Remarks to New America Foundation by James K. Glassman

Anyone who has tried to get a high-speed connection to the Internet knows that it can be an exercise in futility. And expensive. Only about 10 percent of Americans have fast, broadband access to the Internet and, as a result, many Web-based businesses that rely on widespread broadband -- in education, entertainment, retailing and more -- have either failed or have never gotten off the ground. The next stage of Internet growth awaits broadband. What happened to it? The problem is not technology. It's public policy. That policy concerns liberating the last mile -- the wire that runs from every American home and business to the greater telecommunications network.

Nearly six years ago, Congress overwhelmingly passed the Telecommunications Act of 1996, which established a blueprint to move the last mile from being a heavily regulated monopoly into full deregulation. But the law has not performed as promised. Today, 91.5 percent of local phone lines are still controlled by the Bell companies -- originally seven, now merged into just four, with two of them (Verizon and SBC) owning the majority of local lines. Prices rose and service deteriorated. The promise of broadband -- fast Internet connections, necessary for a high-tech revival -- remains unfulfilled for 90 percent of Americans. The Bells' own solution to the impasse is for Congress to gut the act and end the requirement that the Bells let competitive local exchange carriers (CLECs) connect to the last mile. The last mile was built by the Bells with government protections and subsidies over the past 100 years, and Congress believed that allowing other firms to tap into it was the best way to bring real competition to local service -- as well as being just and fair.

Access to the last mile is needed for DSL, telephone-based broadband. Although CLECs pay for the privilege of interconnection and what is called leasing unbundled elements, the Bells have done their best -- through foot dragging and lawsuits -- to slow them down. In the process, many CLECs have run out of money.

Karen Kornbluh of the New America Foundation in her excellent piece in the Washington Monthly compares the CLECs "to the Gingerbread Boy of the fairy tale, riding across the river on the nose of the fox. Their sole means of transportation has every incentive to do them in." Verizon and SBC alone have been fined over $400 million, but, with so much at stake, that's a pittance.

Now, the Bells want to wipe out the CLECs altogether. "Unleash us," they are effectively telling Congress, "and you'll get better phone service and broadband, too." The vehicle for killing off the CLECs is a bill sponsored by the chairman and ranking member of the Commerce Committee, Reps. Billy Tauzin (R-La) and John Dingell (D-Mich). While politicians are searching for a broadband solution, few are excited by Tauzin-Dingell, and the bill has languished. But lately, with a war on, Speaker Dennis Hastert has grown tried of fighting his Commerce chairman. As a result, the bill could come to the House floor the first week of December.

The Bells have a powerful lobbying machine. SBC last week named William Daley, the former chairman of Al Gore's presidential campaign, as its president. Daley has no telecom experience, but he's a seasoned pol -- although picking a prominent partisan Democrat like Daley could antagonize GOP leaders. The Bells have made mistakes in earlier tries to force a vote. Their original angle was that Tauzin-Dingell would improve rural service; then they said it would boost high tech. Neither approach worked. Now, in desperation, they have seized on terrorism.

In a speech the week after the Sept. 11 attacks, Ivan Seidenberg, the co-CEO of Verizon, told a Goldman Sachs conference that "this whole scheme of CLEC interconnection is a joke." Then, he darkly raised the specter of terrorism. "We need to rethink security," he said. "We've got people running through our buildings with FCC permits, and we don't even know who they are." Those people, of course, are CLEC employees, doing what the 1996 act lets them do. Meanwhile, Verizon's other co-CEO, Charles Lee, told an audience, according to the Boston Globe, that the lesson of Sept. 11 "is that the nation needs phone giants like the Baby Bells to be as strong as possible, even if it means policies that accelerate the demise of smaller competitors."

They've even applied this security argument at the state regulatory level. CLECs need honest wholesale rates for the resale of services. In New York, they have had to buy the unbundled elements for $25 and then have had to turn around and sell them at $30 to be competitive. That leaves them only $5 for all their marketing costs and other expenses. On May 16th, a New York administrative law judge recommended a significant lowering of rates. Verizon's appeals of those findings are based on the notion of security being compromised. They've even suggested that only competitors who build their networks from scratch should be allowed to compete.

Security is an important issue -- and, to be fair, Verizon lost employees in the attacks and responded well after severe damage to its central office. But security concerns are no reason for Congress or state regulators to let the Bells off the hook or extend their monopoly control to broadband -- and perhaps to long distance as well. Monopolies act in predictable ways. They reduce supply and raise prices, and they have little incentive to invest in new technology.

The Bells are making another argument. They're saying that Congress might as well give them the job because the CLECs are dead anyway.

This is flat-out untrue.

As Mark Twain put it in another context, reports of the death of the CLEC industry have been greatly exaggerated. It is true that many companies have gone under -- in large part because of the Bells' stalling. But many other firms remain solid. The CLEC industry employs tens of thousands of Americans, and those jobs are in severe jeopardy under Tauzin-Dingell.

To find out just where the industry stands, we recently examined a sample of 15 publicly traded CLECs for potential longevity. We calculated the number of quarters it would take to deplete their stockholder equity (or book value) if losses continued at the same rate as they have over the past year. We found that seven of the 15 would survive for at least eight quarters (or two years) under current business conditions and ten would survive for at least four quarters (one year).

Those estimates are conservative since business conditions are almost certain to improve if the economy begins to recover next year and if policy changes are made to insure competition, rather than monopoly, in telecommunications.

Among the companies we examined were Allegiance Telecommunications, whose revenues doubled over the nine months ending Sept. 30 (compared to the same period last year) to $365 million. Allegiance had $500 million in cash on its balance sheet at last report (June 30), and, even if losses continue at the current rate, the company will have a positive net worth for another two years.

We calculate that McLeod USA has a longevity at current loss rates of more than four years; Pac-West Telecomm, eight years; SpeedUS.com, a smaller CLEC that concentrates in the New York City area, four years; and Time Warner Telecom as extending for many decades.

CLECs that have had financial troubles have moved to restructure. For example, Covad Communications, a leading national broadband services provider that uses DSL (Digital Subscriber Line) technology, last week secured $150 million in loans and other financing -- part of a restructuring agreement that "should carry the company through to a point when it will be cash-flow positive, sometime in the second half of 2003," according to a Reuters report that quoted Covad's CEO, Charles Hoffman. And Ted Forstmann, the New York financier, recently added $275 million to his $1 billion stake in McLeod.

Meanwhile, companies like Allegiance and Time Warner are not just survivors. They are now "thrivers," as David Fore, a Bear Stearns analyst, stated in a report to clients on Nov. 12. But they are threatened by the politics of re-monopolization -- as embodied in the Tauzin-Dingell bill.

In addition, the Association of Local Telecommunications Services (ALTS) recently reported that 150 CLECs are currently doing business in the U.S., with 77,000 employees. (These figures do not include employees of larger, integrated companies like AT&T, Sprint and WorldCom, which provide local as well as long-distance, wireless and cable service.) ALTS also reports that the CLECs have built $56 billion in telecom network infrastructure over the past five years, including $25 billion in the past year alone. Companies such as Cbeyond and Focal have been adding employees in the past year. It is precisely such companies that provide the innovation and competition that spread advanced technology to U.S. consumers and that drive down prices.

But if competition and consumer choice are goals, how do we get there? Regulators could try to get tougher with the Bells, and clearly they should. New York regulators need to lower wholesale rates to promote competition. But a better approach would be "structural separation" or divestiture -- the same process that succeeded with long distance. This time, each of the four Bells would be split into two companies -- one wholesale and one retail (each owned by Bell shareholders but completely separate legal entities, with separate managements). The wholesale company would own and maintain the last mile and would lease access to it to all comers -- including the retail Bell operating company, which, in turn, would be free to enter any business it wanted. The wholesale company would have a big incentive to cooperate with the retailers -- since its income would come from them. And the retailers would compete to offer consumers the best service at the lowest price. As broadband spread rapidly, the U.S. economy would be the biggest beneficiary of all.

A variation on this theme was detailed in a piece in the current issue of the American Enterprise by Andy Kessler. Kessler agrees with Karen and me that Tauzin-Dingell is no solution: "The incumbents, the Baby Bells, are monopolists. When you own a government-mandated monopoly, your programming models always output