Politics 📍

To Kevin M. Warsh, the Federal Reserve’s more than $6 trillion portfolio of government bonds and mortgage-backed securities is emblematic of everything that has gone wrong at the institution he hopes to lead.

The Fed’s decision to expand its portfolio by so much and so quickly since the 2008 global financial crisis has stoked inflation, worsened inequality and distorted the process of how financial assets are priced, according to Mr. Warsh, who is awaiting confirmation to become the next chair. The growing size of the investments on its balance sheet has jeopardized the Fed’s own independence by treading into territory far outside its congressional mandate, he believes. And it has made Wall Street overly reliant on the Fed, creating an unhealthy expectation that the central bank will always be ready to ride to the rescue.

Mr. Warsh’s plan to rectify this appears, on the surface, relatively straightforward. He wants the Fed to have a smaller footprint in financial markets and for there to be closer coordination with the Treasury Department on what the Fed holds in its portfolio and what the government issues in terms of debt to fund itself. Mr. Warsh has argued that reducing the central bank’s holdings will give officials space to lower interest rates, something President Trump has long desired. The rationale is that longer-term rates are likely to rise as the balance sheet shrinks, which then could be offset by lowering short-term rates.

Achieving all of this will be anything but straightforward, however. It will take careful planning and a significant amount of time in order to avoid creating damaging volatility.