Fed-Treasury $3.9 Trillion Swap Proposed Ahead of Warsh Hearing

A radical proposal to overhaul the Federal Reserve’s balance sheet is gaining attention as President Trump’s nominee for chair, Kevin Warsh, prepares for his confirmation hearing. The plan, detailed in a Wall Street Journal op-ed, suggests a nearly $4 trillion asset swap between the Fed and the U.S. Treasury to resolve a core monetary policy dilemma.

A new ‘Fed-Treasury Accord’ could allow the central bank to shrink its balance sheet while simultaneously cutting interest rates, a key objective for the Trump administration.

The proposal, authored by Donald L. Luskin, chief investment officer of TrendMacro, comes as Warsh faces lawmakers on Tuesday. Warsh has publicly advocated for both a smaller Fed balance sheet and lower interest rates, two goals that are typically at odds. Quantitative tightening, or shrinking the balance sheet, removes liquidity and tends to raise borrowing costs, while cutting the policy rate does the opposite. “Mr. Warsh’s goals seem to work against each other,” Luskin wrote. “Cutting rates eases Fed policy and supports today’s productivity-led growth. But shrinking the Fed’s assets is ‘quantitative tightening,’ undoing the good work of lower rates.”

The Fed’s balance sheet, which swelled to nearly $9 trillion during the pandemic, currently stands at approximately $6.7 trillion. Luskin’s proposal aims to return it to around $2.5 trillion, a level consistent with the amount of currency in circulation. This would involve the Fed shedding about $1.9 trillion in Treasury securities and $2 trillion in mortgage-backed securities, effectively ending the quantitative easing era that began in 2008.

This maneuver could untangle the Fed from fiscal policy and allow it to focus solely on its monetary mandate, a long-stated goal of Warsh. The proposal surfaces just as Warsh, who has called for a "regime change" at the central bank, is set to face questions from the Senate Banking Committee about his plans to reshape the institution and its role in the economy.

How a New 'Fed-Treasury Accord' Could Work

The core of the proposal is a direct swap of assets and liabilities between the Federal Reserve and the U.S. Treasury. The Fed would transfer its holdings of Treasury and mortgage-backed securities back to the. In return, the Treasury would assume the corresponding liabilities from the Fed's books—primarily the $3 trillion in commercial bank reserves and nearly $1 trillion from the Treasury's own general account currently held at the Fed.

To manage these new liabilities, the Treasury would create a new type of security, akin to a savings account for banks, offering daily liquidity and a floating interest rate pegged to the Fed’s policy rate. This would preserve the "ample reserves" environment for the banking system but house it within the Treasury.

“The Fed would go back to being a central bank, and the Treasury to being a treasury,” Luskin argued, suggesting this would restore the Fed’s independence.

Warsh's Vision and the Policy Paradox

The proposal offers a potential path for Kevin Warsh to achieve his seemingly contradictory policy objectives. For months, he has argued that the Fed’s "bloated balance sheet" can be reduced, and that the "largesse can be redeployed in the form of lower interest rates." This plan provides a theoretical framework for doing just that. By transferring the assets to the Treasury, the Fed could reduce its footprint in financial markets without triggering the tightening effects of a traditional balance sheet runoff.

This could give Warsh the room to pursue the lower interest rates demanded by President Trump, without being constrained by the inflationary risks of an oversized balance sheet. However, the idea faces significant political and practical obstacles.

Hurdles and Headwinds

The most immediate roadblock is the Treasury itself. Treasury Secretary Scott Bessent rejected the idea of a new Treasury-Fed Accord last month. Furthermore, the legality of the Fed trading directly with the Treasury on this scale is questionable and would likely require an act of Congress.

Democrats on the Senate Banking Committee are also expected to grill Warsh on his extensive financial holdings, which exceed $100 million, and his past policy stances. While Warsh is expected to be confirmed, the process may not be swift, potentially delaying any major policy shifts. Until a new chair is confirmed, Jerome Powell is expected to remain in the role, with his term as a governor running until 2028.

This article is for informational purposes only and does not constitute investment advice.