[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
                    ENCOURAGING CAPITAL FORMATION IN

                       KEY SECTORS OF THE ECONOMY
=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                 DOMESTIC MONETARY POLICY, TECHNOLOGY,
                          AND ECONOMIC GROWTH

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 18, 2002

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 107-66







                       U. S. GOVERNMENT PRINTING OFFICE
79-320                          WASHINGTON : 2002
___________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001






                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
             Terry Haines, Chief Counsel and Staff Director

         Subcommittee on Domestic Monetary Policy, Technology, 
                          and Economic Growth

                   PETER T. KING, New York, Chairman

JAMES A. LEACH, Iowa, Vice Chairman  CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          BARNEY FRANK, Massachusetts
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
RON PAUL, Texas                      BERNARD SANDERS, Vermont
STEPHEN C. LaTOURETTE, Ohio          JAMES H. MALONEY, Connecticut
DOUG OSE, California                 DARLENE HOOLEY, Oregon
MARK GREEN, Wisconsin                MAX SANDLIN, Texas
CHRISTOPHER SHAYS, Connecticut       CHARLES A. GONZALEZ, Texas
JOHN B. SHADEGG, Arizona             MICHAEL E. CAPUANO, Massachusetts
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
FELIX J. GRUCCI, Jr., New York       WILLIAM LACY CLAY, Missouri
MELISSA A. HART, Pennsylvania        MIKE ROSS, Arizona
SHELLEY MOORE CAPITO, West Virginia








                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    April 18, 2002...............................................     1
Appendix
    April 18, 2002...............................................    33

                               WITNESSES
                        Thursday, April 18, 2002

Alexander, Anthony J., President and Chief Operating Officer, 
  FirstEnergy Corporation........................................     5
Glenchur, Paul, Vice President, Schwab Capital Markets, Schwab 
  Washington Research Group......................................    18
Kuhn, Thomas R., President, Edison Electric Institute............     4
Levin, Blair, Managing Director and Telecommunications and Media 
  Regulatory Analyst, Legg Mason Wood Walker, Inc................    20
Mitchell, Bryan J., Chairman and CEO, MCG Capital Corporation....    13
Trabandt, Charles A., Vice President, Charles River Associates, 
  Inc............................................................     7

                                APPENDIX

Prepared statements:
    Alexander, Anthony J.........................................    34
    Glenshur, Paul (with attachment).............................    86
    Kuhn, Thomas R...............................................    39
    Levin, Blair.................................................    93
    Mitchell, Bryan J. (with attachment).........................    72
    Trabandt, Charles A..........................................    52



      ENCOURAGING CAPITAL FORMATION IN KEY SECTORS OF THE ECONOMY

                              ----------                              


                        THURSDAY, APRIL 18, 2002

             U.S. House of Representatives,
         Subcommittee on Domestic Monetary Policy, 
                   Technology, and Economic Growth,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 10:00 a.m., in 
room 2128, Rayburn House Office Building, Hon. Peter King, 
[chairman of the subcommittee], presiding.
    Present: Chairman King; Representatives Oxley, Grucci, 
Capito, Biggert, J. Maloney of Connecticut, C. Maloney of New 
York and Clay.
    Chairman King. The hearing will come to order. Today, the 
Domestic Monetary Subcommittee continues its work which began 
last year to examine economic growth issues and the steps that 
Congress can take to help facilitate that needed growth.
    I would like to welcome our distinguished guests from the 
energy and telecommunications sector. Clearly, the segments of 
the economy you represent drive a very large percentage of U.S. 
industrial capacity and are catalysts for a variety of other 
business activities.
    I recognize that because your respective industries are 
identified as critical infrastructures for purposes of national 
security, much of your post 9-11 focus has been on security and 
fail-safe systems. That, added to the climate brought about by 
the most recent corporate failures, has surely raised some 
degree of uncertainty, which is generally not conducive to 
capital formation.
    Because you have driven so much of the economic growth in 
the past decade, in this critical recovery period, I believe 
the relevant question in the context of encouraging growth is 
what hurdles your respective industries face that detract from 
your ability to raise capital and, in turn, spur growth in your 
sectors. I look forward to receiving your testimony and any 
recommendations you may make to help Congress better understand 
what it can do to break down existing barriers to capital 
formation and improve investor confidence.
    With that, I would now like to recognize the Ranking Member 
of the subcommittee, who works very closely with me, my friend 
from New York, Ms. Maloney, for any remarks she may have. And 
the Chair would also note that your full statements will be 
included in the hearing record, without objection.
    Thank you.
    Mrs. Maloney.
    Mrs. Maloney. I thank the Chairman, my colleague from the 
great State of New York, for calling this hearing. We are 
meeting today in this subcommittee today to discuss capital 
formation and the unique challenges facing the energy and 
telecommunications sectors, specifically.
    During the 1990s, our Nation enjoyed an unparalleled period 
of economic prosperity that included exploding values in the 
equity markets. Investment in the internet and telecom greatly 
increased as staples of the new economy. However, in the past 
few years, the sector has become a poster child for the dot-com 
collapse and the devaluation of the Nasdaq.
    While it is appropriate to review Government policies that 
affect these two sectors, my belief is that clearing up the 
questions about the accounting practices of these two sectors 
and the recovering economy will have the most significant 
impact in pumping investment back into them. The SEC is 
currently conducting inquiries into the accounting practices of 
a number of energy and telecom companies. Given the explosion 
of Enron and Global Crossing, we can hardly expect investors to 
rush back into these sectors until these issues are resolved.
    While capital raising in the entire economy has waned in 
the past 2 years, the economy in general is now improving 
faster than many had anticipated. Economists can rightly point 
to the resiliency of consumer spending for preventing a harsher 
period of recession.
    In the fourth quarter of 2001 alone, new data indicates 
that the GDP grew 1.7 percent, powered by a 6.1 percent 
increase in consumer expenditures. Spending by business on 
fixed capital dropped for the fourth consecutive quarter, this 
time by 13.8 percent. However, business spending on computers 
and computer related devices increased for the first time since 
the end of 2000.
    While preliminary estimates will not be available until the 
end of the month, forecasters believe that economic growth 
continued to increase during the first quarter of this year. 
The recovery has produced little evidence that the excess 
capacity of communications equipment has substantially narrowed 
to the point that demand will increase substantially anytime 
soon.
    Capital formation also continues to be affected by adverse 
long-term interest rates. The Fed reduced interest rates 11 
times last year, after raising them the previous 2 years. But 
long-term interest rates remain high, partly as a result of the 
return of massive Government deficits.
    The Congressional Budget Office's projection of the 
baseline budget surplus for 2002 through 2011 was $5.6 trillion 
a year ago. But it has dropped to just $1.7 trillion in the 
last report, a drop of nearly $4 trillion. The president's 
recent budgetary proposals would further reduce the projected 
surplus to less than $500 billion over those same 10 years and 
would result in a projected deficit of almost $200 billion in 
2002 through 2006.
    There is little doubt that this return to deficits will 
have a major impact on all aspects of the economy, including 
energy and telecom. I think all Members need to keep these grim 
statistics in mind as we vote on the issues before us.
    Chairman King. Thank you, Mrs. Maloney.
    I now recognize the Chairman of the Full Committee, the 
gentleman from Ohio, Mr. Oxley.
    Mr. Oxley. Thank you, Mr. Chairman.
    I welcome our witnesses to today's hearing, which is really 
about the health of the U.S. economy. Capital investment is the 
fuel that feeds America's economic engine, and while consumer 
spending has been cited as the recent hero, ultimately, it is 
capital investment by business that drives our economy, 
allowing companies to grow and innovate.
    One of the early goals I set as Chairman of this committee 
was to use our unique forum to promote overall economic growth. 
Capital formation has been a long-standing interest of this 
committee.
    Last year, the Oversight and Investigations Subcommittee 
held a hearing on regulatory barriers to capital formation, and 
today, the Domestic Monetary Policy, Technology, and Economic 
Growth Subcommittee turns its attention to two specific 
industries, energy and telecommunications. These are two 
capital intensive sectors that traditionally have saved a 
rebounding stock market. But this time, they seem to be lagging 
behind.
    We have seen investor confidence shaken by the dramatic 
fall of companies like Enron and Global Crossing. Enron cast a 
shadow over the electric power industry, even though retail 
customers were virtually unaffected by its collapse. As for the 
telecom and technology sectors, by all accounts the current 
state of investment is quite grim.
    What I believe has gone unnoticed is that Enron and Global 
Crossing are not representative of their industries as a whole. 
After all of the media coverage of recent months, it is time to 
bring back balance to the picture. Congress also needs to 
identify ways that it can promote growth in these markets, 
because that is what attracts capital.
    I believe the CAARTA bill passed by our committee this week 
is one key to enhancing investor confidence. Why should people 
care about what Congress does about capital formation? When 
capital becomes more expensive for utility companies, costs go 
up for consumers. When telecommunications firms cannot raise 
adequate capital, the market becomes less competitive, and 
consumers are denied choice.
    We have seen this happen in the telecom sector. In fact, 
lately, many companies have found that even the commercial 
paper market is extraordinarily stingy which leads to higher 
financing costs.
    We have two excellent panels to discuss the state of 
capital formation in their industries. I would particularly 
like to welcome the President of the Edison Electric Institute, 
Thomas Kuhn, an old friend; the President and Chief Operating 
Officer of FirstEnergy, Tony Alexander, who comes to us from 
Akron, where FirstEnergy's headquarters is based.
    I look forward to this morning's testimony, Mr. Chairman, 
and I yield back.
    Chairman King. Thank you, Chairman Oxley.
    I would like to now welcome the witnesses who are here this 
morning. As Chairman Oxley said, we have Mr. Thomas Kuhn, the 
President of Edison Electric; Mr. Anthony J. Alexander, the 
President and Chief Operating Officer of FirstEnergy 
Corporation; and Mr. Charles A. Trabandt, the Vice President of 
Charles River Associates.
    We will start with Mr. Kuhn. I would ask each of the 
witnesses to try to keep their statements to approximately 5 
minutes. We are not going to be banging gavels on people, but 
we would like to keep the statements to roughly 5 minutes, and 
your full statement will be, without objection, included in the 
record.
    Mr. Kuhn.

    STATEMENT OF THOMAS R. KUHN, PRESIDENT, EDISON ELECTRIC 
                           INSTITUTE

    Mr. Kuhn. Mr. Chairman, Congresswoman Maloney, Chairman 
Oxley, and Members of the subcommittee, I am Tom Khun, 
President of the Edison Electric Institute. EEI is the 
association of U.S. shareholder-owned electric companies and 
industry affiliates and associations worldwide. I very much 
appreciate the opportunity to testify before you today on this 
very, very important subject with respect to capital formation 
in the electric utility industry.
    The electric utility industry is one of the most capital 
intensive industries in the country. Our $872 billion worth of 
assets represent about 9 percent of the assets of all 
businesses in this country.
    Electric companies have been through an enormous change 
over the last 10 years as they make the transition from 
vertically integrated regulated monopolies to diverse companies 
operating in competitive markets. The past year brought 
additional financial challenges for the electric industry, 
starting with the California electricity crisis, continuing 
with the terrible events of September 11th and the resulting 
economic downturn, and ending with the collapse of Enron.
    Enron has brought much greater scrutiny to the energy 
industry. But I would like to emphasize that Enron's collapse 
was a financial story, not an energy story. Electricity supply 
and delivery were not disrupted and prices remained stable. 
Nevertheless, Enron did deal a blow to investor confidence 
that, at least in the short term, has affected the cost of 
capital for energy companies.
    More generating capacity is definitely needed to meet the 
demand for more electricity. Electricity and the economy grow 
on almost a one-to-one basis.
    Congress can remove a tax impediment to building more 
generation by shortening the depreciable lives of generation 
facilities. Other barriers to investment in generation are the 
Public Utility Holding Company Act and uncertainty in 
environmental policy.
    Competitive wholesale and retail electricity markets place 
more demands on a transmission grid that was not designed for 
such purposes, resulting in dramatically increased congestion 
in the transmission area. According to the Federal Energy 
Regulatory Commission, transmission bottlenecks cost consumers 
more than $1 billion over the past two summers alone. Yet 
largely due to regulatory uncertainty and inadequate returns, 
investment in transmission is decreasing rather than 
increasing.
    Transmission investments in 1999 were less than half of 
what they had been in 1979. Maintaining transmission adequacy 
at its year 2000 level would require a quadrupling of 
transmission investments during the current decade.
    FERC should be given authority to help site new 
transmission lines with appropriate State participation. PUHCA 
should be repealed, because it acts as a barrier to the 
formation of interstate independent transmission companies. And 
financial incentives, including higher rates of return and 
other appropriate innovative pricing mechanisms, are needed to 
attract capital to fund investments in transmission expansion.
    Congress should shorten the depreciable lives of property 
used in the transmission and distribution of electricity. To 
efficiently meet our Nation's energy needs, the electric 
industry requires the same ability that other industries have 
to more rapidly depreciate assets for Federal income tax 
purposes.
    As part of H.R. 4, the energy bill, the House last summer 
approved a reduction in depreciable lives for gas distribution 
facilities to 7 years. Facilities in other capital intensive 
industries, such as pulp and paper mills, steel mills, 
automobile plants, and even cigarette manufacturing plants, are 
depreciable over 7 years. All this is in stark contrast to the 
15 or 20-year depreciable lives for electric generation, 
transmission, and distribution facilities.
    The Federal tax code also should be amended to defer taxes 
on the sale, and eliminate taxes on the spin-off, of 
transmission facilities for transmission-owning companies that 
seek to join FERC approved regional transmission organizations, 
as contained in H.R. 4, the energy bill that passed this 
summer. In this time of historic change in the electricity 
industry, it is critical that Congress continue to pursue 
measures that will promote capital investment in the electric 
industry, which will encourage the development of badly needed 
generation and transmission facilities.
    Thank you again for allowing me the opportunity to testify 
today. I will be glad to answer any questions you might have 
after the other panelists have finished.
    [The prepared statement of Thomas R.. Kuhn can be found on 
page 39 in the appendix.]
    Chairman King. Thank you, Mr. Kuhn.
    Mr. Alexander.

    STATEMENT OF ANTHONY J. ALEXANDER, PRESIDENT AND CHIEF 
           OPERATING OFFICER, FIRSTENERGY CORPORATION

    Mr. Alexander. Good morning, Mr. Chairman and Members of 
the subcommittee. My name is Tony Alexander, and I am president 
and chief operating officer of FirstEnergy, based in Akron, 
Ohio.
    FirstEnergy is a registered public utility holding company. 
Our seven electric utility operating companies comprise the 
Nation's fourth largest investor owned electric system, based 
on serving 4.3 million customers in Ohio, Pennsylvania, and New 
Jersey.
    Encouraging capital investment in the Nation's electric 
system is critically important, because maintaining an 
affordable, reliable supply of electricity with a strong 
network to produce and deliver it is essential to our economic 
growth. With the development of competitive electricity 
markets, utility companies no longer have the obligation to 
build generating capacity and recover those costs through 
utility rate-making.
    Instead, the competitive market will determine if and when 
capacity is built. This fundamental change in the manner in 
which electricity supplies will be developed has a significant 
impact on capital formation in the industry.
    Investments in the energy industry, particularly in 
generation assets, must now compete with every other capital 
requirement in the market, and that means it is essential that 
regulatory, tax, and other burdens do not discourage investment 
in this sector. In fact, generating facilities should be 
treated like other competitive businesses.
    I believe there are several ways to encourage needed 
investment in this segment of our industry. First, Government 
should provide more favorable tax treatment for generation 
assets. Shorter depreciation periods would free up capital for 
reinvestment in energy markets and make those markets more 
attractive to new investors.
    The current 20-year depreciation periods for generation 
assets are outdated and far longer than for other capital 
intensive industries. It makes sense that electric generating 
facilities have tax treatment similar to other capital 
intensive industries. Tax credits are another way to attract 
capital to the energy industry.
    Second, the industry needs a greater degree of certainty 
with respect to future environmental regulations governing 
generating facilities. Potential investors in generation need 
to know what the regulatory future holds. Without good 
prospects for solid returns, they will not tie up capital for 
new or expanded facilities.
    Third, the Government needs to support competitive energy 
markets by allowing those markets to develop unimpeded. That 
includes ensuring that wholesale electricity prices are market 
based. Artificial price caps or pricing subject to refund will 
only serve to stifle competition and create barriers to 
investment.
    In addition to generation, the competitive electricity 
market also depends on an adequate transmission system. Even 
though transmission is still regulated, utility companies are 
being required to turn over control of their transmission 
assets to third parties.
    There are limited options available that will encourage 
investments in assets over which the owner will have no control 
of operations, pricing, or expansion. One way, however, is to 
remove barriers to divestiture by reducing the current tax 
liabilities for the sale of transmission assets.
    Another is through so-called participant funding, which 
requires that new investment in transmission be paid for by the 
party requesting the expansion. And, finally, rate-making 
allowances that produce sufficient returns will allow the owner 
to make needed investments in the transmission network.
    In order to create and support the kinds of markets that 
were envisioned when States and the Federal Government promoted 
competition, we first need to ensure that the steady and 
growing capital requirements of the electric industry are met. 
Only with an adequate supply of electricity produced from 
diverse sources that include coal, nuclear, natural gas, and 
renewables and the proper system to deliver it can customers be 
assured of reliable and reasonably priced electric service.
    Thank you for the opportunity to share my views on this 
important topic. I would be more than willing to answer any 
questions you might have after the other panelists have spoken.
    [The prepared statement of Anthony J. Alexander can be 
found on page 34 in the appendix.]
    Chairman King. Thank you very much, Mr. Alexander.
    Mr. Trabandt.

STATEMENT OF CHARLES A. TRABANDT, VICE PRESIDENT, CHARLES RIVER 
                        ASSOCIATES, INC.

    Mr. Trabandt. Good morning, Mr. Chairman, Congresswoman 
Maloney, and Chairman Oxley. Thank you for the opportunity to 
testify before the subcommittee today on this important subject 
of capital formation in the energy industry.
    My testimony reflects my experience as Vice President of 
Charles River, advising electric utilities recently, as well as 
8 years as a Managing Director in the energy and power group at 
Merrill Lynch's investment banking division, where I worked on 
capital formation for energy and utilities around the world, 
and 8 years as a commissioner at the FERC, working on these 
similar issues.
    At the outset, I would commend this subcommittee and the 
full Financial Services Committee for bringing a specific focus 
to the critical capital formation considerations in the context 
of the ongoing congressional debate about our national energy 
policy and the reactions to the Enron situation. I have been 
asked to testify today about the impact of recent developments 
in the electric power industry, including the situation in 
California and the collapse of Enron, and my prepared testimony 
provides some considerable detail on those matters.
    I generally support the recommendations made in Mr. Khun's 
testimony and also Mr. Alexander's testimony with regard to 
action that can be taken by Congress to facilitate capital 
formation. As Tom's testimony demonstrates, there is a critical 
need for capital investment in the Nation's electric 
infrastructure, which requires both investor confidence and 
assured access to capital markets going forward.
    The Federal Energy Regulatory Commission, FERC, in Order 
2000 sought to address that need by providing structural and 
regulatory flexibility for independent for-profit transmission 
companies or so-called transcos. That flexibility has spawned a 
new generation of proposed transcos in every region of the 
country with participation by investor-owned utilities and some 
public power entities, including Mr. Alexander's FirstEnergy 
Company, which has provided considerable leadership in that 
area.
    It is clear from a business and financial perspective that 
a properly structured for-profit business model could access 
capital markets for equity from financial and strategic 
investors and for investment grade debt to maintain, upgrade, 
and expand the transmission infrastructure. I cite in my 
testimony a deal between the Alliance Transco LLC with National 
Grid USA as the proposed managing member as one example of the 
types of commercial business arrangements that can be 
negotiated with significant infrastructure investment.
    FERC policy initiatives should be formulated in a manner to 
facilitate such arrangements in the emerging energy markets. 
FERC also has initiated an ambitious program for establishing 
four or five regional transmission organizations across the 
country which will implement a uniform market design now under 
development on a national basis. This effort is intended to 
materially advance competition in wholesale electricity markets 
over the next 2 years and will be a significant response to the 
difficulties in California.
    The recent Supreme Court decision in the Order Number 888 
case is seen as solidifying FERC's authority under the Federal 
Power Act to pursue the new policy. And just yesterday, the 
chairman of the Tennessee Valley Authority announced an 
agreement with major southeast and midwest utilities to support 
a seamless eastern electricity market that would run from the 
Atlantic to the Rockies and from the Gulf Coast to the Canadian 
border. That is a big step forward in the FERC plan and should 
advance the wholesale markets.
    While FERC pursues a more robust competitive wholesale 
market under Federal law, State authorities still maintain 
predominant jurisdictional control of State retail competition 
policies and programs. As a practical matter, the nationwide 
drive toward retail competition at the State level, which New 
York was one of the pioneers of, has stalled precipitously as a 
result of regional differences, the events in California, and 
Enron.
    Seventeen States now have some form of competition for 
retail customers while other States have essentially slowed 
significantly or stopped all together movement toward retail 
competition. Perhaps the best hope for supporters of retail 
competition would be FERC's success in advancing truly 
competitive wholesale markets across the country, as they have 
set out to do over the next 2 years.
    The competitive wholesale market has continued to function 
reasonably well despite the Enron collapse, with no 
interruption in physical supply and with no excessive price 
volatility or spikes, albeit it during a winter season of very 
mild weather and with very low demand on both the industrial 
and commercial sides as a result of the economic slowdown.
    Nonetheless, the many issues surrounding Enron have 
negatively affected a number of our energy companies and caused 
a loss of investor confidence that must be addressed to assure 
needed access to capital markets for infrastructure 
investments. Many companies have already taken decisive action 
in the form of comprehensive recapitalization plans now being 
implemented to respond to credit quality and accounting 
challenges.
    Somewhere in the vicinity of about $10 billion has been 
raised over the last couple of months as part of those 
recapitalization plans. But, as Mr. Oxley said in his opening 
statement, some companies have also experienced great 
difficulty in obtaining capital because of credit quality 
concerns and because of the reticence of many investors today.
    But assured access will only be restored when there is a 
greater degree of regulatory certainty regarding the Enron 
related issues. This committee's leadership on accounting 
reform legislation which you reported Tuesday is a positive 
step forward, and, hopefully, other committees in Congress will 
follow your example to take measured and carefully considered 
action with regard to the going-forward practices in the 
industry.
    I would respectfully urge Congress, the Administration, and 
Federal regulatory agencies to strive to complete the Enron 
reviews in a timely manner and adopt any clearly needed reforms 
with carefully considered and measured actions which will 
support competitive energy markets. At the end of the day, 
greater regulatory certainty in all forms of regulation and an 
increased degree of stability for the industry will be required 
for assured access to capital investment for the critical 
national energy infrastructure needs that Tom Kuhn laid out.
    Thank you, Mr. Chairman, for this opportunity to testify. I 
look forward to questions.
    [The prepared statement of Charles A. Trabandt can be found 
on page 52 in the appendix.]
    Chairman King. Thank you, Mr. Trabandt.
    We will have votes coming up on the floor in several 
minutes. With that, I will yield my time right now to the 
Chairman of the Full Committee, Mr. Oxley.
    Mr. Oxley. Thank you, Mr. Chairman. I appreciate that 
courtesy.
    Mr. Kuhn, the Financial Services Committee just recently 
passed our legislation addressing accounting and appropriate 
disclosure issues raised by Enron. Just in general, what are 
your thoughts in terms of the approach that our committee took? 
There were folks who were less than enthusiastic about our 
approach, in the media, for example, and I am wondering, from 
your perspective, what tone you would recommend that the 
legislation take.
    Mr. Kuhn. Mr. Chairman, I think basically what I have 
pointed out on Wall Street and elsewhere--and I think there is 
a general consensus--is that Enron was a business and a 
financial situation, not an energy situation. So I commend you 
and the committee for approaching the Enron situation from an 
overall business perspective and looking at it from the 
standpoint of accounting practices and disclosure rules that 
would apply to all businesses. I think that is the approach 
that definitely should be considered and looked at.
    There are some specific issues in the accounting area with 
respect to the energy industry that we are addressing with FASB 
and with the SEC and with the rating agencies and with Wall 
Street. We have a very aggressive program at EEI right now to 
bring our companies together to review all our accounting 
practices and disclosure practices, to look at best practices, 
and to deal with these things on a going-forward basis.
    But I believe your approach was right on target in terms of 
looking at the situations from a broader based business 
standpoint, from doing things that make sense to do as a 
starting point. I know there are thousands of ideas out there 
that are very regulatory in nature, and I would just urge you 
to cautiously, as you have done, make sure that they are 
addressing the problem, the absolute problems, and not re-
regulating in a way that I would think would hurt competitive 
markets or hurt financial markets in general.
    Mr. Oxley. Well, Chairman Greenspan testified here last 
month, and one of the things that he emphasized was the ability 
of the capital markets to fix problems within its system. And 
you pointed out the fact that your member companies are re-
examining a number of issues, including their auditing and 
their accounting procedures.
    That is obviously happening all over the corporate world, 
because it is demanded by the shareholders and by the boards of 
directors. So you could be congratulated for your leadership in 
that area. I think it is critically important.
    Let me turn to Mr. Alexander. I know that the repeal of 
PUHCA, which has been an issue that has been around for, I 
guess, as long as I have been in Congress--some say that 
because of Enron, PUHCA should be retained, maybe even 
strengthened, even though the SEC continues to support 
conditional repeal.
    I know what you are going to say, but I need to hear you 
say it, anyway, in regard to PUHCA and what effect it would 
have on FirstEnergy, specifically.
    Mr. Alexander. The industry position, obviously, is that 
the Holding Company Act has outlived its usefulness in 
connection with the way the industry is going right now. It is 
a very highly regulatory driven Act being applied to an 
industry that is trying to deregulate.
    And as such, it really does not fit, and it is an 
impediment to some of the things that the industry would like 
to do, and it tends to slow down your ability to raise capital 
in a timely way if you are a holding company. Those things need 
to get addressed, either by the SEC in the way it applies the 
Holding Company Act, or by repealing the Act and finding other 
means to maintain some regulation over the parts of the 
industry that require it, generation not being one of them any 
longer.
    Mr. Oxley. Let me ask you this, then. If we assume that the 
status quo maintains, and that is at the end of the day, 
Congress is unable or unwilling to repeal PUHCA, is it your 
testimony that the SEC could, on its own initiative, amend or 
change the PUHCA to make it more realistic in today's world?
    Mr. Alexander. I do not think the SEC can amend it. They 
can apply it in a way that allows transactions to be completed 
in a more timely way--financing transactions--instead of 
perhaps a year or longer--or mergers, instead of being the last 
one to go, they could start addressing the regulatory side to 
try to speed up their processes so that, yes, it is a 
regulatory burden, but as long as that burden does not delay 
transactions from being completed or financing from taking 
place in a timely way so you can take advantage of market 
opportunities, then that is something the agency can deal with 
and should be dealing with today.
    Mr. Oxley. Thank you.
    Mr. Kuhn. Mr. Chairman, if I could add to that----
    Mr. Oxley. Yes.
    Mr. Kuhn. Obviously, with an interpretation by the SEC and 
a great deal more work from lawyers, sometimes you can get to 
the same conclusion. But, basically, what the existence of 
PUHCA does is it discourages a lot of investment in generation 
and transmission from companies that do not want to become 
subject to the Holding Company Act, also.
    So you have players that might want to make investments in 
generation or transmission that otherwise will not make them. 
That impedes capital investment that is critically needed in 
the industry right now.
    Mr. Trabandt. Mr. Chairman, I would also add that the 
Circuit Court of Appeals recently reversed an SEC decision in 
the AEP merger case, specifically because it found that the SEC 
had been too loose in its interpretation of the law. And I 
think that is a good example of where repeal is probably not 
only the best solution but the only really good solution for 
purposes of allowing financial transactions to go forward.
    Second, I would offer that as an investment banker, I 
actually went out to recruit investment in a major transmission 
company that FirstEnergy and 9 other utilities were trying to 
form. And we were repeatedly told by both strategic partners 
and financial investors that they were unwilling to make the 
investment, which would translate directly into infrastructure 
development, because they would become subject to PUHCA's 
requirements.
    And on Wall Street, those requirements are a major 
disincentive and PUHCA it does have a material effect on the 
ability to raise capital from these types of industrial 
undertakings.
    Mr. Oxley. Speaking of raising capital, obviously, the 
whole issue with competitive markets has put a strain on 
transmission. Let me just ask all of you, in your view, is 
investment in upgraded transmission systems keeping pace with 
demands being placed on our system?
    Mr. Kuhn. Mr. Chairman, the very simple answer is no, it is 
not, and transmission is the most vulnerable part of our 
system. Under wholesale competition, the number of transactions 
that are occuring on the transmission system are growing 
exponentially.
    Basically, the transmission system was built to 
interconnect neighboring utilities. So you might almost make 
the analogy that it was kind of a country road.
    Now we want to create with competition a super highway, and 
the transmission system definitely needs to be upgraded to deal 
with all these additional transactions on the transmission 
system. Last year, the Federal Energy Regulatory Commission 
study showed that more than $1 billion was lost by consumers 
over the last two summers because of congestion in the 
transmission system.
    We desperately need additional investment in the 
transmission system. We need higher returns on investment for 
transmission. We need to decrease the depreciable lives of 
transmission assets. I think these things would help greatly in 
terms of getting much needed investment in the transmission 
area.
    Mr. Oxley. Mr. Alexander, what has been your specific 
situation with FirstEnergy in regard to transmission?
    Mr. Alexander. Well, Mr. Chairman, we have obviously 
continued to invest in our transmission system, although it is 
more and more difficult to make business decisions, because you 
do not really control the asset ultimately. Ultimately, this 
asset is going to be controlled by someone else, and they are 
really making the capital investment decisions that are going 
to have to be made when we actually get into operating regional 
transmission organizations.
    Transmission across the entire system needs to be improved 
and upgraded to allow for these literally thousands of 
transactions that the system was not designed or built to 
accommodate. And as long as we are going to continue down the 
path of deregulated competitive generation business--now, years 
ago, when a utility built a power plant, it built its power 
plant and then it built its lines to get that power into its 
system. Now, you can go to a power plant, any place you choose, 
and someone else's responsibility is to build those lines, and 
you might not be building it to the area where those lines are 
primarily directed. They may be directed to some other market.
    So the entire spectrum of transmission has to be looked at 
totally differently as we move more and more toward competitive 
generation markets. And the system is just not there on the 
transmission side at this point to allow for all of the 
transactions that people would like to make.
    There are thousands of transactions that are made on a 
daily basis. Let's not discount the transmission system we have 
today, because it is a very good system. It allows for a lot of 
transactions, but not all of them.
    Mr. Oxley. Thank you.
    Mr. Trabandt, you have had, obviously, some experience on 
Wall Street. You were at FERC. You were a consultant to the 
energy industry. What is your take on this whole issue 
regarding transmission?
    Mr. Trabandt. I think it is very important, Mr. Chairman, 
in that regard to focus on something that Tom's testimony 
pointed out, and that is we need an enormous amount of new 
generation in the country. Much of the financing that is being 
done now is to connect new power plants to the grid, rather 
than to deal with the issues surrounding the upgrading and 
improvement and reliability of the existing system as it is 
today, which, as Tom said, is not designed for a market 
operation.
    So we really do have what is tantamount to a potential 
crisis in that part of the industry today that needs to be 
addressed. I think what is very important--and I think our 
respective testimonies focused on this, perhaps in somewhat 
different ways--is that regulatory policies at FERC definitely 
need to establish incentives in terms of the rates, terms and 
conditions that are going to be established for transmission 
service so that there is a proper return for investment.
    Today, there is not an incentive to invest in transmission 
as a general matter. We have a couple of examples where there 
were investments in so-called merchant transmission lines, but 
so far, no one has successfully built one of those because of 
the inherent concerns with the returns and the financing 
associated with them.
    So, I think that it is quite important that regulatory 
policies, the tax policies, and the general overall energy 
policy maintain a focus on this. I think it is important that 
Mr. Bush's national energy policy that was released last year 
really did highlight this issue. The issue has tended to be 
overtaken by California, Enron, and other things. But I think 
capital formation for investment in the transmission sector is 
critically important for the country.
    Mr. Oxley. Thank you.
    Thank you, Mr. Chairman.
    Chairman King. Thank you, Chairman Oxley.
    Ms. Maloney has had to leave. She does have a series of 
questions which we will submit to the witnesses in writing, and 
if you could get back to her within the next week or 10 days, 
that would be greatly appreciated.
    As for my own questions, actually, everything has been 
answered. Your statements are comprehensive, and your dialog 
with Mr. Oxley has really touched on all the questions I would 
have asked.
    We have to go vote. We will be in recess until about 11:10.
    Mr. Chairman, unless there are further questions, I think 
we can excuse this panel at this time.
    So I want to thank you for taking the time to be here. We 
certainly appreciate your cooperation and your assistance, and 
you are excused. Thank you for being here.
    The hearing stands in recess until 11:10, at which time we 
will have our second panel.
    [Recess.]
    Chairman King. The hearing will come to order. I want to 
welcome our second panel today and thank them at the outset for 
taking the time and trouble to come down here and give us the 
benefit of their knowledge and wisdom and their insights.
    I would like to welcome Mr. Bryan Mitchell, the Chief 
Executive Officer of MCG Capital; Mr. Paul Glenchur, Director 
of Schwab Capital Markets; and Mr. Blair Levin, Managing 
Director of Legg Mason. I would ask each of you to make an 
opening statement. If you can possibly keep it to roughly 5 
minutes, that would be appreciated.
    We are not going to be pulling the plug on anyone, but if 
you could keep it to 5 minutes, it would be appreciated. In any 
event, your full testimony will be incorporated into and made a 
part of the record.
    So, with that, I would ask Mr. Mitchell to make his opening 
statement.

 STATEMENT OF BRYAN J. MITCHELL, CHAIRMAN AND CEO, MCG CAPITAL 
                          CORPORATION

    Mr. Mitchell. Thank you, Mr. Chairman. I appreciate it and 
thanks for giving me the opportunity to express my thoughts in 
front of your subcommittee.
    I wanted to give you a brief description of the background 
of our company so you can put into context our comments. Our 
company is a publicly traded solutions-focused financial 
services company that works with high growth small private 
companies. We assist those companies in prioritizing their 
opportunities and managing their risks of growth.
    We apply an expert activist investment philosophy to these 
companies, and we do that by focusing on very specific industry 
sectors in which we invest. We develop financial, operational, 
and regulatory expertise in these marketplaces, and we actively 
apply that knowledge to support these companies.
    The basic investment thesis of our company is to trade 
upside for a less speculative, more stable path to value 
creation, and it is that bias that we bring to the discussion 
today. As a bit more background, our company has an investment 
portfolio today of about $675 million. A little over 25 percent 
of that investment portfolio is in the telecommunications 
industry, and the remainder is in media, information services, 
and technology.
    Our company, in the fourth quarter of last year, completed 
a $240 million IPO and issued $265 million worth of investment 
grade bonds to support our investment activities in the telecom 
sector and technology sector. And we have had our basic 
investment philosophy validated, in our view, by the capital 
markets by completing those capital transactions in December of 
2001 in a very difficult capital market environment.
    I think the last point I would make around our background 
is that we have been active in investing in telecommunications 
for over 10 years, and we have deployed over $2 billion of 
capital and over 200 transactions in that time period. And our 
basic approach is to assess the fundamentals of growth markets 
and identify the path to cash flow and profits, which 
ultimately create significant enterprise value.
    It is the assessment of that critical path to cash flow and 
profitability that I would like to focus on as it relates to 
assessing capital formation in the telecommunications industry. 
Our focus in the space has been really in a range of different 
service providers, long distance, niche markets, prepaid 
services, conference calling, the hospitality industry, 
integrated services such as the local long distance data 
bundling models that are out there and messaging models, and, 
ultimately, and I think most importantly, for the purpose of 
this testimony today, is in the UNE-P CLEC area.
    The basic framework that we have brought to bear as it 
relates to investing in telecommunications companies is 
identifying companies that are able to acquire customers that 
have high net present value. And inherent in the 
telecommunications business is a cost to acquire a customer, 
the marketing, the provisioning costs, that is in excess of the 
current period, that current month's revenue stream. It is 
inherently a negative cash flow investment proposition.
    So what we look to identify is the predictability of the 
future revenue streams of that customer and the gross profit 
margin in fulfilling the particular service that that customer 
procures that generates positive cash flow in the out periods, 
that when discounted to a present period, exceeds the cost of 
acquiring that customer. And I think in this framework, as you 
build that critical mass of customers, you can then look to 
take the next step in terms of stepping up the return on 
investment curve by building facilities in which the gross 
profit margin increases as you push forward.
    Now, when we initiated our activity, in particular, in the 
local services marketplace, we did that based on what we deemed 
to be a very favorable regulatory environment related to the 
Telecom Act of 1996, a significant price-value proposition for 
a very large universe of consumers, where the greatest value 
proposition of deregulation was to the advantage of small 
businesses and residential customers, of which there are very 
many. The basic belief was that smaller competitors can 
significantly out-perform by being better at the basics, as it 
relates to what a customer sees, the customer service, the 
billing clarity, the pricing policies, the provisioning 
elements of the business.
    And, lastly, we felt that the Telecom Act of 1996 provided 
a terrific framework for encouraging innovation. I think within 
the context of the Telecom Act of 1996, the Act really provided 
for three basic entry strategies for competitive telephony.
    The first was a total service retail model, which 
essentially was a retail minus, the regional Bell's price minus 
a percent. And, essentially, your new entrance came in as 
marketing and billing agents for the incumbent providers of 
telephony.
    The facilities model, which is also obviously one more, 
involved a significant PP&E investment, very sizable capital 
expenditures, and essentially made use of some elements of the 
public switch network. The last model which we have focused in 
on is the UNE-P or network elements recombined.
    If you think about the basic framework of the Act, it was 
designed to allow the key elements of completing a phone call 
to be unbundled and procured by the competitive infrastructure. 
In the three components, there is really sort of seven specific 
components, but they basically roll up into access, switching, 
and transport of a telephone call.
    What the UNE-P model represents is a cost-plus approach 
rather than a retail-minus, and it is that cost-plus approach 
that allowed those entrants to generate a reasonable return on 
capital that could facilitate additional flows of capital into 
that marketplace. Now, each one of those components that were 
envisioned by the Act has a very significant and meaningful 
position, and, clearly, the Act was very well thought out in 
that regard.
    The total service resale model presents a low-cost entry 
strategy. Your investment capital is primarily to acquire 
customers.
    The sort of customer acquisition model is a critical 
element in that regard, and there is a fairly low gross profit 
margin which creates a long timeframe for return on investment. 
In other words, you burn money to build a pool of customers, 
you get this critical mass of paying customers, and then you go 
about the capital expenditure investment to generate a profit 
margin. That is a fairly long path, given the lack of return on 
capital while you are acquiring the critical mass of customers.
    The other model, which has been obviously very notorious 
for its impact on sort of the trouble in the markets, is a sort 
of build it and they will come--the facilities based model. 
Now, obviously, there are significant entry costs. There is a 
significance reliance on favorable access terms, which I think 
is very important and was expressed effectively in the Telecom 
Act of 1996.
    There is, however, also a very long scaling timeframe. 
There is high gross profit margins upon reaching scale, but you 
have got to get your plants built, and then you have got to 
acquire those customers. Both of those cost a lot and do not 
throw a lot of return back on the capital that you invest. And 
as you ultimately load your network, that is when the gross 
margins begin to kick in.
    And, lastly, I think the facilities framework is really 
designed to serve the higher margin larger users out there, the 
large corporate users or the very concentrated, from a 
population density perspective, users in the market.
    The last entry element, UNE-P, really does present to some 
extent the best of both, with a little bit of extra. We think 
it provides a low-cost market entry point. It is a customer 
acquisition entry model.
    It has a much shorter payback on customer acquisition, 
because there is sufficient gross profit margin associated with 
buying the network elements at a cost basis rather than a 
retail-minus basis, so that you can generate a gross profit 
margin with about 20,000 or 25,000 access lines. That allows 
you to continue to propagate with profitability new customer 
acquisition, which ultimately allows you, I believe, to step 
into the facilities framework.
    The capital expenditures associated with this model 
typically focus on customer centric issues. Most customers in 
the marketplace do not feel that the existing infrastructure is 
not effective at completing their calls. They feel more along 
the lines of ``my bill is confusing; the pricing mechanic does 
not make sense; I need service and it takes a long time; I call 
customer service and I do not get that.''
    So from our perspective, the basic building blocks of 
building a competitive framework involve serving those sort of 
front and center customer issues up front, and we think that 
this framework is supportive of that.
    And then, lastly, by being able to unbundle the network and 
then recombine those network elements, it gives innovative 
firms that have built a critical mass and are generating 
returns the opportunity to create product and service 
innovations by bundling hardware and software with the existing 
network elements to create enhanced services, things like 
unified messaging or follow-me calling or enhanced conference 
calling services or enhanced voice mail services. And this 
innovation, which has been really lacking from the incumbents, 
is really the biggest promise of telecom deregulation.
    Then, lastly, I think what UNE-P represents is the stepping 
stone to the higher margin facilities based business model. So 
as I look at what Congress did in 1996, I think there was an 
enormous amount of brilliance embedded in the Act.
    But, I think it is essential that Congress continue to 
support all three elements of the Act, the resale model, which 
creates ubiquity in the marketplace; the UNE-P component, which 
allows for a stepping stone to profitability through quicker 
cash flow and quicker profitability, which at this point is 
really what the capital markets are looking for--they do not 
like that long-term horizon of capital burn before they begin 
to see a return on their capital, and I also think it creates a 
very effective service platform for the average customer, the 
small user, the person who has eight lines in his business or 
12 lines in his business rather than the large Fortune 500 
companies--and then, lastly, the facilities strategy to serve 
the most complex customers and generate the highest margins.
    I think the three together will facilitate capital 
formation. And I think that leads to someone sort of saying, 
``Well, boy, it all seems to be so well thought out and works 
so well--what happened?'' It sort of begs the question: Why are 
we in the position that we are in?
    I think that one of the strengths and one of the weaknesses 
of the economy is its willingness to speculate for gain, to 
drive lots of capital into circumstances to create the upside. 
And I think the capital market simply went for the brass ring.
    If you think about it, it is a $200 billion-plus revenue 
marketplace, and to secure 20 to 30 percent of that from the 
monopoly market to a competitive market represents $40 billion 
to $60 billion at a two to three times multiple on revenue. 
That is $180 billion of market cap that was available to be 
created. There was a pent-up gold rush into that market cap 
model, and everyone went for the highest margin business model, 
the facilities based model.
    I think the capital markets ignored a bit a more rational 
step framework that was established in the Act through total 
service resale, UNE-P, and then facilities based advocacy. So I 
guess the question is what sort of point of view do I have as 
it relates to how we perpetuate or reinvigorate capital 
formation in the space.
    The question is, also, is there still a reason to force the 
incumbents to keep open all three entry strategies, and we 
believe very emphatically yes. We think it is a central theme 
to capital formation in the marketplace, and we think through 
the FCC's triennial review proceedings, which are underway, the 
results of that will really, I think, determine the outcome.
    From a public interest perspective, we do not think people 
are going to build the Novo networks to serve the small guy. 
And competitive telephony, as it is configured today, will 
allow all to benefit as each strategy has an opportunity to 
flourish over time.
    I think my second point would be that what Congress can do 
to facilitate flows of capital is to continue to hold the 
incumbents to cost studies that allow for buy rates on the 
public switch network elements that can support margin and that 
will perpetuate capital inflows.
    Then, lastly, I would say that enforcement is a critical 
issue. And, in fact, rather than lessening the terms of the 
Act, I think the terms of the Act need to be more fully 
embraced. It is important to note, in my view, that old 
monopolies die hard, and as such, enforcement mechanics should 
not be undermined.
    I think the Tauzin-Dingell bill appears to create a 
protected safe harbor for the Bells to invest in next 
generation networks that will not be subject to open access as 
provided for in the Telecom Act of 1996. And I think that would 
be a dangerous precedent and deleterious to capital formation 
in the telecommunications industry.
    Again, I would like to thank you for the opportunity to 
speak before the subcommittee, and I would be pleased to 
entertain any questions anyone might have.
    [The prepared statement of Bryan J. Mitchell can be found 
on page 72 in the appendix.]
    Chairman King. Thank you, Mr. Mitchell.
    The subcommittee has been joined by Congressman Grucci, who 
does have a particular expertise in this area, and he will be 
asking questions later. But now, I would like to ask Mr. 
Glenchur to give his opening statement.

  STATEMENT OF PAUL GLENCHUR, VICE PRESIDENT, SCHWAB CAPITAL 
         MARKETS L.P., SCHWAB WASHINGTON RESEARCH GROUP

    Mr. Glenchur. Thank you, Mr. Chairman and Members of the 
subcommittee. It is my pleasure to discuss with you issues 
related to capital formation in the telecom market.
    As the vice president of Schwab Capital Markets, Washington 
Research Group, I work with a staff of analysts that examine 
the regulatory, legislative, and political factors affecting 
investments in various industries, including telecom, 
technology, energy, health care, financial services, and 
international trade. We work with institutional investors to 
address their concerns in these areas.
    I would like to say at the outset, however, that today's 
comments and views represent my own, not those of Charles 
Schwab and Company or Schwab Capital Markets.
    It was only a couple of years ago that the telecom and 
technology markets were ablaze. Equity values soared and 
capital investment was flowing into these sectors.
    But as we all know, telecom and technology have suffered a 
meltdown. Telecom carriers, pursuing a land rush mentality, 
assumed substantial amounts of debt to build and expand the 
reach of their networks.
    The bursting of the internet and dot-com bubble undermined 
a major portion of the customer base for telecom service 
providers. Revenue struggled to keep up with debt service 
obligations. We have seen numerous bankruptcies and threats of 
more to come.
    The investment community obviously suffered along with the 
telecom carriers. They were enthusiastic about the promise of 
telecom competition and the migration to new and exciting data 
services over upgraded networks.
    To a great extent, investors believed that expanding 
telecom networks to allow flexible configuration of services to 
customers in all major metropolitan areas offered the greatest 
potential upside in the new telecom environment. But building 
networks in all major cities required the assumption of huge 
amounts of debt.
    A variety of factors pressured the revenue growth of 
upstart telecom service providers. Competition for high volume 
business customers led to disruptive pricing as carriers 
attempted to achieve revenue targets regardless of 
profitability.
    Internet service providers struggled and went out of 
business, disconnecting service or cutting back demands for 
service. Regulatory actions also were involved in affecting the 
projections of competitive local exchange carriers.
    The economic slowdown worsened a difficult situation. The 
expansive revenue growth anticipated from new data services 
failed to materialize. Meanwhile, debt burdens continued to 
squeeze upstart carriers. Investors pulled back, refusing to 
invest additional money in telecom service providers. Suddenly, 
the emphasis was on cash flows rather than the reach of a 
provider's network.
    As illustrated by the last couple of years, it is difficult 
to make a business work when it requires massive up-front 
capital investment and entails substantial customer acquisition 
and retention costs. Ongoing regulatory battles between 
incumbent and competitive carriers also have increased 
regulatory uncertainty in the sector.
    At this time, there is little growth in the telecom 
industry. Without profit growth, there are few incentives to 
invest.
    But despite the downturn in the industry, there is room for 
optimism. A necessary shakeout will mean inevitable 
consolidation and the survival of carriers with the most 
sustainable business models and financial structures.
    New data services and other offerings will continue to 
leverage upgraded telephone, cable, and wireless networks. But 
the healing process will take time.
    Carriers are reluctant to assume additional debt, a factor 
discouraging industry consolidation. Meanwhile, the burden of 
maintaining networks and upgrading them to add capacity or 
provide new services remains a costly exercise at a time when 
adoption rates for new services lack visibility. But technology 
is forcing the migration to new service models.
    Telephone carriers face competitive pressure from wireless 
substitution, IP telephony, and instant messaging. Broadcast 
and cable operators face a fragmented audience among numerous 
video offerings that pressures traditional advertising models. 
Commercial wireless service providers are making critical 
investments in data services.
    Although futurists may be excited about today's telecom 
opportunities, reluctant investors fit the ``once burned, twice 
shy'' characterization. They want to see killer apps that drive 
penetration rates for new services. The pendulum has swung from 
irrational exuberance to abject pessimism.
    History teaches, however, that we tend to overestimate 
change in the short run, but underestimate change over the long 
run. And, hopefully, the melt-down represents the first part of 
that equation.
    As Washington considers legislative or regulatory proposals 
to jump-start the telecom economy, some level of caution is 
warranted. Major initiatives lead to the inevitable legal 
challenges in Federal court and the results are unpredictable. 
The resulting uncertainty can actually discourage capital 
investment.
    Moreover, legislative and regulatory actions cannot force 
changes in human behavior. As noted above, there is genuine 
excitement about the potential of new technologies and high 
bandwidth services. What is not clear is how consumers will 
embrace these new capabilities over wireline and wireless 
networks.
    What is the value proposition for these services? We do not 
need 100 megabits a second for e-mail. Consumers and business 
are struggling with this question today. We must be realistic 
in our expectations of what Government policy will accomplish.
    Thank you, Mr. Chairman.
    [The prepared statement of Paul Glenchur can be found on 
page 86 in the appendix.]
    Chairman King. Thank you, Mr. Glenchur.
    Mr. Levin, please.

STATEMENT OF BLAIR LEVIN, MANAGING DIRECTOR, TELECOMMUNICATIONS 
   AND MEDIA REGULATORY ANALYST, LEGG MASON WOOD WALKER, INC.

    Mr. Levin. Thank you very much, Mr. Chairman, Ranking 
Member Maloney, Members of the subcommittee. I am Blair Levin, 
Managing Director of Legg Mason. I am an analyst, and in that 
role, I advise institutional investors about the impact of 
Government policy on telecommunications and media companies.
    Let me start by saying that I think the telecom situation 
is different than the energy situation in a very critical 
aspect. Telecommunications went through an historic change in 
the last 5 or 6 years.
    Every industry that has gone through an historic change has 
seen a cycle of over-investment and then a retreat from the 
market. This was true of the railroads in the 1800s, and it was 
true of the auto industry in the early 1900s, and it was true 
of the computer chip industry and the computer industry.
    That does not mean that these industries, all of which are 
critical to the success of our economy, are fundamentally 
flawed. It just means that when you have change, you have 
enormous investment, because, as the first speaker mentioned, 
there was a brass ring to be grabbed, and now the market is 
obviously retreating.
    I think as an indication of the fundamental health, but the 
problem of the industry--the revenues in the telecom industry 
last year grew at a rate of 7.5 percent, ranking as one of the 
highest among industries. But the profits of the industry 
dropped about 52 percent, and that is obviously very 
problematic.
    Mr. Chairman, I think you asked the right question by 
asking what are the hurdles that need to be overcome so you get 
the appropriate level of investment. Let me say I think that 
first, there are three preconditions to investment in the 
telecom industry.
    The first is competition, because without the opportunity 
for competition, you do not have investment in new entrants. 
Also, traditionally, the incumbents do not invest as much, and, 
certainly, there are a lot of examples which I cite in my 
written testimony that as competition starts to come online, 
you have both investment in competitors as well as more 
investment by the incumbents in upgrading our networks.
    Second, I think there needs to be a growth opportunity in 
both revenues and profits. Mr. Glenchur talked about that, and 
I think that is absolutely right. None of us in this room are 
going to invent those killer apps, but, nonetheless, we have to 
make sure that the companies realize they can get the benefits 
of inventing those killer apps.
    Third, there has to be, as Chairman Oxley mentioned, 
innovation in the marketplace. There have to be new kinds of 
goods and services. And here, there is a particular problem in 
telecommunications, because there is a tension between 
innovation in the networks themselves and innovation at the 
edge of the networks. I think we have to make sure that the 
delicate place is balanced, so that both investments kind of 
make sense, because that is what really drives the kind of 
innovation that increases consumer welfare gains as well as the 
economy.
    In making sure that those preconditions are met for 
investors, I think Government itself faces three challenges, 
first, to make sure that there is a balanced policy. All the 
policy debates center around the question of what are good 
incentives for investments.
    But it turns out there is a lot of tension between 
facilities based investors or those who want to lease networks, 
between certain kinds of facilities based investors. It is much 
easier to say than to do, but the simple truth is--and my 
written testimony goes into some examples of this--we need to 
make sure that all different kinds of investors have an 
opportunity to see revenues and profits, because otherwise, we 
will not get the kind of competition and innovation that 
America needs.
    Second, we need to rationalize the revenue streams in 
telecom. One of the things that makes telecom different than 
these other sectors--which I noted earlier as going through 
historical cycles--is that it is very heavily regulated. And we 
need to, when possible, have the market sending the right 
pricing signals.
    In my testimony, I talk a little bit about the problems of 
retail rate setting and universal service and the very 
complicated Federal-State jurisdictional battles that still, I 
think, give the market problematic signals and lead the market 
to underinvest in the sector, because they cannot tell where 
the market really is and where the growth is going to be and 
whether they should invest in a company who, unfortunately, may 
really depend on a regulatory regime for their profits.
    The third thing is we need speed and certainty in 
decisionmaking. The others have talked about that, and my 
written testimony goes through some examples. But again, I 
think the Congress did a very good thing when it passed the 
1996 telecom act by telling the FCC to get a number of 
decisions made within a very short period of time.
    But we have the ironic situation where the Congress asked 
the FCC to establish the pricing rules within 6 months, which 
it did. And now 6 years later, the courts have still not 
finally addressed the question of what is the appropriate 
pricing regime. So I go into some concrete proposals for how to 
speed up that decisionmaking and how do you make it more 
certain.
    There is a limit to what Government can do. Obviously, as 
Mr. Glenchur mentioned, consolidation and other market forces 
are going to return this sector to a greater sense of 
profitability and make it more attractive to investors.
    But, nonetheless, I thank the subcommittee for giving me 
this opportunity to testify, and I think that the Government 
does have a very critical role to making sure that capital 
formation in the telecom industry improves over the next 3 
years.
    Thank you very much.
    [The prepared statement of Blair Levin can be found on page 
93 in the appendix.]
    Chairman King. Thank you, Mr. Levin.
    I want to thank each of the panelists for their testimony. 
I have one question I will ask at the start, and then I will 
turn it over to Mrs. Maloney and then to Mr. Grucci.
    I will ask the three of you to comment on this. To what 
extent do you see the issue of access lines being a capital 
deterrence, and how does this issue affect the decisions of 
Wall Street analysts?
    Mr. Levin. Could you just clarify on the question of access 
lines? I am not sure I know what you mean.
    Chairman King. Actually, the last mile, basically, we are 
talking about.
    Mr. Mitchell. Oh, OK. I will start. I think that having 
open access to last mile is absolutely critical and essential 
to building any kind of a competitive framework. And the buy 
rates on that last mile need to be constructed in a way that 
the companies that are competing can generate a reasonable 
profit margin so they can cover their costs and generate a 
return on capital.
    So capital will form up to acquire customers and create--
the first part of the competitive infrastructure, in my view, 
is a critical mass of customers to make prudent ROI judgments 
on, in terms of investing in expanded facilities.
    Mr. Glenchur. The last mile is obviously the whole critical 
part of this debate, and in terms of what we ought to do to 
reform telecom regulation. Whether it is for phone connections 
or it is for broadband connections, it is the great advantage 
that incumbents have, whether it is the Baby Bells, the 
incumbent phone carriers, or cable operators, having that 
direct connection with the customer.
    Unlike the infrastructure for long distance, the barriers 
to entry in terms of coming into the local market are pretty 
substantial. It is much more costly to invest in the local 
infrastructure to solve the last mile problem or to offer 
competitive alternatives. And that is why we have seen so many 
of the telecom meltdowns that we have seen and the bankruptcies 
and the pending bankruptcies. So this is a very, very difficult 
challenge.
    I would also say that beyond just that connection, you are 
looking at a lot of advantages that incumbents have in terms of 
brand identity, constant contact with the customer, and 
entrenched customer relationships, which has raised the 
acquisition cost for a lot of upstart carriers or those who 
would enter this market to try to offer that alternative. And 
it takes time to try to overcome those hurdles, to find the 
right business model and financial model to make a business 
case for entering this market. But it is the great challenge, 
and it is really at the heart of the difficulties the industry 
faces today.
    Mr. Levin. I would certainly echo that. I think it is 
notable that a great deal of the investment that occurred in 
the post-1996 environment went into the long-haul side, and 
prices have dropped dramatically, performance has improved 
dramatically in the long haul networks. But we did not see the 
same kind of investment or improvements in price and 
performance in the last mile.
    On the other hand, I think that more and more, there are 
beginning to be last mile substitutes, whether it be on the 
wireless side--I think we are going to see more cable CLECs in 
the efforts over the next year. So, obviously, we want to see 
more improvements in the performance of that last mile, but I 
would be cautious about making any dramatic changes in the 
policy at this point in time, because I think that could hurt 
investment into the last mile at this point more than help it.
    Chairman King. Mrs. Maloney.
    Mrs. Maloney. I just would like to ask the panel to react 
to what Mr. Kuhn said earlier. In his statement, he made a 
point that he was trying to distinguish Enron's practices from 
those engaged in by other energy companies in order to restore 
investor confidence in the whole industry.
    But several other energy companies, including counter 
parties to Enron, have announced that the SEC has opened 
inquiries into their accounting practices. So, basically, the 
point is we are trying to get more investor confidence into 
energy companies and telecom companies. But how can we get that 
investor confidence when all of this is being announced, 
whether it is Global Crossing or Enron or whatever.
    Global Crossing was a telecommunications company, was not 
it? It was not in energy. It was in telecommunications.
    So as long as that cloud is out there with Global Crossing 
and alleged accounting practices in other telecommunications 
companies, for then Enron--that was totally an energy company. 
How can we get investors to come back with confidence and put 
their capital there when this cloud is out there?
    Mr. Glenchur. I think that is right. It is another burden 
to have to overcome at a very difficult time in the industry. 
They are burdened with substantial debt, and we have seen the 
bankruptcies, and we are probably going to see more of those. 
What is positive is some of the companies are working out of 
bankruptcy, and that is favorable.
    But if you look in the telecom industry, it is not just 
Global Crossing. You have seen questions raised with respect to 
WorldCom, Qwest. You have seen the SEC opening an inquiry in 
Adelphia, a cable company, now, raising questions about off-
balance sheet debt.
    And these are problematic, because it increases the due 
diligence that one must perform with respect to potential 
transactions in this sector, in terms of what kind of debt you 
are going to assume in doing a deal, as well as whether you 
have a good sense about the scope of the burdens that you may 
be taking on. It actually may have somewhat of a chilling 
effect on the ability to see consolidation take place that 
might ease some of the troubles in the sector.
    Mrs. Maloney. Well, energy projects are often financed and 
held through special purpose vehicles, the so-called SPEs, that 
do not appear on the books of the sponsoring companies. How 
frequently is this type of financing vehicle used in the 
telecommunications industry? Doesn't the telecommunication 
industry use these SPEs in their accounting practices?
    Mr. Mitchell. From my perspective, there is not nearly as 
much frequency in that regard. The sort of accounting issues 
that, I think are more prevalent in the telecommunications 
industry are sort of bartering arrangements and sort of income 
recognition issues more so than moving things off of the 
balance sheet so they cannot be seen.
    I think that this kind of issue of accounting policy and 
accounting framework tends to be highlighted in industry 
sectors where there is a lot of growth, which creates a lot of 
investor interest and creates an opportunity for people to 
engage in perhaps less savory activities. But I think, to some 
extent, it is a separate and distinct issue to the underlying 
construct of profitable business models.
    Is there the ability to develop, and is there a supportive 
framework from a regulatory perspective for the formation of 
profitable business models. And, you know, I think telecom is 
plagued with its share of accounting issues, but I think the 
bigger issue in telecom is companies that investors invested in 
that did not make money, and they knew it did not make money 
when they invested in it. And the task of making money was so 
extended that it created investor indifference and, ultimately, 
investor dissatisfaction, which then created a lot of pressure 
on the leverage side of the houses, as was mentioned by Paul.
    Mrs. Maloney. I think the first and best thing that we 
could do as a Nation to get people to invest capital in 
telecommunications is to restore confidence that the businesses 
are well managed. When someone reads about a Global Crossing, 
it is not fair to say that every company is the same. It 
certainly is not. Most companies are honest, hard working, and 
doing a great job.
    But we need to restore investor confidence. I think that is 
probably the biggest thing we could do to get people to start 
investing capital back into telecommunications.
    So I would like to ask what the industry is doing to assure 
investors that these off balance sheet entities do not conceal 
additional liability or losses. And what is being done by the 
industry to weed out overly aggressive or misleading practices?
    Obviously, the best thing that could happen for 
telecommunications is that there is not another Global 
Crossing, there is not another scandal, you could say, of sort 
of misleading investors. And Government is trying to do their 
role. We have had extensive markups on bills that increase 
oversight. The SEC is trying to do their role. But what is 
industry doing to weed out aggressive or misleading practices?
    Mr. Levin. I would like to answer that with two comments. 
First, I think we need to make a distinction between misleading 
investors in what one might think of as a conscious way, where 
you do not reveal information you should reveal--clearly, this 
was the case in Enron. Based on press reports--and I want to 
emphasize based solely on press reports, it appears to be that 
Adelphia was engaged in off book accounting.
    But that is very different from what I think is the major 
problem facing telecom, which is the business models did not 
live up to expectations, primarily because of mis-estimations 
of supply and demand. So there were a number of companies that 
went into the long-haul business. The demand did not increase 
as much as they had anticipated. There was much greater supply. 
Prices dropped. That is a more normal problem, but I think that 
that is more of the problem in the telecom sector than some 
kind of misleading.
    And, second, let me say to the extent that there is 
misleading, I have got to tell you that the market reacts just 
like Washington. In other words, when there is an issue, 
everybody goes and focuses on that issue. And I can assure you 
that as soon as Adelphia came out with their statement that 
they had been borrowing money that had not been revealed, every 
single cable company was immediately asked by every single 
analyst, OK, tell us what you have too.
    So I think that the market is self-correcting in some ways. 
That is not to say there is no further Government role 
necessary. But the market is now, I think--well, Mr. Glenchur 
stated that we have gone from irrational exuberance to some 
kind of over-pessimism.
    We have also, as analysts--it used to be that the job of 
the analyst was to search for the great new thing which would 
bring huge upside. Now, I think analysts are very focused on 
what is the missing thing that actually I can discover that 
reveals that there is enormous downside. So I think the 
marketplace is reacting by searching for those kinds of 
problems.
    Mrs. Maloney. Well, then, what can we do to help you? What, 
specifically, could Government do to help with capital 
formation for telecommunications? I mean, I see it as investor 
confidence. You say that is adjusting. When all these scandals 
are out, investors pull back. But if that is adjusting, and 
that is not a problem, then what could be done?
    Mr. Mitchell. I think the first step is private capital 
formation. I think you need to distinguish sort of private 
equity and large institutional funds that invest in companies 
separate and distinct from the individual investors maybe 
through their mutual funds or whatever.
    From my perspective, I think there was great brilliance in 
the Telecom Act of 1996, and I think that it would be a mistake 
to sort of throw the baby out with the bath water. We have to 
recognize that frequently, in the economy, particularly around 
substantial growth sectors--and I think Blair mentioned that 
telecommunications revenue growth is still up substantially--
there is a proclivity to over-invest, to create speculative 
fervor around these growth sectors.
    I think when that happens, the markets do correct 
themselves, and what we do not want to do is over-respond from 
a regulatory perspective. Let's look at the brilliance of the 
stepped business models toward inevitable profitability that 
was established in the 1996 Act, and let's make sure we enforce 
those provisions and hold people, particularly the incumbents, 
to the critical metrics of reasonable buy rates and open access 
and do not find ways for them to avoid open access on the data 
side and keep it open on the voice side, because at the end of 
the day, data and voice are the same thing. It is bits and 
bytes. And so it is just sort of voiding the old monopolies' 
desire to protect themselves and make sure we stay true to the 
original framework of the Act.
    Mr. Glenchur. I think that Blair stated this pretty well, 
that the investment community will be a disciplinarian for the 
market, and you are seeing companies having to respond to that. 
The ``build at all costs'' model has been discarded, and now 
you will see competitive carriers with tighter geographic 
focus, more customer segmentation.
    You have seen the models adapt to the change in the capital 
environment. The capital markets are brutal, and they are 
forcing discipline on the market.
    At the same time, we still have a very, very expensive 
infrastructure build-out ahead at a time when we really, again, 
do not know how fast or how deeply these new services that will 
be offered and enabled by this infrastructure investment will 
be taken up by consumers, which still makes it speculative and 
risky. But I think it is good now that we are seeing the hype 
come out of the market, the concept investing come out of the 
market, and fundamentals like cash flows and profits are 
reemphasized, and that is painful.
    But that process did self-correct, and I think it is good 
to let that begin to run its course from a financial and 
business standpoint. There are broader policy issues that I 
know Congress has debated that regulators are looking at that 
affect various regulatory incentives in the market, and those 
are worthwhile debates to have. But I think that, in general, 
we are seeing the healing process, and we need to make sure 
that nothing is done to interfere with that.
    Mr. Levin. I would just echo those comments again to the 
extent that there are folks who are deliberately not revealing 
information that they should have revealed or that we need to 
change the rules to make sure they reveal that information. 
That is certainly an appropriate role for the Government and 
the SEC with the capital markets.
    Mrs. Maloney. Isn't it a criminal offense not to reveal the 
information that you have debt that you are not really--to lie, 
basically, to lie to your auditor? Isn't that a criminal 
offense?
    Mr. Levin. I am not an SEC lawyer, and I think there are 
always questions--obviously, there are a lot of questions about 
what needs to be revealed and what is not. And I think that 
that is at the heart, obviously, of a lot of the investigations 
of Andersen. I think those are very legitimate and important 
questions for this subcommittee and, really, the entire 
Government to look into.
    But I do make a distinction, and I think it is an important 
distinction, between those players who were withholding 
information and those players who simply guessed wrong. They 
did not guess wrong because they were not smart and did not 
work hard. They guessed wrong because markets are 
unpredictable. So I want to make sure we do not punish them, 
because if we punish them, then people will not invest in new 
innovative companies that, I think bring a lot of value to this 
American economy.
    Mrs. Maloney. Thank you.
    Chairman King. Thank you, Mrs. Maloney.
    Congressman Grucci.
    Mr. Grucci. Thank you, Mr. Chairman. It seems to be a New 
York issue here. We have all New York representatives.
    My question goes along the lines of competition and 
bringing competition into the marketplace. How can we encourage 
young upstart companies to get into the telecom industry, and 
can they access capital to do so? How can we help in creating 
the environment for capital to grow so that it can be accessed 
by these new startup companies?
    I guess we will go down the line. If anyone wishes to 
answer that first, that is fine with me.
    Mr. Mitchell. Well, Congressman, that is exactly what my 
company does. We are in the business of financing private 
companies with $5 million to $25 million of capital to support 
creation of what we hope to be, in the long run, a larger and 
ultimately perhaps public companies.
    And from our perspective, our company has been rewarded by 
this fundamental cash flow discipline that we have applied to 
investing in this space to our ability to raise over $500 
million in December of 2001 to re-deploy back into this market, 
so that the capital market, sort of on a wholesale basis, had, 
I think, a firm step-by-step process of building moderately 
profitable to very profitable businesses with good visibility 
on profits and cash flow. And I think the Act has built a 
framework for that, and I think continued access to the network 
elements on an unbundled basis is a very important part of 
constructing a profitable business model and a business model 
that will then perpetuate innovation.
    I think the first issue is is there a framework that you 
can go out and negative spend to acquire customers in the 
context of near-term profitability as you gross up your 
customer base. And the facilities build model, straight up, 
does not provide that.
    The amount of capital you need to spend to get the 
facilities and the amount of negative burn that needs to occur 
to get the customers puts profitability so far off that the 
capital markets have said, ``I just do not have the tolerance 
for that long view of things, in terms of return on 
investment.''
    My personal view is I think that the Act has developed a 
good framework for that, and it is sort of making sure the buy 
rates make sense and making sure you can get those individual 
network elements for the facilities guys for access, for the 
UNE-P guys for access, transport, and switching, and, 
ultimately, for resale guys a reasonable access to the overall 
network at a reasonable price.
    Mr. Grucci. Does anyone else wish to answer?
    Mr. Glenchur. Yes, I would just say briefly that, again, I 
think that the competitive market for telecom services, the 
competitive carriers and the upstart carriers--I mean, they are 
trying to overcome a very difficult financial climate, and the 
capital markets are generally not open to them at this point, 
at least not as much as they were. I think a lot of the hype 
and the concept has come out of the investing, and there is 
discipline being imposed on the market as they explore the 
kinds of models that will work and the kinds of financial 
structures that will be sustainable, and that is a good 
process.
    Eventually, as you see the consolidation and the shake-out, 
some players emerge who have the right approach, as the third 
or fourth generation competitive local exchange carrier going 
forward. So I think that healing process is critical here, 
because that will be something that all investors will want to 
know about and will have questions about and will demand 
answers, in terms of what kind of model a carrier has to 
compete, given today's climate.
    I also think it is important for the FCC to continue to 
enforce the rules that Congress has established, provisions for 
competition--the FCC implements and enforces them. As the 
commission explores changes in this area, obviously, that 
creates some uncertainty in the market, and that is another 
difficulty to overcome.
    But to the extent that the rules----
    Mr. Grucci. Congress starting to go on, and I want to get a 
second question in, and we will start with Blair, if he wishes 
to answer this.
    Chairman King. Congressman Grucci, you can have as much 
time as you want.
    Mr. Grucci. Thank you, Mr. Chairman.
    The next question I wanted to ask is are there restrictions 
and impediments that put the smaller companies at a 
disadvantage over the bigger companies? Is there some kind of 
regulatory relief or regulatory assistance that might make it 
more appetizing to invest in a small company if, indeed, they 
had access to that kind of help?
    Second, the Tauzin-Dingell bill was designed to bring 
competition into the field. I would like to hear all of your 
responses as to whether or not you are seeing that. Do you 
think that will grow, and do you believe that we ought to bring 
the cable companies into that loop where they are also covered 
under the Tauzin-Dingell bill?
    Blair, why don't we start with you?
    Mr. Levin. I suspect Mr. Mitchell could answer the question 
about small companies better than I, but let me make a couple 
of quick observations and then talk about your other question. 
I think there is a distinction between--telecom is really a big 
player game, and when you are talking about running these huge 
networks, huge data pipes, huge voice pipes, you really need 
scale.
    There are a number of small telecom companies in this 
country that are in, geographically, generally rural areas. And 
I think there are certain things that Congress is considering 
in terms of regulations to limit the restrictions on them. But 
that is different than saying that a small CLEC can arise in 
Long Island or in New York and really compete with the big 
guys.
    Going back to your earlier question, after the 1996 Act, we 
saw hundreds of new companies form. In some sense, they acted 
as an enormous success in terms of generating a lot of interest 
in telecom, and a lot of capital was invested. But what we have 
seen is that it is a big player game, and we just have to 
accept that that is the economics of the business.
    On the other hand, a lot of the best things that have 
happened have been at what we think of as the edge of the 
networks, with new applications and innovations. And I think it 
is important that the people who--whether they be things like 
e-mail or instant messaging or file sharing or whatever--that 
those folks have access to the networks, so that they can make 
money off of bringing those innovations into the marketplace.
    On the other hand, we want to make sure the big guys have 
incentives to invest in faster and faster networks. And that is 
the tension which I talk about in the written testimony, but I 
think it really calls for a certain kind of balanced policy 
where you really have to get into the weeds of the details of 
the policy. But that is the goal that we ought to shoot for, 
where everybody has an incentive to invest in all parts of the 
network.
    In terms of the Tauzin-Dingell bill, I do not have any 
particular comments to make as to whether it is a good or bad 
idea. I think it goes to an earlier point I made, which is, 
yes, it is about investment, and, very frankly, if the bill 
were to pass, I would say the obvious thing to investors, which 
is invest more money in Bells, invest less money in CLECs and 
IXCs.
    I do not think the bill will, in at least the short and 
medium term, affect the fundamental competition between cable 
and DSL, because that competition, in my opinion, has a lot 
more to do with the fundamental economics of providing 
broadband services, and that goes to the economics of the 
networks. And I have read a variety of different studies, but 
just roughly speaking, I think the cost for the Bells to 
provide a DSL services is, in rough order of magnitude, 30 to 
50 percent more than the cable companies providing a cable 
modem service.
    You can really play with the numbers, because so much 
depends on how many people you are serving. But my point is 
there are economic reasons that cable is beating the Bells that 
really have nothing to do, in my opinion, with regulation.
    So I would just make that obvious observation, that it 
really depends on where you want the investment to go. But if 
you take the point----
    Mr. Grucci. If you wanted the investment to bring 
competition into an area, how would you encourage that to 
happen?
    Mr. Levin. Well, I think there are a number of things. For 
example, I think that one of the constraints on competition 
today is that a lot of cities have regarded their rights of way 
as a money-making opportunity. So they either tax or have some 
kind of fees on companies that, in my opinion, hurts 
competition.
    If a new CLEC wants to come in and put in pipes under the 
ground, obviously, the city has a right to get reimbursed for 
direct costs, and, obviously, there are problems for cities of 
digging up streets. I am not saying the cities have no rights 
here.
    But on the other hand, if the city is essentially saying, 
``We have a scarce resource, a right of way, which we should 
treat--and we should kind of, shall we say, auction it off, or 
we should try to make money here,'' I think that is an 
impediment to competition. I am delighted to see that a number 
of people, such as the NTIA director, Nancy Victory, have 
recently said that this is a big problem.
    Also, several States have taken action to prevent local 
Governments from using the rights of way in that way. But, 
frankly, a State-by-State approach is much too slow, and I 
think Federal action may well be warranted to make sure that 
all facilities based competitors have a right to the right of 
way.
    Mr. Grucci. Just on that issue, I used to be the supervisor 
of a township of 450,000 people, and we did have franchise 
agreements with a cable company on Long Island. I almost 
shudder to use this word in this town, but it is an 
infinitesimal amount of revenue that came to the municipality 
as compared to what the gross revenues of the cable company 
were.
    For our municipality, it was probably less than $2 million 
a year in franchise agreements, and I know that they made tens 
of millions of dollars in gross receipts from just my township 
alone. While that may certainly add to the cost of the final 
product, which is what the consumer pays for, I do not believe 
that is driving away competition, because anybody would have 
the rights to that area. The lease agreements would be open to 
anyone who wishes to come and lease that space, the right of 
way.
    I am concerned with these giant companies coming in, and if 
you are saying that we have to accept the fact that this may 
only be a game for the big players, then what happens when, as 
in the accounting industry, the big eight went to the big six 
which went to the big five which is going now to the big four. 
I mean, what do we end up with, one cable company throughout 
the entire country, one telecommunications company throughout 
the entire United States?
    I do not think that would be good for the consumer. They 
would end up paying the brunt of all of that.
    Mr. Glenchur. Well, fortunately, the FCC is in the process 
now of looking at how consolidation in telecom and in media--
well, primarily in media--will impact the idea of having all 
voices brought down to a small number, and whether it has 
impacts on the diversity of viewpoints and localism and the 
extent to which, historically, the FCC's effort to protect that 
has worked, and they are looking at that very issue. And I 
think maybe by the end of the year, we will have a better sense 
about how this kind of consolidation, as we go to fewer players 
and larger players, will affect those very issues.
    Mr. Grucci. The issue that I am concerned with is how it 
affects the consumer. Let me just say locally--because that is 
the issue that is the topic of today--we have really one cable 
company that provides access to the TV stations, other than a 
dish or an antenna, and a dish is the real small guy in the 
marketplace trying to be a player.
    There is a war going on now between the two top guys in the 
Yes network and cable company, and as a result, the consumers 
are being denied the ability to watch Yankee baseball games. 
And while I am not a huge fan of sports--I enjoy watching it--
there are those who are, and they cannot access that unless 
they now go out and get a completely different system for their 
homes. And that is my fear, that if you end up with one or two 
companies where the consumers can go for this kind of service, 
they are ultimately going to bear the high cost of that new 
service.
    Mr. Mitchell. Well, I think your point, Congressman, is 
right on--and I would suggest that, in fact, you can create a 
very viable business model around serving Long Island, 
Westchester County. I invest in companies that do exactly 
that--60,000 customers in Westchester County, and why those 
customers come to work with my little CLEC that does not have 
enormous levels of facilities and all this pipe and what-not--
they come because we have clearer bills, which might be less 
expensive.
    When they call to get another line put in their house, we 
respond on the phone immediately. We come out and provision 
that line in 5 days in a very reliable fashion.
    Basic consumer facing service improvements are enough for a 
lot of customers to make a decision to change from the regional 
Bell to a competitive player. And that basic initial building 
block, if you can do it profitably, will allow you to build the 
cluster of customers, like one of my companies that has 60,000 
customers in Westchester County, and then we can take a look at 
whether or not we should, in fact, be investing in additional 
facilities that allow us to bring more innovation, broadband 
services, and other things.
    We have got a profitable cluster of customers, and that 
makes me, as a capital investor, much more anxious to look at 
making additional investments of capital into that company. I 
think the Act has a provision for that, and I think what we 
have to be very careful about in the Tauzin-Dingell bill is the 
opportunity for the entrenched historic monopoly businesses to 
find a safe harbor in data and broadband, which actually can 
serve as sort of the next generation voice network as well, and 
sort of leave behind to that small customer service innovator 
that wants to become a product innovator an antiquated system 
or an antiquated methodology.
    And if you give them the safe harbor, they will take it. 
There is absolutely no doubt about it, and----
    Mr. Grucci. Isn't that what happened with the cable 
companies? Didn't they find a safe harbor in the Tauzin-Dingell 
bill?
    Mr. Mitchell. I am less able to speak to the issues in 
Tauzin-Dingell relating to cable than I think--and 
telecommunications. But I think the same concept applies.
    Mr. Levin. Could I just real quickly give the----
    Mr. Grucci. Sure.
    Mr. Levin. The question about media ownership, in 
particular, I think is one that really needs to be on the 
radar, because the courts have significantly undercut the FCC's 
ability to actually regulate in this area. But I think it is 
worth noting that this debate over the S network--there is a 
certain kind of--the marketplace is working to a certain 
extent. A cable company is not carrying it, one satellite 
company is not carrying it, but the other satellite company is.
    In fact, in the most recent quarterly results of Direct TV, 
they had a big increase in subscribers, and a lot of people 
think it has to do with the fact that a number of people chose 
to get the S network, and they want to do it. I think that, you 
know, it is an interesting question, which I am sure the folks 
at the Department of Justice and the FCC will look at. If you 
allow the two satellite guys to merge, then what happens to 
that competitive dynamic for programming?
    So that is a very important question. I generally tell 
investors what I think will happen in the world, whether or not 
it is a good thing or a bad thing. You obviously have to worry 
about what is being served in the public interest here.
    I would just say that I think these issues of ownership are 
incredibly important and deserve an awful lot of study. And we 
have to be very careful, because, in fact, I think both the 
telecom industry and the media industry have delivered an awful 
lot of benefits to American society, both in terms of providing 
a diversity of viewpoint as well as economic growth.
    Mr. Grucci. Thank you, Mr. Chairman. I appreciate your 
indulgence and your generosity with the time.
    Chairman King. Thank you, Mr. Grucci. I think you went a 
bit overboard, though, in being such a strong advocate for the 
Yankees, especially since the Mets are doing considerably 
better than the Yankees lately, and I think your constituents, 
even though they elected you, are still too enlightened to get 
that excited about the Yankees when the Mets are the proper 
alternative.
    Ms. Capito, do you have any questions?
    Ms. Capito. Thank you, Mr. Chairman. I have no questions.
    Chairman King. We have votes coming up in the next several 
minutes. Do any of you want to comment on any of the points 
that your fellow panelists made this morning? I am not trying 
to look for a fight, but is there anything you want to add or 
amplify on a point that was made by one of your fellow 
panelists?
    Mr. Glenchur. I would only say, again, that with respect to 
what we need to do, in terms of Tauzin-Dingell or any other 
regulatory efforts to modify the competitive landscape, the 
rules that players will compete under, that we just be very, 
very cautious about how much unpredictability that can create 
and how expectations about the future have to adjust and 
whether it actually deters investment in the sector. I think 
that those are not easy questions to answer, but I think that 
we do need to be cautious about that.
    Chairman King. I want to thank the witnesses for their 
testimony. You have gone above and beyond the call of duty. We 
greatly appreciate it, and I speak for myself and the Ranking 
Member, Ms. Maloney, and the other Members of the panel.
    I also want to note that a number of Members may have 
additional questions for the panel, and, without objection, the 
hearing record will remain open for 30 days for Members to 
submit written questions to witnesses and to place the 
responses in the record. So ordered, and, with that, the 
hearing stands adjourned.
    Thank you very much.
    [Whereupon, the hearing was adjourned.]



                            A P P E N D I X



                             April 18, 2002
[GRAPHIC] [TIFF OMITTED] 79320.001

[GRAPHIC] [TIFF OMITTED] 79320.002

[GRAPHIC] [TIFF OMITTED] 79320.003

[GRAPHIC] [TIFF OMITTED] 79320.004

[GRAPHIC] [TIFF OMITTED] 79320.005

[GRAPHIC] [TIFF OMITTED] 79320.006

[GRAPHIC] [TIFF OMITTED] 79320.007

[GRAPHIC] [TIFF OMITTED] 79320.008

[GRAPHIC] [TIFF OMITTED] 79320.009

[GRAPHIC] [TIFF OMITTED] 79320.010

[GRAPHIC] [TIFF OMITTED] 79320.011

[GRAPHIC] [TIFF OMITTED] 79320.012

[GRAPHIC] [TIFF OMITTED] 79320.013

[GRAPHIC] [TIFF OMITTED] 79320.014

[GRAPHIC] [TIFF OMITTED] 79320.015

[GRAPHIC] [TIFF OMITTED] 79320.016

[GRAPHIC] [TIFF OMITTED] 79320.017

[GRAPHIC] [TIFF OMITTED] 79320.018

[GRAPHIC] [TIFF OMITTED] 79320.019

[GRAPHIC] [TIFF OMITTED] 79320.020

[GRAPHIC] [TIFF OMITTED] 79320.021

[GRAPHIC] [TIFF OMITTED] 79320.022

[GRAPHIC] [TIFF OMITTED] 79320.023

[GRAPHIC] [TIFF OMITTED] 79320.024

[GRAPHIC] [TIFF OMITTED] 79320.025

[GRAPHIC] [TIFF OMITTED] 79320.026

[GRAPHIC] [TIFF OMITTED] 79320.027

[GRAPHIC] [TIFF OMITTED] 79320.028

[GRAPHIC] [TIFF OMITTED] 79320.029

[GRAPHIC] [TIFF OMITTED] 79320.030

[GRAPHIC] [TIFF OMITTED] 79320.031

[GRAPHIC] [TIFF OMITTED] 79320.032

[GRAPHIC] [TIFF OMITTED] 79320.033

[GRAPHIC] [TIFF OMITTED] 79320.034

[GRAPHIC] [TIFF OMITTED] 79320.035

[GRAPHIC] [TIFF OMITTED] 79320.036

[GRAPHIC] [TIFF OMITTED] 79320.037

[GRAPHIC] [TIFF OMITTED] 79320.038

[GRAPHIC] [TIFF OMITTED] 79320.039

[GRAPHIC] [TIFF OMITTED] 79320.040

[GRAPHIC] [TIFF OMITTED] 79320.041

[GRAPHIC] [TIFF OMITTED] 79320.042

[GRAPHIC] [TIFF OMITTED] 79320.043

[GRAPHIC] [TIFF OMITTED] 79320.044

[GRAPHIC] [TIFF OMITTED] 79320.045

[GRAPHIC] [TIFF OMITTED] 79320.046

[GRAPHIC] [TIFF OMITTED] 79320.047

[GRAPHIC] [TIFF OMITTED] 79320.048

[GRAPHIC] [TIFF OMITTED] 79320.049

[GRAPHIC] [TIFF OMITTED] 79320.050

[GRAPHIC] [TIFF OMITTED] 79320.051

[GRAPHIC] [TIFF OMITTED] 79320.052

[GRAPHIC] [TIFF OMITTED] 79320.053

[GRAPHIC] [TIFF OMITTED] 79320.054

[GRAPHIC] [TIFF OMITTED] 79320.055

[GRAPHIC] [TIFF OMITTED] 79320.056

[GRAPHIC] [TIFF OMITTED] 79320.057

[GRAPHIC] [TIFF OMITTED] 79320.058

[GRAPHIC] [TIFF OMITTED] 79320.059

[GRAPHIC] [TIFF OMITTED] 79320.060

[GRAPHIC] [TIFF OMITTED] 79320.061

[GRAPHIC] [TIFF OMITTED] 79320.062

[GRAPHIC] [TIFF OMITTED] 79320.063

[GRAPHIC] [TIFF OMITTED] 79320.064

[GRAPHIC] [TIFF OMITTED] 79320.065

[GRAPHIC] [TIFF OMITTED] 79320.066

[GRAPHIC] [TIFF OMITTED] 79320.067

[GRAPHIC] [TIFF OMITTED] 79320.068

[GRAPHIC] [TIFF OMITTED] 79320.069

