Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why Kevin Warsh Could Reshape the Fed From Inside Wall Street
Transcript
- Lucas: So there's a headline from CNBC this afternoon that I can't stop thinking about. It's about Kevin Warsh and what they're calling a real Fed 'regime change' that may happen deep inside Wall Street's plumbing. Luna: Plumbing — meaning the operational guts, not just the interest rate decision. Lucas: Exactly. And I think this is one of those stories that sounds inside-baseball but actually tells you where the next decade of monetary policy is heading. Warsh, for those who don't recall, was a Fed governor during the financial crisis. He was deeply involved in the emergency lending facilities. He's also been a vocal critic of the Fed's post-2020 framework — the whole 'average inflation targeting' experiment. Luna: Right, he's been saying for years that the Fed got too deep into credit allocation, that the balance sheet became a political tool. Lucas: That's the critique. And now, with the yield curve still inverted — the 10-year Treasury is at four point five seven percent, the 2-year at four point zero four, that's a spread of roughly 49 basis points — the market is signaling that the Fed's current stance is too tight for long-term growth but too loose for inflation credibility. So the conversation about 'who runs the plumbing' matters a lot. Luna: I want to get into the plumbing specifics. But first — is Warsh actually being considered for a role? The headline says 'may happen.' Lucas: The reporting is speculative but serious. Warsh has been advising on financial stability issues informally. And there's a sense that the next phase of Fed policy won't be about the fed funds rate — it'll be about how the Fed manages the discount window, the repo market, and its emergency lending facilities. That's the plumbing. The rate decision is just the thermostat setting. The plumbing determines whether the heat actually gets to the rooms. Luna: I like that analogy. So what would a Warsh-inspired regime change look like in practice? Lucas: Two big things. First, a return to a more rule-based approach to the discount window. Under the current framework, banks are reluctant to use it because there's a stigma — they worry it signals weakness. Warsh has argued that the Fed should make the discount window a routine, standing facility, almost like a public utility. That would normalize borrowing and reduce the need for ad-hoc emergency facilities. Luna: Which would also reduce the need for the Fed to keep a massive balance sheet. If the plumbing works in normal times, you don't need the crisis toolkit deployed permanently. Lucas: Exactly. The second big thing is the repo market. Remember September 2019, when repo rates spiked to 10 percent? The Fed had to step in with overnight operations. Warsh has argued that the Fed should pre-position liquidity through a standing repo facility — so that spikes don't happen in the first place. That's a structural change, not a crisis response. Luna: And that would be a regime change because it shifts the Fed from being a firefighter to a building inspector. Lucas: That's the framing exactly. And the reason it matters now is that the yield curve is still inverted, the VIX is at 16.58 — relatively calm — but the underlying structure of the Treasury market is fragile. The past few years have shown that when liquidity dries up, even a calm VIX can't protect you. Luna: Let's talk about the inversion. 49 basis points between the 10-year and the 2-year. That's not as deep as it was in 2023, when we hit over 100 basis points inverted. But it's still inverted. Historically, that's a recession signal. Yet the market seems to be looking through it. Lucas: Right, and that's the tension. The real GDP growth number came in at an annualized 2 percent for the first quarter of 2026, up from basically zero late last year. So the economy is growing. But the bond market is saying 'I don't trust this.' The long end is demanding a term premium because of fiscal deficits, inflation uncertainty, and the sheer supply of Treasury issuance. Luna: So the inversion isn't a recession signal this time — it's a fiscal signal. Lucas: That's a key debate. And it's where Warsh's plumbing reforms come in. Because if the Fed can make the Treasury market more resilient — if it can ensure that repo markets don't freeze up when issuance surges — then maybe the yield curve can normalize without a recession. That's the hope. Luna: But is that realistic? I mean, the Fed tried to normalize the balance sheet in 2018 and we got the repo blow-up in 2019. Lucas: That's the cautionary tale. Warsh was actually critical of how the Fed handled that normalization — he said they didn't communicate the plumbing changes clearly enough. So part of the regime change would be about transparency. The Fed would say: 'Here's our standing repo facility. Here are the terms. Use it or don't, but it's there.' That's very different from the current approach where facilities are announced in a crisis. Luna: So you're saying the regime change is as much about communication as about tools. Lucas: Absolutely. And Warsh understands that. He's a lawyer by training, not an economist. He thinks about institutional design. The Fed has been run by economists for decades — PhDs who think about models and forecasts. Warsh thinks about incentives and market structure. Luna: Interesting. But there's a risk here: if you normalize the discount window, you might encourage moral hazard. Banks might take on more liquidity risk knowing they can always borrow from the Fed without stigma. Lucas: That's the classic objection. Warsh's answer is that you pair the standing facility with strict collateral requirements and a penalty rate. You don't make it cheap — you make it reliable. So banks know they can access liquidity, but at a cost that incentivizes them to manage their own liquidity first. It's like having a fire extinguisher that works, but you still have to pay for the fire department. Luna: And the fire department in this case is the Fed's balance sheet. Which brings me to another headline I saw — about the government taking equity stakes in companies. Do you think that's related? Lucas: Indirectly, yes. If the plumbing of the financial system is robust, the government is less likely to need to step in with equity injections during a crisis. Warsh was part of the TARP oversight — he saw how messy that was. So his whole philosophy is: fix the plumbing so you don't need the bailout. Luna: That's a compelling narrative. But let's get concrete. What would be the first sign that this regime change is actually happening? Lucas: I'd watch the Fed's statement on the standing repo facility. Right now, it's still described as a temporary measure. If they make it permanent — and if they lower the rate or expand the eligible collateral — that's a signal. Also watch for changes in the discount window. The Fed recently raised the primary credit rate to match the top of the fed funds range. That's a small step. A Warsh-led regime would go further: maybe a tiered system where banks can borrow amounts up to a certain threshold automatically. Luna: And what about the VIX? It's at 16.58, which is low. If the market is calm, why should the Fed change anything? Lucas: That's the paradox. The VIX is a measure of equity volatility, not bond market plumbing. The repo market can seize up while the VIX is at 12. And in some ways, a low VIX lulls people into complacency. The real risk is that the Treasury market — the deepest market in the world — becomes less liquid because of structural issues. The Fed should fix the roof while the sun is shining. Luna: Alright, so let's say Warsh gets a formal role — maybe as Vice Chair for Supervision or something similar. What's the timeline? Lucas: The CNBC piece suggests it could happen in the next few months. The administration has been filling regulatory posts, and the Fed's current Vice Chair for Supervision, Michael Barr, has been in the hot seat. There's speculation he might step down. If that happens, Warsh is a natural replacement. He's already been confirmed by the Senate once, so the process would be smoother. Luna: So the regime change could come through personnel, not just policy. Lucas: Exactly. And that's why the headline is about 'deep inside Wall Street's plumbing.' It's not a dramatic rate cut or a new QE program. It's about who controls the levers that nobody thinks about until they break. Luna: One last thing — the yield curve. You mentioned 49 basis points inversion. If the Fed fixes the plumbing, does that automatically steepen the curve? Lucas: Not automatically, but it removes a source of stress. The inversion is partly driven by a liquidity premium on long-term bonds — investors demand extra yield because they worry about disorderly market conditions. If the plumbing is more reliable, that premium should shrink. So you could see the curve normalize without the Fed having to cut rates. That would be the ideal outcome: a steeper curve driven by lower term premiums, not by recession fears. Luna: So Warsh's potential return is really about institutional resilience. It's not about dovish or hawkish — it's about making the system work better. Lucas: That's the thesis. And it's a refreshing change from the usual debate about whether the next move is a hike or a cut. The plumbing matters more than the dot plot, and Kevin Warsh might be the person to remind everyone of that. Luna: Alright, I'm going to start paying more attention to the discount window. Who knew that could be interesting? Lucas: Markets are full of hidden leverage points. We'll keep watching this one.