* Fed chair nominee Warsh wants Fed to hold fewer bonds

* Warsh reiterates smaller balance sheet means lower

rates

* Analyst see any balance sheet evolution as long-term

project

NEW YORK, April 21 (Reuters) - Kevin Warsh, tapped by

President Donald Trump to lead the Federal Reserve, told a

Senate panel on Tuesday he would work with the Treasury

Department to help achieve his goal of a smaller Fed balance

sheet, in an effort observers say would represent a long-term

project for the central bank.

"Working with the Treasury Secretary, we're going to have to

find a way in which we can take the balance sheet and make it

smaller," he said as part of his confirmation hearing to succeed

current Fed Chair Jerome Powell.

Warsh's opposition to large-sized Fed holdings rests on a

few fronts: He thinks it benefits Wall Street over Main Street,

while forcing the Fed to keep higher short-term rates than would

otherwise be the case. He also thinks that while using bond

buying during the financial crisis nearly two decades ago was

defensible, recent use cases aren't.

"The big balance sheet has become an ordinary, recurring

force" and "has been quite unhelpful, and is part of the reason

why the Fed is in the business of politics," Warsh said. If Fed

holdings were smaller, "I think interest rates could be lower,

inflation could be better, and the economy could be stronger,"

he said.

Warsh remained largely aspirational on how he'd get Fed holdings

down, but he said whatever the Fed would do under his command

would be well communicated and done "slowly and deliberatively."

Warsh's comments on the central bank's extensive holdings of

cash, bonds and other assets are among his first of real

substance on an issue that's become core to central bank

monetary policy making.

BIG BALANCE SHEET

Since the financial crisis, the Fed has used purchases of

Treasury and mortgage bonds to help calm financial markets in

times of high stress and to provide stimulus to the economy when

the interest rate target is near zero and can be cut no further.

This system and the tools to achieve it have seen Fed

holdings go from under a trillion dollars in the run-up to the

financial crisis starting in 2007 to a peak of $9 trillion in

2022, as the Fed navigated the COVID-19 pandemic. Fed holdings

now stand at $6.7 trillion and a recent New York Fed report

projected that based on technical factors Fed holdings could hit

$10 trillion by the end of 2035.

Most Fed officials are unconcerned by the size of Fed

holdings. For them, the most critical issue is that the rate

control system operated by the central bank works very well,

while robust levels of liquidity in the financial system help

protect against shocks.

The case against a large Fed balance sheet has centered on a few

concerns. For one, large holdings have driven the Fed into a

loss-making position it is still trying to dig out of, and while

that does not affect Fed operations, there are concerns it could

become a political problem for the central bank at some point.

Others worry large Fed holdings of bonds distort markets and

make the central bank too big a player in what would normally be

private markets.

If Warsh is confirmed as Fed chair, his efforts to cut Fed

holdings would challenge an interest rate management toolkit

that effectively limits how far the central bank can reduce its

holdings and maintain strong control over its interest rate

target.

COORDINATION ASPECT NOT YET CLEAR

Market participants said Warsh hasn't yet made clear how the

Fed and Treasury would work together on the balance sheet.

Derek Tang, an analyst at research firm LH Meyer, said he

believes "Warsh would like Treasury and the Fed to communicate

more clearly to each other what their respective plans" over

Treasury debt issuance, and to better coordinate their

respective positions.

Observers doubt however that Warsh would push the Fed to

sell Treasury debt.

"Warsh certainly seemed to suggest a gradual approach to

decreasing the balance sheet, which to me suggests that outright

asset sales are unlikely," said Gennadiy Goldberg, head of U.S.

rates strategy at TD Securities.

FRAMEWORK FORMING

Over recent weeks an effort inside and outside the Fed has laid

out a potential pathway to reduce the Fed's balance sheet, and

that emerging framework argues easing liquidity regulations and

doing more to induce usage of central bank liquidity facilities

would reduce demand for bank reserves, in turn allowing the Fed

to hold fewer assets.

Some have also argued that a smaller Fed balance sheet would

lead to higher long-term rates and that this increase in

restraint would allow policymakers to cut their interest rate

target to balance that out.

New York Fed President John Williams told reporters at the end

of March that higher long-term rates resulting from a smaller

Fed balance sheet theoretically opens the door to lower

short-term rates to offset those headwinds, but he cautioned it

is hard to measure in advance how much lower the central bank

rate target could go.

(Reporting by Michael S. Derby, Editing by Franklin Paul and

Andrea Ricci )