x_repost_queue

# Federal Reserve 6: The philosophy of the Federal Reserve: limited, boundary; can it be realized?

2026-07-17·x-repost-20260717-164504

Federal Reserve 6: The philosophy of the Federal Reserve: limited, boundary; can it be realized? According to the latest data for May 2026, the Federal Reserve holds at least about 3 trillion [adequate reserves], which the United States accumulated through years of QE that year. Most of these QE assets are long-term Treasury bonds issued by the U.S.

federal government and MBS taken over from the market. Remember, reserves do not belong to the Federal Reserve. They are assets in the accounts of commercial banks and governments. They are reflected in the books of the Federal Reserve and are the liabilities of the Federal Reserve.

If we want to reduce the excessively "sufficient" reserves on the Fed's books, here comes the problem. To reduce this part of "liabilities", we must simultaneously reduce the corresponding "assets". So what assets are you selling? And can we achieve the goal of cutting interest rates simultaneously? Difficult, really difficult.

## The Fed’s assets have been severely distorted After switching from [Adequate Reserves] to [Limited Reserves] mode, if the Fed wants to cut interest rates, the reserve requirement ratio IORB and the overnight lending rate ON RRP will have less effect. The only effective tool is basically to trade short-term treasury bonds in the secondary market.

So, it means that the balance sheet shrinkage in the hands of Wash is no longer a method of not renewing the investment in short-term government bonds when they expire, because after switching to [limited reserves], because he has to cut interest rates, cutting interest rates means buying short-term government bonds. At this time, the logic became clear.

Wash wanted to shrink his balance sheet, and the assets he wanted to shrink were actually: long-term Treasury bonds and MBS. Everyone knows the maturity of long-term treasury bonds. We calculate it based on 5 years, and the longest term is 30 years. MBS mainly focuses on housing loans, and their terms are generally as high as about 20 years.

The ultra-long-term return package means that the duration is too long, and the Fed itself is exposed to the risk of natural interest rates. Here is an interesting thought impact for ordinary people: Aren’t interest rates determined by the central bank?

When will the central bank itself be affected by "interest rates" and have its own assets still have "interest rate risks"? Let’s hold off for now and continue talking about MBS.

MBS has another risk: “prepayment risk” , liabilities such as "demand deposits", once MBS assets are turned into cash in advance, then these money will be accumulated on the asset side of the Federal Reserve and turned into reserves on the liability side, injecting more excess liquidity into banks, and also destroying the Fed's own plan to "reduce excessive excess reserves".

This will cause the Fed's own balance sheet to be too bulky and "distorted", making it difficult for it to return to its role as a "flexible bank of last resort." MBS was the asset that supported the Fed's collapse after the real estate bubble burst in 2008.

Warsh believed that this was an unconventional QE asset operation that year and went beyond the core responsibilities of the central bank. Long-term treasury bonds are also the asset type that Warsh most likely needs to reduce, or control the proportion of. In the final analysis, the duration is too large.

Once the natural interest rate changes, the Fed's own assets will expand and shrink in a relatively large proportion. Moreover, if Warsh wants to further reduce the balance sheet without reducing short-term Treasury bonds, he can only reduce MBS and long-term Treasury bonds.

Currently, MBS is about US$2 trillion, and the stock of long-term government bonds with a remaining maturity of more than five years is also about US$2 trillion. Each accounts for about 30% of total assets. Here is another data: the proportion of U.S.

debt with a remaining maturity of more than 10 years accounts for more than 40% of its total holdings of U.S. debt. This shows how high the duration of the Fed’s Treasury bonds is. Therefore, there is really no way to reduce the balance sheet without reducing MBS and long-term government bonds.

The above only explains why Wash must reduce MBS and long-term treasury bonds from a matter perspective. ## Fed Philosophy: Limited, Boundary Let’s look at it from the perspective of the “Federal Reserve Philosophy”.

When Warsh came to power, there was actually a force behind it that wanted the Fed to return to its true role of "limited (financial) government." Since 2008, the Federal Reserve has transformed from a financial and monetary institution with clear boundaries of powers and responsibilities to a core focus of the U.S. government.

The Federal Reserve is essentially just a bank, but its main responsibility is not to make profits, but to maintain the stability of its own "Federal Reserve Notes" monetary system.

But after 2008, the Federal Reserve began to participate in the real estate market, securities market, corporate market, and even people's livelihood and wealth distribution are also related to it. The deficit that the U.S. government cannot absorb is also financed by it, and U.S. industrial imports and exports are also related to it.

It even wants to be the savior for all U.S. economic crises. As long as a crisis occurs, the Federal Reserve will end up accepting assets whose prices have plunged. This is actually another kind of rigid payment. Wall Street is essentially getting a free put option from the Fed.

To a monetarist, or to the monetarists behind the Fed, the Fed has crossed the line and the cost of paying for this "put option" is too great. This is also Wash's core judgment.

## There is a group of people who want the Fed to return to limited borders Although Trump has repeatedly hoped that the Fed’s continued release of water will help his election campaign, Trump’s core decision-making power is still filled with absolute conservatives, such as Paul Winfrey.

Winfree), hoping that the Fed will significantly shrink its balance sheet and limit its role as a lender of last resort. Ron Paul, conservative congressman, It even advocates the most extreme "limited borders" proposition - that the central bank (the Federal Reserve) itself should not exist.

In contrast, Kevin Warsh is considered the "less extreme" among them. From the perspective of market efficiency, some investors and institutions are also worried that the Federal Reserve's excessive intervention will distort asset prices, and hope that its functions will return to its roots, so that it can still provide support for the market in the future.

Before QE in 2008, the Fed's asset sheet was small, short-duration, and single-structured. At the end of 2007, the total assets of the Federal Reserve were less than one trillion U.S. dollars. The assets were almost composed of short-term U.S. debt, and the comprehensive duration was only about 4 years.

On the liability side, there are not many reserves of commercial banks. The main thing is the circulating "Federal Reserve Notes" - US dollars. The US dollars account for 87% and the reserves are only 13%. Only such a Federal Reserve can be a lightweight, safe, and flexible Federal Reserve.

Full text

# Federal Reserve 6: The philosophy of the Federal Reserve: limited, boundary; can it be realized?

# Federal Reserve 6: The philosophy of the Federal Reserve: limited, boundary; can it be realized? According to the latest data for May 2026, the Federal Reserve holds at least about 3 trillion [adequate reserves], which the United States accumulated through years of QE that year. Most of these QE assets are long-term Treasury bonds issued by the U.S. federal government and MBS taken over from the market. Remember, reserves do not belong to the Federal Reserve. They are assets in the accounts of commercial banks and governments. They are reflected in the books of the Federal Reserve and are the liabilities of the Federal Reserve. If we want to reduce the excessively "sufficient" reserves on the Fed's books, here comes the problem. To reduce this part of "liabilities", we must simultaneously reduce the corresponding "assets". So what assets are you selling? And can we achieve the goal of cutting interest rates simultaneously? Difficult, really difficult. ## The Fed’s assets have been severely distorted After switching from [Adequate Reserves] to [Limited Reserves] mode, if the Fed wants to cut interest rates, the reserve requirement ratio IORB and the overnight lending rate ON RRP will have less effect. The only effective tool is basically to trade short-term treasury bonds in the secondary market. So, it means that the balance sheet shrinkage in the hands of Wash is no longer a method of not renewing the investment in short-term government bonds when they expire, because after switching to [limited reserves], because he has to cut interest rates, cutting interest rates means buying short-term government bonds. At this time, the logic became clear. Wash wanted to shrink his balance sheet, and the assets he wanted to shrink were actually: long-term Treasury bonds and MBS. Everyone knows the maturity of long-term treasury bonds. We calculate it based on 5 years, and the longest term is 30 years. MBS mainly focuses on housing loans, and their terms are generally as high as about 20 years. The ultra-long-term return package means that the duration is too long, and the Fed itself is exposed to the risk of natural interest rates. Here is an interesting thought impact for ordinary people: Aren’t interest rates determined by the central bank? When will the central bank itself be affected by "interest rates" and have its own assets still have "interest rate risks"? Let’s hold off for now and continue talking about MBS. MBS has another risk: “prepayment risk” , liabilities such as "demand deposits", once MBS assets are turned into cash in advance, then these money will be accumulated on the asset side of the Federal Reserve and turned into reserves on the liability side, injecting more excess liquidity into banks, and also destroying the Fed's own plan to "reduce excessive excess reserves". This will cause the Fed's own balance sheet to be too bulky and "distorted", making it difficult for it to return to its role as a "flexible bank of last resort." MBS was the asset that supported the Fed's collapse after the real estate bubble burst in 2008. Warsh believed that this was an unconventional QE asset operation that year and went beyond the core responsibilities of the central bank. Long-term treasury bonds are also the asset type that Warsh most likely needs to reduce, or control the proportion of. In the final analysis, the duration is too large. Once the natural interest rate changes, the Fed's own assets will expand and shrink in a relatively large proportion. Moreover, if Warsh wants to further reduce the balance sheet without reducing short-term Treasury bonds, he can only reduce MBS and long-term Treasury bonds. Currently, MBS is about US$2 trillion, and the stock of long-term government bonds with a remaining maturity of more than five years is also about US$2 trillion. Each accounts for about 30% of total assets. Here is another data: the proportion of U.S. debt with a remaining maturity of more than 10 years accounts for more than 40% of its total holdings of U.S. debt. This shows how high the duration of the Fed’s Treasury bonds is. Therefore, there is really no way to reduce the balance sheet without reducing MBS and long-term government bonds. The above only explains why Wash must reduce MBS and long-term treasury bonds from a matter perspective. ## Fed Philosophy: Limited, Boundary Let’s look at it from the perspective of the “Federal Reserve Philosophy”. When Warsh came to power, there was actually a force behind it that wanted the Fed to return to its true role of "limited (financial) government." Since 2008, the Federal Reserve has transformed from a financial and monetary institution with clear boundaries of powers and responsibilities to a core focus of the U.S. government. The Federal Reserve is essentially just a bank, but its main responsibility is not to make profits, but to maintain the stability of its own "Federal Reserve Notes" monetary system. But after 2008, the Federal Reserve began to participate in the real estate market, securities market, corporate market, and even people's livelihood and wealth distribution are also related to it. The deficit that the U.S. government cannot absorb is also financed by it, and U.S. industrial imports and exports are also related to it. It even wants to be the savior for all U.S. economic crises. As long as a crisis occurs, the Federal Reserve will end up accepting assets whose prices have plunged. This is actually another kind of rigid payment. Wall Street is essentially getting a free put option from the Fed. To a monetarist, or to the monetarists behind the Fed, the Fed has crossed the line and the cost of paying for this "put option" is too great. This is also Wash's core judgment. ## There is a group of people who want the Fed to return to limited borders Although Trump has repeatedly hoped that the Fed’s continued release of water will help his election campaign, Trump’s core decision-making power is still filled with absolute conservatives, such as Paul Winfrey. Winfree), hoping that the Fed will significantly shrink its balance sheet and limit its role as a lender of last resort. Ron Paul, conservative congressman, It even advocates the most extreme "limited borders" proposition - that the central bank (the Federal Reserve) itself should not exist. In contrast, Kevin Warsh is considered the "less extreme" among them. From the perspective of market efficiency, some investors and institutions are also worried that the Federal Reserve's excessive intervention will distort asset prices, and hope that its functions will return to its roots, so that it can still provide support for the market in the future. Before QE in 2008, the Fed's asset sheet was small, short-duration, and single-structured. At the end of 2007, the total assets of the Federal Reserve were less than one trillion U.S. dollars. The assets were almost composed of short-term U.S. debt, and the comprehensive duration was only about 4 years. On the liability side, there are not many reserves of commercial banks. The main thing is the circulating "Federal Reserve Notes" - US dollars. The US dollars account for 87% and the reserves are only 13%. Only such a Federal Reserve can be a lightweight, safe, and flexible Federal Reserve.

← Back to archive