Power and Politics in Banking Today

When President Trump named Kevin Warsh as his choice for Federal Reserve chair last month, the news immediately raised questions and set off debate about how Warsh might lead. Would he govern as a pro-growth policymaker aligned with the administration, or would he continue the very disciplined focus on inflation that defined his earlier career?  And what would a Warsh Chairmanship mean for the banking sector’s ability to continue posting strong profits given that the Fed determines not just interest rates but also plays an important role regulating the risks taken by banks and determining the soundness of the financial system?

The nomination came just days before Warsh had been scheduled to speak at a Corporations and Society Initiative (CASI) lunch at Stanford Graduate School of Business. His unsurprising need to cancel created an opportunity for a timely conversation on how economic governance and banking are evolving. Stanford finance professors Anat Admati and Amit Seru led the February 10 discussion, Power and Politics in Banking Today, drawing on their expertise in regulation, financial stability, and central bank policy.

Student moderator Tunc Ekin Yavuz opened by noting that central banks have played an increasingly visible role in the wake of the Global Financial Crisis (GFC) of 2007-2009. He asked where these institutions stand today and what their expanding influence signals for the future.        

Admati explained that before the GFC, the Federal Reserve was a relatively quiet institution with a balance sheet under $1 trillion. Its role as a central bank was largely confined to traditional functions such as providing liquidity to stabilize banks and prevent panics. After the collapse of Bear Stearns in March 2008, the failure of Lehman Brothers six months later, and the ensuing systemic shocks, the Fed launched a policy of quantitative easing (QE), purchasing long-term securities from the open market to increase the money supply and deploying other unprecedented tools to keep the economy afloat.

“They came up with every single measure to make sure that the world financial system didn't implode,” she said. “And in that process, they started buying a lot of securities, making loans to all sorts of institutions, swap lines to other central banks. They were very, very active at that point.”

Following the financial crisis, the Federal Reserve's balance sheet grew to over $4.5 trillion in early 2015. The Fed stepped in again during the Covid-19 crisis with measures that spiked it to nearly $9 trillion in early 2022. The result, she argued, is a central bank that has shifted from a behind-the-scenes stabilizer to a highly visible economic power broker, often stepping in when elected policymakers do not.

“The Fed became more important in the economy,” she argued. “So, when the politicians don't want to do things, they intervene in markets because they have a lot of capacity to do that if the law allows them.”

Admati noted that Kevin Warsh has visited her classes regularly for more than a decade, offering students his perspective on economic policy and the Federal Reserve. Warsh, who served on the Fed’s Board of Governors from 2006 to 2011, stepped down in part because, she said, he opposed the central bank’s expanding balance sheet. In the years since, he has become an outspoken critic, arguing that the Fed has drifted beyond its core mandate through what he calls institutional “mission creep.”

Seru picked up on that thread, noting that the Fed’s global reputation rests on a hard-won foundation of independence, credibility, and disciplined governance. Its original mandate, he explained, was to conduct monetary policy to support the goals of maximum employment and stable prices.

To carry out its core mandate, Seru explained, the Fed has to monitor financial stability continuously, assessing vulnerabilities in bank balance sheets, funding structures, and interconnected markets before stress becomes crisis. It also implies that the Fed acts as a lender of last resort, stepping in during panic-driven liquidity shocks to stabilize markets and keep credit flowing. Traditionally, the central bank has drawn a clear line: it provides temporary liquidity to solvent institutions, while insolvent firms that failed because of their own risk-taking must raise capital, restructure, or exit. Maintaining that distinction, he suggested, is essential not only for discipline in markets but also for preserving the Fed’s credibility and independence.

Seru suggested that these lines have blurred in recent years as the Fed’s expanding role in financial stability and crisis intervention has increasingly treated solvency concerns as liquidity problems. Such dynamics have also begun to constrain monetary policy choices. As seen during the inflation surge in 2022, concerns about banking-sector fragility complicated and arguably delayed decisive tightening. In this way, challenges on the financial stability front can spill over into monetary policy, potentially denting the Fed’s credibility in executing its mandate independently.

“How do you figure out whether there is solvency versus liquidity, especially during a crisis?” he asked.

Seru warned that markets increasingly assume the Fed will step in whenever turmoil arises, creating a broad ‘too big to fail’ expectation that risks turning central bank actions into government-backed rescues at the public’s expense.

“Remember, if we decide to save insolvent institutions, and we have done that many times, then it becomes a fiscal problem, and that is outside Fed’s mandate” he added.

Such perceptions, he said, can erode trust and independence unless the Fed demonstrates rigorous accountability by showing that emergency interventions address liquidity rather than solvency.

“Going forward, I think it's a problem that Kevin [Warsh] faces,” he remarked. “Based on what I have heard Kevin say over the past 11 years when he's been here, I think he wants [the Fed] to be more rule-based, he wants it to be more transparent and at the end, it's going to be about accountability.”

Admati agreed that many episodes of turmoil in the financial markets where the fed intervened using its lender of last resort function, were not about liquidity problems or market panic. These episodes instead reflect serious solvency concerns that regulators had failed to confront and address earlier. She argued that the largest banks operate with built-in advantages that give them access to sources of enormous profits. Many of the ways they are able to profit, or to hide losses, are almost impossible for outsiders to see and fully understand. Many, including Warsh, have expressed concerns about the poor quality of banks’ disclosures and their lack of transparency, which makes it difficult to assess risks to individual banks and to the system.

Admati was particularly critical of the Federal Reserve’s record as a regulator, arguing that it has repeatedly fallen short, from pre-2008 mortgage oversight failures to more recent episodes such as the collapse of Silicon Valley Bank in March 2023.

“The Fed, on the regulation side, gets low marks from me and, it's a problem because they were charged under the Dodd-Frank Act with solving the ‘too big to fail’ problem.”

In her view, the central bank’s dominant role has the added effect of overshadowing other watchdogs such as the FDIC, while its ability to intervene in crises may allow both regulators and banks to avoid fully confronting losses.

The discussion shifted to the growing role of non-bank institutions, from private credit funds to crypto platforms, that increasingly perform some functions once dominated by traditional banks. Yavuz asked whether these parallel systems pose additional risks to an already fragile system.

Seru cautioned that despite their modern packaging, many of these newer players carry similar weaknesses, including limited transparency, heavy leverage, and mismatches between short-term funding and long-term investments. Some models, like classic private equity backed by patient, sophisticated investors, can work well. But he warned that risks increase when those same non-bank entities begin reaching everyday investors who may not fully understand what they’re buying into.

“We are going to, again, have someone step in to bail out the entities when bad stuff happens,” he remarked. “That's where we are headed because we are implicitly using the U.S. balance sheet to back almost everything.”

Yavuz pressed the panel on whether private financial markets can truly remain separate from public risk, noting that private assets often “leak” into the broader system through institutional investors, pension funds, and interconnected markets. Admati shared her fears that the financial system is layering new forms of opacity on top of old ones, creating a web of shadow institutions that are difficult to monitor and increasingly intertwined with traditional finance. Ordinary investors are drawn in indirectly through retirement funds and other pooled vehicles, and when a crisis hits, they are often the ones who are hurt the most.

“What you're not seeing are clever ways within that system that the savvy people are using to protect themselves,” she said. “The end investors, who are either depositors or some retail investors for pension funds, are going to end up being harmed when this whole house of cards implodes, and that could happen.”

To illustrate the danger, Admati pointed to the bailout of AIG during the financial crisis. Although AIG was not a bank, its collapse would have cascaded through the system because of its contractual links to major financial firms. An even bigger danger, Admati noted, is the complacency that has grown from recent government actions that reinforce the notion that the government will step in stop a crisis from becoming a catastrophe.

“The 2007-2009 crisis was not big enough to truly impress people because the government was able to pull out all the stops and prevent a bigger harm, which the government didn't do in the 1930s,” she explained.  “We're not going to seriously learn a lesson because after the Great Depression, all kinds of institutions were built that are being eroded right now.”

Yavuz stepped back to ask a broader question: if finance is meant to serve the real economy as part of a social contract, has it begun to function less as a tool and more as a source of risk? Admati replied by recalling how she once taught finance primarily as a force for economic good, highlighting its core functions such as enabling payments, channeling savings to productive investment, sharing risk, and supporting corporate governance. Over time, however, she said her view has grown more skeptical.

“The financial sector has become very extractive and if you dig behind some of our political problems right now and some of the erosion of trust, I think you will find financialization is taking over the economy. Everything is financialized.”  Admati said the public’s lack of understanding of the issue is fueling legitimate public anger.

Seru added that political influence across the system makes it difficult for markets to function the way a truly competitive system should.

“If you take risk, you should bear consequences of the risk. That seems like a reasonable thing to do,” he said. But when large financial firms expect intervention once their risks go wrong, market discipline weakens, potentially discouraging new entrants and stifling innovation.

Finance, in their shared assessment, remains capable of delivering enormous value, but whether it is currently fulfilling that role for society as a whole is an increasingly open question.

An audience member asked how Kevin Warsh might govern the Federal Reserve and what Admati and Seru hope to see from his leadership once he assumes the chair role.

Seru responded by emphasizing that the Fed’s institutional design limits any single individual’s ability to dominate the board. Built over decades, its committee structure, layered governance, and decision processes are intended to preserve credibility and constrain power.

“For one person to influence policy is very hard,” he said. “That's how it's been set up, and to that extent I think Kevin will have to basically manage the governance inside.”

Seru added, “I think if he sticks with his principles which I have heard, we'll get to a better place.”

Admati said that she does not see Warsh as a rigid ideologue, but more as someone with “pretty sensible views overall.”  But as she was quick to point out, the work ahead won’t be easy.

“He attacked the Fed a lot so that's probably not endeared him to some people there,” she observed. “but he'll have to live with them and deal with the other governors.”

 “It's not a one man show.”