The Warsh-Bessent Fed-Treasury Accord

Warsh wants lower interest rates, but he also wants to shrink the Fed’s balance sheet. A new Fed-Treasury accord, echoing the one that gave the Fed its independence in 1951, would allow for a return of the Fed’s asset holdings to the level of currency outstanding – today $2.4 trillion – without any quantitative tightening. Currently when the Fed accepts so-called excess reserves from banks, it is effectively issuing a riskless security – full-faith-and-credit, one-day maturity, automatic rollover and floating rate. That funds bond and MBS purchases which take maturity out of the public markets, making it easier for the Treasury to fund debts and deficits, and distorts credit allocation. An accord to end all that could swap the bonds and MBS back to Treasury, with the Treasury assuming the obligation of the excess reserves. This would require creation of a new Treasury vehicle like a savings account, which would be as attractive to banks as the Fed’s excess reserves, but also to stablecoin issuers and the public. Trump will have reestablished Fed independence.