Warsh Might Be Just The Asset Wheeler Dealer That Trump Wants At The Fed

Because who doesn't want that kind of mentality in that gig?
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The time is drawing close for President Trump to make his pick for the Fed Chair, and it seems that the choices have narrowed to an essential continuation of the polices of Chair Janet Yellen, or taking the different and potentially disruptive path of nominating former Fed governor Kevin Warsh.

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Yellen herself appears to have an outside chance to retain her position, according to many reports, after previous favorite Globalist Gary Cohn fell from Trump's favor. Since that time Warsh's name has circled as the most likely nominee, while current governor Jerome Powell has also emerged as another finalist for the role.

Either Yellen or Powell would likely hew closely to the monetary policies of recent years; Powell has rarely differed from Yellen on major policy issues, and the biggest gap between the two appears to be on financial deregulation, which Powell seems more willing to accept. Any deviations from the bank's current orthodoxy under Yellen or Powell would likely be a response to changing circumstances or composition of the Fed board and Federal Open Market Committee. Certainly, as part of the group that settled on the current approach to balance sheet policy, either would continue the recently-initiated policy of allowing assets to mature and roll of the bank's balance sheet.

Warsh, however, has intimated that he would impose a very different future on the bank broadly, and if you dive a bit deeper into his history as a policymaker, it's easy to see why many financial world observers think a Warsh-led bank could tack very differently on policy matters. That's not only true of rates, where Warsh is more inflation-focused and hawkish than Yellen and some of the other current governors, but especially true of balance sheet policy.

In 2010, when Warsh was a governor and the FOMC in the early stages of building the gargantuan balance sheet it is only now beginning to roll back, policymakers were already engaged in a debate about the exit strategy for their asset purchases. (FYI: As a historical documentation of the laughable hubris of Fed policymakers, the transcripts from 2010 are rich: Warsh himself correctly identified that the major corporate world would lead the recovery, but far from accurately predicted that would also mean an upsurge in labor productivity) A key point in that 2010 debate was whether the bank would simply allow assets to roll off the balance sheet, or whether and how the bank would engage in sales of the assets once it deemed them no longer necessary.

The Bernanke and Yellen-led bank have came down firmly on the former position, with Yellen and other policymakers promising an "autopilot" like reduction of the balance sheet. But Warsh took a very different view at the time, and one that would be a massive departure from current policy, and argued that "if properly communicated, financial markets seem to me to be ready to incorporate clear, credible, properly sized, prospective communications about asset sales." 

He added in the meeting that he was against signaling that the bank would hold on to its large balance sheet for "decades" or "allowing normal maturity schedules to dictate our holdings," which is exactly what the central bank has now declared it will do. While this position is one born of a more dove-ish policy persuasion and means more accommodation for markets over a longer period of time, it is also that comes from a sense of caution. Because Yellen and other officials have no idea, really, what sort of impact asset sales would have on markets and the economy, and because the bank has never attempted anything like large-scale asset sales, they have attempted to make the process of balance sheet reduction as conservative as possible.

Warsh mostly waved those concerns aside in 2010, suggesting instead that the bank should proactively look to push assets out of its door in a controlled but nevertheless far more aggressive fashion.

"We bought assets people didn't want at prices they wouldn't pay. To the extent that market are now interested in buying these assets ... we should take them up on that rare opportunity. So I'm an opportunistic seller of assets," Warsh told Yellen and others.

Interestingly, he has also said that the Fed should coordinate its plans for drawing down its balance sheet with the U.S. Treasury. This proposal would likely meet with a healthy amount or resistance at the Fed, which does not typically consult with the Treasury on monetary matters in an effort to guard a policy independence that it considers sancrosanct. 

Here, at least, Warsh’s approach seems far more sensible than the one offered by Yellen or Powell — the Fed has intervened in an unprecedented manner in the U.S. Treasury market, which, despite being the world’s most important asset market, is also somewhat backward: full of smaller players and strangely bifurcated, worryingly opaque and, according to some in the financial industry, less liquid than the world's safe haven market ought to be.

So, whether markets can expect more of the same or more policy experimentation depends now on, gulp, Trump.

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