Why the Incoming Fed Chair Could Face Challenges in Reducing the Size of the Central Bank

Main Points

• The Federal Reserve's assets have expanded to $6.6 trillion.
• Kevin Warsh, set to become the next Fed Chair in May, may aim to shrink the balance sheet.
• Reducing the Fed's holdings could lead to increased market swings and higher mortgage rates.

When Kevin Warsh first joined the Federal Reserve in 2006, the central bank's assets were under $850 billion. Today, that figure has soared to $6.6 trillion—almost eight times larger.

This dramatic increase has long been a concern for Warsh, who may now consider paring back the Fed’s influence in financial markets. However, the Fed’s expanded role has also been credited with stabilizing markets during times of crisis. The central bank purchased trillions in bonds during the financial turmoil of 2008 and 2020, which helped lower mortgage rates and fueled a surge in home purchases and refinancing.

Now, financial markets have grown accustomed to the Fed’s massive balance sheet, making a return to pre-2008 norms a complicated task.

As Padhraic Garvey of ING described, “Trying to reverse this is like squeezing toothpaste back into the tube—not impossible, but likely to get messy.”

Since being nominated by President Donald Trump on January 30, Warsh has not publicly commented on his plans for the Fed’s balance sheet. However, in a previous opinion piece, he described the balance sheet as “bloated” and suggested it could be “substantially reduced.” He argued that a smaller balance sheet would give the Fed more flexibility to cut interest rates, aligning with Trump’s calls for lower rates.

Warsh also noted, “Wall Street has easy access to money, while credit remains tight for Main Street.”

Still, some analysts warn that reducing the Fed’s balance sheet could unsettle markets and drive up mortgage costs, potentially undermining efforts to make homeownership more affordable.

This is one reason why a dramatic shift in policy is not widely expected.

As Bank of America’s Mark Cabana put it, “Warsh is unlikely to be as aggressive on the balance sheet as some in the funding markets fear.”

Why It’s Important

The size of the Fed’s balance sheet affects mortgage rates, market stability, and borrowing costs. Any changes under Warsh could have significant implications for homebuyers, investors, and banks.

The Impact of Quantitative Easing

The Fed’s bond-buying programs have had real effects for consumers. In 2020 and 2021, low interest rates encouraged home purchases and allowed many homeowners to refinance at lower monthly payments.

The initial round of quantitative easing in 2008 helped steady markets during the financial crisis. While economists continue to debate the effects of later rounds in 2010 and 2012, the intention was to keep borrowing costs low, support long-term business investment, and stabilize the mortgage market.

Even after the Fed ended its QE programs, the balance sheet remained in the trillions. The most recent reduction brought the balance sheet down from nearly $9 trillion after the pandemic to the current $6.6 trillion. The Fed paused its efforts to shrink the balance sheet late last year, as signs emerged that further tightening could strain the financial system.

Officials remain cautious, recalling the disruptions of September 2019, when cash stopped flowing smoothly through the system, causing interest rates to spike and forcing the Fed to intervene.

Quantitative easing has also faced criticism. Some believe it has contributed to wealth inequality by boosting stock prices and calming markets, while others—including Warsh—worry that these periods of stability make the economy more fragile and require even larger interventions during downturns.

In April 2025, Warsh remarked that QE has become “a nearly permanent part of central bank policy,” making it easier for Congress to run larger deficits, knowing the Fed’s bond purchases would keep government borrowing costs down.

He warned, “Each time the Fed steps in, it expands its reach, crosses more boundaries, increases debt, misallocates capital, and raises the risk of future shocks—forcing even bigger responses next time.”

Scarcity Versus Abundance

At the heart of the debate is whether the financial system should operate with scarce or abundant reserves.

Before 2008, banks held relatively little cash and borrowed from each other as needed, with the federal funds rate serving as the price for overnight loans. The Fed managed this rate by adjusting the amount of money in the system daily.

The 2008 crisis changed this model, as the Fed injected large amounts of cash into the system. At the same time, Congress tightened banking regulations to make institutions safer, which also contributed to the Fed’s larger balance sheet.

Experts caution that even modest changes to these rules carry risks. Banks now maintain larger cash reserves as a safety net, often exceeding regulatory requirements, and they hold these reserves at the Fed—further inflating the central bank’s balance sheet.

As Michael Gapen of Morgan Stanley noted, “Reducing liquidity requirements could lower demand for reserves and allow for a smaller Fed balance sheet, but it might also weaken the financial system’s resilience during stress. There’s no free lunch.”

Despite his skepticism of QE, Warsh is expected to favor maintaining ample reserves, according to BofA’s Cabana. Warsh may conclude that the drawbacks of returning to scarce reserves outweigh the benefits, given the potential for more volatile funding conditions.

BMO’s Ian Lyngen observed, “There’s no clear path to a smaller central bank presence in financial markets. Major changes could destabilize funding markets.”

One way to reduce the Fed’s balance sheet—lowering banks’ need for reserves—would require regulatory adjustments that could take months or years to implement.

As Lyngen summarized, “A smaller balance sheet isn’t out of reach for a Warsh-led Fed, but achieving it will likely be a gradual process.”