As things turned out, our scripted presentation before judges Bernanke, McTeer, and Gramlich went off well; we delivered an accurate depiction of some of the conflicts on the board at the time. Our recommendation was to keep the Fed funds rate steady at 1.25 percent, although my Gramlich character — who in earlier rounds had dissented and recommended a further round of rate reduction — voted along with everyone else but with a "bias toward easing." Here's how part of the dispute played out in the transcript, via an exchange between my Gramlich and Tim's Bernanke:
Gramlich: Much of the effect of the fiscal stimulus package will be negligible in the short term, especially the reduction in dividend taxes. And even that part which takes effect immediately will be largely negated by cutbacks in state budgets. Other forces could restrain household spending as well. The job market is weakening, with the four-week moving average of initial jobless claims hovering in the 400,000 region, generally a sign of stagnation. In addition, non-farm payrolls declined by 308,000 in the month of February, the largest decline since the immediate aftermath of September 11. Significant increases in unemployment could likely lead to a retrenchment in consumer spending. Uncertainty over the labor market has contributed to the lowest level of consumer confidence in a decade, foreboding less than steady sailing ahead. Rising energy costs, with oil looming near $40 per barrel, are also dragging consumption expenditures downward. Household debt has risen to high levels, due primarily to families taking on new mortgages. These mortgages have proven to be too much for some homeowners, as mortgage delinquency rates have increased.
Bernanke: But if you dig beneath the surface, household debt numbers aren't as gloomy as you suggest. In fact, the consumer has taken advantage of the unusual opportunity offered by low interest rates to do some balance sheet restructuring. Probably about 25 percent of equity extraction has been used to pay off more expensive nondeductible consumer credit, e.g., credit and auto loans. This restructuring has not come at the cost of a substantial increase in leverage. Loan-to-value ratios for home mortgages have barely changed in recent years, and the great bulk of cashed-out equity has been taken out by long tenure homeowners who have retained substantial equity after their extraction. The apparent recent increase in the household-sectors debt burden has actually resulted in households realizing a more tax-efficient and collateralized form of debt, resulting in lower leverage and payments, not the reverse.
You can see why the real Ed Gramlich went on to question Tim, the fake Ben Bernanke, so aggressively in the question-and-answer portion. Gramlich had chaired the Fed's Committee on Consumer and Community Affairs for most of his tenure on the board and had become an early expert in the growth in subprime lending. In early 2003, no federal regulator of any consequence had sized up the truly unsustainable trajectory of these loans, so that all the home-equity "collateral" that Bernanke (or Tim as Bernanke, in this case) was hailing as tax-efficient and safe was still years away from plummeting to, say, 50 percent of its value.
