Ma Bell's Lost Sons

John C. Wohlstetter
The American Spectator
March 6, 2006
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The same year Merian Cooper's epic King Kong was produced (1933) he issued a sequel, Son of Kong. Little Kong was smaller, kinder, gentler, and like his pop did not survive the end of the movie. Ma Bell, like the original Kong, was captured, exhibited for public amusement, and ultimately destroyed. The son escaped capture, but perished when his island universe exploded like Krakatoa. Ma Bell's kids, in a world inhabited by corporate behemoths like Google, Microsoft, and media mega-firms, may well perish in a market ka-boom.

The lesson of the ape films is to beware of messing around with Mother Nature's creations, as the Law of Unintended Consequences takes over. There is a lesson, too, in the generation-long saga of Ma Bell -- the siege, her surrender, and her imminent reincarnation: Beware of messing around with market structures. Just as with Mother Nature, the Law of Unintended Consequences takes over.

Forty years ago an upstart known as MCI was in the midst of a struggle to enter the private-line long distance market versus AT&T; other upstarts soon followed. Thirty years ago, with the aid of a complaisant federal appeals judge and a deregulatory wind from the White House and Congress, MCI was allowed to enter the public-switched long distance telephone market. Twenty-plus years ago (1984), MCI's nemesis, AT&T, was sundered by another federal judge (the storied Harold Greene), at the behest of a fanatical crusader (William Baxter, Reagan's first antitrust chief) who believed that the scale economies of segmenting long distance (LD) terrestrial microwave would exceed scope economies derived from integrating LD with local copper wire. On his hunch and little more, the deed was done. But imminent advances in fiber-optics would rapidly make LD microwave obsolete and in 15 years end LD as a stand-alone business.

Ma Bell's seven offspring were encased in the handcuffs Ma Bell had worn. Newly freed AT&T, promised deregulation in 1984, was stiffed. Protected and nurtured every step of the way, MCI, Sprint, and what became WorldCom fared well -- for a while. Ten years ago came passage of the Telecom Act, letting everyone enter any business -- except that the Federal Communications Commission (FCC) did not implement the Act that way. Rather, per what baseball sage Yogi Berra called "deja vu all over again," the agency extracted vast subsidies for the so-called competitive local exchange carriers (CLECs) to erode Bell local market shares.

But the FCC's designated David vanished in the post-2000 Telecom Meltdown that vaporized some $2 trillion of the industry's apogee value of $2.7 trillion. Three market shifts doomed local carriage profitability. First, cellular traffic exploded with nationwide pricing (after the 1994 AT&T-McCaw Cellular merger), siphoning voice traffic from the wireline carriers. This reversed an FCC absurdity Europe avoided: the 1981 decision to establish hundreds of distinct cellular markets to prevent big-firm wireless dominance. Second, the explosion of online Internet access (per the confluence of the Pentium PC, the fast dial-up modem and consumer browser software) siphoned off voice traffic to electronic text (e-mail), cheaper and more convenient for non-urgent messages. Third, cable entered via its own facilities, instead of, as before, via accessing Bell networks.

It is regulatory hubris for regulators to micro-manage complex market structures to handicap big firms and aid small fry, in equal parts conceit (we can do it) and sympathy (we should do it). NBA's Wilt "the Stilt" Chamberlain once explained his unpopularity: "Nobody loves Goliath." Thus the calamitous 1995 Next Wave "C" Block auction, which tied up wireless spectrum, enabled undercapitalized firms to buy licenses, go bankrupt, and then get bought out by large firms that were denied the spectrum at the outset. The result: a massive windfall for folks who never put up a single cell tower -- billions of consumer welfare sacrificed while non-producers reaped enough buy-out capital to buy private jets.

What if AT&T buys Bell South? Assume that after payment of appropriate givebacks to regulators -- in effect, bribes paid in the form of pre-emptively surrendering certain potential benefits of the deal -- it wins regulatory approval. We'll see a market with the original seven offspring of Ma Bell reduced to three, with the eighth largest local firm (once GTE) and the two largest long distance firms (AT&T & MCI WorldCom) combined with six Bells into AT&T & Verizon. The past decade's musical-chairs coupling reads like a session at Hef's Playboy pad: Bell Atlantic buys Nynex, GTE and MCI WorldCom to form Verizon; SBC buys Pacific Telesis, Ameritech, AT&T and now (in AT&T's name) bids for Bell South. Cellular? Myriad property swaps were mandated as part of Bell mergers.

While allowing these mostly horizontal local mergers, when did the feds kill a deal? Twice: Clinton FCC Chairman Reed Hundt killed the vertical merger proposed in 1997 for AT&T and then-SBC/Telesis; Hundt successor William Kennard killed the 2000 deal between MCI WorldCom and local/LD carrier Sprint. While the FCC vigorously policed Bell company conduct and various mergers it entirely missed WorldCom's record fraud, including its inflation of Internet traffic numbers, which was the prime cause of the Internet market-value bubble.

Should the government now block further telecom consolidation? With landline usage in irreversible decline, more young customers choosing a wireless phone as their default connection, and broadband demand exploding, let regulators exhibit a quality all too rare among governing elites: modesty. There is no reason to believe they can guess right this time. Telecommunications consumption is driven, as with all commodities, by cost. With three nationwide networks today -- landline, cable, and wireless, the first two of which are broadband (albeit far less "broad" than in Asia) -- regulators should let markets work. This is a big-firm core business with peripheral niches. Whether Ma Bell's Kiddie Kong twins prosper should be left to the market, just as Kong's kid had to fend for himself. Little Kong wasn't fast enough. Ma Bell's kids had better be.

John C. Wohlstetter is a Senior Fellow for Technology & Democracy at the Discovery Institute, which sponsors his issues blog, Letter From the Capitol.