell leaving his rank & file Board of Governors seat before January 2028 would presumably create a vacancy for Trump to install another Stephen Miran.
I’m no fan of Powell’s policies but compared to another Miran he’s the lesser of two evils.
That’s not the math. There are 7 slots on the Board of Governors, one of which is Powell’s. He is Board member and Chair in one slot. If Powell stays on the Board till Jan 2028, but Warsh gets confirmed as Chair, there is no slot for Warsh, and Miran has to bow out of his slot to make room for Warsh. That was the agreement from the beginning when Miran was appointed, which is also why Miran was reluctant to give up his White House job — and had both jobs for a while simultaneously — because his stint at the Fed could be over in May 2026, when Warsh gets confirmed, and Powell decides to not resign from the Board, and Miran has to bow out by agreement to make room for Warsh.
Wolf, I like the new option “Notify me of follow-up comments by email”.
I selected the box after one of my comments. Now I am getting email notifications for Every comment on the article. Not just replies to my comment. Is that the way it is supposed to work?
That’s not how it’s supposed to work. I turned it off before because it was going wild.
I have now turned it on for my own comments to see what it does to my inbox. I might have to turn if off again.
Let me know if this issue continues.
Wolf, are you sticking to the stance that the balance sheet can not go below , I think you said 5.6 Trillion?
What does Warsh have in mind? Below that?
I said that first about 3 years ago or so, but the minimum balance sheet is a moving target, just like nominal GDP, driven by economic growth and inflation.
My calculation was based on the Fed remaining within its “ample reserves regime.”
If it abandons that and goes back to a demand-based regime, the balance sheet can go lower because reserves can be lower than $3 trillion. If reserves can be $1.5 trillion, the Fed could reduce its current balance sheet by about $1.5 trillion. So that takes it close to $5 trillion today. But five years from now, that figure will have moved on with inflation and nominal economic growth, and it might be $6 trillion.
The concept of a moving target is really important. The Fed’s balance sheet has ALWAYS grown roughly in line with inflation and the nominal economic growth. That makes total sense.
The two other big liabilities on the balance sheet are demand-based, and they’re growing roughly with the nominal economy and inflation, and they have already done that in the three years since I first said that:
1. The government’s checking account (TGA) whose “desired level” is now $900 billion and that will be moved to $1 trillion soon; the Fed doesn’t control the TGA balance; the Treasury does.
2. and currency in circulation (paper dollars), now $2.4 trillion, such under mattresses in South America, based on demand by consumers and drug dealers around the world.
SO if the Fed keeps its balance sheet level for years, while the TGA keeps rising and currency in circulation keeps rising, then reserves would keep shrinking. This is a form of soft QT, and you can see how the Fed shrank reserves after QE ended in 2014. Five years from now, if we get lots of nominal economic growth and inflation, that $5 trillion minimum may have become $6 trillion. Everything is a moving target.
Mr. Wolf writes: “…Inspector General for the Federal Reserve to “scrutinize the building cost overruns.”” (Context: Mr. Wolf’s article that the investigation is being dropped).
How about my housing (building) cost overrun thanks to Powell’s purchase and the Federal Reserve balance sheet’s “deathgrip” on Mortgaged Backed Securities (MBS).
Is Thom Tillis my hero? His comments are so logical, I don’t expect them from a elected official.
Is there a chance I’ll have a political party again (I’m a true neoliberal fiscal conservative that doesn’t give a damn what you do at your own home)?
LOL just read on his wiki he won’t seek re-election due to harassment over the deficit reckless OBBB. Of course.
He can be logical now because he has nothing to lose; he’s outa there. He’s leaving.
Wolf, I’m happy to stipulate that Powell has a terrible record as Fed chairman, what with the insanely inflationary policies he (and his predecessors) initiated and then stuck with, for far too long.
That said, both he and Senator Tillis are surely not foolish enough to imagine that Pirro will hesitate to reopen her sordid investigation the moment Powell agrees to leave. Unless the bad faith effort to prosecute Powell is properly put to rest, the Trump administration’s backtracking in this case is nothing more than an obvious act of deception.
I doubt either Tillis or Powell are simple-minded enough to believe that Pirro has genuinely given up on her politicized attempt at prosecution. My expectation is that they’re both clear-eyed enough to demand DOJ assurances that this sham investigation will not be restarted as soon as Powell agrees to leave.
This assurance might take the form of a grant of immunity, a presidential pardon, or some other enforceable legal commitment (absent new and dramatic developments, which there’s no real reason to expect) to drop an investigation that everybody has understood from the start to be purely political in nature.
I hate the modern trend of using the criminal process as a weapon, but we lost that battle back when Martha Stewart and Scooter Libby were prosecuted on trumped up “making false statements” charges.
Conducting investigations for the sake of conducting investigations, in the hope that somewhere along the line, someone will tell a lie about something, even if it’s not related to any crime, is a course of action worthy of a totalitarian country.