[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



 
 HEALTH OF THE TELECOMMUNICATION SECTOR: A PERSPECTIVE FROM INVESTORS 
                             AND ECONOMISTS
=======================================================================

                                HEARING

                               before the

          SUBCOMMITTEE ON TELECOMMUNICATIONS AND THE INTERNET

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                            FEBRUARY 5, 2003

                               __________

                            Serial No. 108-3

                               __________

       Printed for the use of the Committee on Energy and Commerce


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house

                               __________


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                    COMMITTEE ON ENERGY AND COMMERCE

               W.J. ``BILLY'' TAUZIN, Louisiana, Chairman

MICHAEL BILIRAKIS, Florida           JOHN D. DINGELL, Michigan
JOE BARTON, Texas                      Ranking Member
FRED UPTON, Michigan                 HENRY A. WAXMAN, California
CLIFF STEARNS, Florida               EDWARD J. MARKEY, Massachusetts
PAUL E. GILLMOR, Ohio                RALPH M. HALL, Texas
JAMES C. GREENWOOD, Pennsylvania     RICK BOUCHER, Virginia
CHRISTOPHER COX, California          EDOLPHUS TOWNS, New York
NATHAN DEAL, Georgia                 FRANK PALLONE, Jr., New Jersey
RICHARD BURR, North Carolina         SHERROD BROWN, Ohio
  Vice Chairman                      BART GORDON, Tennessee
ED WHITFIELD, Kentucky               PETER DEUTSCH, Florida
CHARLIE NORWOOD, Georgia             BOBBY L. RUSH, Illinois
BARBARA CUBIN, Wyoming               ANNA G. ESHOO, California
JOHN SHIMKUS, Illinois               BART STUPAK, Michigan
HEATHER WILSON, New Mexico           ELIOT L. ENGEL, New York
JOHN B. SHADEGG, Arizona             ALBERT R. WYNN, Maryland
CHARLES W. ``CHIP'' PICKERING,       GENE GREEN, Texas
Mississippi                          KAREN McCARTHY, Missouri
VITO FOSSELLA, New York              TED STRICKLAND, Ohio
ROY BLUNT, Missouri                  DIANA DeGETTE, Colorado
STEVE BUYER, Indiana                 LOIS CAPPS, California
GEORGE RADANOVICH, California        MICHAEL F. DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire       CHRISTOPHER JOHN, Louisiana
JOSEPH R. PITTS, Pennsylvania        TOM ALLEN, Maine
MARY BONO, California                JIM DAVIS, Florida
GREG WALDEN, Oregon                  JAN SCHAKOWSKY, Illinois
LEE TERRY, Nebraska                  HILDA L. SOLIS, California
ERNIE FLETCHER, Kentucky
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho

                  David V. Marventano, Staff Director
                   James D. Barnette, General Counsel
      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

          Subcommittee on Telecommunications and the Internet

                     FRED UPTON, Michigan, Chairman

MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                      Ranking Member
CLIFF STEARNS, Florida               BOBBY L. RUSH, Illinois
  Vice Chairman                      KAREN McCARTHY, Missouri
PAUL E. GILLMOR, Ohio                MICHAEL F. DOYLE, Pennsylvania
CHRISTOPHER COX, California          JIM DAVIS, Florida
NATHAN DEAL, Georgia                 RICK BOUCHER, Virginia
ED WHITFIELD, Kentucky               EDOLPHUS TOWNS, New York
BARBARA CUBIN, Wyoming               BART GORDON, Tennessee
JOHN SHIMKUS, Illinois               PETER DEUTSCH, Florida
HEATHER WILSON, New Mexico           ANNA G. ESHOO, California
CHARLES W. ``CHIP'' PICKERING,       BART STUPAK, Michigan
Mississippi                          ELIOT L. ENGEL, New York
VITO FOSSELLA, New York              ALBERT R. WYNN, Maryland
CHARLES F. BASS, New Hampshire       GENE GREEN, Texas
MARY BONO, California                JOHN D. DINGELL, Michigan,
GREG WALDEN, Oregon                    (Ex Officio)
LEE TERRY, Nebraska
W.J. ``BILLY'' TAUZIN, Louisiana
  (Ex Officio)

                                  (ii)















                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Atkinson, Robert C., Director of Policy Research, Columbia 
      Institute for Tele-Information.............................    17
    Bath, Blake, Managing Director, Lehman Brothers, Equity 
      Research...................................................    24
    Brodeur, Stephen B., President, Cambridge Strategic 
      Management Group...........................................    27
    Crandall, Robert W., Senior Fellow, The Brookings Institute..    30
    Strumingher, Eric, Investment Analyst, Cobalt Capital........    42

                                 (iii)














 HEALTH OF THE TELECOMMUNICATION SECTOR: A PERSPECTIVE FROM INVESTORS 
                             AND ECONOMISTS

                              ----------                              


                      WEDNESDAY, FEBRUARY 5, 2003

              House of Representatives,    
              Committee on Energy and Commerce,    
                     Subcommittee on Telecommunications    
                                          and the Internet,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 1 p.m., in 
room 2123 Rayburn House Office Building, Hon. Fred Upton 
(chairman) presiding.
    Members present: Representatives Upton, Stearns, Gillmor, 
Cox, Whitfield, Shimkus, Wilson, Bass, Terry, Tauzin (ex 
officio), Markey, Davis, Gordon, Engel, Wynn, Green, and 
Dingell (ex officio).
    Staff present: Howard Waltzman, majority counsel; Will 
Nordwind, policy coordinator; Hollyn Kidd, legislative clerk; 
Jon Tripp, press; Gregg Rothschild, minority counsel; and 
Brendan Kelsey, minority professional staff.
    Mr. Upton. Before the Chair recognizes himself for an 
opening statement, I have a brief unanimous consent request 
that has been shared with all members of the subcommittee 
yesterday.
    As members may recall, there was a lengthy discussion about 
opening statements at our Energy and Commerce Committee 
organization meeting last week. Chairman Tauzin and Ranking 
Member Dingell discussed a possible committee rule change to 
address what are often very lengthy periods for opening 
statements.
    The following request is modeled after that discussion. I 
would ask unanimous consent that during the period for opening 
statements, and prior to the recognition of our first witness 
for testimony, any member may completely defer his or her 3-
minute opening statement, and instead of using the 3 minutes, 
transfer them during an initial round of witness questioning.
    By way of explanation, a couple of points. One, if a member 
comes after all opening statements have been completed, he or 
she will be just entitled to the normal 5 minutes of 
questioning. And, two, members may only defer their statement 
completely, all 3 minutes, or not at all. That is, they can 
deliver a 1-minute opening statement and then reserve 2 minutes 
for questioning--that doesn't happen. That won't happen. It is 
all or nothing.
    So is there discussion on the request? Hearing none, 
without objection, that will be the order, and the Chair thanks 
all members. And I will not waive my right to give an opening 
statement.
    I will only get 5 minutes.
    So good afternoon. I want to welcome everyone to the first 
hearing in the 108th Congress of the Telecommunications and 
Internet Subcommittee. I especially want to welcome our new 
members on both sides of the aisle. In addition, I want to 
especially recognize our able ranking member, Mr. Markey, and 
our vice chairman, Mr. Stearns, who is on his way. And I look 
forward to another productive 2 years.
    While I am glad that we are meeting today, I wish we 
weren't meeting under these circumstances. It has been said 
that the telecommunications sector used to be the propeller of 
our nation's economy, but it is now the heavy anchor weighing 
it down.
    The telecommunications sector has issued an SOS. The 
industry has lost more than half a million jobs and $2 trillion 
in market value. In addition, the sector is burdened by 
approximately $1 trillion in debt. And what I always considered 
industry giants in the telecommunications equipment 
manufacturing and infrastructure field--companies like Lucent, 
Nortel, Alcatel, Ericsson, Corning--they have suffered 
devastating layoffs and massive cuts in capital investment, and 
the news is no better elsewhere in the sector.
    For Verizon, capital expenditures declined from $17.3 
billion in 2001 to $11.9 billion in 2002. For SBC, capital 
expenditures dropped from $11.2 billion in 2001 to $6.8 billion 
in 2002. For Bell South, capital expenditures fell from $6 
billion in 2001 to $3.8 billion in 2002. For Qwest, capital 
expenditures dropped from $8.5 billion in 2001 to approximately 
$3 billion in 2002. Thus, the total decline in capital 
expenditures from 2001 to 2002, just by the RBOCs, was $17.5 
billion.
    The long distance carriers have also experienced a decline 
in capital expenditure. AT&T's capital expenditures declined 
from $5.8 billion in 2001 to $3.8 billion in 2002. Sprint 
declined from $5.3 to $2.2.
    Wireless companies have also experienced a significant 
decline in capital expenditures. In 2001, capital expenditures 
declined by 16.1 percent. In 2002, capital expenditures fell by 
more than 25 percent. For the whole sector, some estimate that 
the capital expenditures could decline an additional 30 percent 
in 2003.
    Of course, the dramatic decline in capital expenditures 
throughout the sector is bad news for the consumer, since it 
means less investment is flowing in for infrastructure to 
provide new services or upgrades of the services that they 
already have. The question is: how can we lift up the anchor 
and get the telecommunications sector propelled and under full 
steam?
    As I look at the evidence and speak with investment 
analysts and economists, I believe that the FCC's rules 
implementing the Telecommunications Act in 1996, particularly 
UNE-P and unbundling of new broadband facilities, have been a 
major contributor to the massive decline in investment in the 
telecommunications sector, particularly in facilities.
    Of course, all of the downstream telecommunications 
equipment manufacturers have suffered greatly as a result of 
this, too. So it is not just an ILEC versus a CLEC problem. As 
I mentioned earlier, the consumer is losing out, too, and all 
boats seem to be sinking with this receding tide.
    Now is the time for the FCC to act boldly and decisively to 
overhaul the regulations. Actions on the triennial review is 
due, and simply reshuffling the deck chairs on this sinking 
ship will not help.
    February 26 the subcommittee hopefully will hear from 
Chairman Powell and the commissioners about the state of the 
telecommunications economy, and we anxiously await their 
testimony, not to mention action on the triennial review in the 
meantime.
    Today we will hear from investment analysts and economists 
about the state of the economy, which will help us understand 
what we need to do to stem the tide of water rushing over the 
gunnels and turn that anchor back into the propeller of the 
nation's economy.
    I yield to my friend Mr. Markey for an opening statement.
    Mr. Markey. Thank you, Mr. Chairman.
    The telecommunications marketplace is in the doldrums. No 
one disputes that. It is not entirely surprising that this is 
the case, because the overall economy is in the doldrums as 
well. The promise, however, of our telecommunications sector is 
that it might help lift us out of the current recession, and 
analyzing what can be done to restock the telecommunications 
revolution is a worthy inquiry.
    Wireline competition for voice and data services, wireless 
competition from advanced mobile services to unlicensed Y-FI 
technologies, the development of increased competition and 
innovation from internet service providers, and competition in 
the video marketplace are all important areas where 
competition-based telecommunications policy can help to promote 
economic growth, create much needed jobs, drive innovation, and 
offer consumers choices.
    How to best start economic activity in this key sector of 
our overall economy is a question that may have multiple 
answers and suggestions. It would be helpful if the 
subcommittee is afforded an opportunity to hear from all such 
legitimate viewpoints. As brilliant as today's panelists are in 
their own fields and areas of expertise, there are equally 
brilliant men and women who may differ dramatically from the 
conclusions reached or suggestions offered by today's panel.
    For a variety of reasons, we were unable to get a broader 
cross-section of witnesses for the subcommittee hearing this 
afternoon, but my hope is that in the future the subcommittee 
will make a special effort to provide members of the 
subcommittee a balanced panel as is possible.
    The health of a marketplace sector can be measured in 
various ways, and one's assessment of marketplace well-being 
depends on what one considers optimum health. The workforce 
looks to job growth and reasonable wage increases over time. 
Consumers typically look to choice, service quality, and price. 
Investors often look to the bottom line--that is, 
profitability. Manufacturers like to have many outlets for 
their products unless, of course, they think they will win the 
contractor's supply long term, one dominant provider.
    Investor risk assessment of what is a healthy investment 
might put them at odds with consumers and workers. Dozens of 
companies engaging in fierce competition with other lower 
prices is what the vast majority of consumers look for. But for 
investors, that kind of competition may not be good for 
investment, because it is a highly competitive marketplace, 
often with low profitability.
    I think that prior to proposing myriad solutions to a 
problem it is useful to identify clearly and convincingly the 
problems we propose to remedy. So what is the problem? Is there 
insufficient competition? Are there too many regulations on the 
incumbent Bell companies?
    Are the subsidies in the system for supporting universal 
service bloated and unnecessary? Or do we need more subsidies 
to encourage deployment of certain broadband technologies? Do 
current FCC regulations need to be modified, or should they 
simply be eliminated? Is our nation's immediate 
telecommunications policy goal deregulation or, rather, 
demonopolization?
    The challenge for telecommunications policymakers for many 
years has been to reform telecommunications statutes and rules 
in a way that substitutes a sound competitive policy framework 
consistent with the public interest, for a hitherto monopoly 
provided services and rules by which such monopolies were 
regulated and safeguarded from competition.
    I believe a competition-based policy is preferable, because 
it maximizes consumer choice, job creation, technological 
innovation, and service quality, and price reductions.
    Last Congress the subcommittee heard testimony from Mr. 
James Henry, managing partner of Greenfield Hill Capital, who I 
think captured part of the problem very succinctly. He said, 
``It is my observation, as an industry analyst, that the 
investment community's willingness to fund telecom companies in 
general, and CLECs in particular, is adversely impacted by 
legislative and regulatory uncertainty.''
    Since passage of the Telecommunications Act, we have 
certainly seen ample uncertainty, through legal challenges to 
implementing rules, constitutional challenges to the act 
itself. My recommendation would be to abide by a sort of 
telecommunications Hippocratic oath. First, do no harm.
    Thank you, Mr. Chairman. I look forward to hearing from the 
witnesses.
    Mr. Upton. Thank you, Mr. Markey.
    Mr. Tauzin?
    Chairman Tauzin. Thank you, Mr. Chairman.
    Let me first join with so many others who asked for prayers 
and thoughts for the families of the shuttle Columbia who lost 
their lives this weekend. We are actually going to reverse our 
schedules tomorrow that we can all mourn together, and I think 
it is important in every one of our hearings that we remember 
them again and particularly in our prayers.
    Mr. Chairman, this is an important hearing. The fact of the 
matter is that whoever you use for service providers in this 
area have been shrinking, and capital expenditures by the same 
service providers have been plummeting. The numbers are 
astounding. The capital expenditures for the four baby Bells, 
for example, dropped $17.5 billion from 2001 to 2002. And the 
reduction in those expenditures doesn't just mean less, you 
know, new services to be offered consumers or better systems to 
offer those new services on. It means that the equipment 
manufacturers are literally in the dumps.
    The U.S. high tech equipment manufacturing base, in fact, 
is dying. Companies have laid off hundreds of thousands of 
employees, and they have idled many plants that used to be the 
economic backbone of their communities.
    For example, Lucent, which employed 150,000 people in 1999, 
now plans to cut its workforce by 35,000 by the end of this 
year. And Corning has been forced to idle four of its five 
fiber optic plants. And, frankly, I am tired of seeing the 
distressed look of our colleague Amo Houghton when I meet him 
on the floor.
    They can't afford to starve much longer, or they are gone. 
And it doesn't take an economic genius to figure out what is 
wrong here. All you have to know is that when you have rules in 
place that tell an incumbent telephone company, ``If you build 
new facilities, your competitors can use them to steal your 
customers,'' and tells the competitor, ``It is better for you 
to park your facilities, not use your own switches, because it 
is cheaper under the Federal rules to use the incumbent 
telephone company's facilities.''
    Now, common sense tells you that when you have rules like 
that in place that disincentivize the investment into new 
facilities by the incumbents, and actually create a condition 
with those who compete against those incumbents, who have built 
their own facilities, no longer use them because it is cheaper 
to use at the subsidized rates the facilities of the incumbent 
companies, but none of them have an incentive to invest in new 
facilities. The incumbents won't invest, the challengers won't 
invest, and the equipment manufacturers die on the vine.
    Now it doesn't take an economic genius to figure that one 
out. And the first step this FCC ought to take is to rip the 
rules that were put in place by Al Gore and Reed Hunt out by 
the roots and throw them away. At the very least, our 
Republican members of the FCC should run a wholesale change in 
the regulatory approach that was taken by Al Gore and Reed 
Hunt.
    The FCC needs today to show some real leadership and 
vision. The so-called UNE-P rules ought to be abolished. New 
facilities, especially fiber, should not be subject to 
unbundling rules. We ought to create an incentive for the 
incumbents to lay out that fiber and connect up America, and we 
ought to create an incentive for those who want to compete 
against them to build their own facilities, rather than to idle 
their facilities to you at subsidized government rates the 
facilities of their competitors.
    We make that simple change, and investments will grow 
again. Equipment manufacturers will come alive again, and the 
sector of our high-tech economy might stop starving to death.
    Mr. Chairman, thank you for holding this hearing today. I 
look forward to hearing the testimony of witnesses.
    [The prepared statement of Hon. W.J. ``Billy'' Tauzin 
follows:]
 Prepared Statement of Hon. W.J. ``Billy'' Tauzin, Chairman, Committee 
                         on Energy and Commerce
    Mr. Chairman, thank you for holding this important hearing today. 
The telecommunications sector has sunk into a state of economic 
malaise. Revenues for service providers have been shrinking. Capital 
expenditures by service providers have been plummeting. Capital 
expenditures for just the four Baby Bells dropped $17.5 billion from 
2001 to 2002.
    This has obvious implications for consumers because it means that 
service providers have less money to spend on making improvements to 
their current infrastructure and on deploying new equipment in order to 
offer advanced services.
    But the reduction in capital expenditures has much worse 
implications for equipment manufacturers. The U.S. high-tech equipment 
manufacturing base is dying. These companies have laid off hundreds of 
thousands of employees and idled many plants that were the economic 
backbones of their communities.
    Lucent, which employed 150,000 people in 1999, has announced plans 
to cut its workforce to 35,000 by the end of this year. Corning has 
been forced to idle four of its five fiber optics plants.
    These companies cannot afford to starve for much longer. While 
there are business and general economic reasons that affect capital 
expenditures, government policy does play a part, and the FCC's current 
unbundling regulations are killing these companies.
    Rules that require a company to share parts of its network, even 
new parts of its network, with competitors are perverse. These rules 
stifle investment by giving ILECs a disincentive to deploy new 
facilities. Why would you deploy new facilities when competitors can 
use that equipment to steal your customers?
    The FCC's current rules also provide a disincentive for CLECs to 
deploy their own facilities. Under the FCC's twisted scheme, it is more 
cost-efficient for a CLEC to use all of an incumbent's facilities than 
to deploy its own equipment. And the fact that neither the ILECs nor 
the CLECs have an incentive to deploy new facilities means one thing 
for equipment manufacturers--they will continue to lay off people and 
close plants important to many of our communities.
    Mr. Chairman, Michael Powell's FCC needs to rip the rules put in 
place by Al Gore and Reed Hundt out by the roots and throw them away. 
At the very least, our Republican FCC Commissioners should want a 
wholesale change to the overly-regulatory approach taken by Al Gore and 
Reed Hundt. The FCC must show leadership and vision in this area. The 
so-called UNE-P must be abolished and new facilities, especially fiber, 
should not be subject to the unbundling rules.
    Only through these changes will all companies have the proper 
incentive to invest in new facilities. And only through these changes 
will equipment manufacturers ever recover.
    Mr. Chairman, thank you again for holding this hearing today, and I 
look forward to hearing the testimony of our witnesses.

    Mr. Upton. Thank you, Mr. Chairman.
    Mr. Dingell?
    Mr. Dingell. Mr. Chairman, I thank you. Mr. Chairman, I 
commend you for holding this subcommittee's first hearing on 
the dismal state of our nation's telecommunications industry. 
This hearing is very badly needed and will serve a very useful 
purpose. Corrective action is needed now to restore vigor to 
this vital sector of our nation's economy.
    In the past 3 years, we have lost about 600,000 jobs 
amongst telecommunications carriers and equipment vendors. 
These were good, rewarding, and productive jobs. Many of them 
were union jobs. Capital investment is decreasing by tens of 
billions of dollars annually. In 2002 alone, there was a 
decline of roughly 47 percent in capital expenditures for the 
telecommunications industry. Without this investment, our 
ability to innovate and keep these high-paying manufacturing 
jobs in America over the long term is put at risk.
    Telecommunications companies and the equipment suppliers 
lost better than $2 trillion in value since March of 2002. 
Millions of retirees and pensioners have been left with fewer 
assets to tend to their needs as they grow older. Bankruptcies 
litter the telecommunications landscape. Although the economic 
toll is great, the human toll may even be greater.
    Last year we in the House did our part to revive the 
telecommunications sector. By nearly a two to one margin, we 
passed the Tauzin-Dingell bill to facilitate and to accelerate 
the deployment of broadband services to all Americans. That 
legislation, had it been enacted, would have reversed the cycle 
of disinvestment and created proper regulatory frameworks for 
new investment in broadband networks.
    The high tech industry has made it clear that in filings 
before the FCC, and in numerous public statements, that 
liberating the last mile to the home from the outdated and 
unsuited old telephone network is critical to unlocking 
investment in broadband infrastructure and services. Our bill 
did exactly that, while preserving access of internet service 
providers to these networks.
    Unfortunately, the bill died in the Senate, and opportunity 
was lost. Precious time has been wasted, and the American 
people have suffered. The state of the industry tends to show 
that it was an unwise act by the Senate.
    But another opportunity lies now in front of us. The FCC 
has five major pending proceedings before it, the outcomes of 
which have the potential to reshape the telecommunications 
industry, and I believe in a desirable way. The most imminent 
of these decisions involves reexamination of the obligation of 
incumbent local exchange carriers to unbundle their network 
elements and to provide them to competitive local exchange 
carriers at wholesale rates.
    Last week I joined Chairman Tauzin, subcommittee Chairman 
Upton, and 19 other members of this committee in sending a 
letter to Chairman Powell outlining our reviews regarding key 
aspects of the Commission's triennial review. I would counsel 
the FCC to read that letter with great care. I also would ask 
unanimous consent that it be inserted in the record following 
my statement.
    Mr. Chairman, let me reiterate a few key points. First, it 
is time to abolish the UNE platform or UNE-P method of resale. 
It is a curious, and, indeed, bizarre invention of the 
Commission that subverted both the language and the clear 
intent of the 1996 Telecommunications Act. Perhaps more than 
any other failing of the Commission in implementing the 1996 
Act--and its failings have been very many--UNE-P has been 
destructive of the capital and infrastructure investment in the 
telecommunications sector.
    Second, as a part of its statutory and court-mandated 
analysis of the network elements that must be unbundled, the 
Commission should conclude that there is no ILEC obligation to 
provide unbundled access to fiber loops and sub-loops used for 
the transmission of packet-based services. Such a rule would 
open the door to new investment in broadband networks, enabling 
consumers to reap the benefits of high-speed internet services.
    Finally, the FCC must discharge its clear responsibilities 
under the 1996 Act, which do not permit it to defer to the 
States as it undertakes its review of which network elements 
must be provided on an unbundled basis. This is a defining 
moment for the Commission.
    The committee can help the Commission to understand that 
fact. It can put us back on the road to facilities-based 
competition. It can reconfigure the regulatory environment to 
provide incentives for investment in equipment and 
infrastructure. Now is the time for decisive Commission action. 
If the Commission fails, then the Congress must act.
    Mr. Chairman, I commend you for the hearing, and I thank 
you for this opportunity to present this statement.
    [The letter follows:]

                      U.S. House of Representatives
                           Committee on Energy and Commerce
                                                   January 29, 2003
The Honorable Michael K. Powell
Chairman
Federal Communications Commission
445 12th Street, S.W.
Washington, DC 20554
    Dear Chairman Powell: We ask that you take prompt action to change 
misguided regulations that have badly distorted important 
telecommunications policies. As we first made clear with our colleagues 
in our letter of September 12, 2002, Congress intended the 
Telecommunications Act of 1996 ('96 Act) to promote choice and 
competition for local exchange and other services--ultimately through 
facilities-based competition. In this respect, the implementation of 
the '96 Act by the Federal Communications Commission (FCC) has been a 
failure. Rather than fostering facilities-based competition, the FCC's 
local-competition rules have encouraged competitive local exchange 
carriers (CLECs) to rely exclusively on networks owned and operated by 
incumbent local exchange carriers (ILECs) to provide services to 
residential consumers. These policies subvert the intent of the '96 Act 
and must be reversed.
    The '96 Act prescribed three methods of competitive entry for 
CLECs: reselling an ILEC's service, using a CLEC's facilities 
exclusively, and using a CLEC's facilities in combination with an 
ILEC's facilities through the purchase of unbundled network elements 
from the ILEC. However, the FCC distorted the '96 Act's requirements to 
manufacture a fourth method of entry by creating the unbundled network 
element platform or UNE-P--in essence a back-door way of forcing the 
ILECs to resell the entire local phone service. To further exacerbate 
the problem, the FCC developed a pricing model for the UNE-P that is 
based on a hypothetical cost model rather than on actual operating 
costs. The hypothetical model permits CLECs to lease network elements 
at a price that is lower than what it cost ILECs to purchase and 
maintain the elements.
    As a result, the FCC created a regulatory fiction that provided 
CLECs with a disincentive to invest in their own facilities. No 
competing carrier has an incentive to risk capital and invest in its 
own facilities when it can simply lease an ILEC's network elements at 
below-cost prices and resell the service. Recent FCC data has confirmed 
the absurdity of this policy. According to the FCC's 2002 Local 
Competition Report, the number of customers served by CLECs using UNE-P 
increased from approximately 500,000 in 1999 to 7.5 million at the end 
of June, 2002.1 Ironically, AT&T and Worldcom, which are 
reported to have more than one million UNE-P customers in New York 
state, operate at least 28 local circuit switches in New York, but do 
not use the switches to provide local service to these 
customers.2
---------------------------------------------------------------------------
    \1\ In contrast, the number of customers served by CLECs using 
their own switching increased from approximately 1 million in 1999 to 4 
million at the end of June, 2002. In addition, the number of customers 
served by CLECs reselling an ILEC's service declined from approximately 
4.5 million in 1999 to 3.5 million at the end of June, 2002.
    \2\ Telecordia, Local Exchange Routing Guide (LERG), January 2002.
---------------------------------------------------------------------------
    There is no question that the '96 Act contemplated that a CLEC 
would be permitted to use elements of an ILEC's network in combination 
with elements of the CLEC's network. But the UNE-P is a regulatory 
fiction that must be eliminated.
    In addition, in the context of the Triennial Review, the FCC must 
produce a sensible national policy regarding which network elements 
meet the '96 Act's stringent ``necessary and impair'' analysis and, 
therefore, must be provided on an unbundled basis. Delegation of that 
determination to the states would be a gross abdication of the FCC's 
statutory responsibility and a clear violation of the law.
    Section 251(d)(1) of the Communications Act, as amended by the'96 
Act, requires the FCC, not the states, to ``complete all actions 
necessary to establish regulations to implement the requirements of 
this section,'' including the determination of which network elements 
must be made available on an unbundled basis. Section 251(d)(2) 
requires the FCC to determine, for network elements that are not 
proprietary in nature, ``whether the failure to provide access to such 
networks elements would impair the ability of the telecommunications 
carrier seeking access to provide the services that it seeks to 
offer.'' While Section 251(d)(3) permits the preservation of state 
access regulations, such regulations cannot ``substantially prevent 
implementation of the requirements of this section and the purposes of 
this part.'' Thus, if the FCC determines that the lack of access on an 
unbundled basis to a particular network element would not constitute an 
``impairment'' under Section 251(d)(2), any state regulation that 
required unbundled access to that element would violate Section 
251(d)(3).
    The FCC, therefore, must engage in a rigorous analysis to justify 
why ILECs should be required to unbundle network elements, and a 
conclusion by the FCC that an element does not have to be unbundled 
cannot be contradicted, ignored, or overruled by state regulations. As 
the FCC conducts this analysis, there are particular elements that 
should not have to be provided on an unbundled basis in accordance with 
Section 251(c)(3).
    For example, circuit switching should not have to be provided by an 
ILEC on an unbundled basis, with the possible exception of an extremely 
limited number of remote and rural areas.3 More than 200 
CLECs operate approximately 1,300 local circuit switches.4 
According to the National Cable and Telecommunications Association, by 
June 30, 2002, cable companies were providing telephone service to 
approximately 2.1 million subscribers, primarily over their own 
switches. How could the FCC determine that a CLEC would be impaired if 
it did not have access on an unbundled basis to an ILEC's circuit 
switch when thousands of such switches are being self-provisioned by 
hundreds of CLECs serving millions of customers?
---------------------------------------------------------------------------
    \3\ Packet switching should also not have to be provided on an 
unbundled basis. The FCC in the UNE Remand Order already acknowledged 
the pervasive deployment of packet switching by CLECs and declined to 
require packet switching to be unbundled except in limited 
circumstances. Given the even greater CLEC deployment of packet 
switching today, the FCC should eliminate the unbundling requirement 
for packet switching in all circumstances.
    \4\ Telecordia, Local Exchange Routing Guide (LERG), January 2002.
---------------------------------------------------------------------------
    Nor should the FCC require ILECs to provide unbundled access to 
fiber loops and subloops used to transmit packet-based services. The 
telecommunications manufacturing sector has been devastated by the 
dramatic decline in capital spending by telecommunications carriers and 
broadband service providers. While capital spending has declined for 
several reasons, the FCC's requirement that ILECs provide access on an 
unbundled basis to new facilities is one of the primary reasons why 
ILECs have reduced their capital investment. We cannot expect ILECs to 
invest in and deploy new facilities when they are required to share 
such facilities with competitors at below-market prices. Moreover, the 
pervasive deployment of fiber loops and subloops would dramatically 
improve the types of services that consumers could access at home and 
at work. While access to broadband services transmitted over copper 
loops has increased over the past several years, such services pale in 
comparison to the types of capabilities that consumers could enjoy if 
fiber accounted for a greater portion of so-called last-mile 
facilities. Our nation's consumers deserve no less. In addition, 
telecommunications equipment manufacturers need the ``shot-in-the-arm'' 
that would accompany massive investment in fiber deployment by ILECs.
    The FCC's impairment analysis regarding fiber loops and subloops 
should support a conclusion that such facilities should not be subject 
to the unbundling requirement. The FCC's impairment analysis must take 
into consideration the fact that ILECs do not enjoy an advantage over 
CLECs with respect to investment in new facilities. The tens of 
billions of dollars that cable companies have invested to deploy fiber-
based facilities throughout their networks demonstrates that investment 
made after the enactment of the '96 Act requires a different impairment 
analysis than facilities that have been deployed by ILECs for decades. 
Not surprisingly, the cable companies have made this investment in the 
absence of the unbundling regulations currently imposed on ILECs.
    Mr. Chairman, your agency faces a tremendous responsibility. The 
future of the U.S. telecommunications equipment manufacturing base will 
be greatly affected by the outcome of the Triennial Review. You have an 
opportunity to remove regulatory impediments to investment in new 
networks and to facilities-based competition. The current rules have 
greatly undermined the achievement of these important goals. We 
strongly urge you to reshape the FCC's existing framework and put the 
telecommunications sector on a path to increased investment and greater 
facilities-based competition.
    We look forward to your response to our correspondence and to you 
and your fellow commissioners testifying before the Committee on Energy 
and Commerce's Subcommittee on Telecommunications and the Internet in 
the coming weeks.
            Sincerely,
W.J. ``Billy'' Tauzin, Fred Upton, Joe Barton, Nathan Deal, Richard 
  M. Burr, John M. Shimkus, Vito Fossella, Roy Blunt, Steve Buyer, 
George Radanovich, Greg Walden, Charles Bass, Mary Bono, Lee Terry, 
John D. Dingell, Rick Boucher, Edolphus Towns, Bobby L. Rush, Eliot 
                  Engel, Albert Wynn, , Gene Green, and Chris John.
cc: Commissioner Kathleen Abernathy
   Commissioner Jonathan Adelstein
   Commissioner Michael Copps
   Commissioner Kevin Martin

    Mr. Upton. Thank you great gentlemen from the State of 
Michigan.
    Mr. Shimkus?
    Mr. Shimkus. Well, Mr. Chairman, I would be the first one 
to waive my opening statements and claim 3 minutes for 
questions.
    Mr. Upton. Done.
    Mr. Whitfield?
    Mr. Whitfield. I would like to waive my opening statement.
    Mr. Upton. Mr. Stearns?
    Mr. Stearns. Mr. Chairman, I want to exercise----
    Mr. Upton. The gentleman is recognized for 3 minutes.
    Mr. Stearns. Thank you, Mr. Chairman. And I commend you for 
having this hearing.
    I was part of the Telecom Conference Committee when we 
passed the Communications Act and saw the possibilities, and I 
think for a while there we thought that it was working. And, of 
course, recently we have seen a lot of nosedive in businesses 
and bankruptcies, and capital investment has come down.
    But I submit that part of this is just the normal business 
cycle, and also I submit that part of this is dealing with the 
Financial Accounting Standards Board. As chairman of that 
subcommittee with jurisdiction over that, I feel a lot of what 
happened was an overextension of capital, and a lot of these 
companies that went into bankruptcy were cooking the books. So 
you can't stop people from cooking the books unless you have an 
accounting standard which is transparent, which we don't have.
    And I submit, Mr. Chairman, that we still need more 
transparency with the financial accounting standard. But I 
think you and the full committee chairman have touched on a 
very important aspect about this whole problem, and that is the 
regulatory uncertainty, and I am sure some of the witnesses 
will bring that out.
    Perhaps the Act, when it was implemented, created a 
regulatory morass of rules and procedures that are overreaching 
and bureaucratic and unnecessary, so that would be good to find 
out if that is true today. There is a number of things that the 
FCC could do, and I hope they will do.
    Mr. Chairman, I have always submitted, and I think Chairman 
Tauzin would agree, that if we could get more spectrum for 
third generation wireless, that would be an impact, enormous 
impact for the telecommunications industry by freeing up the 
analog, the UHF on the video--the television, to give them that 
third spectrum--that spectrum for the third generation.
    And, second, if we could iron out the additional content 
rules so that high definition television could start to 
explode. And, third, if broadband could be more available to 
all the public, so that, in fact, instead of an ISDN line or a 
DSL line or a 56K modem, you had broadband, a million or 2 
million kilobits per second.
    Now, you would leave your computer on. You would be able to 
download videos, pay for them, download CDs, and there would be 
an enormous increase in productivity in America. So third 
generation wireless, high definition television, and broadband 
are three of the areas that I think would help. And regulatory 
uncertain in this area would be helpful if the FCC would move 
to alleviate that problem.
    I will conclude by saying that in a capitalistic system 
like we have we can expect up and downs, and I think the market 
will come back. And, obviously, I think the government should 
get out of the way and let industry have the opportunity to do 
so.
    And I thank you, Mr. Chairman.
    Mr. Upton. Thank you, Mr. Stearns.
    Mr. Wynn?
    Mr. Wynn. Thank you, Mr. Chairman. I appreciate the trend 
that seems to be evident of members waiving, and I also 
appreciate the chairman's wisdom in giving us the option to 
defer. And so I will take advantage of that at this point. 
Thank you.
    Mr. Upton. Thank you.
    Mr. Gordon?
    Mr. Gordon. I will also defer, so we can get on and listen 
to our witnesses. thank you.
    Mr. Upton. Mr. Gillmor?
    Mr. Gillmor. Thank you, Mr. Chairman, and I will be brief.
    You know, what a tremendous difference just a little bit of 
time makes. A few years ago telecom stocks were going through 
the ceiling. Profits were strong, and all departments were 
talking about the endless growth in telecom. Employment was 
high.
    Then, everything hit the wall, and revenues actually 
declined for a lot of companies, and they still are. There are 
billions of dollars of investment lost, very little investment, 
very little now in equipment, and for those affected worst of 
all, there were tens of thousands of people laid off probably 
permanently.
    So I guess what I would hope we would have--I would like to 
let them answer--the panelists answer the questions that have 
been raised on the FCC rule as it affects the regional 
telephones and what impact that has had on investment and will 
have in the future. But also, I would like to know whether this 
group thinks something has fundamentally changed in telecom. Is 
it still a growth industry, or are we going to see kind of a 
stable--more of the same for the next couple of years?
    So those are the kind of things hopefully that will be 
developed. I do have a statement that I would ask go into the 
record in addition to what I have just said. And with that, I 
will waive back, Mr. Chairman.
    [The prepared statement of Hon. Paul E. Gillmor follows:]
  Prepared Statement of Paul E. Gillmor, a Representative in Congress 
                         from the State of Ohio
    I thank the Chairman for the opportunity to address the health of 
the telecommunications sector, as well as providing an environment in 
which Members are offered the chance to learn more about and discuss 
this important subject without any kind of commitment to supporting or 
opposing specific legislation.
    Over the years, this subcommittee has been active in keeping pace 
with the high-speed developments in the private sector. However, we 
must also give special attention when the telecommunications industry 
is facing difficulty. There is no question that this sector is 
experiencing a decline in business and investment. With the lack of new 
infrastructure, equipment suppliers suffer, as do service providers and 
their employees, further stunting research and development. Ultimately, 
this slows consumer spending and demands for telecommunications 
services.
    Keeping this scenario in mind, I look forward to hearing from the 
expert witness panel of investors and economists, and in particular, 
any feedback regarding potential regulatory solutions, such as the 
Federal Communication Commission's (FCC) upcoming unbundled network 
element (UNE) Triennial Review.
    In my home state of Ohio, incumbent local exchange carriers (ILECS) 
employ thousands and serve many more. In my rural district in Northwest 
Ohio, one incumbent local phone company employs 325 employees, serving 
138,000 of my constituents. They, along with others, have consistently 
conveyed their concerns regarding competitors' exclusive reliance on 
their networks, preventing facilities-based competition. They are also 
troubled by the potential regulation of voice services into an already 
competitive broadband market. I also share their concerns, and feel 
that this hearing is certainly a step in the right direction, as 
Congress should continue to focus on spurring growth within the 
telecommunications sector.
    As we all are aware, there is a great deal of controversy with 
respect to the deployment of broadband services. This complex issue has 
divided Congress and the American people, as well as polarized segments 
of the telecommunications industry. However, we also know that 
broadband deployment is essential, especially in rural America. 
Communities equipped with broadband technology provide an environment 
conducive to encouraging economic growth by attracting new business, 
residents, knowledge, and jobs.
    Again, I thank the Chairman and yield back the remainder of my 
time.

    Mr. Upton. Thank you.
    Mrs. Wilson?
    Mrs. Wilson. Thank you, Mr. Chairman. I would ask unanimous 
consent that at the appropriate point in the record to include 
a piece of research by J.P. Morgan, U.S. Equity Research, and 
it is entitled ``Communications Equipment: Potential FCC 
Ruling,'' and it is dated January 16, 2003.
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    In addition to that, I would have some questions that I 
would like to have submitted for the record if--in the 
eventuality that I am not here at the time that you come to me.
    Mr. Upton. Without objection.
    Mrs. Wilson. Thank you, Mr. Chairman. And with that, I look 
forward to hearing the witnesses.
    Mr. Upton. Thank you.
    Mr. Terry? Mr. Terry defers.
    Okay. The experiment worked. Congratulations.
    [Additional statement submitted for the record follows:]
Prepared Statement of Hon. Barbara Cubin, a Representative in Congress 
                       from the State of Wyoming
    Thank you, Mr. Chairman.
    I would like to thank you all for coming Today to share your views 
on the health of the telecommunications sector.
    As experts on economics and financial markets, I look forward to 
hearing your testimony.
    As you know, since the passage of the Telecommunications Act of 
1996, we have seen a great deal of change in how these important 
services affect our country; from home and work, to security and 
defense, and as an engine helping drive our economy.
    Hindsight has shown us that there is a close correlation between 
the economic boom of the late 1990's, and the passage of this act. 
Today, however, we are witnessing a steep decline in capital 
expenditures by the telecom sector which appears to be having a 
substantial effect on the health of the economy. Now that this act is 
reaching a point of maturity, we need to ascertain what barriers exist 
to maximizing the benefits customers receive while giving companies a 
firm, clear and dependable regulatory environment to compete in.
    In this hearing I would like to learn your opinions about these 
barriers: are they regulatory in nature? Can congress address them? Or 
are they simply manifestations of the business cycle? In short, we must 
find the cause and fix it before it's too late. With equipment 
manufacturers downsizing and investment in new technology stalled, we 
need to exhaust our options as a Congress, if necessary, to right the 
ship and achieve the true intent of the Telecommunications Act.
    An important issue to me is the closing of the gap between rural 
and urban service. Representing a rural state, I know firsthand how 
important telecommunications are to Wyoming residents. They are a 
lifeline. Often with hundreds of miles separating cities, our phone 
lines allow us to connect to our neighbors, the Internet, and 
participate in the global economy, and do so while living in our 
rugged, frontier state. Unfortunately, rural America lags behind the 
rest of the country in comprehensive choices and innovative 
telecommunications solutions. I would like to see that changed.
    I do understand that there are inherent costs in serving rural 
markets that don't exist in other places. Nevertheless, it is important 
to ensure that any legislative solution or regulatory approach that is 
taken keep these real and serious concerns in mind.
    I look forward to hearing your testimony and welcome you to the 
Subcommittee.

    Mr. Upton. We are delighted to have a panel of outstanding 
witnesses today, and we will be led off by Mr. Robert Atkinson, 
Director of Policy Research-CITI, from Columbia University; Mr. 
Blake Bath, Managing Director of Lehman Brothers, Equity 
Research; Mr. Steve Brodeur, President of Cambridge Strategic 
Management Group; Mr. Robert Crandall, Senior Fellow of The 
Brookings Institute; and Mr. Eric Strumingher, Investment 
Analyst for Cobalt Capital.
    And, gentlemen, we appreciated getting your testimony in 
advance. It is all made part of the record in its entirety, and 
I would like to limit your opening remarks to 5 minutes. And we 
will start with Mr. Atkinson. The time is yours. Welcome.

STATEMENTS OF ROBERT C. ATKINSON, DIRECTOR OF POLICY RESEARCH, 
   CITI, COLUMBIA UNIVERSITY; BLAKE BATH, MANAGING DIRECTOR, 
     LEHMAN BROTHERS, EQUITY RESEARCH; STEPHEN B. BRODEUR, 
  PRESIDENT, CAMBRIDGE STRATEGIC MANAGEMENT GROUP; ROBERT W. 
  CRANDALL, SENIOR FELLOW, THE BROOKINGS INSTITUTE; AND ERIC 
        STRUMINGHER, INVESTMENT ANALYST, COBALT CAPITAL

    Mr. Atkinson. Good afternoon, Mr. Chairman and members of 
the subcommittee. My name is Robert Atkinson. I am currently 
Director of Policy Research at the Columbia Institute for Tele-
Information, CITI, at the Columbia Business School in New York.
    I am appearing here today in my personal capacity rather 
than on behalf of CITI, and I am bearing all the expenses of 
being here. And I am glad to do so.
    From 1985 to mid-1998, I was responsible for the regulatory 
and public policy matters of Teleport Communications Group, 
TCG, which was the first, and certainly by current standards 
the most successful CLEC. TCG, I should note, was very much a 
facilities-based CLEC. I was personally and deeply involved in 
all of the legal and regulatory policy battles that shaped the 
first 13 years of local competition. It started well beyond 
1996.
    In addition, and after a decade as a private company, I 
helped to take TCG public in mid-1996 and saw how much investor 
sentiment shapes the evolution of a business. Shortly after TCG 
was acquired by AT&T in mid-1998, I had the good fortune of 
being recruited to be a deputy chief of the FCC's Common 
Carrier Bureau.
    I developed the greatest respect and sympathy for the FCC 
during my 18 months at the agency. The Commission was, and 
still is, attempting to implement an ambiguous statute, the 
Telecom Act of 1996, while the view of the industry was, and 
still is, changing more quickly than regulatory due process and 
agency workload can possibly accommodate.
    One obvious problem was that there was little or no 
experimental evidence for the Commission to evaluate, just 
endless speculation, hypothesis, and rhetoric. I should also 
note that during the very good times of the telecom boom there 
seemed to be very little concern among the parties petitioning 
the FCC about the fundamental health of the telecom industry or 
whether any of the decisions the FCC was taking might have a 
fundamentally adverse impact on the industry's health in the 
future.
    So what about the health of the telecom sector, and what is 
the impact of regulation on that health? Briefly, as we have 
obviously heard this morning, the overall health industry is 
poor, but it is slowly improving. Clearly, some companies are 
in critical condition and may not recover, and it is too soon 
to predict when or if there will be full recovery from any 
others. It is also too soon to know precisely how much 
regulation has contributed to the meltdown, although I am sure 
it is probably--it was a contributing factor.
    It is worthwhile to note that the telecom meltdown was a 
simultaneous worldwide event, and that each country has 
different laws and regulations and different degrees of 
regulation. I suppose it is possible that the simultaneous 
nature of the meltdown around the world was just coincidence 
and that the U.S. meltdown, in fact, could be largely 
attributable to the peculiarities of U.S. regulation.
    However, it is more likely that regulation played a 
relatively minor role, and that other common factors, such as 
the laws of physics and the laws of human nature, which are the 
same in all countries, are more responsible.
    CITI is in the midst of getting to the bottom of your 
questions that you have asked us to address. With a grant from 
the Alfred P. Sloan Foundation and supporting grants from a 
cross-section of the telecom industry, CITI has embarked on a 
year-long project entitled ``Remedies for Telecom Recovery.''
    While our research and recommendations are far from 
complete, I believe that my CITI colleague, Professor Eli Noam, 
has put his finger on the reason for the poor health of the 
telecom sector. He summed it up simply in just two words: 
fundamental volatility. If the telecom industry has entered a 
period of chronic volatility, which is brand-new, we have never 
had this volatility before, boom-bust cycles will become the 
norm rather than just a one-time aberration.
    As we have discovered over the past 2 or 3 years, telecom 
managers, investors, and regulators have few tools and little 
or no experience in dealing with the uncertainties of a 
volatile boom and bust. Deer in the headlights is an apt 
description of how industry, government, and investors reacted 
to the meltdown. We need to do better than be a herd of deer 
next time.
    One thing we can do is minimize some of the volatility. 
Professor Noam has suggested, for example, that price cap 
formulas could include automatic price inflaters that kick in 
during downturn, and wholesale prices and interconnection 
charges could be changed to distribute these additional 
revenues throughout the sector.
    Some changes in policy might also minimize the severity of 
the next downturn, since some policies are--probably have 
contributed to the volatility that we are currently 
experiencing. It is certainly conventional wisdom that the 
Telecom Act contributed to the telecom boom, but it is 
important to note that the euphoria affected totally 
unregulated sectors. So the connection between the boom and the 
Telecom Act may not be as direct as some thing.
    More certainly, the Telecom Act contributed to the bust. 
First, it inhibited the experimentation that can reduce risk in 
the first place and make recovery faster and more effective. 
Simultaneously, the Act created a legal and policy gridlock 
that spooked investors and prevented regulators from responding 
more effectively to the downturn.
    The gridlock comes from the micromanagement inherent in the 
Act, which took away the FCC's freedom to adjust policies in 
the light of unexpected or changed circumstances such as the 
rapid development of the internet or a monumental bust in 
investor confidence.
    My co-management also provides fertile ground for endless 
due process, so that every FCC decision seems to lead not to 
finality but to litigation, where fundamental decisions are 
made not by an expert agency but by judges and their law 
clerks.
    Mr. Upton. Mr. Atkinson, I am sorry to say your 5 minutes 
is up, so----
    Mr. Atkinson. It goes so quickly.
    Mr. Upton. We will come back to you.
    Mr. Atkinson. Thank you very much.
    Mr. Upton. Very well. Thank you.
    [The prepared statement of Robert C. Atkinson follows:]
Prepared Statement of Robert C. Atkinson, Director of Policy Research, 
                Columbia Institute for Tele-Information
    Good afternoon, Mr. Chairman and Members of the Subcommittee.
    Thank you for inviting me to testify this afternoon on the health 
of the telecommunications industry despite the fact that I am neither 
an investor nor an economist. Rather, I am a telecom lawyer and the 
Director of Policy Research at the Columbia Institute for Tele-
Information (CITI) at the Columbia Business School in New York.
    I should note, however, that I am appearing today in my personal 
capacity rather than as a representative of CITI and that I am 
personally bearing all the expenses associated with this testimony.
    My personal involvement in the development of local competition 
since 1985 shapes my view of the health of the sector and the impact of 
regulation on that health, so let me briefly review that experience to 
provide you with a context for my comments.
    Beginning in 1985, I was responsible for the regulatory and public 
policy matters at the Teleport Communications Group (TCG), which was 
the first and certainly, by current standards, the most successful 
CLEC. That put me personally right in the middle of the development of 
the state and federal local competition policies that laid the 
foundation for the Telecom Act of 1996.
    TCG was very much a ``facilities-based'' CLEC, deploying our own 
fiber optic networks and local switches in over 30 markets across the 
company. We wanted to control our own destiny for two reasons: first, 
we didn't expect our incumbent competitors to help us; and, second, we 
wanted to differentiate our services on non-price factors so that we 
wouldn't have to compete solely on the basis of price. I learned that 
it takes a long, long time to develop a viable CLEC business: there is 
no quick solution, just lots of blocking and tackling.
    TCG was a private company for its first ten years. Because private 
investors tend to be stingy with their capital, TCG had to be prudent, 
conservative and grow carefully. But private capital is also patient, 
which allowed TCG to pursue a longer term strategic vision rather than 
responding to the whims of public equity markets. Based on this 
experience, I was quite surprised to see that start-up CLECs were 
immediately ``going public'' in the late 90s to cash in on valuations 
based on ``comparables'' with mature ``incumbent CLECs'' such as TCG 
and MFS. It was the case of the irrational business plan meeting the 
irrational investor.
    But after ten years of conservative, steady development and sound 
financial performance under the discipline of private capital, TCG was 
ready to ``go public'' in mid-1996, shortly after the passage of the 
Telecom Act of 1996. The IPO ``road show'' and subsequent dealings with 
the investors and analysts gave me the opportunity to see ``up close'' 
how the Telecom Act affected institutional investors' willingness to 
invest in the CLEC sector.
    In the typical ``roadshow'' presentation, our Chairman and CFO gave 
a presentation on the company's background, strategy and solid 
financial performance. Then the prospective investor, instead of 
focusing on the fundamentals, would often turn to me and say ``what's 
up with this Telecom Act?'' A frequent investor concern was whether the 
Act would make it ``too easy'' for new entrants to get into the space 
being occupied by established CLECs such as TCG and MFS and whether 
unbundling would undercut the value of our existing investments. I 
couldn't answer those questions because the roadshow was conducted 
before the FCC's Local Competition Order of August of 1996 although the 
answer turned out to be ``yes.'' But after that Order was released, 
TCG's stock struggled for a time.
    The last chapter of the TCG story was its acquisition by AT&T in 
mid-1998, for about $12 billion in AT&T stock. The acquisition of TCG 
represented a quick way for AT&T to develop local networks capable of 
serving its large business customers, but it could do little for AT&T's 
``mass market'' consumer and small business customers.
    Fortunately for me, I was recruited to the FCC in late 1998 to be a 
Deputy Chief of the Common Carrier Bureau and, in order to comply with 
conflict-of-interest laws, was required to sell all of my telecom-
related investments at what turned out to be near the peak of the 
bubble. As they say, it is better to be lucky than smart.
    I developed the greatest respect and sympathy for the FCC during my 
18 months at the agency. The Commission was (and still is) attempting 
to implement an ambiguous statute--the Telecom Act of 1996--while 
dealing with an industry that was (and still is) changing more quickly 
than regulatory due process and agency workload can possibly 
accommodate. One problem I saw was that little or no experimental 
evidence was available for the Commission to evaluate--just endless 
speculation, hypothesis and rhetoric.
    I should also note that, during the very good times of the telecom 
``boom,'' there seemed to be little concern among parties petitioning 
the FCC about the fundamental health of the telecom industry or whether 
any FCC decisions might have a fundamentally adverse impact on the 
industry's health in the future.
    To complete my personal context, I commuted to the FCC from my home 
in New Jersey for 18 months--until mid-2000--when Eli Noam, the founder 
of CITI, offered me the much shorter commute to Columbia in New York. 
And I should add that I am the current Chairman of the North American 
Numbering Council (NANC), the FCC advisory committee concerned with 
managing the telephone numbering system.
    So, what about the health of the telecom sector? And what is the 
impact of current telecommunications regulation on the financial health 
of telecommunications companies?
    Briefly, the overall health of the industry is poor, but slowly 
improving. Clearly, some elements are in critical condition and may not 
recover at all and it is too soon to predict when or if there will be a 
full recovery for many.
    It is also too soon to know precisely how much regulation has 
contributed to the ill health, although I'm sure that it was a 
contributing factor. It is worthwhile to note that the telecom 
``meltdown'' was a simultaneous, world-wide event and that each country 
has different laws and regulations and different degrees of regulation. 
So, the simultaneous nature of the meltdown might be just a 
coincidence, and it might be possible that the U.S. meltdown could be 
largely attributable to the peculiarities of U.S. regulation. However, 
it is more likely that regulation played a relatively minor role and 
that other common factors--such as the laws of physics and the laws of 
human nature, which are the same in all countries--are responsible.
    CITI is in the midst of answering your questions. With a grant from 
the Alfred P. Sloan Foundation and supporting grants from a cross-
section of the telecom industry, CITI has embarked on a year-long 
project entitled ``Remedies for Telecom Recovery''.
    With the aid of advisory committees composed of experienced experts 
from academia, industry, government, unions and consumer organizations, 
we will be identifying the root causes of the telecom ``meltdown'' and 
developing practical and workable managerial, financial and public 
policy remedies. We expect to release a final report on our findings 
and recommendations in early October and we hope that our work will 
help this Subcommittee and other policy makers as well as telecom 
managers and investors.
    While our research and recommendations are far from complete, I 
believe that my CITI colleague, Prof. Eli Noam, has put his finger on 
the reason for the poor health of the telecom sector. He has summed it 
up simply in just two words: fundamental volatility.
    As Prof. Noam has pointed out, while business cycles are not new to 
many industries, in telecom they are a new phenomenon. Until recently, 
the network industry progressed in only one direction: up. Telecom used 
to be less volatile than the economy as a whole. It grew steadily, with 
long planning horizons hardly ruffled by the normal business cycle. But 
today, in sharp contrast, the fragmented telecom sector may well have 
become much more volatile than the overall economy: more like the 
office construction business, less like water utilities. And the reason 
for this is the basic cost characteristics of telecom industry have 
evolved to be more like office construction and less like water.
    Fortunately, the present downturn appears to be ending: there are 
signs that the industry has ``bottomed'' and that the survivors will 
begin to grow, albeit slowly and cautiously.
    So, the real challenge for the industry is what happens next? If 
the sector is just working through the consequences of a one-time boom 
and bust, then there really isn't much that anyone should do: we'll be 
back to the ``good ``ol days'' of steady growth and good health soon 
enough.
    But if Prof. Noam is correct, the telecom industry has entered a 
pattern of chronic volatility where boom-bust cycles will become the 
norm rather than an aberration.
    As we discovered over the past 2-3 years, telecom managers, 
investors and regulators have few tools and little or no experience to 
deal with the uncertainties of a volatile boom and bust. ``Deer in the 
headlights'' is an apt description of how industry, government and 
investors responded.
    If telecom has become a chronically volatile business, we need to 
do better than be a herd of deer: all the corporate strategies and 
cultures, all the investor expectations and all the laws and 
regulations that were premised on certainty and predictable growth will 
have to be changed, perhaps radically . . . and soon. This may require 
wrenching changes in processes, policies and people.
    Of course, we don't have much experience with volatility and 
uncertainty in telecom to make long-term predictions. And it is true 
that we are learning from the recent past.
    As a first step, we can and probably should try to minimize some of 
the volatility. For example, Prof. Noam has suggested that price cap 
formulas could be modified to provide for automatic price inflators 
that are triggered during a downturn, as a counter-cyclical measure. At 
the same time, wholesale prices would be lowered, also automatically, 
to distribute the additional revenues throughout the sector and to 
establish a safeguard against unfair retail prices.
    But if we fail to identify and then tame all the drivers of telecom 
volatility--which is not likely in such a complex business--we must 
expect considerable uncertainty to be with us into the foreseeable 
future and we must be prepared to quickly develop and adopt different 
management strategies, investor expectations, and laws and policies.
    There are many causes for the boom and bust. CITI's ``Remedies for 
Telecom Recovery'' project will attempt to catalog them and I'm sure 
that, in addition to volatility, the list will include the separate 
dot.com bubble, technological advances that increased capacity too 
quickly, flawed business plans, and fraud. I believe that the 
Telecommunications Act of 1996 contributed to the new volatility of the 
telecommunications sector and is therefore a contributing cause of the 
sector's current poor health.
    Specifically, the Telecom Act amplified both the boom and the bust. 
It is likely that the new law contributed to the telecom ``boom'' by 
encouraging investors to believe that there would be less risk and more 
reward from investing in the sector. (But it is important to note that 
euphoria affected totally unregulated sectors, so the connection 
between the boom and the Telecom Act may not be as direct as some 
think.)
    The Act contributed to the ``bust'' in two ways. First, it 
inhibited the experimentation that can reduce risk in the first place 
and can makes cures faster and more effective. Simultaneously, the Act 
created a legal and policy ``gridlock'' that spooked investors and 
prevented regulators from responding more effectively to the downturn.
    For all its well-meaning intentions about loosening the grip of 
government, the Telecommunications Act ended up centralizing all 
fundamental telecommunications policy in the Federal Communications 
Commission (FCC), effectively federalizing the 50 states with respect 
to local competition and preempting the judicially-supervised modified 
final judgment (MFJ) with respect to Bell entry into long distance. 
This centralization appeared to satisfy investors' desire for less risk 
and more reward by providing what turned out to be the illusion of 
greater ``certainty'' and ``predictability''. This change in investor 
sentiment made more capital available at less cost and that helped to 
fuel the boom.
    However, to assuage the concerns of the habitually warring and 
suspicious factions in the industry, the Telecom Act did not simply 
establish broad policy goals ``such as competition in all markets and 
less regulation--and then leave it to the FCC to achieve them. Rather, 
the statute itself sought to micromanage the implementation. 
Unfortunately, the result has been a legal gridlock that has, so far, 
thwarted achievement of the Act's fundamental objectives.
    As we know, the Act set numerous implementation deadlines, 
specified three pricing methodologies for ILEC-CLEC interconnection, 
established a detailed system for negotiating, mediating and 
arbitrating interconnection agreements, and imposed a 14-point 
checklist to be satisfied before a Bell could offer long distance 
services. There is nothing substantively wrong with these policies 
except that they took away much of the freedom of the implementing 
agency--the FCC--to adjust policies later in light of unexpected or 
changed circumstances . . . such as the rapid development of the 
Internet or a monumental ``bust'' in investor confidence.
    If the Act took flexibility from the FCC, it took even more from 
the States. With respect to local competition, it is useful to 
recognize that the Telecom Act was neither revolutionary nor 
innovative. Rather, the Act largely codified into national law and 
policy the results of many experiments conducted by State public 
utility commissions (PUCs) over the prior decade to introduce local 
competition.1
---------------------------------------------------------------------------
    \1\ Local competition (at least in the modern era) did not start 
with the Telecom Act. Rather, it started when the New York Public 
Service Commission, in mid-1985, issued a Certificate of Public 
Convenience and Necessity to Teleport Communications, proposing to 
provide local high-capacity private lines in New York City. By the 
early 1990's, many other PUCs had authorized ``Competitive Access 
Providers'' (CAPs) to provide unswitched local services. In so doing, 
the States had required ``central office collocation,'' later known as 
``collocation'' after the FCC ratified the various PUC decisions, and 
some forms of loop unbundling to facilitate this initial phase of local 
competition.
    The pattern repeated for switched local services: in 1994 the NYPSC 
authorized the first competitive local exchange service in the country 
and by the end of the following year--1995--fourteen ``Competitive 
Local Exchange Carriers'' (CLECs) had installed 70 competitive central 
office switches. Such issues as mutual compensation, now known as 
``reciprocal compensation,'' number portability, and OSS 
interconnection were being addressed and had been at least partially 
resolved on a state-by-state basis.
---------------------------------------------------------------------------
    This state-by-state experimentation--with its admittedly untidy 
look of ``muddling through''--did not provide the ``certainty'' and 
``predictability'' sought by investors.
    Ironically and not appreciated by investors at the time and perhaps 
even today, ``muddling through'' was and is much less risky than a 
single federal policy, particularly one that gets ``gridlocked'' in 
interminable due process. That is because ``muddling through'' in the 
States allows for a continuous and low-risk iterative process of field 
experimentation, testing, and fine tuning of business strategies and 
public policies before irrevocable, major investment bets are placed.
    Although the Act stopped the state-by-state experimentation, it did 
not empower the FCC to undertake its own experiments. Instead, 
everything became a single high-risk roll of the dice. Now, every FCC 
decision--because it has such far-reaching application--literally 
becomes a ``federal case'' and leads not to finality but to litigation, 
with fundamental decisions being made not by an expert agency but by 
judges and their law clerks. This sort of gridlock cannot engender 
investor confidence.
    It is also important to note that the Telecom Act also gridlocked 
the entry of the Bell companies into long distance markets. The 
flexible standard of sec. VIII(C) of the MFJ 2 became the 
detailed, specific and rigid ``14 point checklist'' of the Telecom Act. 
Each of the 14 points became a point of contention, friction, and 
delay--more gridlock wearing away investor confidence.
---------------------------------------------------------------------------
    \2\ ``The restrictions . . . shall be removed upon a showing by the 
petitioning BOC that there is no substantial possibility that it could 
use its monopoly power to impede competition in the market it seeks to 
enter.''
---------------------------------------------------------------------------
    Ironically, by the end of 1995, at least two Bell companies (New 
York Tel and Illinois Bell) were ready to seek interLATA relief under 
the MFJ standard on the basis of competition in their major markets 
(i.e., New York and Chicago).
    Whether Judge Greene would have granted their initial applications 
is, of course, unknowable. But my involvement in negotiations with 
Ameritech and the Department of Justice leads me to conclude that Judge 
Greene would have allowed them to enter to establish the regulatory 
carrot that would encourage other BOCs to open up and to begin to free 
themselves from the MFJ stick. My guess is that most BOCs would have 
been in most of the long distance market years earlier if the Telecom 
Act had not passed.
    In the guise of promoting competition, the Act and the FCC 
regulations that followed have created an enormous regulatory apparatus 
and set of requirements. The Act has created a set of companies and 
industries whose very survival is by the good graces of federal 
regulators. This dependency relationship is not one that makes for a 
healthy policy environment or acceptable investment risk.
    If the Telecom Act has increased investor risk by eliminating 
experimentation and gridlocking decision-making, what should be done? 
My answer, of course, is to increase experimentation and reduce 
gridlock.
    I expect that CITI's final report, due in October, will provide a 
comprehensive set of recommendations on these and many other topics. At 
the present, I can think of a few things that could be done to 
simultaneously encourage experimentation and reduce the gridlock:
1. First, wherever possible under the law and Constitution, the FCC 
        should use the States as laboratories, particularly on local 
        telecom issues.
    As they did in the past, a few States will make decisions that the 
FCC will regard as ``good'' and a few others will make ``poor'' 
decisions. Then it is likely that other States will copy and improve 
the ``good'' results and, when the evidence is clear and convincing, 
the FCC can quickly and confidently make national policy based on 
experimental evidence rather than speculation . . . no more risky rolls 
of the dice.
    I believe that investors would soon understand and appreciate the 
certainty, predictability and risk containment inherent in State-
federal experimentation and, as a result, be more willing to invest on 
more favorable terms.
2. Second, the FCC should reform the carrier-to-carrier ``negotiation 
        and arbitration'' process established by sec. 252 for 
        interconnection agreements to encourage experimentation and 
        minimize regulatory involvement.
    It is important to remember that many of the issues that are 
consuming the FCC and the industry and bothering investors--including 
unbundling, collocation, reciprocal compensation, quality measures--can 
and should be determined by the negotiation and arbitration process 
established by sec. 252. That is the ``deregulatory'' approach to 
carrier-to-carrier relations envisioned by the Act.
    By ``fixing'' the interconnection agreement process 3, 
there would be no need for endless speculation about whether UNE-P is 
good, bad or indifferent or whether ``bill & keep'' is a better mutual 
compensation system. The real-world results of a variety of 
interconnection agreements--the results of experiments--would speak for 
themselves. The proven answers can then be applied to subsequent 
negotiations, arbitrations and the few regulatory decisions that still 
might be needed.
---------------------------------------------------------------------------
    \3\ My recommendation is that the FCC should specify the use by 
State Commissions of ``baseball arbitration,'' where one side wins all 
the disputed issues and the other loses every issue. The arbitrator 
would be guided by the goals of the Communications Act. The mere 
prospect of ``baseball arbitration'' should encourage early, non-
regulated settlement since it forces parties to be reasonable and start 
at the middle rather than at the extremes in the expectation that an 
arbitrator will ``split the baby.''
---------------------------------------------------------------------------
    States should also be encouraged to use private, expert commercial 
arbitrators to speed the process, lower the cost and reduce regulatory 
gaming, with the State's role being limited to reviewing and adopting 
the arbitrator's decision.
    Any agreements, negotiated or arbitrated, should only be subject to 
``opt in'' by other parties, not ``pick & choose'' to encourage real 
bargaining and to ensure that there are a substantial variety of 
experiments.
    Finally, the geographic scope of arbitrated (but not negotiated) 
agreements should be limited to relatively small areas--perhaps as 
small as exchange areas--so that there will be many different 
arbitrated arrangements within a State and even between the same two 
carriers. Each of these different arrangements will be an experiment, 
the results of which can be fed back into private carrier-to-carrier 
negotiations (perhaps between the carriers to make all their agreements 
uniform) and better informed, less speculative regulatory policies and 
future arbitrations.
    I appreciate the opportunity to appear before you this afternoon. I 
look forward to sharing with you and other policy-makers the results of 
CITI's ``Remedies for Telecom Recovery'' project. I'm confident that 
our research and analysis will help you to get to the root causes of 
the telecom industry's meltdown and provide you with a clear 
understanding of the sort of policies that can prevent or at least 
ameliorate the impact of subsequent downturns.

    Mr. Upton. Mr. Bath?

                     STATEMENT OF BLAKE BATH

    Mr. Bath. Good afternoon, Mr. Chairman and distinguished 
members of the committee. I thank you for the privilege of 
speaking with you about the state of the telecommunications 
industry and the impact of regulation on the health of the 
sector.
    My perspective on the sector is derived from my 10 years as 
an industry financial analyst at Lehman Brothers and Sanford C. 
Bernstein, and my nearly 4 years as a financial analyst at MCI 
Communications prior to that. My clients include mutual funds, 
pension funds, investment advisors, banks, hedge funds, and 
others who commit capital to the sector.
    I would like to focus my comments today on four topics--the 
evolution of the telecom industry since the 1996 Act, the 
impact of telecom regulation on capital investment, the state 
of competition in the consumer market for telecommunications, 
and, finally, the impact of these issues on how investors view 
the telecom sector.
    The evolution of the telecom sector since the signing of 
the Telecom Act of 1996 has been profound. At the time of the 
Act, the revenue composition of the services sector was 90 
percent wireline voice, 5 percent wireless, and 5 percent data. 
Voice calling was distinctly separated from local--between 
local and long distance for both wired and wireless calling, 
and the industry structure in each geographic market largely 
consisted of monopolies, duopolies, and very well-behaved 
oligopolies.
    Every sector of the services industry grew at or above the 
rate of growth of the overall economy. Not surprisingly, 
investors were very keen on the telecom industry for its 
combination of growth and stable operating performance. In the 
last 7 years, the industry has evolved dramatically. The 
industry's revenue composition is now 40 percent wireline 
voice, 30 percent wireless, and 30 percent data.
    Voice services for wireless callers very rarely distinguish 
between local and long distance, and this type of any distance 
offering is taking hold in the wireline industry as well. The 
telecom sector across wired and wireless, voice, and data is 
now robustly competitive with virtually all customers in all 
geographies enjoying a range of supplier choices and technology 
choices to meet the rapidly evolving and growing needs.
    Investors are considerably less enthusiastic about 
committing capital to the sector, and industry valuations are 
among the lowest they have been relative to the market since 
the 1984 breakup of AT&T.
    On the impact of telecom regulation on capital investment, 
I believe there is compelling evidence that deregulation of 
telecom subsectors has led to strong growth in spending. Since 
the 1996 Act, the growth in telecom services revenues has come 
predominantly from wireless and data services as I highlighted 
earlier.
    These are two areas that are substantially deregulated and 
where the capital investment and technological evolution has 
been most dramatic. Since the 1996 Act, capital spending on 
wireless networks has grown at nearly three times the rate of 
growth of spending on wireline. Capital spending in the cable 
sector has also grown substantially since it was deregulated in 
the mid-1990's, with cable spending growing twice as fast as 
telecom spending and giving birth to a range of new services, 
including high-speed internet access and video on demand.
    In my view, the analysis of the state of competition in the 
consumer market for voice and data communications is often 
modeled, because of an unwillingness to look at the impact of 
intermodal competition between wired and wireless and the 
growing importance of data communications to residential 
customers.
    Current competition for consumer share of wallet is 
intense. In each major metropolitan area, customers seeking 
voice services have a choice of six wireless providers, the 
local telephone company, one or two of the national long 
distance companies, and, in many cases, the cable company.
    Customers wanting high-speed internet services largely 
choose between the RBOC and the cable company. Customers have 
clearly embraced the opportunity for choices of providers and 
technologies. In each of the last 3 years, 2 or 3 million 
customers per year have discarded their wireline phones in 
favor of wireless, which can offer any distance packages and 
mobility.
    Noteworthy is that wireless pricing is currently below that 
of wireline, with a package of 1,000 anytime, any distance 
minutes, at $40 to $50 per month, versus the packages from the 
national long distance companies for wireline services at $50 
to $60 per month, and the RBOCs at comparable levels. I see 
nothing that is going to reverse the trend toward more and more 
customers choosing wireless over wireline, particularly if 
wireless carriers are given the incentive to continue 
substantial investment to bring their network voice performance 
in line with wireline networks.
    One major opportunity for the wireless companies would 
clearly be the 10 million customers over the last 3 years who 
have chosen a UNE-P-based competitor for service. On the data 
side, cable companies have taken two-thirds of the 16 million 
residential lines for high-speed internet access. I believe 
that will grow to 40 million by 2007, and that ultimately these 
broadband networks will carry packetized voice.
    In the interest of time, I just would defer you to the rest 
of my statement.
    [The prepared statement of Blake Bath follows:]
  Prepared Statement of Blake Bath, Managing Director, Lehman Brothers
    Good Afternoon.
    I thank you for the privilege of speaking with you about the state 
of the telecommunications industry, and the impact of regulation on the 
health of the sector. My perspective on the sector is derived from my 
10 years as an industry financial analyst at Lehman Brothers and 
Sanford C. Bernstein, and my nearly four years as a financial analyst 
at MCI Communications prior to that. My clients include mutual funds, 
pension funds, investment advisors, banks, hedge funds, and others who 
commit capital to the sector.
    I would like to focus my comments today on four topics: the 
evolution of the telecom industry since the 1996 Act; the impact of 
telecom regulation on capital investment; the state of competition in 
the consumer market for telecommunications; and, finally, the impact of 
these issues on how investors view the telecom sector.
                                   i.
    The evolution of the telecom sector since the signing of the 
Telecommunications Act of 1996 has been profound. At the time of the 
Act, the revenue composition of the services sector was 90% wireline 
voice, 5% wireless, and 5% data. Voice calling was distinctly separated 
between local and long distance for both wired and wireless calling, 
and the industry structure in each geographic market largely consisted 
of monopolies, duopolies, and very well-behaved oligopolies. Every 
sector of the services industry grew at or above the rate of growth of 
the overall economy. Not surprisingly, investors were very keen on the 
telecom industry for its combination of growth and stable operating 
performance.
    In the last seven years the industry has evolved dramatically. The 
industry's revenue composition is now 40% wireline voice, 30% wireless, 
and 30% data. Voice services for wireless callers very rarely 
distinguish between local and long distance, and this type of ``any 
distance'' offering is taking hold in the wireline industry as well. 
The telecommunications sector--across wired and wireless, voice, and 
data--is now robustly competitive, with customers in virtually all 
geographies enjoying a range of supplier choices and technology choices 
to meet their rapidly evolving and growing needs. Investors are 
considerably less enthusiastic about committing capital to the sector, 
and industry valuations are among the lowest they have been relative to 
the market since the 1984 breakup of AT&T.
                                  ii.
    On the impact of telecom regulation on capital investment, I 
believe there is compelling evidence that deregulation of telecom sub-
sectors has led to strong growth in spending. Since the 1996 Act, the 
growth in telecom services revenues has come predominantly from 
wireless and data services, as I highlighted earlier. These are two 
areas that are substantially deregulated, and where the capital 
investment and technological evolution has been most dramatic. Since 
the ``96 Act, capital spending on wireless networks has grown at nearly 
three times the rate of growth of spending on wireline. Capital 
spending in the cable sector has also grown substantially since it was 
deregulated in the mid-1990s, with cable spending growing twice as fast 
as telecom spending and giving birth to a range of new services 
including high speed internet access and video on demand.
                                  iii.
    In my view, the analysis of the state-of-competition in the 
consumer market for voice and data communications is often muddled 
because of an unwillingness to look at the impact of inter-modal 
competition between wired and wireless and the growing importance of 
data communications to residential customers. Current competition for 
consumers' share of wallet is intense.
    In each major metropolitan area, customers seeking voice services 
have a choice of six wireless providers, the local telephone company, 
one or two of the national long distance providers, and, in many cases, 
the cable company. Customers wanting high speed internet services 
largely need choose among the RBOC and the cable company. Customers 
have embraced the opportunity for choices of providers and 
technologies. In each of the last 3 years, 2-3 million customers per 
year have discarded their wireline phones in favor of wireless, which 
can offer ``any distance'' packages and mobility. Noteworthy is that 
wireless pricing is currently below that of wireline, with a package of 
1000 anytime/any distance minutes at $40-50 per month, versus the 
packages from the national long distance companies at $50-60 per month 
and the RBOCs at comparable levels. I see nothing that would reverse 
the trend towards more and more customers choosing wireless over 
wireline, particularly if wireless carriers are given the incentives to 
continue substantial investment to bring their network voice 
performance in line with wireline networks. One major opportunity for 
the wireless companies would be the 10 million customers over the last 
3 years who have chosen a UNE-P based competitor for service.
    On the data side, cable companies have taken two-thirds of the 16 
million residential lines for high speed internet access. I believe the 
number of consumers choosing broadband access will grow to 40 million 
by 2007, and that ultimately these broadband networks will carry 
packetized voice. Notably, the cable industry has taken fewer than 2 
million telephony customers, due to the uncertainty about technological 
evolution and the type of regulatory environment that will exist for 
telephony in the coming years. Without question, the cable companies 
would look more favorably on investing in telecom voice service if 
regulation favored facilities-based competitors.
                                  iv.
    Finally, the impact of the current environment on how investors 
view the telecom sector--investors despise uncertainty and excessive 
competition, two things they believe exist in abundance right now in 
telecom. Investors are encouraging companies to enter a ``bunker'' 
mentality: conserve cash until the regulatory, competitive, and demand 
landscapes show greater clarity and investors can be more confident in 
return on invested capital. I believe the FCC and the state commissions 
will play a critical role in the weeks and months ahead in clearing 
away some of the regulatory uncertainty, creating an environment which 
favors facilities-based investment, and embracing a market of fewer--
but perhaps stronger--competitors.
    I would be happy to answer any questions you have.

    Mr. Upton. I like the word ``defer.'' Thank you.
    Mr. Brodeur?

                 STATEMENT OF STEPHEN B. BRODEUR

    Mr. Brodeur. Thank you. Mr. Chairman, distinguished members 
of this committee, thank you for the opportunity to appear 
before you today.
    My name is Steve Brodeur. I am the President of the 
Cambridge Strategic Management Group. We are a leading provider 
of management consulting services to the emerging and 
established telecommunications operators, equipment 
manufacturers, and financial services companies.
    The firm's practice areas encompass a wide variety of 
disciplines within the sector, including market opportunity and 
competitive analysis, financial analysis, and economic 
evaluation. Throughout the firm's 13-year history, we have 
helped clients, incumbents, and new entrants alike evaluate 
business opportunities and identify and assess critical risk 
factors, whether entering new markets or deploying new 
technologies. We have also provided in-depth economic analysis 
and advice to financial services companies and large operators 
seeking to invest in the telecom sector.
    As directed by your staff, today I am not here to provide a 
policy statement on any matters appearing before the Congress 
or the FCC. Furthermore, I would not even characterize myself 
as a regulatory expert, having only loosely followed the day-
to-day discourse between the various parties in these 
regulatory matters.
    What I am is an observer of the economics of the 
telecommunications industry, with over 15 years of consulting 
experience in the sector. What I can say to you today is that 
in those 15 years I have never seen a greater period of 
uncertainty. As you know, and as has been mentioned here, there 
are a record number of bankruptcies in the sector today, and 
there are even more companies in financial distress.
    These companies include large and small operators and 
manufacturers alike. As you have mentioned, there are some 
500,000 jobs that have been shed in this sector since 2001. 
Liquidity is virtually absent in the sector right now, with 
external financing extremely tight, and internal financing 
constrained by ongoing economic uncertainty.
    Many companies operate also with unprecedented levels of 
debt. Capital investment has been spoken about already today--
has fallen dramatically among both large carriers and small 
carriers alike, which has had tremendous downstream impact on 
wholesale infrastructure providers like Level 3 and Willtel, 
and equipment manufacturers like Lucent and Nortel.
    Perhaps most importantly, there have been significant 
shifts in purchasing and usage behavior among residential and 
business customers; for example, substitution of wireless 
services for wireline, local, and long distance usage, and the 
substitution of wireless access for second lines in the home.
    The results of these purchasing changes is that many 
operators have seen absolute revenues decline and lines and 
service decline. Given the highly fixed cost nature of most 
telecom operators, new and old alike, this produces severe 
impact on their profitability.
    Competition with the industry has also been fierce with 
different competitors, CLECs, cable companies, satellite 
providers, large carriers, using different network service 
delivery platforms to offer select services across a variety of 
customer segments within the industry.
    Regulation has been a factor but not the only one in 
contributing to the state of the industry today. Regulation, 
though, clearly will be a factor in the continued emergence of 
competition in the sector and continued investment by existing 
operators in cutting edge technology and capabilities.
    About a year ago, we complete a study for Corning in which 
we examined the impact of extending today's unbundling 
regulatory paradigm to fiber loop facilities, fiber loop 
facilities being a new broadband infrastructure designed to 
replace copper facilities to the home. In that analysis, we 
concluded that incumbent providers like SBC and Bell South 
could rationally build fiber loop facilities for roughly 30 
percent of households without regulation, but only 5 percent of 
households if today's unbundling paradigm were extended to 
these fiber loop facilities.
    The heart of this economic analysis is an extremely 
complicated investment decision that each incumbent operator 
must undertake--a decision that is complicated enough even 
before considering the impact of regulation. To make this 
decision in an economically rational manner, each incumbent 
will need to estimate its present and future market takeup 
rates across voice, long distance, broadband, data, and video, 
estimate the average revenue per customer for those services, 
and estimate operating costs and capital expenditures.
    Making these estimates is extremely difficult, given that 
most ILECs have only recently entered the long distance 
business and don't have any presence in the video sector 
whatsoever. Add to this that there is no unassailable market 
research to guide these estimates of market takeup and revenue, 
and the absolute investment in fiber loop facilities may reach 
$40 to $50 billion, you can see why this is a very, very 
difficult decision to make.
    Now overlay the impact of regulation. Today's unbundling 
paradigm extended to fiber loop facility only makes it more 
complicated and risky, and ultimately reduces the likelihood of 
broad fiber facilities deployment.
    I will submit the rest of this for the record.
    [The prepared statement of Stephen B. Brodeur follows:]
Prepared Statement of Stephen B. Brodeur, President Cambridge Stratgeic 
                            Management Group
    Mr. Chairman, thank you for the opportunity to appear before you 
today. My name is Stephen Brodeur. I am the President of the Cambridge 
Strategic Management Group (or CSMG). CSMG is a leading provider of 
management consulting services to emerging and established 
telecommunications operators, equipment manufacturers, and financial 
services companies. The firm's practice areas encompass a wide variety 
of disciplines within the sector, including market opportunity and 
competitive analysis, financial analysis, and economic valuation. 
Throughout the firm's 13-year history, we have helped clients 
(incumbents and new entrants alike) evaluate business opportunities and 
identify and assess the critical risk factors, whether in entering new 
markets or deploying new technologies. We have also provided in-depth 
economic analysis and advice to financial services firms and large 
operators seeking to invest in the telecom sector.
    As directed by your staff, I'm not here to provide a policy 
statement on any matters appearing before the Congress or the FCC. 
Furthermore, I would not even characterize myself as a regulatory 
expert, having only ``loosely''' followed the day-to-day discourse 
between the various parties in these regulatory matters. What I am is 
an observer of the economics of the telecom industry, with over 15 
years of consulting experience in the sector. What I can say to you 
today that in those 15 years I have never seen a period with greater 
uncertainty.

 As you know, there have been a record number of bankruptcies 
        in the sector and there are still many more companies in 
        ``financial distress.'' These companies include large and small 
        operators and manufacturers alike.
 The sector has shed roughly 500,000 jobs since the beginning 
        of 2001.
 Liquidity is virtually absent, with external financing 
        extremely tight and internal financing constrained by ongoing 
        economic uncertainty.
 Many companies--big and small--operate with unprecedented 
        levels of debt.
 Capital investment has fallen dramatically among both large 
        carriers and small carriers alike, which has had tremendous 
        ``downstream'' impact on wholesale infrastructure providers and 
        equipment manufacturers.
 Perhaps most importantly, there have been important shifts in 
        purchasing behavior among residential and business users (for 
        example, the substitution of wireless services for wireline 
        local and long distance usage and the substitution of wireless 
        access for second lines in homes). The result of these 
        purchasing changes is that many operators have seen absolute 
        revenue and lines in service decline. Given the fixed cost 
        nature of most telecom operators, this has severely impacted 
        profitability.
 Competition within the industry has also been fierce, with 
        different competitors (CLECs, cable companies, satellite 
        providers, large carriers, etc.) using different network 
        service delivery platforms to offer select services across a 
        variety of segments within the sector.
    Regulation has been a factor--but not the only one--in contributing 
to the state of the industry today. Regulation, though, will clearly be 
a factor in the continued emergence of competition in the sector and 
the continued investment by existing operators in cutting-edge 
technology and capabilities.
    About a year ago we completed a study for Corning in which we 
examined the impact of extending the unbundling regulatory paradigm to 
fiber loop facilities. In that analysis, we concluded that ILECs could 
rationally build fiber loop facilities--a completely new broadband 
infrastructure--to roughly 30% of US households without regulation--but 
to only 5% of US households if the unbundling regulatory paradigm were 
extended to these fiber loop facilities.
    The heart of this economic analysis is an extremely complicated 
investment decision that each ILEC must undertake--a decision that is 
complicated even without considering the impact of regulation. To make 
this decision in an economically rational manner, each ILEC will need 
to (1) estimate its present and future market take-up rates across 
local voice, long distance voice, broadband internet access, data 
services, and video; (2) estimate its average revenue per customer for 
those customers it serves across the same set of services; and (3) 
estimate its operating costs and capital to support the fiber loop 
facilities business.
    Given existing levels of competition and the fact that most ILECs 
have only recently entered the long distance and broadband markets and 
have no significant presence in the video sector, this fiber loop 
facilities investment is inherently risky. Add to this that there is no 
unassailable market research to guide these market take-up and revenue 
per customer estimates and that the absolute investment in fiber loop 
facilities may total as much as $40-50 billion and you can begin to 
understand the magnitude of this decision.
    Today's regulatory paradigm extended to fiber loop facilities only 
makes it more complicated and risky and ultimately reduces the 
likelihood of broad fiber loop facilities deployment.
    Robust investment, of course, is crucial to the continued vitality 
of the sector. I applaud the Committee for tackling the difficult 
challenges facing the telecom industry today. It is a critical sector 
for our economy and its health should be of paramount importance. I 
would be happy to lend my knowledge of the sector to the Committee in 
whatever way is most appropriate.

    Mr. Upton. Thank you.
    Mr. Crandall?

                 STATEMENT OF ROBERT W. CRANDALL

    Mr. Crandall. Thank you, Mr. Chairman, members of the 
subcommittee. My name is Robert Crandall. I am a Senior Fellow 
in economic studies at The Brookings Institution. I come here 
today to testify for myself. My views do not represent those of 
The Brookings Institution.
    But I think to put what is happening today in context, it 
might be useful to hear from someone with an experience of 30, 
35 years in looking at regulated and deregulated industries, 
and I have had about 25 years of experience in looking at the 
telecom sector.
    We have been through this before. By the way, I am just 
going to summarize the statement which I submitted for the 
record. We have been through deregulation liberalization of 
airline, of trucking, of railroad, of air cargo, of natural 
gas, natural gas distribution, and we know what happens. We 
know that, first of all, we can't predict what is going to 
happen. We know that a period of turmoil will ensue.
    In the case of airlines and trucking, we could have been 
sitting 20 years ago talking about many of the same problems 
afflicting the airline industry, as they are parking planes in 
Arizona, as their stocks had had a run-up and suddenly had 
collapsed in the 1982 recession. It takes a long time to work 
through a period of economic liberalization of any industry, 
and particularly one with deregulation.
    Now, fast forward 1996 to 2003. Here we have an industry 
which has been heavily regulated for decades, whose rate 
structure is thoroughly distorted by regulation, which is 
subject to very rapid technical change, and is now subject to 
the intervention of a new phenomenon--namely, the internet.
    Shortly after the 1996 Act was passed, we were involved in 
the stock market bubble. Just before the Act was passed, the 
FCC deregulates AT&T's long distance services. Three years 
before the Act was passed, we began to open up the spectrum for 
competitive wireless, expanding the number of wireless carriers 
from two to six nationally.
    We regulated in 1992, and then deregulate cable programming 
services. And then we impose upon the industry in the 1996 Act 
a completely untried, new set of wholesale regulatory 
approaches, none of which we could predict how they would work 
out.
    Well, in this environment, and particularly from the stock 
market bubble investment surge, but a large part of that 
investment was in capacity, which was driven by an anticipation 
of incredibly rapid growth in demand, some of it fed by 
rhetoric from WorldCom. And also, it was fed by very ambitious, 
but untried, business plans by the new competitive local 
carriers.
    Now, 7 years later we sit here and we see that those plans 
of the competitive local carriers have mostly collapsed. They 
spent $45-, $50 billion over this period. At one time, their 
market capitalization was estimated at $80 to $100 billion. 
Today it is about $1 billion.
    We have tremendous excess capacity in the long haul market, 
because wireline telecommunications revenues have not grown at 
all since the 1996 Act was passed. They have growth about 1 
percent or slightly less per year, since the 1996 Act was 
passed, in nominal dollars but not at all in real dollars when 
you just take account of the limited amount of inflation we 
have had over that period.
    All of the growth in revenues has come from the wireless 
sector. Now, when you invest this amount of money and have this 
tremendous surge with investment spending rising from $40 
billion to $100 billion in the sector, a large part of it going 
into the wireline sector and no revenue growth, you are bound 
to have disappointment.
    So the thrust of my testimony is that if we are to see 
recovery, and don't think that recovery in the telecom sector 
is going to be all that important for the overall economy--
telecom is still only 2 percent of GDP, and it has fallen since 
the 1984 AT&T breakup. But if we are to have recovery in the 
telecom sector, it must come through revenue growth.
    We are not going to get that revenue growth in traditional 
telephone services, because deregulation is working, or at 
least liberalization is working. Prices are falling 
dramatically. Price elasticities in demand are less than one. 
As a result, revenues are falling for traditional services. You 
have got to get growth in new services.
    Those new services aren't going to be introduced by the 
competitive local exchange carriers. They are on their backs 
and have no new service stuff in the first place. That is why 
they are on their backs, in part.
    They are not going to come from the long distance sector. 
The wireless sector is waiting out what to do about 3G and 
Spectrum and all of that. That is a long ways away. It is going 
to have to come from the last mile investment, and that is why 
I would agree with several of you today that one of the things 
one can do is to clarify and reduce the regulations on the 
incumbent local exchange carriers for advance services the UNE-
P. Advance services are much more important than the UNE-P, 
because those people using the UNE-P are not going to succeed 
with it.
    Thank you very much.
    [The prepared statement of Robert W. Crandall follows:]
Prepared Statement of Robert W. Crandall, Senior Fellow, The Brookings 
                        Institution 1
---------------------------------------------------------------------------
    \1\ The views expressed in this testimony are those of the author. 
They do not represent the views of the Brookings Institution, its 
Trustees, or its other staff members.
---------------------------------------------------------------------------
              the health of the telecommunications sector
    Mr. Chairman and Members of the Subcommittee, I am pleased to be 
here this afternoon to express my views on the current state of the 
U.S. telecommunications sector. This is an important topic, given the 
severe downturn that has occurred in equity values and capital 
expenditures in the sector. Indeed, telecommunications is suffering the 
greatest financial distress and general turmoil that I have seen in the 
roughly 25 years that I have been studying this industry.
    As we focus on the current dire condition of the telecommunications 
sector in this proceeding, we should recall that we have been through 
similar problems in other sectors after they were first opened to entry 
and subjected to deregulation. For example, similar, but less severe 
problems gripped the airline and trucking industries shortly after they 
were deregulated in 1978 and 1980, respectively. A surge in investment 
by the airlines led to excess capacity that was exacerbated by the 
rather deep 1982 recession. As a result, airline stocks tumbled in 
1982. Similarly, the natural gas pipeline industry suffered through 
much more severe adjustments to natural-gas and oil price deregulation 
in the 1980s. Finally, no one needs to be reminded of the recent 
difficulties that California utilities faced when ``deregulation'' was 
instituted in that state in the 1990s. In each case, policymakers, 
industry participants, and economists could not predict how these 
industries would adjust to entry and deregulation or who the winners 
and losers would be. We simply knew that prices would eventually be 
lower under deregulation, and that output would be greater.
    These observations are important, because, as my colleague Clifford 
Winston has found, deregulation has created much larger benefits in 
virtually every instance than many economists and other observers would 
have expected.2 Given the turbulence that often follows from 
opening markets to competition and from deregulation, we should have 
expected the 1996 Telecommunications Act to create similar turmoil. The 
1996 Act was not as deregulatory as many of the earlier statutes, but 
it opened a regulated market to competition and thereby threatened to 
place considerable pressure on an incredibly distorted regulatory rate 
structure. For this reason, in October 1996, I opined in a speech in 
Maine that ``all hell would soon break loose'' in the telecom sector. 
As it turned out, my prediction was premature, and it may have been 
right for at least some of the wrong reasons. Neither I nor anyone else 
could have predicted the 1998-2001 stock market bubble that swept the 
sector, the nature of the competition that would develop, the 
regulatory policies that would be adopted under the new Act, nor the 
telecommunications market's response to all of these events.
---------------------------------------------------------------------------
    \2\ Clifford Winston, ``Economic Deregulation: Days of Reckoning 
for Microeconomists,'' Journal of Economic Literature, Vol. 31, 
September 1993, pp. 1263-89.
---------------------------------------------------------------------------
               the telecom surge--rhetoric meets reality
    The years leading up to the 1996 Act were a period of excited 
discussion about the potential of the ``Information Superhighway'' 
3 and the promise of network convergence. The declining cost 
of fiber-optics transmission and the technological progress driving 
microprocessor technology (at a rate described by Moore's Law) led some 
to predict that communications bandwidth would soon be virtually 
free.4 Households, physicians, teachers, and businesses 
would be able to send and receive high-speed video images that would 
substitute for personal diagnoses, provide remote monitoring, allow 
remote tutoring, and supply much more personalized access to 
entertainment. Once the telecommunications sector was opened to 
competition and deregulated, innovation could flourish, thereby 
allowing subscribers access to new services and providing existing 
services at dramatically lower prices.
---------------------------------------------------------------------------
    \3\ Vice President Gore was credited with this description of 
modern communications technology. See, for example, http://www-
tech.mit.edu/V113/N65/gore.65w.html.
    \4\ George Gilder, Telecosm: The World after Bandwidth Aiundance. 
Simon & Schuster, 2000.
---------------------------------------------------------------------------
Capital Spending and Market Valuations
    The 1996 Act was not deregulatory. It created a vast new system of 
wholesale-price regulation of local services that was only vaguely 
spelled out in the statute. Indeed, local telecommunications would 
continue to be intensely regulated by the states and the FCC. On the 
other hand, long distance and wireless services were essentially 
deregulated before the Act was passed. Both sectors had begun to invest 
heavily in infrastructure in the early 1990s, and the lure of the 
Internet would entice them to accelerate this investment after 1996. 
Moreover, new local carriers sprouted from everywhere and were able to 
attract enormous amounts of capital. The result was an investment boom 
that continued for more than five years.
    Figure 1 shows the acceleration in capital spending in the 
telecommunications sector that occurred after 1995 in both nominal 
dollars and constant dollars.5 Between 1987 and 1996, 
nominal and real (inflation-adjusted) capital spending increased at 
average rates of 4.8 and 4.5 percent per year, respectively. In the 
next four years, however, the growth rate soared to more than 20 
percent per year. By 2000, real capital spending had risen 148 percent 
from its 1996 level. This surge in capital spending was accompanied by 
an even greater rise in the prices of telecommunications industries 
equities--a stock market ``bubble'' that burst with a vengeance in 
2000-01. (Figure 2) 6
---------------------------------------------------------------------------
    \5\ These data are from the Bureau of Economic Analysis, U.S. 
Department of Commerce, downloaded on August 25, 2002 from http://
www.bea.doc.gov/bea/dn/faweb/AllFATables.asp#S3 They are investment 
expenditures in current dollars and constant dollars for the 
``telephone and telegraph'' industry.
    \6\ The indexes in Figure 2 are calculated from monthly closing 
prices of individual equities. The RBOC index is a weighted average of 
the common equities of SBC, Bell South and Verizon. The CLEC index is a 
weighted average of the equities of Allegiance, Covad, McLeod, Time 
Warner Telecom, and XO Communications. The wireless index is a weighted 
average of the equities of Leap, Nextel, RCCC, and Sprint PCS. The 
long-distance index is a weighted average of the equities of Sprint and 
WorldCom.
---------------------------------------------------------------------------
    The bubble gripped three of the four major groups of carriers: the 
new CLECs, the wireless carriers, and the long-distance 
companies.7 The largest rise was in the CLEC index in Figure 
2, which also shows the greatest collapse. The wireless stocks were 
next in the upsurge, and the long-distance stocks were third. The Bell 
companies enjoyed much less of a surge in 1998-2000 and suffered less 
in the downturn as they essentially tracked the S&P 500, which had a 
much more modest bubble.
---------------------------------------------------------------------------
    \7\ My ``long-distance'' sample includes only Sprint and WorldCom. 
AT&T was very much a cable company for a good part of this period. 
Global Crossing and Qwest were much more than long-distance companies.
---------------------------------------------------------------------------
    Of the facilities-based long distance companies, only AT&T remains 
with any market capitalization attributable to long distance, and even 
AT&T has lost roughly one-third of its market cap in the two months 
since it spun off its broadband division. It now appears that the long 
distance companies must offer a wider bundle of services to survive.
    At this point, it appears that very few of the new competitive 
local carriers ('``CLECs'') are likely to survive and prosper. Once the 
repository of more than $80 billion in market capitalization, the 
publicly traded CLECs now have a scant $1 billion in total market cap 
after reporting more than $40 billion of spending on capital facilities 
between 1996 and 2001. As was the case in the airlines and trucking 
industries two decades ago, a large number of new entrants have 
foundered on bad business plans and a disappointing market.
    Even the stocks of the Bell companies are only slightly above their 
1996 levels, hardly a stunning result in the wake of the 1999-2001 
surge in their capital expenditures. The wireless sector's equity 
prices are about two-thirds of their 1996 values. The cable television 
companies, who are not included in my analysis, also appear to be 
relatively stable. Thus, the problems in telecom are heavily 
concentrated in the companies with large national fiber networks who 
offer long distance services, the new local entrants, who offer little 
new after investing more than $40 billion, and to a lesser extent, the 
wireless carriers. This is not to say that the incumbent local carriers 
operators are prospering in this environment, but the equity markets 
are suggesting that they are not in long-term difficulty.
    As a result of the collapse in market valuations, capital spending 
declined substantially in 2001-02, a decline that was exacerbated by an 
incredible series of bankruptcies of telecommunications carriers. Total 
capital spending has fallen from more than $100 billion in 2000 to less 
than $40 billion last year, according to most estimates, and it is 
forecast to remain low for at least the next year. This decline in 
capital spending is clearly the most alarming aspect of the current 
telecom malaise for it portends a slowdown in the deployment of new 
technology and even the possibility of a degradation of traditional 
services if it continues. Capital spending is now less than it was when 
the act was passed seven years ago.
    The capital spending boom is now widely acknowledged to have 
created excess capacity in data and voice transmission,8 but 
the rise in investment spread far beyond fiber-optic transmission 
facilities. Capital spending by the new local carriers increased from 
virtually nothing to nearly $20 billion in 2000.9 The 
wireless sector increased its capital outlays from $8.5 billion in 1996 
to $18.4 billion in 2000.10 And the regional Bell Companies 
(including GTE) increased their wireline capital spending from $20.8 
billion in 1996 to $35.7 billion in 2000 even though they were largely 
banned from interstate communications.11 All of these 
companies have pulled back substantially since 2000.
---------------------------------------------------------------------------
    \8\ Yochi J. Dreazen, ``Wildly Optimistic Drove Telecoms to Build 
Fiber Glut,'' Wall Street Journal Online, September 26, 2002.
    \9\ It is unclear how much of this reported capital spending was 
devoted to productive capacity. Much of it may have been spent on 
office facilities, collocation cages, marketing-related equipment, etc. 
For a discussion of this issue, see Larry F. Darby, Jeffrey A. Eisenach 
and Joseph S. Kraemer, The CLEC Experiment: Anatomy of a Meltdown, 
Progress and Freedom Foundation, September 2002, p. 10 et seq.
    \10\ CTIA, Semiannual Wireless Survey.
    \11\ Total investment spending by wireless carriers is published by 
the Cellular Telecommunications Industry Association. All other data 
are calculated by the author from reports by publicly-traded companies 
to the Securities and Exchange Commission.
---------------------------------------------------------------------------
Telecom Revenues
    Perhaps the most surprising feature of the telecom industry since 
1996 has been the absence of growth in carrier revenues despite the 
explosion of the Internet and the strong growth of the economy. Between 
1987 and 1995, the growth in telecom output (its contribution to the 
``gross domestic product'' of the entire economy) and capital spending 
growth were virtually identical.12 But after 1995, the 
industry's output did not accelerate very much in nominal dollars, 
rising from a 4.6 percent growth rate during 1987-95 to just a 6 
percent growth rate after 1995. Figure 3 provides annual data from the 
Commerce Department on investment and output, as measured by gross 
product, for the telephone and telegraph industry. Given that current-
dollar GDP grew at a 5.8 percent average annual rate during this 
period, the growth in telecom spending was surprisingly low and far 
below the growth in nominal capital spending. Indeed, the value of 
telecommunications output in nominal dollars has grown more slowly than 
has durable-goods manufacturing in recent years.13
---------------------------------------------------------------------------
    \12\ These data are obtained from BEA at http://www.bea.doc.gov/
bea/dn/faweb/AllFATables.asp#S3 and www.bea.doc.gov/bea/dn2/gpo.htm.
    \13\ The Federal Reserve Board's Industrial Production Index for 
durable goods manufacturing rose at an average annual rate of more than 
8 percent per year between 1995 and 2000.
---------------------------------------------------------------------------
    Most of the growth in telecommunications services output and 
revenues in recent years has come from the wireless sector. The local 
exchange companies, long distance carriers, and wholesale fiber-optic 
transmission companies, have seen little or no growth in their total 
revenues. (See Figure 4.) Between 1996 and 2001 (2002 data are not 
available yet), end-user wireline revenues increased by less than $8 
billion, from $159.4 billion to $167 billion, or only 0.9 percent per 
year. In real, inflation-adjusted terms, wireline revenues actually 
decreased by about 1 percent per year.14 This was surely not 
the explosive growth that had been anticipated from the IT revolution 
and ``deregulation.''
---------------------------------------------------------------------------
    \14\ This does not imply that telecom output declined. Given the 
sharp declines in the price of telecom services, real output was 
increasing substantially throughout this period.
---------------------------------------------------------------------------
    The lack of revenue growth does not mean that there was no real 
output growth in telecommunications, but that the output growth was not 
great enough to more than offset the substantial decline in prices that 
was occurring. Prices of transmitting the trillions of bits of 
information generated by the Internet fell dramatically, but the demand 
response to these price declines was not sufficient to boost revenues. 
Real output growth was substantial, but not as spectacular as many have 
suggested. Figure 5 shows the recent trend in the telecom industry's 
contribution to gross domestic product in real terms along with its 
contribution to gross domestic product in nominal dollars that was 
shown previously in Figure 3.
Regulatory Changes
    Though the 1996 Act was not deregulatory, telecom regulation was 
changing during the period preceding that Act and in the first few 
years of implementing it. Between 1993 and 2000, the following 
regulatory changes combined to make the telecom sector a treacherous 
environment for investment when combined with the technological changes 
also buffeting the industry:

1. Wireless communications were opened to competition for the first 
        time in 1993, and wireless rates were largely deregulated;
2. Government auctions were initiated in 1995 to provide the requisite 
        spectrum for new wireless competitors;
3. AT&T's interstate long distance rates were deregulated by the FCC in 
        1995;
4. Local telecommunications services for residential and small business 
        customers were opened to competition by the Telecommunications 
        Act of 1996;
5. Local incumbents were required by the 1996 Act to lease network 
        facilities to new entrants at regulated prices; but the extent 
        of the required unbundling and ``line sharing'' remained 
        uncertain due to court reversals of FCC decisions;
6. In 1997, the FCC launched a sweeping new program to reduce 
        international ``accounting rates'' and to increase competition 
        in international services.
7. In 1999-2000, the ``UNE Platform'' began to replace other forms of 
        competitive local entry as AT&T, WorldCom, and others responded 
        to the deep discounts that states offered for leasing 
        (essentially reselling) the incumbent' networks.
    All of these changes occurred as equity and debt capital poured 
into a large number of telecom companies, funding hastily constructed 
investment plans. In this environment, one had to expect a large number 
of failures, and this expectation was surely fulfilled. A tabulation of 
recent telecom bankruptcies found that 59 firms have filed for 
bankruptcy protection in the last few years.15
---------------------------------------------------------------------------
    \15\ Converge! Network Digest accessed at http://
www.convergedigest.com/Mergers/finan
cialarticle.asp68ID=4160 (1/20/03)
---------------------------------------------------------------------------
                        why was growth so slow?
    The lack of revenue growth for wire-based telecom carriers after 
1996 can be attributed to perhaps three factors. First, competition in 
wireless and long distance services began to drive prices down 
substantially. Because the demand for traditional telecommunications 
services is price inelastic, these price declines translate into lower 
subscriber expenditures unless there are important new uses of these 
services. Second, the revolution in wireless communications has 
siphoned enormous amounts of traffic from the wireline network, 
particularly the over-priced long distance traffic. Third, new 
services, such as broadband, were slow to develop, in part because of 
regulatory uncertainty.
Household Spending.
    Approximately 60 percent of all end-user telephone expenditures are 
made by households. Census data show that the share of household 
expenditures devoted to telephone service remained remarkably constant 
throughout the1980s at about 2 percent of their overall 
expenditures.16 Beginning in 1993, however, this share rose 
gradually to 2.3 percent. In nominal dollars, the average household 
spent $877 in 2000 compared to $658 in 1993.17 However, 
household data collected by TNS and reported by the FCC, reproduced in 
Table 1, show that all of this increase reflected a growth in wireless 
spending, not expenditures on traditional wireline services. Rising 
expenditures on local service, reflecting principally the increase in 
FCC mandated subscriber line charges, could not offset the decline in 
long distance spending.
---------------------------------------------------------------------------
    \16\ U.S. Bureau of the Census, Current Population Survey, as 
reported in FCC (2002b), p. 46.
    \17\ Id.
---------------------------------------------------------------------------
    Why have these revenues fallen in an era of explosive growth of the 
Internet/ The reason must be that revenues from the new uses of the 
telephone network have not offset the decline in revenues from falling 
long-distance rates. Given that the residential demand for local access 
has an estimated price elasticity of less than -0.05, any increase in 
local rates would lead to higher expenditures on local services. The 
modest increases in local rates that occurred after 1995, reflecting 
principally the increase in FCC mandated subscriber line charges as a 
substitute for per-minute carrier charges, could not offset the decline 
in long distance spending as Table 1 shows. This decline in spending is 
much greater than can be accounted for by lower rates; it obviously 
reflects a substantial shift to wireless services. Competition is truly 
working.

                                                                         Table 1
                                           Average Annual Household Expenditures on Telephone Service ($/Year)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                            Total Non-
                                Year                                 Local  Carriers   Long Distance       Wireless     Total  Spending      Wireless
                                                                                          Carriers         Carriers                          Spending
--------------------------------------------------------------------------------------------------------------------------------------------------------
1995...............................................................             358              250               82              690              608
1996...............................................................             359              250              108              717              609
1997...............................................................             379              305              129              813              684
1998...............................................................             398              270              164              832              668
1999...............................................................             402              257              205              864              659
2000...............................................................             416              211              279              906              627
2001...............................................................             426              176              351              953             602
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: FCC.

The Growth of Wireless.
    The 1996 Act provided major policy changes towards the wireline 
telecommunications sector, but it largely ignored the wireless sector. 
Competition in the delivery of mobile wireless services had been 
limited to two carriers per local market by FCC policy since the 1970s, 
but liberalization was thrust on this sector by Congress three years 
before the 1996 Act was passed. The 1993 Omnibus Budget Reconciliation 
Act instructed the FCC to begin auctioning spectrum for commercial 
wireless uses. These auctions began in 1995, and construction of the 
new digital ``PCS'' networks was just beginning when the 1996 Act was 
passed.
    The 1993 legislation that established the spectrum auctions 
essentially eliminated price regulation of wireless services. States 
may now regulate these rates only if the carriers have ``market 
dominance,'' an unlikely condition in today's wireless sector, even in 
rural areas. The auctions of 120 MHz of spectrum essentially allowed 
four new entrants into wireless services in each local market to 
compete with the two carriers that were already operating there. Since 
1996, the wireless industry has been transformed by mergers and 
consolidations into an industry with six, large national carriers
    Although the U.S. launched its ``second-generation'' digital 
wireless service somewhat after Europe and Japan, wireless is now 
growing very rapidly. (See Figure 6) By mid-2002, the number of 
wireless subscribers had risen to almost 135 million; by 2004 or 2005 
the number of wireless subscribers is likely to exceed the number of 
fixed access lines.18 The substitution of wireless for 
traditional wire-based telephony is developing very rapidly. Many 
households, particularly those with young adults, do not even have a 
traditional copper-wire telephone service. Others are using their 
wireless service rather than their home telephone for long distance 
calls. The effect on traditional wire-based telephone carriers is 
obvious. Long distance revenues for wire-based carriers are now 
declining rapidly, and the number of fixed access lines is now also 
falling after decades of steady growth.
---------------------------------------------------------------------------
    \18\ The Cellular Telecommunications Industry Association's Semi-
Annual Wireless Survey found that there were 134.6 million wireless 
subscribers in June 2002. At this time, the FCC's Local Telephone 
Competition: Status as of June 30, 2002 reported that there were 189.1 
million wire-based switched access lines in the country.
---------------------------------------------------------------------------
    The potential stumbling block for wireless operators is the 
technology required to provide higher-speed Internet access. In Europe 
and other parts of the world, carriers have paid billions of dollars in 
auctions for spectrum designated for ``Third Generation'' wireless 
services (3G). But these services are likely to be much slower and less 
easy to use than fixed-wire broadband services, such as cable modems 
and DSL, or even ``WiFi'' services.
Regulatory Uncertainty.
    In most other sectors, the liberalization of entry has been 
accompanied by, or at least followed by, rate deregulation. This is 
clearly not the case in telecommunications. The profound changes that 
have gripped, if not overwhelmed the telecommunications sector have not 
changed the traditional regulatory policy towards retail rates very 
much. State regulatory commissions continue to regulate local retail 
rates very much as they did in 1996 despite the growth in wireless, the 
steady expansion of competitive local carriers, and the lurking threat 
of cable telephony.
    The 1996 Act also ushered in a major new form of regulation: 
network unbundling at cost-based rates. After seven years of intense 
intra-industry battles, the FCC has maintained a rather steady course 
of intense wholesale regulation and has not placed any pressure on the 
states to deregulate retail rates. In fact, unbundling and line-sharing 
requirements have actually increased with the passage of time. And new 
services, such as broadband services, have been subject to asymmetric 
regulation since 1996.
    Fortunately, there are numerous proceedings open at the FCC that 
could alter the regulatory landscape substantially.
    a. Network Unbundling--The FCC's approach to wholesale unbundling 
has been controversial from the outset, in part because of the vague 
language in the 1996 Act. Facilities are to be unbundled and made 
available to entrants if without them the entrants would be 
``impaired'' in competing with the incumbents.19 But what is 
the measure of ``impairment?'' Moreover, should a facility be unbundled 
everywhere if it is determined that the entrants would be ``impaired'' 
somewhere without it? The FCC on two separate occasions essentially 
decided that virtually everything in the incumbents' networks must be 
unbundled and that there should be no differences between rural and 
urban areas or across states. This broad approach to unbundling is 
unique to the United States and has been the source of controversy for 
more than six years.
---------------------------------------------------------------------------
    \19\ Section 251(d)(2)(B).
---------------------------------------------------------------------------
    The most recent challenge to this broad-based approach to 
unbundling was mounted by the incumbent telephone carriers in 2001 in 
the form of a petition to the U.S. Court of Appeals for the District of 
Columbia. The court's opinion in May 2002 requires the FCC to 
reconsider its unbundling requirements and, in particular, its 
requirement for line sharing with entrants seeking to offer DSL 
services, but not basic telephone service.20 The court 
criticized the Commission for failing to account for the effect of 
competition in determining whether the absence of an unbundled element 
would ``impair'' the ability of entrants to compete. As of this 
writing, the FCC has not responded to this court order.
---------------------------------------------------------------------------
    \20\ U.S. Telecom Association, et. al. v. FCC, 290 F.3d 415 (D.C. 
Cir.), May 24, 2002.
---------------------------------------------------------------------------
    The Commission now has the opportunity to back off from its broad 
attempt to require everything to be unbundled and to bring U.S. policy 
to a less interventionist level that is consistent with that employed 
elsewhere in the world. First, if it decides that certain switching and 
transport functions need not be unbundled, it would bring an end to the 
use of the ``UNE Platform'' that now accounts for one third of all 
entrants' lines. This would force entrants to build facilities or to 
scale back their local services where they are essentially reselling 
the incumbents' services. Second, the Commission can end its 
unsuccessful attempt to force intra-platform competition in broadband 
through line-sharing requirements. Both decisions would lead the 
Commission in a deregulatory direction and reverse six years of 
increasing regulation of inter-carrier relationships.
    b. Broadband--Economic regulation is generally premised on the 
existence of market failure due to monopoly. In telecommunications, 
competition is increasing rapidly in most markets. However, one cannot 
claim that the delivery of the new broadband Internet services are or 
are even likely to be plagued by problems of monopoly. Cable television 
systems compete actively with telephone-company DSL services, and a 
variety of wireless and satellite services are under development. 
Because these services have developed over facilities that were 
originally designed to carry other communications services, they have 
been subject to the threat or actuality of regulation under different 
provisions of the Communications Act. Recently, however, the FCC has 
decided that cable modem service is an ``interstate information 
service,'' and therefore subject to the FCC's jurisdiction. It is also 
contemplating the appropriate regulatory approach to all wireline 
broadband services, including DSL.21
---------------------------------------------------------------------------
    \21\ FCC, Notice of Inquiry, In the Matter of Inquiry Concerning 
High-Speed Access to the Internet over Cable and Other Facilities, GN 
Docket 00-185, September 28, 2000; Declaratory Ruling and Notice of 
Proposed Rulemaking, GN Docket 00-185, March 15, 2002.
---------------------------------------------------------------------------
    Through a welter of different proceedings, the Commission has the 
opportunity to exercise ``forbearance'' from regulating any of these 
services under Section 706 of the Act. Unfortunately, it has been 
examining these options for a very long time without reaching any 
decision on whether to regulate cable modem service or to forbear from 
regulating any of these ``advanced'' services, allowing the market to 
drive technology, facilities deployment, and pricing of the services. 
Once again, the Commission has the opportunity to move in a 
deregulatory direction in a market that is evolving rapidly and has no 
clear tendency towards monopoly.
                      policy options for recovery
    In a sense, the telecommunications industry is suffering from the 
effects of successful competition. The cost of accessing and using 
traditional telecommunications services is declining rapidly, led by 
the aggressive competition among six national wireless companies. 
Further competition will place more downward pressure on the 
traditional local and long distance rates, particularly as the fiber-
based local carriers drive down business rates in central business 
districts. Wireless rates will continue to fall. All of this is 
beneficial to consumers and the economy, but it does not provide the 
resources for growth and expansion of the network. These forces will 
further reduce telecom revenues. As wireless continues to replace 
wireline services, the incentives to invest in the traditional 
telephone network will be further reduced.
    If we are to see a revival of capital spending, it must be 
stimulated by the development and deployment of new services that 
expand telecom revenues. But the incentive to develop these new 
services is clearly impeded by the continuing uncertainty over attempts 
to regulate the wholesale and retail access to these services. Wireless 
companies, local incumbent carriers, and cable companies cannot and 
will not underwrite large capital expenditures to develop new services 
if they must share the gains with rivals or be subjected to rate 
regulation in selling these services to customers. For this reason, the 
FCC should make it clear that traditional telephone companies and cable 
television companies will not face regulation of their new high-speed, 
broadband Internet services.
    Decisions regarding unbundling of network facilities for the 
delivery of traditional telephone service are also important, but not 
as important as the removal of regulation from the newer services. The 
spread of the UNE platform will increase the appearance of competition, 
but not the reality of it. Simply allowing other carriers to deliver 
the same service over the same facilities to the same customers at a 
greater social cost will not promote competition. The UNE platform is 
not stimulating the development of new local services. Nor are the 
companies offering local service over the UNE platform using this 
network strategy to gain a toe-hold before moving ahead to build their 
own networks. Indeed, I believe that the securities markets are already 
telling us that those using the UNE platform are not likely to thrive 
from such a strategy. For a while, the increase in transactions costs, 
the bickering over wholesale rates, and the uncertainty over the UNE-
P's effect on the incumbents' cash flows will simply displace more 
productive uses of these resources. But eventually, I believe, the UNE 
platform will die because it is not an economically viable method of 
organizing a network industry in which there is so much technical 
change.
    The United States was not alone in experiencing a 
telecommunications ``bubble.'' Virtually every other developed country 
suffered a similar boom-bust cycle. The exaggerated expectations for 
telecom created by the Internet and general IT revolution were met with 
stark reality in Europe, Asia, and Oceania at about the same time. 
Stock market valuations in many of these countries also soared in 1998-
2000 only to collapse in 2000-02. Capital spending in 
telecommunications collapsed everywhere, placing most telecom equipment 
suppliers in severe difficulty. The only way out of these problems is 
to allow investors to find and fund productive new uses of 
telecommunications. Otherwise, declining prices will translate into 
declining revenues and little appetite for capital spending.
[GRAPHIC] [TIFF OMITTED] T6044.006

[GRAPHIC] [TIFF OMITTED] T6044.007

[GRAPHIC] [TIFF OMITTED] T6044.008

    Mr. Upton. Thank you very much.
    Mr. Strumingher?

                 STATEMENT OF ERIC STRUMINGHER

    Mr. Strumingher. Thank you, Mr. Chairman.
    Mr. Upton. Is that button on?
    Mr. Strumingher. That would help. I, too, am pleased to 
give some observations about the health of this industry, this 
time from the perspective of an investor in the industry. Since 
1994, I have worked as an investment analyst, specializing in 
the telecommunications industry and related industries, and I 
am currently an analyst for Cobalt Capital, which is an 
investment partnership that at times will take positions and 
whose returns will be influenced by policy decisions made by 
the Federal Government.
    I just want to state up front that my intent in providing 
this testimony is to provide an empirical analysis based on my 
observations of the impact that government policies have on 
industry investment returns and not to recommend or to 
influence specific policies that could benefit or disadvantage 
individual industry participants.
    I hope that your committee will be able to use this 
information in order to better understand how the actions in 
Washington impact outcomes on Wall Street, and consequently on 
investment in the telecom industry. I will also focus my 
comments on important industry growth area, about which 
uncertainty over important aspects of regulation appear to this 
observer to be detrimental to the health of the industry 
overall and, indeed, asymmetric in their application across 
industry participants.
    In my opinion, clarity, consistency, and predictability in 
regulation, coupled with an overarching bias toward restraint, 
will minimize the cost of capital for industry participants, 
thereby encouraging increased investment and strengthening the 
industry.
    The consequences of the Telecom Act of 1996, some intended 
and others likely not, have been such that there are critical 
areas of potential investment for the industry in which Federal 
regulation lacks all of the necessary conditions listed that I 
just mentioned to minimize the cost of capital, with the 
possible exception of what appears to be an evolving bias 
toward regulatory restraint by some at the FCC.
    The most glaring example to me of an area in which the 
above conditions that I just mentioned are absent is in the 
regulation of broadband access to the telecom network, and the 
uncertainty surrounding the future duties of the incumbent 
local telephone companies to lease elements of this network to 
competitors.
    To frame the discussion, I must point out that the very 
notion that a shareholder-owned corporation is subject to 
mandates requiring it to lease out its primary asset to 
competitors at a rate dictated by the government is, to say the 
least, atypical when looked at against the backdrop of the U.S. 
economy overall.
    Now I am not here to judge whether this is good public 
policy or not, but merely to point out this idiosyncracy that 
local telephone companies face here, and it is a foundation for 
investor analysis of this sector--clearly, the one that raises 
the cost of capital for these companies, and, thus, discourages 
investments.
    Now, compounding this, the lack of clarity, consistency, 
and predictability of regulation with respect to future 
investments in broadband infrastructure just really complicates 
the issue even further. And what I am really specifically 
referring to here is the investment requirements to deploy 
fiber optic-based technologies deeper into the access network 
in order to deliver bandwidth to homes, educational 
institutions, and health care facilities, places that are 
generally outside of the main commercial districts of our 
cities, and to bring the same to also more sparsely populated 
parts of the country.
    Now, I am not here to hold myself out as an expert on the 
intricacies of FCC regulation in this area. But I can tell you 
that there is sufficient uncertainty surrounding the potential 
obligations to lease out ``elements'' of this network to 
competitors that is raising the cost of funding the investment 
for the incumbent phone companies. Simply put, investors are 
far less likely to embrace aggressive plans to invest in this 
kind of network upgrade when there is uncertainty over what in 
the vernacular of telecom regulation is called unbundling.
    In the absence of clear regulation, investors will be far 
less tolerant of additional investment and more likely to 
demand their money back through increased share buybacks and 
dividends. Managements, on the other hand, will be far more 
likely to explore investing outside of the United States in 
geographies where they can more easily evaluate risk associated 
with their investment.
    What makes this situation somewhat perplexing to me is that 
policymakers are addressing the very same issue for the cable 
industry with far less ambiguity. While there has been no 
affirmative claim by the FCC stating that cable broadband 
access will remain deregulated in perpetuity, the mere absence 
of such existing regulations compared with the requirements 
currently placed on the local telephone companies gives an 
investor more confidence that the future resale requirements 
will be less onerous.
    The only legitimate reason that I can see for this current 
asymmetry between the two industry segments is that the Federal 
Government feels like public policy is advanced by choosing 
winners here, and that is truly perplexing when you think about 
it.
    My comments, while focusing primarily on the local 
telephone companies, can be equally applied to other companies 
in the telecom food chain. AT&T is currently spending 
significant resources to market bundled local and long distance 
voice telephone service. If they are not going to be able to do 
this over time, they shouldn't be investing the money right now 
to go after these customers, and they should be returning money 
to shareholders--basically, harvesting their consumer 
investment.
    I do have a lot more to say on this, but, unfortunately, it 
looks like I am about to get the gavel. So I will just submit 
the rest of my testimony for the record, and I am happy to 
answer any questions that you might have.
    [The prepared statement of Eric Strumingher follows:]
  Prepared Statement of Eric Strumingher, Investment Analyst, Cobalt 
                                Capital
    I am pleased to give some observations about the health of the 
telecommunications industry from the perspective of an investor in the 
industry. Since 1994, I have worked as an investment analyst 
specializing in the telecommunications industry and related industries. 
I am now an analyst for Cobalt Capital, an investment partnership that 
at times takes positions in companies who's returns will be influenced 
by policy decisions made by the federal government. However, my intent 
in providing this testimony is to provide an empirical analysis, based 
on my observations, of the impact that government policies have on 
industry investment returns and not to recommend or influence specific 
policies that could benefit or disadvantage individual industry 
participants. I hope that your committee will be able to use this 
information in order to better understand how actions in Washington 
impact outcomes on Wall Street and, consequently, on investment in the 
telecommunications industry. I will focus my comments on an important 
industry growth area in which uncertainty about important aspects of 
regulation appear to this observer to be detrimental to the health of 
the industry and indeed asymmetric in their application across industry 
participants.
    In my opinion, clarity, consistency, and predictability in 
regulation coupled with an overarching bias toward restraint will 
minimize the cost of capital for the telecommunications industry, 
thereby encouraging increased investment and strengthening the 
industry. The consequences of the Telecommunications Act of 1996, some 
intended and others likely not, have been such that there are critical 
areas of potential investment for the industry in which federal 
regulation lacks all of the necessary conditions listed above to 
minimize the cost of capital, with the possible exception of what 
appears to be an evolving bias toward regulatory restraint by some at 
the FCC.
    The most glaring example of an area in which the above conditions 
are absent is in the regulation of broadband access to 
telecommunications networks and the uncertainty surrounding the future 
duties of the incumbent local telephone companies to lease elements of 
their networks to competitors. To frame the discussion, I must point 
out that the very notion that a shareholder-owned corporation is 
subject to mandates requiring it to lease its primary asset to its 
competitors at a rate dictated by the government is to say the least 
atypical when looked at against the backdrop of the U.S. economy. I'm 
not here to judge whether this is right or wrong from the standpoint of 
public policy but merely to point out that this idiosyncrasy serves as 
a foundation for investor analysis of the local telephone companies and 
is clearly one that raises the cost of capital for these companies and 
thus discourages investment. Moreover, the lack of clarity, 
consistency, and predictability of regulation with respect to future 
investments in broadband infrastructure.
    Here I am specifically referring to the investment requirements to 
deploy fiber optic-based technologies deeper into the access network in 
order to deliver increased bandwidth to homes, educational 
institutions, and healthcare facilities that are generally outside of 
the main commercial districts of our cities and to bring the same to 
the more sparsely populated parts of the country. While I do not hold 
myself out as an expert on the intricacies of FCC regulation in this 
area, I can tell you that there is sufficient uncertainty surrounding 
the potential obligations to lease out ``elements'' of this new 
investment to their competitors that it is raising the cost of funding 
these investments. Simply put, investors are far less likely to embrace 
aggressive plans to invest in this kind of network upgrade when there 
is uncertainty over what is in the vernacular of telecom regulation 
``unbundling'' obligations. In the absence of clear regulatory policy, 
investors will be far less tolerant of additional investment and more 
likely to demand their money back through increased share buy backs and 
dividends. Managements will be far more likely to explore investing 
outside of the United States, in geographies where they can more easily 
evaluate the risk associated with their investment.
    What makes this situation somewhat perplexing to me is that policy 
makers are addressing the very same issue for the cable industry with 
far less ambiguity. While there has been no affirmative claim by the 
FCC stating that cable broadband access will remain deregulated in 
perpetuity, the mere absence of such existing regulation compared with 
the requirements currently placed on the local telephone companies 
gives an investor more confidence that future resale requirements will 
be less onerous. The only legitimate reason that I can see for the 
current asymmetry that exists in broadband regulation among the cable 
and local telephone industries is that the federal government feels 
that public policy is advanced by choosing winners here.
    My comments, while focused primarily on the local telephone 
companies, can be equally applied to other companies in the 
telecommunications food chain. Clarity on regulation is equally 
important for shareowners of AT&T as it is for Verizon. AT&T is 
currently spending significant resources to market a ``bundled'' local 
and long distance voice telephone service through leasing the local 
access network of the incumbent local telephone companies. To me, this 
investment only makes sense in the context of a long-term plan in which 
AT&T will be able to provide broadband access to these subscribers as 
it is likely that voice and data services will migrate onto one 
converged network over time and that carriers will need the ability to 
offer both services with a competitive cost structure in order to 
survive. The current lack of clarity is raising AT&T's cost of capital 
as is evidenced by a declining stock price. Current and prospective 
investors in the company would benefit from more certainty over the 
course of future regulation. Should the company be spending 
aggressively to defend its consumer long distance business through 
bundling it with local telephone service, or should it be harvesting 
this business and returning cash to investors? The answer to these 
questions hinges on regulatory clarity. Much the same can be said about 
another participant in the telecommunications food chain, namely the 
manufacturers of equipment used in the telecommunications network. 
Investors in companies such as Lucent, Nortel, Corning, and others face 
difficult decisions on funding the large investment in research and 
development required to develop market-leading technology. The 
difficulty in making this decision is compounded by the lack of clarity 
in regulation, causing investors to just walk away from the sector.
    By way of conclusion, I believe that in regulating this industry 
policy makers must not lose sight of the fact that strong companies, 
both service providers and equipment vendors, are essential to a strong 
telecommunications industry. These companies, however, are owned by and 
run for the economic benefit of private shareholders who seek an 
economic return in excess of their investment cost. The lack of 
clarity, consistency, and predictability of industry regulation is 
raising the cost of capital for the industry, thereby weakening its 
participants. Importantly, the only legitimate explanation that I see 
for the current state of ambiguity in the rules is that the federal 
government is generally conflicted as to whether the local telephone 
companies should be run for the benefit of their shareholders or for 
the benefit of U.S. citizens generally. This is an inherently unstable 
equilibrium. I believe that there is ample evidence to suggest that 
inertia in clarifying regulation in this industry is destroying value 
not only for shareholders but also for citizens generally. To put it 
bluntly, I see only two ways for government to skin the cat on this 
issue: either spell out the rules of the game clearly and allow private 
investors to evaluate the risks associated with an investment based on 
these rules, or nationalize the telephone system and lease it out as a 
platform to resellers at tax-payer subsidized rates that are deemed to 
achieve the redistribution of wealth or other policy goals that are 
deemed to be in the public interest. I can't see how the current 
straddling of the fence benefits anyone.
    I look forward to responding to any questions that you may have on 
my testimony.

    Mr. Upton. Well, thank you very much. Thank all of you. And 
as I read your testimony last night, and as I listened to many 
of you, to all of you talk this afternoon, it seems--and as I 
look at a whole series of analysts' reports done over the last 
number of months with regard to the health of the teleco 
industry, it seems as though almost virtually every one cites 
the example of what is going to happen with UNE-P--what is the 
FCC going to do with UNE-P, and will things continue about at 
the same level, or are they going to make massive changes and 
try to remove that, in my view as an obstacle to capital 
growth.
    And as I listen to you talk about the unbundling of 
broadband, coupled with UNE-P, I would like each of you to 
maybe expand a little bit in terms of your analysis, knowing 
that you only have about 40 seconds each before my time 
expires, to expand specifically just on that angle. What will 
happen to the teleco industry if, in fact, the FCC makes some 
rather dramatic changes and removes the UNE-P requirement, and, 
thus, allow things to go freely? Mr. Atkinson? Would it be 
better or worse?
    Mr. Atkinson. It could be better, and it could be worse. 
The problem is that there is really no way to predict. We don't 
have any evidence. You know, it is speculation on a lot of 
sides, and everyone is claiming the sky is going to fall. 
Probably in some markets it will be much better. In large 
cities, large urban markets, we know, you know, UNE-P probably 
isn't necessary. In rural markets, smaller markets, it might 
be. So if you took a meat axe approach to the--you know, said 
``all in/all out,'' you are going to get kind of a meat axe 
result, and you need a scalpel result.
    Mr. Upton. Now, one of you in your testimony talked about 
allowing the States to experiment. Some States--it was you? 
Okay. I don't know how workable that is, but you, as a former 
FCC employee, do you think that that is possible?
    Mr. Atkinson. Well, my observation coming----
    Mr. Upton. In Massachusetts versus Michigan? Holy Cross 
versus the Wolverines?
    Mr. Atkinson. My experience comes from my pre-FCC life, 
where before the Telecom Act States made all of the decisions, 
State by State. It looked pretty ugly and inconsistent, but 
they made the decisions to open up a collocation, to allow 
local competition in the first place. And, actually, you got to 
fine-tune these policies. Each State made a little step 
forward. Some got it right; some got it wrong. If it was right, 
other States adopted it, and then eventually the FCC and 
Congress adopted the right results.
    And my concern is that the lack of the ability to fine-
tune, to experiment, really says we are going to place a big 
bet on one outcome. Now that may be right, and the FCC is a 
pretty smart group of people. But if they get the UNE-P 
decision or the UNE decision wrong again, where does that leave 
us? I mean, you know, we need to experiment, I think.
    Mr. Upton. Mr. Bath?
    Mr. Bath. I guess, in my view, the elimination of UNE-P 
would be favorable for the industry. Really, I think as Eric 
Strumingher mentioned, the elimination of that unbundling 
requirement would lower the cost of capital; therefore, 
improving hurdle rates for the telephone companies.
    As I said in my written testimony as well, there is 10 
million plus UNE-P customers out there that would be prime 
candidates for the wireless companies seeking to offer local 
voice services to those companies as well as the cable 
companies who to date have taken less than 2 million local 
telephony customers. Certainly, if you eliminate UNE-P, the 
opportunity--industrial opportunity to compete in telephony for 
cable becomes much greater.
    Mr. Upton. Mr. Brodeur?
    Mr. Brodeur. I think it would be both good and bad. In the 
short term, it would be bad, as the UNE-P allows a competitor 
to access and provide sets of services that would be hard to 
do. But in the long term, it would be good, because you would 
force an investment on the part of other carriers to provide 
local services. Otherwise, it is just a price gain that is 
somewhere between what the UNE-P rates are and the retail 
price.
    Mr. Upton. Do you think that it would begin to reverse the 
long-term--the last couple of years trend in terms of capital 
investment, then, from the sharp decline to coming back up to 
where they were?
    Mr. Brodeur. It could contribute to improving that. It is 
not--it will not solely do that.
    Mr. Upton. Mr. Crandall?
    Mr. Crandall. It is a minor event, I think, in terms of the 
future of the industry, because those people using UNE-Ps are 
not going to succeed. MCI and AT&T are the two major users. 
AT&T stock has fallen by 30 percent since it spun off its 
broadband assets. MCI is not going to succeed with this.
    I think it will help raise capital for the Bell companies, 
but in a marginal way. I think the broadband piece is much more 
important.
    Mr. Upton. Well, you just have to agree or disagree, Mr. 
Strumingher. I am out of time.
    Mr. Strumingher. You are putting me on the spot. I think we 
need clear rules on both UNE-P and all unbundling, because 
either a competitor will have access to everything, or they 
should have access to nothing. This state of straddling the 
fence where we are now, and we have been for it seems like an 
eternity, has got to stop.
    Mr. Upton. Thank you.
    Mr. Markey?
    Mr. Markey. Thank you, Mr. Chairman.
    In 1994, this committee and the Congress passed a bill, the 
Markey-Fields bill, which had 400 votes on the House floor, and 
then Senator Dole killed it over in the Senate. Here is what it 
says in terms of its goals. It says, ``To make available, as 
far as possible to all people of the United States, regardless 
of location, a switch broadband telecommunications network 
capable of enabling users to obtain affordable, high-quality 
voice, data, graphics, and video telecommunications services,'' 
making reference to its digital quality.
    Now, that legislation was killed. However, obviously what 
we were interested in is dislodging from the Bells this DSL 
technology which they had but were not deploying, because much 
like the black rotary dial phone that we all had in our living 
rooms in 1980, they were refusing to deploy anything because 
they had no competition.
    Or, as in 1993 when we created the third, fourth, fifth, 
and sixth cell phone companies, they were refusing to move from 
analog because they had no competition. And so the interesting 
development since 1996 when the Telecom Act passed is that now, 
just a brief 6 years later, more than 75 percent of all 
American homes have broadband passing their front door. That 
didn't happen before the 1996 Act, even though the Bells had 
the technology and had no impediments in terms of the 
deployment of it.
    So this inducement of paranoia is something that actually 
played a big role, as it did in every other area, right back to 
black rotary dial phones, that they said if you allowed any 
other competitor to sell one and they plugged it in in their 
home, it would ruin the whole phone system for greater Boston 
or any other system in America. We have heard it over and over. 
This is just a continuation of that complaint.
    So the interesting thing, though, is even though Americans 
have, through the duopoly, access--75 percent of them--to 
broadband, they are not subscribing. A very small percentage 
are subscribing to something that is now available to them 
because the price is too high.
    So the question is: how do you solve that problem? Do you 
guarantee that there are no new competitors able to use this--
these wires in order to get into homes, to provide new 
services, to provide interesting price structures? Or do you 
say once again to the Bells, ``Don't worry. No paranoia. 
Continue to just do your research, but you don't have to 
deploy''? Which is going to work better for America? What is 
going to work better for the consumer, not just for--all of you 
represent basically that investor perspective.
    I am talking here about consumers. They have been the 
beneficiary of the 1996 Act. It has been a huge, roaring 
success. The Bells weren't deploying anything. So my question 
is, to anyone who wants to take it, isn't it better that we get 
more competition that will lower prices and increase the 
quality of services, so we get the price down from $55 or $60 
down to $35, and then they will get 75 percent of Americans 
subscribing rather than having this--that is, the future that I 
have heard this panel express has a name for it.
    It is called the past. You are advocates for the past, over 
and over again. So I want to hear from at least somebody here, 
somebody that does support more competition, not less.
    Yes, Mr. Atkinson?
    Mr. Atkinson. There is a potential new development which is 
coming along I hope called powerline communications. Now, if 
you got--that would make--it is the idea of using the powerline 
to every home, to every plug in your home, upgraded to some of 
these trials have gone to five megabits. Could be a very, very 
inexpensive broadband connection, which would break the duopoly 
and at least----
    Mr. Markey. Can I call and get the----
    Mr. Atkinson. There are some very--there are some trials 
going on around the country.
    Mr. Markey. No. I mean, I need--I said I want to dump my 
company today, so----
    Mr. Atkinson. You have got to keep your eye on it. 
Obviously----
    Mr. Markey. While I am waiting for that to arrive, can I 
keep the competition in place waiting for that? Or would I be a 
fool to wait for a new technology that might never actually 
fulfill its promise?
    Mr. Atkinson. It is a risk that the technology certainly 
won't evolve.
    Mr. Markey. But that is that boom-bust that is--prefer not 
to go that route, and just take the bird in the hand until 
something new comes along.
    Mr. Atkinson. Well, a third or more competition certainly 
would, you know, provide the competition for--and lower prices, 
etcetera, for consumers. That is a good thing. Investors will 
go, hmmm, that is not a good thing. Maybe I don't want to 
invest in it. Yes, that is the typical--the tradeoff and a 
concern.
    The question, of course, would be, should we have--in the 
sense from a government policy point of view, carrots or sticks 
to----
    Mr. Markey. Should we change policy in anticipation of 
technology----
    Mr. Atkinson. No, it should----
    Mr. Markey. [continuing] that may not arrive, or should we 
wait for the technology to arrive and then change the policy 
because the technology is here?
    Mr. Atkinson. I would go with my--do an experiment to see 
what happens in----
    Mr. Markey. Thank you, Mr. Atkinson.
    Yes, sir?
    Mr. Strumingher. Yes. I would just offer one or two 
observations in response to your statement. First of all, I 
think you can't just consider the price. You have to consider 
the economic return to not just the incumbent but all 
competitors in providing the service. Right now there are many 
different providers of DSL service--for example, COVAD, 
Earthlink, just to name two, or AT&T and other--who are 
currently leasing out the copper loop to deliver service over 
DSL.
    They are pricing at the same level roughly as the 
incumbents. The reason--well, in my opinion--they don't consult 
me about their pricing decisions. But in my opinion, the reason 
is because it is an expensive service to provide. None of these 
is actually making money at DSL yet. There are large 
provisioning costs involved. There are lots of costs in ramping 
the business up. So I say you have got to consider both the 
price, but also the cost of providing the service when you take 
a look at it.
    The second----
    Mr. Markey. If they eliminate that competition, do you 
think the Bells are going to lower prices and increase 
deployment if there is no pressure on them at all? That just 
seems like it is anti--that is counterintuitive. That is not 
how they have acted for the first 100 years of their existence.
    Mr. Strumingher. Yes. Actually, that is not what I was 
saying. I wasn't suggesting that we should do that. I was just 
pointing out that we need to take a look both at the price and 
the cost of delivering the service.
    The second point that I would make in this that I think is 
important is a comparison of price and value that the customer 
is receiving. Right now, if you want to get dial-up access to 
the internet, a lot of people buy a phone line or lease a phone 
line from the Bell company, and then lease another phone line 
that they use for their internet service.
    It varies depending on geography, but the rough cost is 
approximately equal to what you would pay for a DSL line, where 
with DSL you can get both a voice service and an always-on 
high-speed connection. So the value received by the consumer is 
actually, in my opinion, better than in the contrary case where 
they are buying two lines.
    Mr. Markey. Mr. Chairman, you have been overly indulgent to 
me. Thank you.
    Mr. Upton. Mr. Tauzin?
    Chairman Tauzin. Thank you, Mr. Chairman.
    Mr. Crandall, you make the point that the spread of a UNE 
platform into these new advance services will increase the 
appearance of competition but not the reality of it. You say in 
your statement, ``Simply allowing other carriers to deliver the 
same service over the same facilities to the same customers at 
greater social cost will not promote competition.''
    If I can draw an analogy maybe--if we need some more 
taxicab competition in this town, does it help us to say that 
we are going to allow competitors to use the incumbent's 
taxicab to drive people around at a discounted rate set by 
government? Does that really increase competition in taxicabs?
    Mr. Crandall. Well, as you well know, I mean, we have been 
in this debate for a long time. The idea of using unbundled 
network elements was one of providing entrance either of the 
ability to access essential facilities that they couldn't build 
themselves economically or to get a toehold prior to building 
their own facilities.
    Chairman Tauzin. The idea was to get things started.
    Mr. Crandall. Yes.
    Chairman Tauzin. I mean, the idea was that they were going 
to have their own taxicabs eventually, their own facilities at 
some point, right?
    Mr. Crandall. Right. How the UNE-P is being used is not for 
getting a toehold and building their own facilities, but, 
rather, for bundling voice services.
    Chairman Tauzin. Yes, but let us not talk about that.
    Mr. Crandall. In places like New York, in order to compete 
with the Bell companies. The only thing they are doing is they 
are getting huge discounts, huge resell discounts.
    Chairman Tauzin. They are getting a resell discount is all 
they are getting. They are serving the same customers over the 
same facilities.
    Mr. Crandall. Let me point out----
    Chairman Tauzin. But I have got to move quickly.
    Mr. Strumingher, you point out the--I think in awfully good 
language the absurdity of this kind of thing. You point out 
that the very notion that a shareholder-owned corporation, 
which is what we are talking about here--the ILECs--that a 
shareholder-owned corporation is subject to mandates requiring 
it to lease its primary assets to its competitors at a rate 
dictated by government is a pretty atypical situation in a 
capital market.
    But you also point out that that isn't true for cable. It 
is true for telephones but not for cable. And no one has yet 
said that government ought to tell the cable company that it 
has to lease out its facilities to competitors at a rate set by 
government.
    What do you think would happen to cable investment in these 
new broadband services if we decided in fairness to subject the 
cable companies to the same rules the FCC has subjected the 
telephone companies to?
    Mr. Strumingher. I think that it would be pretty 
destructive.
    Chairman Tauzin. Pretty destructive?
    Mr. Strumingher. Yes, very destructive.
    Chairman Tauzin. In what way?
    Mr. Strumingher. Well, this is perhaps for the cable 
industry its best growth opportunity. And if you all of a 
sudden cast doubt upon the industry's ability to earn a return 
on this investment because there are unclear rules or onerous 
rules on reselling this asset to their competitors, you 
increase dramatically their cost of capital.
    Chairman Tauzin. But, you see, what we have done--you 
really put it to us pretty good here in this statement. What we 
have done is we have decided to tell the cable companies, ``We 
are not going to do that to you. We want you to go out and make 
these investments and earn capital--earn, you know, profits on 
your capital investments. But we are going to do it to the 
telephone company, your competitor in this broadband area.''
    So, therefore, we decided to make cable the winner and 
telephones the loser. That is essentially what you said. The 
only--this is your quote. ``The only legitimate reason I can 
see for the current asymmetry that exists in broadband 
regulations among the cable and the local telephone industry is 
that the Federal Government feels that public policy has 
advanced by choosing winners here.''
    Now, simply read, that is telling us that we decided to 
make cable companies winners over telephone companies. Is that 
right?
    Mr. Strumingher. Yes. I can't really see the policy 
objective in so doing, but that is the way it appears to me. 
And it is kind of perplexing.
    Chairman Tauzin. Well, it certainly is to me. It is 
perplexing to me that we would want to have competition in 
broadband services and only make cable the winner. If we really 
want competition, we should have a really level playing field.
    Now, if you had to choose--if you were advising me and the 
FCC today on whether we ought to subject cable companies and 
telephone companies to all of these rules similarly, so we are 
not picking a winner, or to take these rules off of both of 
them--and everybody else by the way, wireless and satellite, 
anybody else who wants to compete--which direction would you 
recommend we go?
    Mr. Strumingher. Well, I don't want to hold myself out as 
an expert on public policy. I hope that I can hold myself out 
as an expert on investing. And I will tell you this----
    Chairman Tauzin. Well, which direction would take us into 
more investments and more services and real competition, Mr. 
Crandall, instead of fake or phony competition? Can you help us 
here?
    Mr. Crandall. Well, surely taking the same view of both 
sectors, not regulating new services that are delivered over 
new facilities is the right approach.
    Chairman Tauzin. Absolutely it is the right approach.
    I yield back, Mr. Chairman.
    Mr. Upton. Thank you.
    Mr. Wynn?
    Mr. Wynn. Thank you, Mr. Chairman.
    Mr. Upton. You are recognized for 8 minutes.
    Mr. Wynn. Thank you.
    Is there anyone on the panel that believes that the primary 
unbundling rules to newly deployed infrastructure by ILECs or 
CLECs makes sense? Guess not.
    Mr. Crandall. Could I answer that in one way, Mr. Wynn?
    Mr. Wynn. Yes.
    Mr. Crandall. We had a conference at The Brookings 
Institution a little over a year ago, and the book is out on 
broadband regulations. It just came out a couple of weeks ago. 
Everyone there, regardless of their views on unbundling, seemed 
to take the same view. That is, for new facilities, there is no 
basis or no justification for requiring unbundling.
    Mr. Wynn. Thank you.
    With regard to State rate-setting, is the primary issue the 
uncertainty or the unfairness? I have heard both allegations. 
What is your sense? If someone on the panel would respond to 
that.
    Mr. Atkinson. I think the allegation is that the TELRIC 
rates set by the States are--have been too low. At least that 
is certainly the allegation of the Bell companies. Of course, 
the consumers of those services think the rates are good or not 
low enough. The difficulty is the States are--to get it right, 
you have to keep trying to get it right. I mean, it is 
Goldilocks pricing, not too high, not too low, you have got to 
get it just right.
    And so the States I think are going to go back and take a 
second look and a third----
    Mr. Wynn. If I could just jump in, is that a result of some 
sort of regional differences, or is it just the quirks of the 
individuals States?
    Mr. Atkinson. You know, the price or the cost of providing 
the service varies typically by density more than just by 
States. Rural areas are more expensive to serve than urban, 
typically, and some companies do better or worse than other 
companies, even for the same kind of geographic area. So it 
varies sometimes by Bell company versus non-Bell company, or 
you can just--it just differs. But the formula is a formula, 
and they apply it differently, and they are going to change it.
    Mr. Wynn. I see Mr. Bath kind of itching to get in on that.
    Mr. Bath. Well, yes, I think the issue from the investors 
that I talked to is that, certainly, as you think about the 
States' incentives--as Mr. Markey noted, the incentive for the 
States is to continue to lower prices to consumers, lower 
prices for the traditional voice services. And so as long as 
the TELRIC/UNE-P requirements are out there, there is certainly 
an investor concern that the States will continue to have a 
motivation to ratchet the rates lower and lower.
    Mr. Wynn. Unfairly low, not just lower but----
    Mr. Bath. Well, I mean, as----
    Mr. Wynn. In relation to the value of the investment.
    Mr. Bath. As low as they can to continue to promote 
competition. Again, from their perspective, they are doing what 
their constituents would ask them to do, which is drive lower 
prices through more competition.
    Mr. Wynn. Okay. I am curious. Everyone talks about clarity, 
consistency, and predictability, most definitely what the 
industry wants. I would submit that that is probably the same 
thing that the consumer wants, and that one of the biggest 
consumer concerns is dropped calls and the lack of consistency 
in terms of their research.
    Has anyone seen a market survey of really what the consumer 
demand is? Is it for the next generation, or is it for this 
generation to work better? What is it that consumers want? What 
drives this market?
    Mr. Atkinson. I think it is all of the above. I mean, it 
is--consumers are very glandular. There are some who want just 
low cost, some who want all of the latest bells and whistles. 
And, you know, they will go to the carrier which gives them the 
best value proposition for what they want. But there is clearly 
a market for cheap and cheerful, and there is clearly a market 
for the most, you know----
    Mr. Wynn. Is there any segment that is larger than the 
others, or is it fairly equally disbursed?
    Mr. Atkinson. I don't know.
    Mr. Crandall. Can I answer that?
    Mr. Wynn. Yes, sir.
    Mr. Crandall. Well, still to this day, the traditional 
services constitute the overwhelming share of consumer 
expenditures. But wireless is growing, as is broadband. But to 
ask a household, what does he want when his choice is among 
services that are--have not yet been perfected?
    My DSL service here in the city of Washington, D.C. 
delivers me 600 kilobits per second. In Japan, if I had the 
choice, it would be between eight and 12 megabits per second. 
So consumers don't even know what the choices could be once 
technology gets rolled out.
    Mr. Wynn. Yes?
    Mr. Brodeur. And then I think the--I would agree that the--
clearly, quality is an issue. The consumer will want good 
quality services, no dropped calls and the like, and they 
clearly want decent pricing or low pricing. But there is also a 
big desire on the part of consumers to see the bundling of 
services, local and long distance together, to see local, long 
distance, and wireless, and broadband all being provided as a 
package to the home or to the business.
    Mr. Wynn. Thank you.
    It seems to me that there is a pretty good consensus that 
this unbundling rule is not working or is inhibiting 
investment. Is it your sense that it is also costing us jobs 
that may be going overseas or other places?
    Mr. Bath. I mean, the unbundling rules are largely being 
used by AT&T and MCI to hold on to the current customers that 
they now have. And as you think about the kind of jobs that 
they are creating, there are certainly creating jobs in the 
advertising community, telemarketing, and customer service, 
etcetera.
    Mr. Wynn. What would happen to those jobs if you didn't 
have the unbundling rules?
    Mr. Brodeur. I would just say that, clearly, unbundling 
does create a disincentive for new investment, particularly 
fiber loop facilities. When you consider the number of jobs 
lost primarily in the manufacturing industry as well as the 
service industry, but primarily the manufacturing industry, but 
if you think about investment in fiber facilities it is not 
just switches and fiber, it is also construction workers that 
build the ditches that the fiber is put into. That is a huge 
component of it. So there is a lot of jobs to be gained there.
    Mr. Wynn. Okay. I think you used the Corning example in 
your testimony?
    Mr. Brodeur. Yes.
    Mr. Wynn. As an example of where you, absent these 
unbundling rules, you could get more investment?
    Mr. Brodeur. There is a much greater incentive for 
incumbent operators to invest in broadband--new broadband 
infrastructure without unbundling today, and that will help 
both Corning and many other equipment manufacturers.
    Mr. Wynn. I think--Mr. Crandall, did you want to say----
    Mr. Crandall. Yes. I wanted to say that UNE-P and 
unbundling new facilities for broadband--the UNE-P probably has 
some unfavorable effects on investment, in terms of maintenance 
of existing plant. But requiring the unbundling of new 
facilities in uncertain ways implemented by the States does 
certainly chill investment in new facilities.
    And to address Mr. Markey's question earlier, there is no 
one who thinks that this unbundling for broadband is going to 
generate much in the way of competitive supply of DSL. And the 
forecasts are that the competitive DSL supplies are going to be 
very small. Today there may be half a million out of, what, 15, 
17 million total broadband subscribes.
    Mr. Wynn. Is it true that there is no real impediment to 
the ILECs or CLECs investing in the new infrastructure?
    Mr. Crandall. Well, I mean, the impediment is demand and 
cost. If you want that, I mean, it is the regulatory 
impediments we are talking about.
    Mr. Wynn. Okay.
    Mr. Atkinson. Really, there is a very good role for UNEs to 
consolidate demand to lower the risk for new investment, 
particularly for startup companies, for competitive companies. 
So, you know, in the right circumstances, UNEs are going to 
create jobs, create new----
    Mr. Wynn. My time is almost up. What do you mean when you 
say consolidate demand? Why does it have to be consolidated?
    Mr. Atkinson. No, to concentrate demand and to test it--to 
build demand to now justify the investment in your own 
facilities. The proper role for----
    Mr. Wynn. And that argument is that you can only do that if 
you have the current unbundling rules. Is that----
    Mr. Atkinson. Not necessarily the precise current 
unbundling rules, but the statute requires unbundling, and I 
think it was intended to provide the ability to aggregate 
demand so investment would be lower risk by the newcomers. The 
newcomers would then, after aggregating the demand, move it to 
their own facility.
    Mr. Wynn. But no incentive for investment for the 
incumbents.
    Mr. Atkinson. There is a--not for the incumbent. Clearly 
not.
    Mr. Wynn. All right. Thank you, Mr. Chairman.
    Mr. Upton. Thank you.
    Mr. Shimkus?
    Mr. Shimkus. Thank you, Mr. Chairman. It is great to have 
the panel here, and I apologize for stepping out. That is part 
of our challenge as a Congressman.
    All of us have been concerned about the economy as a whole, 
and a lot of us lived through the good days of the expansive 
telecommunication age and all of the great things that 
occurred, and then we have also, with the economic slowdowns, 
are putting up and surviving with the way the economy is today 
at the time.
    I wasn't a member during the 1996 Telecom Act. I was back 
home in Illinois, and I have been trying to follow this as we 
move forward. But I have been a consumer and have tried 
different types of technologies to do my job. You know, many 
people do it now at home. And I have gone from dial-up to 
recently switching to cable broadband at home and cable 
broadband in my townhouse here, because of the bundling aspects 
and what they have been able to provide me. And they are 
marketing a good price.
    And so the question is: if I, as just a consumer, have made 
a decision, based upon looking at what is out there in the 
market right now, and I have said for me it is worth my money 
to switch--an ISP, I switched really, in essence, from the 
dial-up, changed my ISP, went to cable.
    What has to be done to the other modes of delivery of high-
speed internet connectivity to encourage anyone else to jump 
into the competitive market, whether it be high-speed cellular, 
whether it be direct satellite, whether it be, you know, 
through the telephone lines, because that is really our--if we 
want the economy to recover, how are we going to--what barriers 
do we lift--and that has been part of the discussion--that may 
have been in place either through the 1996 Telecom Act or 
through FCC ruling, or what do we lift or do we have to put in 
place?
    And, of course, there is a difference in the investment 
community based upon--even here on the panel--of more 
government regulation or less. I would like just to start 
from--to my left and go down and see if you can just address 
that question for me in the generic arena.
    Mr. Atkinson. There is nothing that a big dose of new 
revenue wouldn't cure for the telecommunications industry and 
the suppliers and everybody. I think it was pointed out earlier 
by one of the other witnesses that, you know, new applications 
are the only thing that is going to bring in new revenue in any 
great quantities.
    I don't know that regulation is going to--of telecom by the 
FCC, for example, is going to make a great deal of difference 
to the kind of applications. Clearly, if there are applications 
that are being held back by FCC regulation, those should be 
definitely eliminated. But it is the content, it is what is 
that, you know, proverbial killer app?
    I think it is somewhat generational, too. You know, people 
with gray hairs may not be the great consumers of some of these 
new applications, but the younger generations are avid, huge 
users of these new services. And as they sort of move into the 
telecommunications buying worlds, they get into their twenties 
and thirties, form households, things like that, there may be 
just a huge, very natural, new demand coming into the system. 
And hopefully we could accelerate that, but it is--new 
applications are going to be new revenue, and that is what we 
need.
    Mr. Shimkus. Mr. Bath?
    Mr. Bath. Yes. I think, if I get at your question properly, 
you know, what you are interested in is how can you get from 
other providers the kinds of high-speed data and internet 
services you get from the cable company. I think the clearest 
path is to lower the cost of capital and create the incentives 
for the telephone companies to deploy those networks more 
aggressively.
    Clearly, eliminating the network unbundling requirements on 
those networks would help. I think, in addition, more spectrum, 
which I know the FCC has worked hard, and, as Mr. Markey 
pointed out, I think the FCC has done a superb job in getting 
as much spectrum out as they can. And then, finally, on the 
satellite side, you know, talk about a sector that has had 
tremendous technological evolution here over the last decade in 
terms of what it can deliver. And recently the FCC has taken 
some action to improve the satellite companies' abilities to do 
that.
    So I do think it is coming. Less regulation, you know, 
certainly, again, lowers the cost of capital and creates the 
proper incentives.
    Mr. Shimkus. And part of that answer is certainty.
    Mr. Bath. Certainty helps. I mean, uncertainty is killing 
the telecom investors', you know, view of the world right now, 
as I said in my written remarks.
    Mr. Shimkus. Yes, great. Thank you.
    Mr. Brodeur. I would add the industry is evolving. I think 
the Telecom Act of 1996 and previous regulatory initiatives 
certainly are all part of the process of this industry and 
improvement of the services that are provided to customers. I 
think the objective should be facilities-based competition all 
the way to the home or to the business. That should be the 
objective.
    Time and time again we have seen, you know, in the--if I 
were in front of you 7 or 8 years ago, there is no way I could 
have ever told you that there would be sets of services now in 
the wireless zone where, you know, effectively you have free 
minutes of long distance usage at the marginal rates on the 
weekends and even in the peak periods. That is because we have 
facilities-based competition.
    I would also note that there have been roughly 150 
competitors that were started in the 1999 through 2001 period. 
Almost three-quarters of them were UNE-based competitors. 
Because the risk for financial investors to make investments in 
those companies was less, there is an incentive not to invest 
in facilities all the way to the home or to the business, and 
that is because of the UNE.
    And that is why I think, as our study indicated for 
Corning, how there is a disincentive especially when it comes 
to incumbents providing fiber facilities. But the overriding 
objective of public policy, I would believe, would be for 
facilities-based competition.
    Mr. Shimkus. Great.
    Mr. Crandall?
    Mr. Crandall. I will echo that and leave Mr. Strumingher 
some time. But let me, in addition, add the fact that 
regulatory uncertainty is probably keeping the cable companies 
from allocating more of their spectrum to broadband services 
for fear that they might be subject to some of the sharing 
requirements that the telephone companies are subject to.
    Mr. Shimkus. Very good.
    Mr. Strumingher?
    Mr. Strumingher. I guess I would just answer by saying we 
should focus not on putting a little tweak here or a little 
tweak here to regulations which might, you know, all of a 
sudden create some huge boom in revenue. I mean, the nature of 
this industry is it is technology-driven, and we don't really 
know what the next great source of revenue is going to be.
    But these opportunities are going to come up. And if there 
is a clear deregulatory bias, if there are clear rules, then 
capital is going to flow toward funding those ideas, which 
they, you know, are at this stage. And, you know, who knows 
what the next great thing is going to be? But when it comes, it 
can get funded.
    Mr. Shimkus. I appreciate the answers.
    Mr. Chairman, I yield back.
    Mr. Upton. Thank you.
    Mr. Dingell?
    Mr. Dingell. Mr. Atkinson, I want to thank you for your 
very helpful testimony. I was reading at page 3, you have a 
very interesting statement in which you said as follows, ``That 
it might make it too easy for new entrants to get into the 
space being occupied by established CLECs, such as TCG and MFS, 
and whether unbundling would undercut the value of our existing 
investments.''
    ``I couldn't answer those questions, because the roadshow 
was being conducted before the FCC's local competition order of 
August 1996, although the answer turned out to be yes. After 
the order was released, TCG's stock struggled for a time.''
    Wouldn't this appearance tend to lend credibility to the 
fact that we need to eliminate some of these rules that 
preclude this--that preclude people from getting relief from 
this kind of situation?
    Mr. Atkinson. Possibly. I think the bigger issue is 
probably the pricing of--you know, if we--our concern--this is 
back in 1996 when I was at Teleport, was that we were very 
concerned with what has happened, that you UNE prices would be 
too low and undercut the value of the investments that we had 
made in the prior 10 years to compete.
    So we were concerned not so much with the requirement of 
the Bell companies to make UNEs available to our--the startups 
that were coming behind us, but the pricing level. And I think 
it may well be that the prices are in some cases too low, and, 
therefore, undercuts.
    Mr. Dingell. And changing back would help this situation.
    Mr. Atkinson. Getting the pricing right is ultimately what 
has to happen. It is a question--access to the elements is 
important, and then you need to get the price right. If it is 
too high, you are not going to get the market aggregation 
function, which will trigger new investment.
    Mr. Dingell. But the best mechanism for fixing that price 
is the market. So you do regulate it, let the market fix these 
prices, get everybody in the business to compete fairly, and 
you have got the problem solved.
    Mr. Atkinson. That would be the--you know, the Telecom Act 
set up the prospect of negotiated interconnection agreements 
precisely where those prices for UNEs would be negotiated. The 
one that the Act has not fulfilled is the ability for CLECs and 
ILECs to negotiate those deals and get that whole process 
completely out of the regulatory process.
    Mr. Dingell. Well, as I read the FCC's order, that is a 
real possibility and would be a desirable consequence. Right?
    Mr. Atkinson. If you can fix the negotiating process to 
make that work, and then get rid of--then the FCC can get out 
of it completely.
    Mr. Dingell. But also address the unbundling problem to 
which you complained in your statement.
    Mr. Atkinson. It would--if you can get the prices right, 
then I would have been happy back in 1996. And if I could have 
negotiated my own interconnection arrangements with the 
incumbent, I would have even been happier, because I would have 
negotiated exactly what I wanted, and my competitors hopefully 
wouldn't have been able to take advantage of my deal. But right 
now, today, you can't negotiate a deal.
    Mr. Dingell. All right.
    Mr. Atkinson. So we have to go back to this regulatory 
morass.
    Mr. Dingell. Now, I note that at page 9 you have some other 
very interesting comments, which I found to be very helpful. 
``In the guise of promoting competition, the Act and the FCC 
regulations that followed have created an enormous regulatory 
apparatus and set of requirements. The Act has created a set of 
companies and industries whose very survival is dependent on 
the good grace of the regulators. The dependency relationship 
is not one that makes for a healthy policy environment or 
acceptable investment risk.''
    Essentially, you are again saying the same thing, and this 
brings us down here again to the fact that we have to address 
this question in which you complain that the Act has created a 
set of companies and industries whose very survival is 
dependent on the decision of Federal regulators.
    So if we, again, absolve ourselves of these Federal 
regulations, the Federal regulators, industry is going to make 
their own judgments, as you have said, on an acceptable 
investment risk. And it would seem, therefore, to me at least 
that the policy would promote, and should promote, facilities-
based competition which by its very nature would eliminate this 
dependency relationship of which you have complained. Am I 
correct?
    Mr. Atkinson. You certainly don't, as a competitor of the 
last--as a real competitor, the last thing you want to be is 
dependent on your big powerful competitor. So that is a big 
reason to become----
    Mr. Dingell. I mean, we want to get that competition, don't 
we?
    Mr. Atkinson. You absolutely do. You want to be free and 
independent.
    Mr. Dingell. Thank you.
    Thank you, Mr. Chairman.
    Mr. Upton. Thank you, Mr. Dingell.
    We will go to Mr. Terry. Mr. Terry is recognized.
    Mr. Terry. Thank you, Mr. Chairman.
    Mr. Strumingher, you and the chairman had a nice colloquy, 
and I want to refer you to the last part of your statement 
where you put it bluntly. You see two ways for government to 
skin the cat on this issue, either spell out the rules of the 
game clearly and allow private investors to evaluate the risk 
associated with an investment based on these rules, or 
nationalize the phone system.
    What I would appreciate is some clarity from you on how to 
make the rules clear. I agree with your statement that 
investors, shareholder-owned companies, are looking for 
certainty and clarity before they are willing to risk their 
money. But what rule--specifically, the rules, what is the 
seminal holdup in the rules, and how would we clarify those? 
What would you suggest needs to be clarified in those rules to, 
you know, release the pent-up dollars out there and reinvest in 
the telecommunications industry?
    Mr. Strumingher. Sure, I will give it a shot. I think from 
point of departure, I would recommend that we have national 
rules with local implementation of the rules. But the rules 
have to be very clearly stated with an affirmative statement 
and a definition of impairment.
    That seems to me to be a critical stumbling block right now 
for regulation. So the FCC should come up with a prescription, 
with a detailed statement on what would define impairment, not 
just for the network as it exists today, but to try to have a 
forward-looking view, so that if a competitor wanted to make 
investments today that might change based on technological 
changes in the future, they might see a path toward being able 
to do that instead of being just--in a real--I would call it a 
vicious cycle of guessing.
    Mr. Terry. All right. Well, in a similar question, I will 
ask Mr. Atkinson--and I think probably in Ranking Member 
Dingell's question you started to go into this area. But in 
your statement you had mentioned that the 1996 Act contributed 
to the bust, and regarding the rules and the gridlock that was 
created by that.
    I am just curious to what could have been removed, what 
specifically could have been removed by way of the rules or 
further better defined that--that we wouldn't have had that 
micromanagement that you mentioned, and we could have prevented 
or either softened that ``bust.''
    Mr. Atkinson. I am not sure I have a specific view of what 
was wrong the last time. My concern is when we get--if we have 
an upturn, as we are having, that when the next downturn 
happens we don't have the continuation of the gridlock, we 
don't have the continuation of the risk.
    And so my recommendation at the end of my testimony is we 
do two things. One is we, first of all, try to get as much of 
the controversy simply out of the regulatory process 
completely, and get it away from the possibility of gridlock, 
and you could do a lot of that if you could get this 
interconnection agreement process to work. That is going to be 
a very difficult thing to do, because there is all kinds of 
problems with bargaining power, respective bargaining power, 
etcetera.
    But if you could pull a ton of the controversy out of the 
regulatory process altogether, you would eliminate a lot of 
gridlock. At the same time, if you had the opportunity to do a 
lot of experiments, you also kind of could make--the can make 
the regulator, to the extent the regulator has to make a 
decision, instead of relying on informed speculation, which is, 
frankly, what a lot of regulators have to do today, they could 
look at real-world results and say, ``What happened over here 
was a good thing. We will do more of that. What happened over 
here was a bad thing. We won't let that happen again,'' and 
have a dynamic process instead of sitting here today, for 
example, or the FCC next week saying, okay, here is the new 
plan, and that is a rigid plan that might work very, very well 
for the next few years because it is based on the current 
situation.
    But as time evolved, as time goes on, as new technologies 
comes in, as the economy either booms again or busts again, the 
optimal regulatory decision made by the FCC next week may not 
be at all appropriate. And so you need flexibility and the 
ability for regulators to kind of get ahead of the problem, or 
at least keep up with the problem, or they become increasingly 
irrelevant.
    Mr. Terry. I would assume, as all of you have mentioned in 
your statements that you need clarity and certainty, if there 
is a particular bill to ``deregulate'' similar to the bill that 
we passed last year, or a similar type of bill, that we must, 
in order to have clarity and certainty, mandate those--that 
deregulation or clarity in the rules upon the States.
    Would you agree that if we left it up to 50 States that 
there would be a lack of clarity and certainty, and that 
perhaps we could exacerbate the problem?
    Mr. Atkinson. I think Mr. Strumingher was correct. What the 
FCC--the right role for the FCC is to be very clear what the 
goals are and what the restrictions are. You wouldn't want to 
just, say, have the 50 States just do whatever they want on a 
whimsical basis. But the Telecommunications Act or the 
Communications Act lays out a goal, a vision.
    As long as the States are constrained to only act toward 
that, and the FCC can always step in and say, ``No, you got it 
wrong,'' and in a sense perhaps act more as an appellate court 
than as a court of original jurisdiction. So that way you can 
get the benefit of good ideas of adapting to the changing 
technology, changing markets, etcetera, and use the FCC to 
backstop against a disaster.
    I think that I would expect from an investor's point of 
view investors would be able to see what is happening in each 
of these experiments, start placing their relatively small bets 
on good things that are looking like they are going to have a 
favorable outcome. And then, as the experiment matures, you 
start placing bigger and bigger bets. That reduces risk.
    Mr. Terry. Does anybody else want to comment on the role of 
the States?
    Mr. Crandall. Yes. I think people underestimate what the 
cost of regulation is at the State level. The debates that have 
taken place over having to unbundle fiber, copper, digital 
loop, carrier types of systems often take a year or 2 in States 
like Illinois, Minnesota, which is ongoing right now, and 
freeze investment on the part of the ILEC, providing some 
certainty, saying, ``You may only have the copper from the 
subscriber back to the remote terminal,'' and that all of the 
rest of the electronics need not be unbundled, would I think 
move things forward substantially.
    Mr. Terry. Thank you. I asked that latter question because 
the--we had, obviously, several opponents of deregulation, but 
one of the opponents that we have had are State PUCs and 
Governors who want to keep--retain some level of power and 
control over telephone utility companies, long distance and 
local.
    So, thank you, Mr. Chairman.
    Mr. Upton. Thank you.
    Mr. Engel?
    Mr. Engel. Thank you, Mr. Chairman. A lot of people here 
today have said a lot of what I want to say, but I wanted to, 
first of all, make it clear that I am certainly not opposed to 
Federal Government regulating the telecommunications industry. 
I think that it is necessary in certain instances, but it is 
clear to me that sometimes there can be unintended 
consequences.
    And I think in this case, in the case of unbundling network 
elements, we have seen where many competitive local exchange 
carriers chose not to build their own facilities, but instead, 
you know, they rented a whole system from a local incumbent. I 
think the 1996 Act and Congress were clear that we wanted and 
need facilities-based competition.
    So I am especially, as others are, concerned about the 
industry's ability to access the capital markets, and I want to 
identify with the chairman, Mr. Tauzin, and his remarks. I am 
not interested in stifling investment, and I think that that is 
what this does.
    I want to ask Mr. Brodeur, in your testimony you state that 
we could rationally build fiber loop facilities and completely 
new broadband infrastructure to roughly 30 percent of U.S. 
households without regulation, but to only 5 percent of U.S. 
households if the unbundling regulatory paradigm were extended 
to these fiber loop facilities. And I would like you to expand 
on that, please.
    Mr. Brodeur. Sure. I will do my best. Essentially, the 
decision that all of the ILECs have to make with regard to 
fiber--and fiber is probably the most--fiber to the home and to 
the business is probably the most important advancement in the 
telecommunications industry from the perspective of services 
for the consumer and the business--is to weigh an incredible 
set of issues.
    As I mentioned in my testimony, you have to make 
projections of your takeup rates of local voice services, long 
distance services, broadband internet services, video services, 
and three of those five are basically things that the ILEC has 
just recently gotten into.
    If the unbundling paradigm is extended to the fiber loop 
facilities, and there are many CLECs that use those facilities 
rather than to invest on their own, it is reasonable to expect 
that the ILEC will have less retail market takeup. That gets 
tradeoff against what the price point is for the wholesale 
loop, whatever it negotiated, whether it is FCC or at the State 
level, whatever it is.
    There is a relationship between the price, the wholesale 
price of that facility that is sold to the CLEC, and the 
incentive for the ILEC to invest. And right now, if you extend 
the current paradigm, unbundling paradigm at TELRIC rates, that 
incentive wouldn't be sufficient for the ILECs to invest fiber 
broadly. It would only be in those very large and very 
lucrative central offices.
    Mr. Engel. Well, thank you. Obviously, it has a negative 
effect on broadband. What is its effect to traditional voice 
services now?
    Mr. Brodeur. To traditional voice services today, there 
would probably be--the implementation of broadband facilities 
wouldn't necessarily change, you know, long distance as we know 
it today or local voice services. But it certainly would change 
how the ILEC or cable company would package those services 
together with other services, which has the potential for 
reducing price.
    Mr. Engel. Thank you. I want to also note that the 
communication workers have sent a memo, and essentially it is 
entitled ``Unbundling Policies Discourage Investment and 
Facilitate Job Loss in the Telecommunications Industry.'' And 
their fact sheet notes that the current unbundling policies 
discourage network investment and facilities-based competition, 
and they call upon the FCC to revise its unbundling policies.
    It seems to me that the FCC should adopt clear national 
standards, because, again, I think this is stifling investment, 
and I think the FCC has a good opportunity here to reverse 
that.
    I know my time is up, and I thank you for your indulgence, 
Mr. Chairman.
    Mr. Upton. Thank you very much.
    Mr. Cox?
    Mr. Cox. Thank you, Mr. Chairman.
    I wonder if all of the members of our panel would agree 
that voice and data will eventually converge into one 
integrated network. Does anybody disagree with that? Anybody 
want to embellish on that, or is that just an obvious fact of--
--
    Mr. Crandall. The question is when, I think, and, I mean, I 
am not an engineer, but I would judge there will be convergence 
at some point. It is a matter of time.
    Mr. Bath. Maybe I could expand on it a little bit. You 
know, we--our firm in New York, it is happening. I mean, we 
have CISCO phones on people's desks, on our trading floors, 
etcetera. And I think it really is going to encourage--you 
know, the larger customers will get it first, and over time you 
will see a clear convergence of voice and data down to the 
smallest of customers. I think it will happen over the next, 
you know, 7 to 10 years, even for very small customers.
    Mr. Atkinson. You are already seeing it in the residential 
space with voiceover IP, if you have a broadband connection in 
your home today. So if you have got a cable modem or DSL, you 
can get your basic telephone service using the existing phones 
that are in your home today and run them over that DSL or cable 
broadband. So right now it is not big, but it is working and it 
seems--consumers seem to like it. They get a good deal on it.
    Mr. Brodeur. And I would add to that that--I would agree 
with the point that was made by Mr. Markey that paranoia drives 
a lot of what goes on in the telecom sector and all others for 
that matter. The paranoia that I think most of the ILECs feel 
today is about true VOIP voiceover--the IP technology and the 
likelihood that the cable companies are going to be able to 
launch that broadly in the next few years.
    Mr. Cox. I want to tighten the screws on this question a 
little bit, because it is abundantly clear that there is such a 
thing as convergence of voice and data already. It is not 
universal, but it is out there in the marketplace.
    And the question is whether this progression toward 
convergence of an integrated network is inevitable, and whether 
we can infer from what we are seeing and the destination toward 
which competition is tending that in the future, at whatever 
time we might stipulate this convergence is accomplished, in 
the future competitors, in order to survive, are going to have 
to offer both voice and data services, essentially over the 
same platforms. Is that an inference that anybody is willing to 
make?
    Mr. Strumingher. I would answer the question by saying it 
would be extremely high risk, in my opinion, for someone to 
fund a business plan that was based on having an uncompetitive 
cost position in one of those two services. So that may be a 
somewhat complicated way of saying that it is going to be very 
difficult.
    Mr. Cox. Is that the same as saying that you cannot compete 
if you don't offer both?
    Mr. Strumingher. No. It is saying that you have to have a 
competitive cost structure in both. Otherwise, you expose 
yourselves to very high risks.
    Mr. Cox. Yes?
    Mr. Atkinson. My only observation would be the big 
convergence will happen in--for many consumers in many markets, 
there will always be probably many thousands, hundreds of 
thousands, millions of people with single-line telephones. You 
know, that is what some people want. But I think certainly as, 
you know, the generation X and Y start moving along, those--
they will certainly be big consumers. But you never have one 
network, one package. It will become, in fact, more and more 
diverse.
    The key will be accessing. This voiceover IP has nothing to 
do, for example, with the provider of the broadband service. It 
is--you plug it in, you get your voiceover IP service from 
someone who isn't affiliated at all with the broadband service 
provider. So a lot of the things like voice, like 
entertainment, are simply applications on an underlying 
broadband network.
    Now, and the question really will be whether the broadband 
network owner is going to restrict access to that network in 
order to be the sole provider of the package of voice and data 
and video, etcetera, or will it be more of an open platform. 
And it will be interesting to see how--and I think we should 
let it work out and see what happens, whether the network 
owners, for their own self-interest, have an open or closed 
approach to these, you know, boxes that people will want to 
plug into that network.
    And history has said, and I think consumers get a better 
deal when you have an open access, it is probably going to be 
how it will evolve. But I think we--you know, regulators don't 
need to step in yet to, you know, kind of tip the scales. I 
think we should see what happens.
    Mr. Cox. There were some other initial expressions of 
interest in response on this point. I don't want to cut anybody 
off.
    Mr. Brodeur. Well, I would say--I would add that in those 
cases where competitors have effectively converged voice and 
data services, their cost positions have been significantly 
better than the incumbents in some cases. There were many 
instances where the cable companies have deployed a voiceover 
IP and an offer of residential households, combined video and 
data, internet access, and voice.
    And in those markets where they do, they have hit--they 
have reached takeup rates of 40 and 50 percent, and that is 
because the cost structure of being facilities-based is so 
good, and it allows them to be very effective competitors.
    Mr. Cox. When we wrote the--I am sorry?
    Mr. Upton. The gentleman's time has expired.
    Mr. Cox. We could go on indefinitely. Thank you, Mr. 
Chairman.
    Mr. Upton. Thank you.
    Mr. Bass?
    Mr. Bass. Thank you, Mr. Chairman.
    Thank you all for being here today. I really am amazed at 
the way that--the ride, if you will, that the 
telecommunications sector has been on for the last 5 years. And 
we have--I believe that the issue of slowing economy and 
overregulation have been discussed with some thoroughness.
    I am interested to know what your perspective is on the 
possibility that part of this whole issue is associated with 
overinvestment and overspeculation, the development of totally 
unrealistic expectations for growth, no profits, and so forth 
and so on, and where we would be--let me make the contention 
that we might be where we are today had these unreasonable 
expectations not been circulated and unreasonable investments 
undertaken, would we not be more or less where we are today 
without that? Anybody want to address that issue? Go ahead.
    Mr. Crandall. There has been investment that has been 
fueled by exaggerated expectations of growth. But a lot of it 
has just been very bad business plans, such as the CLEC 
business plans. Nobody would suggest that the investment that 
has gone into wireless networks has been excessive, though the 
current consumer reports will detail for you how bad the 
coverage of some of the major national wireless carriers is 
still today. They still need more investment.
    Normally, I would suggest that my 600 kilobits per second 
on my DSL in Washington is as good as the telephone company can 
do without more investment. I mean, they need more investment 
to get that up. So the excess investment has been directed 
mostly to fiber optics capacity across the country and into the 
oceans, and there is no doubt that the owners of that have 
suffered rather dramatically. We still need substantial amounts 
of investment in new technologies, both in wireless and in the 
last mile in the wireline network.
    Mr. Brodeur. I would add that the temptation here with such 
a meltdown in the telecom sector is to paint everything black. 
There are many instances of companies that have been created 
during the Telecom Act--since the Telecom Act in 1996 that are 
viable companies, many more that aren't viable companies.
    The issue going forward is how, you know, as the industry 
has evolved--because I guarantee what we were talking about in 
1996, the lexicon, did not include much about the internet back 
then. The issue is how to evolve the regulation to meet the 
market, and I think that is the most important thing that needs 
to happen now.
    Mr. Bass. Okay. Anybody else?
    Mr. Atkinson. My comment would be that, you know, we have 
to certainly be careful about overstimulating--you know, if it 
was overstimulated in the 1990's and we created an artificial 
boom that led to a terrible bust, we certainly have to worry 
about doing that again. And so artificial stimulation of 
anything is probably a bad idea, whether it is done by 
government or just by normal fear.
    But, you know, the issue that I brought up in my testimony 
was, you know, is this a one-time issue, or is it going to 
happen again and again and again? Boom-bust, boom-bust, boom-
bust. If it is going to go away all by itself back to the nice, 
steady, normal growth, we can all go home.
    The prospect of boom-bust, boom-bust, boom-bust, that is a 
problem, because eventually investors will give up, and they 
will never come back if they get burned time after time after 
time. And that is where we have to be--with a reasonably long-
time view of this have to be very concerned about a cycle of 
booms and busts in the telecom business, which we have never 
had before.
    Mr. Bass. Is it anybody's contention that the major problem 
behind these--this boom-bust cycle is the regulatory structure?
    Mr. Atkinson. My testimony certainly said it is maybe a 
minor--it kind of can amplify a boom and a bust, but it is not 
a root cause.
    Mr. Bass. Okay. Mr. Atkinson, one quick follow-up to 
Congressman Terry's question. You talked about the issue of 
experimental evidence not being available for FCC ruling, and I 
think you alluded to the idea that States might be the proper 
environment or laboratory in which these experiments might 
occur.
    Obviously, one of the problems with that is that you have 
50 different experiments going on. To what extent should the 
FCC provide guidance or help out or do something in order to 
make this process a little bit more reliable and a little 
better for--you know, more productive?
    Mr. Atkinson. I think that would be a very good role for 
the FCC to take, to make sure that the experiments were heading 
toward the goals set out by Federal policy, by the Telecom Act, 
etcetera, and to make sure that some State--I would assume a 
State would correct itself if it was heading for disaster. But 
by looking at the variety of results or ways to get to those 
results, the FCC could then periodically decide this is the 
best way to go.
    And that is how we got to local competition the first time 
around, and a lot of other things, is letting the States do 
things first, and then the FCC and Congress saying, ``Hey, this 
was a good idea. Let us make this national policy.''
    And it is a low-risk way to let a dynamic industry thrive 
instead of, you know, central command and control with some, 
you know, expectation of perfect foresight, which is, in this 
kind of a business, I think a very risky kind of position to 
assume, that anybody has anything close to perfect foresight. 
There is no evidence of that whatsoever.
    Mr. Bass. Thank you, Mr. Chairman.
    Mr. Upton. Thank you, Mr. Bass.
    I know a number of us have perhaps just a couple of 
questions left before we adjourn. Mr. Brodeur, what would be 
the impact on fiber development if the FCC requires that the 
ILECs give the CLECs a 1.5 megabit data channel on a fiber sub-
loop?
    Mr. Brodeur. I haven't specifically studied a 1.5 megabit 
channel, but I will tell you it ultimately revolves around the 
price that the ILEC would receive for that channel from 
whatever CLEC would want to buy it.
    If the price point is high enough, there will be an 
incentive for the ILEC to invest that fiber and provide that 
service at wholesale. If it is too low, there is no incentive, 
and, therefore, no development of--deployment of fiber.
    Mr. Upton. So it is a similar argument to the UNE-P, then.
    Mr. Brodeur. Yes.
    Mr. Upton. In essence.
    Mr. Atkinson, I know a little bit about TCG, and I am just 
curious that if it was still independent, not swallowed up by 
AT&T, do you think that it would still be--if UNE-P was 
dislodged or no longer in effect, do you think that it would be 
survivable--that is, be doing fine?
    Mr. Atkinson. I think so. I think so, if we remained in the 
same--if we had also been owned largely--even though we are a 
public company, large investors are the cable TV companies, I 
look at the success that Cox has had in providing residential 
telephone service over cable plant as an innovative service, 
and plugged into a Class 5 switch.
    Well, the original plan was all of those cable companies 
would be plugging into teleport switches. We would have filled 
those switches during the day with business traffic, cable 
companies would have filled them nights and weekends with 
residential traffic, and, collectively, been a pretty powerful 
competitor. You know, so I--if that model had continued, yes, I 
think we would have done very well.
    Mr. Upton. And it is pretty close to what is known as 
facility based.
    Mr. Atkinson. At that point, like Cox, Cox is totally 
facility based. They only use their own cable plant for the 
loop. They don't even use loops. It would have been a totally 
facility-based network. However, we would have probably used 
unbundled loops in markets where the cable plant wasn't 
upgraded, in markets where we didn't have a cable company 
affiliate.
    So in our long-range plan, we simply said we would prefer 
to use affiliates, i.e. cable companies' facilities, for the 
last mile to residential consumers. If that is not available, 
having a UNE loop of some sort would be a good fill-in.
    Mr. Upton. Thank you.
    Mr. Bath. Maybe just to add on to that, Time-Warner Telecom 
Company I am familiar with has had a very similar business 
model, reported earnings, strong performance, yesterday 
actually said demand is accelerating, and, in fact, they are 
going to be picking up their capital spending plans.
    Mr. Upton. So, in fact, if the UNE-P was again removed, 
your estimate would be that they would be doing just fine in 
the future?
    Mr. Bath. I think they are doing fine. They do have a 
facilities-based model. And, clearly, the removal of UNE-P in 
the backdrop would improve their outlook.
    Mr. Upton. Okay. Thank you.
    Mr. Markey?
    Mr. Markey. Thank you, Mr. Chairman, very much.
    I wanted to begin by demonstrating the bipartisanship that 
has always characterized this subcommittee by wishing your 
staffer, Will Nordwind, all the best as this is the last 
telecommunications hearing before his marriage on February 15. 
Oay? I just wanted to congratulate Will.
    And while I am in the business of congratulating people, I 
read your testimony, Mr. Atkinson, and I just wanted to 
congratulate you on the foresight of getting hired at the 
Federal Communications Commission. That forced you to divest 
all of your telecommunications stock.
    I thought that, you know----
    Mr. Atkinson. It proves that it is better to be lucky than 
smart.
    Mr. Markey. And I would also like to note how fortunate all 
government employees who were hired between 1998 and 2001 were.
    The last point that I would like to make is that in this 
area, as in just about every other area of telecommunications 
policy, we are forced to deal with issues in a way that creates 
a goal and then various paths that we can take in order to 
accomplish those goals.
    So back in 1987 on this committee, it was argued that it 
was totally unfair to allow companies called CompuServe and 
AOL, information services, to have this extra boost in the 
regulatory system. And it went on and on for year after year, 
because we were trying to encourage it.
    Now, there are a lot of incumbents that didn't like the 
idea, but we had a goal to create an information service 
sector. And the Reagan FCC wanted to shut it down, but this 
committee forced them not to. It was just a decision we made.
    I think when AOL purchased Time-Warner, 10 years later it 
kind of seems maybe it was a good idea, maybe not now for Time-
Warner, but in terms of the change in our environment. But it 
was just a policy decision we made.
    MCI and Sprint during the 1970's and early 1980's--again, 
we forced carriage, because we knew they couldn't go down the 
street building a three-foot telephone pole immediately. It was 
going to take some time, although there were many that said, 
``Why don't they just go build their own telephone poles across 
America?'' But it has taken a long time to get the long 
distance competition which we had.
    In the video business, our committee passed a law in 1992--
Mr. Tauzin and I are the co-sponsors of it--that mandate that 
the cable companies have to sell at reasonable prices their 
programming to the satellite industry.
    Now, the cable industry didn't like having to sell CNN and 
all of the rest of their cable programming to a competitor. But 
we wanted to encourage a nascent industry, and, by doing so, to 
revolutionize the video marketplace.
    Now, even as late as last--as this year, the Federal 
Communications Commission is now extending those rules 
mandating the sale of that programming, and I think everyone on 
this committee agrees with it, even though it is 11 years later 
and the satellite industry has 20 million customers now. And I 
guess some people would argue it is plenty of time for them to 
come up with their own CNN or their own sports programming or 
their own movies. But we do it to encourage a policy long term.
    So here there, without question, has been unquestioned 
methods in the deployment of DSL, Verizon and others, are now 
well over 60 percent of deployment of DSL in their regions when 
they were at zero in 1996. And that is a good thing. That is a 
revolution, and it created, to a very large extent, something 
that we call the NASDAQ.
    Now, it turned into a bubble, without question, but the 
bubble was related to this massive deployment, paranoia-
induced, that was out there. And our country still derives a 
lot of benefits from it. We sprinted out to the lead. We have 
to now absorb what happened.
    But the question that we have on an ongoing basis, whether 
it be reasonable access to programming for satellite companies, 
reasonable access compensating the incumbent, compensating the 
cable companies here, compensating the Bells for access to the 
lines, for MCI back in the 1970's and early 1980's, for AOL and 
CompuServe--you know, how long does it go on?
    And I would continue that we are nowhere near enjoying the 
full benefits from the paranoia that was induced, be it, Mr. 
Atkinson, that much of the problems that they now suffer from 
are completely unrelated to whether or not they are forced to 
be compensated for leasing any of these component parts. I read 
most of the analysts, and they just don't agree with any 
conclusion that relates the problems of the Bells with that, if 
the Bells do have problems.
    Or that it is going to lead to any massive deployment, 
since they have already hit the sweet spot for the most part in 
the first 50, 60, 65 percent deployment, whether or not they go 
to the most rural parts of the areas. Or in the unlikely 
prospect that they ever start to try to create programming, 
create ideas, that is just not what the Bells do. They don't 
come up with new programming.
    You have to find ways where the ISPs, where the library 
reincarnations of the dot-coms create the ideas that because of 
the paranoia and lowering the prices, and creating the new 
product, that millions of people want to subscribe.
    But it is highly unlikely that they are going to go any 
deeper into their territories than they already have, except on 
an incremental basis, in the absence of some dramatic 
turnaround in the economy at large, because they have already 
done what makes the most sense, the first 50, 60 percent, urban 
and suburban America. But going further than that is unlikely 
anyway.
    So we might be debating here a program of subsidies, and we 
might want to talk about that. But in terms of removing the 
pressure that has transformed the lives of all Americans with 
all of these new technologies that are now available to them in 
the last 5 or 6 years, you know, and companies--Yahoo and 
Google that no one ever heard of, those are all products of the 
1996 Act.
    And I just think that it would be a big mistake for us to 
remove that pressure in order to satisfy a recovering 
monopolist's desire to go back to the way the world used to be. 
I think our job is to ensure that we don't have that recidivism 
that they so ardently desire replace the new competitive 
marketplace that has served our country in a way that has 
revolutionized the economy.
    And by the way, most people attribute about 30 percent of 
all of the growth in the GDP from 1995 to 2000 to the 
information sector. And if the Bush administration wants to see 
that extra percentage added on to their plans for improvement 
in the GDP, I hope they are not deluding themselves into 
believing that broad-based tax cuts for the upper 2 or 5 
percent is going to do it.
    You have to have a telecommunications policy as well that 
is incenting hundreds and thousands of companies to go out into 
the marketplace. And this policy that is being proposed heads 
in just the opposite direction.
    Thank you, Mr. Chairman.
    Mr. Upton. Thank you, Mr. Markey.
    Gentlemen, I want to again thank you for your testimony 
today. It was particularly enlightening, and we look forward to 
using it as a base as we go to the next train on February 26 
with Chairman Powell.
    The hearing is adjourned.
    [Whereupon, at 3:18 p.m., the subcommittee was adjourned.]

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