Warsh's Path to Balance Sheet Reform: Bowman and Bessent Are Key
Alina Collins
Fed Chair-designate Kevin Warsh wants to sharply shrink the $7 trillion balance sheet, but the path runs not through the Fed stopping bond purchases — it runs through bank-regulation relief that Michelle Bowman and Scott Bessent are already pushing.
Why can't the Fed just shrink on its own?
The intuitive answer — buy fewer bonds — misses a constraint. Bank rules force lenders to park large reserves at the Fed; those reserves sit on the Fed's liability side.
This means → as long as banks must hold elevated reserves, the liability side stays bloated, and the asset side (mainly Treasuries) has no room to compress.
In plain terms = the balance sheet is a pool. Bank regulation is the inflow pipe — you cannot drain the pool without turning off the pipe first.
What exactly is the "inflow pipe"?
The core rule is the Liquidity Coverage Ratio (LCR) — a requirement that banks hold cash and other high-quality assets to survive short-term runs.
The result: roughly $3 trillion in reserves locked at the Fed, about 40% of the nearly $7 trillion balance sheet.
ING's global head of rates strategy Padhraic Garvey put it bluntly: "Stopping bond buybacks cannot be done in isolation — it must move in tandem with regulatory change. The two are interdependent."
What are Bowman and Bessent doing about it?
Fed Vice Chair for Supervision Michelle Bowman said on June 4 she is pushing "sound liquidity management." In March she flagged liquidity hoarding by banks, calling it a drag on credit availability.
Treasury Secretary Scott Bessent called the same month for a reset of liquidity-regulation rules.
This reflects a coordinated push from the regulatory side to clear the path: lower reserve requirements → banks park less at the Fed → Fed liabilities shrink → room opens to slim the asset side.
Where does the three-person policy alignment come from?
Warsh, Bowman, and Bessent were all nominated by President Trump, forming a unified front on balance-sheet reform.
Yet the Fed is still running "reserve-management purchases" — buying about $10 billion in short-term T-bills through the cycle ending July 13.
This means → until the regulatory plumbing is in place, meaningful shrinkage cannot start. The pace of policy coordination — not the Fed's unilateral intent — is the variable that determines whether this overhaul actually happens.
Content is for reference only, not financial advice.