It has been less than two months since Kevin Warsh was sworn in as Chair of the Federal Reserve (“Fed”) Board, and yet already he is famous for his style of heavily limited public communication. After his first (and only so far) Federal Open Market Committee (“FOMC”) meeting, the Committee issued an unusually short statement, Warsh’s press conference was notably shorter than his predecessor’s, and he did not contribute to the Fed’s “dot plot” of economic and policy rate projections. During his nomination hearing, he skillfully evaded the toughest questions, but now, as a confirmed Chair, Warsh must communicate and answer to Congress about how he intends to lead the Fed.
That is incredibly important because the actions of the Fed affect the lives of every American. From the health of the job market to the cost of a mortgage, credit card, or everyday goods, the Fed’s decisions shape the economy in ways households experience daily. Through its role in preventing, and if necessary responding to, financial turmoil and crashes, and in providing Americans with safe, reliable and efficient payment services, the Fed carries out many critical responsibilities.
The Chair of the Fed has the most influence over those responsibilities, which is why Congress must press Warsh on how he intends to approach each of the Fed’s responsibilities. In his first FOMC meeting, he was clear about his goals for monetary policy: deliver price stability and consider how to shrink the Fed’s balance sheet. There is much less clarity on his stance on bank supervision and regulation, a very important and often overlooked responsibility of the Fed. He previously expressed support for the massive and dangerous deregulatory efforts of Vice Chair for Supervision Bowman, which could have a significant effect on his goals of price stability and a smaller balance sheet by creating financial instability. He also has been vague about how he sees crypto affecting the financial system and what to do about the current green-lighting of crypto banks by providing them with bank charters and access to Fed payment accounts.
Put simply, Chair Warsh must provide clear views on these critical public policy issues, and Congress, in its role overseeing the Fed, must ask the hard questions of him. Below are a few key topics that policymakers should address with Chair Warsh.
Banking Regulation: Stability Cannot Be Optional
Warsh originally served as a Governor at the Fed from 2006 – 2011. He was a proponent of the Fed’s prevailing ideology before the 2008 crash of “markets know best” and of weak supervision and regulation that permitted the excessive risk-taking and inadequate capital at Wall Street banks. This misguided approach culminated in the worst financial collapse since the Great Depression (see here).1 Having witnessed the catastrophic consequences firsthand and having been directly involved in the Fed’s response, he should know just how critical strong bank supervision and regulation are to financial stability, price stability, and maximum and broad-based employment.
Unfortunately, while his statements (see here and here) in the early years after the 2008 crash indicated general support for stronger rules for and oversight of large banks, his support, when campaigning for the Chair position, to significantly weaken bank capital rules and supervisory oversight is troubling and incoherent when compared to his views after the crash. The combination of these deregulatory actions will drastically reduce capital at the largest banks to the levels they had just before the 2008 crash, a fact that should have Warsh in strong opposition to those actions, considering how well he knows the devastation that comes with large bank failures that result from inadequate capitalization.
Unfortunately, the Fed under the direction of Vice Chair for Supervision Bowman has consistently and intentionally obfuscated the total impact of its deregulations, but Warsh nonetheless should be pressed on the loosening of post-crisis protections and his significant and troubling shift in stance on large bank regulations. Warsh should oversee a better regulatory process that is rooted in the Fed’s safety and soundness and financial stability objectives. Congress should press Warsh on this about-face and demand that Warsh use his role as Chair to reverse the bad policies being implemented, bring credibility to the Fed’s regulatory role, and, importantly, not compromise financial stability for short-term gain.
On community banks (which disproportionately fund the real economy and yet face significantly higher capital requirements than Wall Street banks) Warsh has expressed similar concerns to Better Markets (see here and here) that community banks face significant competitive disadvantages that are driving a reduction in both their numbers and share of banking system assets. However, his views in this area also lack coherence because the ability for community banks to succeed is actively undermined by his recent public support of Bowman’s proposal to gut large bank capital requirements (see here). Bowman’s proposal would expand the competitive advantage large banks have over small banks. Warsh must explain clearly what has changed in the structure, risk profile, or interconnectedness of the financial system to justify weaker guardrails.
The stakes are high to maintain the safety and soundness of the banking system because failure to do so can result in another financial crisis and the type of large-scale monetary policy actions that have continued since the 2008 crash. That threatens Warsh’s stated goals of price stability and reducing the Fed’s balance sheet. A central lesson from that crash is that effective monetary policy depends on a stable and well-functioning banking and financial system (see here), and in fact, the execution of monetary policy is mostly done through banks. Furthermore, only a well-capitalized banking system can truly support healthy, durable economic growth in both good times and bad.
Congress must ask hard questions about Warsh’s recent support for reducing capital requirements and for the weakening of supervision, especially pressing on how those positions are consistent with the hard-learned lessons of the 2008 crash. In particular, the Congress should require clear answers about whether he supports requiring strong capital requirements for Wall Street banks, preserving the integrity of the Fed’s supervisory stress test, and ensuring that the Fed’s supervisory authority is used to prevent systemic risk rather than to accommodate industry pressure.
Crypto Is a Danger to the Banking System and Monetary Policy
As a central bank, the Fed serves as a “bank for banks” that Congress in 1913 “establish[ed as] a monetary system that could respond effectively to stresses in the banking system.” That’s because banks were—and remain—the primary source of support to our economy through economic cycles, during good times and bad, and so the Fed was designed to work through them. In multiple statutes, “banks” are defined as “depository institutions”—real traditional banks that take deposits and use those deposits as funding to make loans to borrowers. However, that is now all being turned on its head as the current administration moves with force and speed to establish crypto banks and bring crypto into the banking system. That includes establishing a separate weak framework of rules for bank-issued stablecoins.
Crypto banks are receiving trust charters from the Office of the Comptroller of the Currency (OCC) at a record pace, and the OCC has even gone further to expand the range of activities crypto banks can engage in to include activities previously only allowed by real banks. The Fed concurrently is pushing through the final piece to fully bring them into the banking system: offering crypto bank accounts with the Fed, so that the Fed can serve as their “bank to banks” as well. Furthermore, the so-called GENIUS Act made it the law that stablecoins can be offered by crypto banks, real traditional banks, and nonbanks.
First, these actions are injecting all the risks of crypto into the banking system, including the Fed. All crypto assets, including stablecoins, have proven to be extremely unstable. Having crypto integrated into the banking system inevitably will result in runs just as it always has, and those runs will have knock-on impacts causing runs at real banks. Giving crypto banks access to the Fed’s payments system and the ability to act as regular banks would allow crypto banks to engage instantly and directly with real traditional banks through the Fed’s system, so the risks at crypto banks could easily immediately and directly spill over to real traditional banks. And regular banks that issue stablecoins inevitably would have to rescue their stablecoin operations when stress occurs. In other words, these assets are the antithesis of safe and sound, and the very banking agencies whose mission it is to maintain the safety and soundness of the banking system are recklessly bringing these assets in and putting extremely weak rules in place.
Second, if stablecoin issuers grow large as a result of the ability to offer interest granted by a loophole in the GENIUS Act, this would drain deposits from banks and slow the economy and starve borrowers from getting much-needed credit, especially Main Street households and businesses. Deposits are vital to the banking system and the real economy because 1) banks fund their loans almost entirely with deposits and 2) banks are the safest, cheapest, and best source of lending. So, fewer bank deposits means less of the bank lending that is highly beneficial to households and businesses. This would be very problematic for economic growth and to the Fed’s dual mandate of maximum employment and stable prices.
Third, crypto integration will increase financial stability risks and complicate the Fed’s implementation of monetary policy. The basic structure of stablecoins is very similar to money market funds, which have repeatedly caused financial stability risks, leading to their bailout in 2008 and again when COVID-19 hit in early 2020. In particular, like money market funds, stablecoin issuers hold large amounts of U.S. Treasury securities, and so runs on stablecoins would cause large-scale sales of Treasuries and therefore massive disruptions to financial markets and to the supply of credit to the real economy. Additionally, with fewer deposits in banks and therefore smaller banks, the Fed’s transmission of monetary policy through banks would be diminished.
Congress must press Warsh on these issues and hold the Fed accountable for its core missions of safety and soundness of the banking system, maintaining financial stability, and executing on its dual mandate for monetary policy. Bringing crypto into the system goes directly against these missions, and Warsh must answer for this.
Conflicting Goals on Monetary Policy
The Fed’s credibility on monetary policy depends on its unwavering commitment to price stability. Warsh recently stated that commitment very clearly—“the Committee will deliver price stability.” While that is seemingly a very clear and straightforward statement, Warsh has muddied the picture by also stating that he is considering essentially redefining how the Fed looks at inflation, and even recently established a task force to help address how to do so.
So, on one hand, he has publicly committed to delivering price stability, but on the other hand, he wants to effectively redefine what price stability means and change how the Fed incorporates current and future information. For example, he has argued that the rise of artificial intelligence will boost productivity and lead to non-inflationary growth and that the Fed must therefore be looking at future trends in combination with current data. That argument is highly speculative, and some of the Fed’s own leadership sees the possibility of the opposite being true.
Congress must demand a clear articulation of how Warsh is thinking about his intended shift in both the definition of price stability and how he envisions the FOMC incorporating the broad set of datapoints he has noted in their decision making. In particular, he should be required to clarify his issues with current inflation data and how he intends to reconcile the conflicting data signals that inevitably arise when considering broad ranges of datapoints.
Conclusion
As Chair of the Fed, Warsh is accountable to Congress and the American people. While the Fed must remain independent to set policy, Congress also has a critical role to ask direct and rigorous questions about the issues laid out in this fact sheet.
The American public deserves to know whether Chair Warsh plans to prioritize long-term economic stability and accountability or weaken the safeguards designed to prevent another devastating financial crisis, and to know how he plans to deliver on real price stability.
