UNITED STATES OF AMERICA

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FEDERAL COMMUNICATIONS COMMISSION

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EN BANC HEARING

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MONDAY,
OCTOBER 7, 2002

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445 12th STREET, S.W.
WASHINGTON, D.C.  20554

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2:00 P.M.

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COMMISSIONERS:

	MICHAEL K. POWELL, CHAIRMAN
	KATHLEEN ABERNATHY
	MICHAEL COPPS
	KEVIN MARTIN

FCC SECRETARY:

	MARLENE DORTCH

PANELISTS:

	SIMON WILKIE
	Chief Economist, FCC

	ROB GENSLER
	Portfolio Manager, T. Rowe Price

	ROBERT KONEFAL
	Managing Director, CFG, Moody's Investors
	  Service



PANELISTS:  (cont'd)

	BARRY NALEBUFF
	Professor, Yale University School of
	  Management

	HAL VARIAN
	Dean of School of Information Management
	  and Systems, University of California,
	  Berkeley

	KIM WALLACE
	Managing Director and Chief Political
	  Analyst, Lehman Brothers

	LARA WARNER
	Director, Credit Suisse First Boston

	LARRY WHITE
	Professor of Economics, NYU Stern School
	  of Business



	I-N-D-E-X

	PAGE


I.	Welcome and Introductions	3

II.	Presentations:

	-- Simon Wilkie	19
	-- Rob Gensler	29
	-- Robert Konefal	41
	-- Barry Nalebuff	50
	-- Hal Varian	59
	-- Kim Wallace	67
	-- Lara Warner	73
	-- Larry White	81

III.	Question/Answer Session	89


	P-R-O-C-E-E-D-I-N-G-S
	(2:02 p.m.)
		CHAIRMAN POWELL:  Good afternoon.  It's 
my pleasure to welcome you to this very important 
hearing en banc on the state of the 
telecommunications industry.  
		But before we get to opening remarks 
and other remarks, I'd like to turn it over to the 
Secretary, who can give us an outline of today's 
program and perhaps an overview of the rules we're 
going to follow for today's program.
		Madam Secretary?
		SECRETARY DORTCH:  Good afternoon, Mr. 
Chairman, Commissioners, and invited panelists.  
Following are the procedures for today's en banc 
hearing.  We will utilize a timekeeping machine 
located in front of Chairman Powell to maintain 
time limits on each presentation.
		The first two panelists will each have 
a total of 12 minutes to make their individual 
presentation.  The green light will signal for the 
first 11 minutes of your remarks.  When the yellow 
light signals, you have one additional minute to 
sum up your presentation and close your remarks.
		The third panelist will have 10 minutes 
to make your presentation.  The green light will 
signal for the first nine minutes of your remarks, 
and when the yellow light signals you will have one 
additional minute to sum up and close your remarks.
		Finally, the remaining panelists will 
each have seven minutes to present.  The green 
light will signal for the first six minutes of your 
remarks.  Again, when the yellow light signals, you 
have one additional minute to sum up your 
presentation and close your remarks.
		For all panelists, the red light 
signals the end of your allotted time.  Please 
conclude your remarks at that time.
		Thank you.
		CHAIRMAN POWELL:  Thank you, Marlene.
		Again, I want to thank everyone for 
joining us today, especially my colleagues who are 
here to discuss the financial state of the 
telecommunications sector, and, more importantly, 
steps that might be needed to try to restore its 
financial health.  And I'd also like to thank in 
advance our distinguished panelists for joining us 
today, all of them eminent in their own fields, and 
we really look forward to the factual basis that 
they'll provide us to give us something to think 
about as we struggle through these difficult times.
		As I've said, we find ourselves in the 
midst of some very difficult times in the telecom 
industry, yet at the same time we find ourselves at 
the point of great opportunity for the sector as 
well.  One of the primary missions of the 
Commission in the short term is to do our part to 
get us from here, the challenging times, to there, 
harnessing that opportunity.
		One of the primary impediments to the 
growth in this sector is the increasing difficulty 
all industry participants are having in attracting 
capital.  Capital, of course, is the lifeblood of 
the telecommunications industry, or any industry 
for that matter, and without it the public interest 
is almost certain to be compromised.
		Infrastructure providers need access to 
capital to operate networks, to maintain and 
improve the quality of service to the American 
telecommunications consumer.  Competitive entrants 
need capital to fund business plans that will allow 
these companies to enter the market, differentiate 
service, become profitable, and provide long-term, 
sustainable competition in the marketplace.
		Both need capital to fund network 
upgrades and develop new services to bring them to 
the market and to themselves become profitable.  
But it's not only the service providers that suffer 
during these times.  There is a whole substrata of 
industries that are dependent on its success.
		Equipment vendors, for example, are 
finding it difficult to find buyers of their wares. 
 Some of these vendors represent the very heart of 
our industries -- research and development efforts. 
 Thus, the impact of a prolonged cash crunch could 
have long-lasting effects on the industry, and 
thereby the nation's productivity and competitive 
edge.
		As I articulated in late July, I 
believe strongly that there are no less than six 
critical steps that the industry must take in order 
to return the flow of capital necessary for this 
industry to recover.  
		First, the Commission certainly must be 
guided in its objectives in protecting consumers in 
the face of a saddening number of bankruptcies.  We 
will make every effort to ensure continuity of 
services as the industry goes through the pain of 
change and restructuring.
		Second, we must, and industry 
leadership must, root out corporate fraud.  In 
order to restore confidence in corporate America, 
this must be done, and those responsible severely 
punished.  
		I have the pleasure of serving on the 
President's Corporate Fraud Task Force, and I echo 
his sentiments when I say that these abuses will be 
found, rooted out, discovered, and punished 
ruthlessly.
		Third, the industry must dedicate 
itself to restoring its balance sheets.  Firms must 
find a way to cut costs, pay down debt, and become 
more transparent and efficient, so that investors 
can fully appreciate the true risks associated with 
the investment that they urge.
		Again, the best companies with the best 
leadership are those who are committed to restoring 
financial fundamentals.  Those that are taking 
these actions should be rewarded; those that are 
not, abandoned.
		Fourth, industry will have to undergo 
some prudent restructuring.  Some consolidations 
and bankruptcy, both restructuring and liquidities, 
will be needed to address insufficient economic 
realities in some markets.  This Commission will 
play an important role in this restructuring, and 
where consolidation is concerned will be vigilant 
in reviewing mergers on their merits, denying anti-
competitive transactions and approving those that 
serve the public interest.
		Fifth, carriers will have to develop 
and deploy new services and drive new sources of 
revenue for their long-term productivity and 
health.  Today we see the promises on the horizon 
of those new services -- broadband internet access 
and the myriad applications and services that might 
be provided over such a rich platform.
		We also see great potential in the 
areas of wireless services, such as ultra wide 
band, wi-fi, and traditional wireless voice 
services.  Today's innovations will be tomorrow's 
profits and growth.
		And, finally, federal and state 
regulators must engage in economic and regulatory 
foundational reform that takes into account the 
experience of the last six and a half years and 
apply them to the realities of today's marketplace. 
 
		Today, at this hearing, we will focus 
largely on the third, fourth, and fifth steps on 
this road to recovery.  It is our hope to bring 
some of the knowledge I have gained in my own 
discussions with various aspects of the financial 
community over the last few months to the 
Commission staff and to give my colleagues an 
opportunity to engage in discussion with this 
group.
		We will hear today about the economy in 
general, the telecommunications market, and how 
capital flows to fund operations.  And we will hear 
from a distinguished panel on their thoughts where 
the industry has been, and, just as importantly, 
where it is going. 
		Again, I want to thank them for being 
here today.  I believe all of us will find today's 
discussion both enlightening and extremely 
informative.
		With that, I have the pleasure of 
turning it over to any of my colleagues for 
comments that they might have.
		Commissioner Abernathy?
		COMMISSIONER ABERNATHY:  Thank you, Mr. 
Chairman.
		First, I want to thank the Chairman for 
all of his efforts in pulling together today's en 
banc.  I think it shows a very real appreciation of 
how significant this issue is for all of us.
		And I want to thank all of the experts 
for coming to D.C. to share your insights and 
thoughts with us.  As always, it's invaluable and 
critical to our analysis.
		I also want to point out, though, that 
despite what many may believe, we are not magicians 
with the power to turn around the flagging economy. 
 We are government regulators, however, and as such 
we have a profound responsibility to stay informed 
and to educate ourselves regarding the technology 
and the services that are offered by the companies 
that we regulate, because only then can we craft 
the regulations that best serve the public interest 
and that are consistent with the statutory 
obligations that are set forth by Congress.
		To my mind, one of the most important 
things the FCC can do is to appreciate the sense of 
urgency that is surrounding our pending 
proceedings, and, specifically, those that are 
related to competition policy and broadband 
services.  
		We're asking fundamental questions 
about the way facilities and services are 
classified and how they are regulated.  And the 
rules that are ultimately adopted will have a 
substantial impact on carriers' incentives to 
invest in infrastructure.
		We must not shy away from these tough 
questions, but we also must appreciate that these 
proceedings create uncertainty in the market, and 
this uncertainty impedes the ability to develop 
long-term business strategies and may chill new 
investments.  So we have to stay focused, and we 
have to move forward.
		While we may not possess the magical 
powers to cure the industry's financial distress, 
our regulatory scheme is clearly a critical piece 
of the puzzle.  So we also must ensure that our 
regulations and our policies are not creating 
impediments to investment and innovation, and that 
we remain focused on our public interest 
obligations.
		Therefore, I look forward to hearing 
your ideas about how we can better do our part to 
stimulate growth and economic recovery for the 
telecom sector.
		Thank you very much.
		CHAIRMAN POWELL:  Thank you, 
Commissioner.
		Mr. Copps?
		COMMISSIONER COPPS:  Thank you.  I, 
too, want to commend the Chairman for scheduling 
this hearing.  These en banc hearings I think are 
just an invaluable way for us to gain critical 
input on stakeholder issues.  I think the one we 
had recently on equal employment opportunity was a 
wonderful learning experience for all of us.  I 
know today's hearing will be, and I hope we will 
have future en banc hearings on the multiplicity of 
proceedings that are before this Commission.
		Today affords us an opportunity, I 
think, to get some needed perspective on telecom's 
difficulties.  We have had probably too many 
simplified explanations of why we are where we are 
and too many silver bullet suggestions for how to 
get out of the mess that we're presently in.  The 
causes are, I imagine we will hear today, complex. 
 The way out is equally challenging.  
		I don't think any of us should be 
thinking in terms of the hundred yard dash to 
recovery -- the quick, easy solution that's going 
to right a world gone amuck.  Rather, it's the 
long, hard contest of endurance.  And in a contest 
like that, every step along the way is important, 
none more so than the first step.
		And I've been trying to impress upon 
all of the folks who have come by my office in 
recent weeks that we ought to be able to find some 
first and targeted and achievable and doable kind 
of steps and stop trying to remake the telecom 
world in one fell swoop on the theory that there is 
one little fix out there that can solve all of our 
problems and put us back on the road to prosperity 
forever.
		But it's hard to get people to listen 
when the decibel level is so high, and I hope today 
we can, with your input, maybe lower the decibel 
level a little bit.
		Let me just observe that so much is at 
stake here on how we proceed to deal with telecom's 
problems.  Some of the sector's problems are no 
doubt internal and traceable to faulty business 
plans.  But probably even more of the problems have 
been generated externally.  
		To name but a few possible causes of 
the distress -- the recession that stalks other 
sectors of the economy in addition to telecom, the 
hyper expectations the market placed on new and 
developing telecom businesses not so many years 
ago, the problems of the financial sector 
generally, corporate governance problems involving 
everything from too-clever-by-far accounting 
practices to a more generalized public reaction 
against obscene severance payments and retirement 
perks, uncertainty about future legislative and 
regulatory policies and programs, and perhaps even 
larger questions going to the protection of the 
public interest during the wild ride that we've 
been on.
		I know that the public interest is not 
our designated subject for discussion today.  I 
would ask our panelists only to be cognizant that 
we are not only addressing an economic problem but 
trying to do so within the context of the public 
interest, consumer benefits, serving all Americans 
no matter who they are and where they live, and 
making available to them the best and most advanced 
telecommunications system possible.
		We are interested, mightily so, in all 
of the economic and commercial dimensions of 
telecom's woes and telecom's recovery.  But in the 
final analysis, we always come back to that last 
ultimate question:  does what is being proposed 
serve the public interest?  It's a big order to fit 
all of this together, but in a recent article I 
read over the weekend George Sorose made a pretty 
good run at it.
		And I won't try to synopsize that 
article here, but I commend it to you if you 
haven't seen it, to my colleagues, for its 
discussion of some of the failings he sees in the 
financial markets, some of the risks he sees in 
focusing too inclusively on the quick profit and on 
so-called economic efficiency, and some of the 
benefits he sees emanating from looking at these 
problems through a broader public interest lens.
		Whether we agree or not with all that 
he says, we equip ourselves much better to deal 
with these issues by thinking about them in the 
broadest possible terms.
		I'll just say for a second and tell you 
at the outset that I'm an optimist about the 
telecom sector.  That is a minority view, of 
course, but I occasionally find myself in the 
minority --
		(Laughter.)
		-- around here.  But my read right now 
is that although there has been a serious toll 
taking telecom's shakeout, this industry is going 
to come back, probably sooner rather than later, 
probably sooner than some of the pundits are 
thinking.  The technologies are there, and they are 
only proliferating.  
		There is obviously an infrastructure 
need in this country tantamount to some of the 
other great infrastructure buildouts that we've 
encountered throughout the course of American 
history.  And demand is growing, so if 
communications is not going to lead our economy out 
of its current troubles and into prosperity in the 
new century, then I don't know what sector is.
		So I'm very much looking forward to 
this session and the perspectives of the 
distinguished presenters who will be -- we will be 
hearing from today.  I thank you all for taking the 
time and trouble to be here with us, and we are 
very much looking forward to your input.
		CHAIRMAN POWELL:  Thank you, 
Commissioner.
		Commissioner Martin?
		COMMISSIONER MARTIN:  Thank you, Mr. 
Chairman, and thank the panelists for spending the 
time with us this afternoon to give us their 
insights into what the Commission can try to do to 
help this particular sector of the economy.
		The telecommunications sector is at a 
critical crossroads and a critical time for both 
the sector as a whole and -- I mean, for the sector 
and for the industry and the economy as a whole, 
and its impact it will have.  We have all seen over 
the last year the dramatic downtown that has 
occurred.  There has been half a million jobs lost, 
and there has been $2 trillion in value lost in the 
stock market of these companies.
		But these are not statistics or paper 
losses.  There are families all across the country 
that have experienced real pain resulting from this 
economic downturn.  And many long-term employees 
have witnessed their life savings disappear with 
little or no severance pay and with their 401(k) 
retirement savings vanishing with the stock market 
slide.
		And I don't believe that the Commission 
has a single silver bullet to this problem for the 
telecommunications sector.  But as I've stated 
before, I do think we can contribute to its 
recovery by establishing a stable, reliable, and 
efficient regulatory environment.
		Regulatory uncertainty and delay 
function as potential entry barriers in and of 
themselves, limiting investment and impeding 
deployment of new services.  I support the 
Chairman's efforts and all of his recent comments 
about the importance of us acting quickly on all 
pending rulemakings and responding to, as 
Commissioner Abernathy talked about, the sense of 
urgency that is out there in the sector as a whole.
		So I think that such prompt 
decisionmaking will be important, and that it will 
be something that we can contribute to in that 
stable environment going forward.
		And so with that, I'll be anxious to 
hear what the panelists have to say about what 
actions and what direction we should be trying to 
take.
		Thank you.
		CHAIRMAN POWELL:  Thank you, 
Commissioner.
		We'd like to begin to provide some 
context for today's discussion by asking Dr. Simon 
Wilkie, the FCC's Chief Economist, to provide an 
overview of the U.S. economy in which these 
problems in the telecommunications sector are 
operating. 
		Professor Wilkie?
		PROFESSOR WILKIE:  Thanks, Mr. 
Chairman.
		I'm going to talk about the overall 
macroeconomic perspective on the economy.  I won't 
be focusing on the telecommunications industry per 
se, only to mention that, of course, it is a 
significant part of the economy and played a 
significant part in driving the previous economic 
expansion in the record-long 10-year expansion we 
had.
		Next slide, please.
		So, actually, just to give you an 
overview, of what we're going to do today, first 
I'll talk about the recession, then the current 
economic situation as it stands.  We'll then talk 
about macroeconomic forecasts, supply and demand 
indicators as the economy currently stands and 
looking forward, potential problems on the 
macroeconomic horizon, how will the economy be 
affected by them, following problems and reasons to 
be cheerful, things that seem to be sound in the 
economy at the moment, and then I'll offer some 
brief conclusions.
		Next slide.
		So let's begin by talking about the 
recession.  As you know, we had a significant 
recession.  The NBER, the National Bureau of 
Economic Research, now dates the recession from 
March 2001.  The recession actually lasted for 
three quarters technically, in the sense that in 
each quarter GDP, gross domestic product, 
contracted for the first three quarters of 2001.  
That's according to the Bureau of Economic 
Analysis.
		Checking industrial production, we see 
that industrial production peaked in June of 2000, 
and it reached a trough -- the low point in terms 
of production of the recession was actually in 
December 2001, and we've had a 7.2 percent decline 
from peak to trough in industrial production, which 
is about average for a recession.
		Real personal income, however, fell 
through 2001, household incomes.  But it has risen 
significantly through 2002.  In fact, an 
interesting point is that it's almost back to the 
levels that it was before the recession.
		Next slide, please.
		So that's the recession that we faced. 
 What about our current economic situation?  Well, 
we seem to be going through a modest and somewhat 
wobbly recovery.  The first quarter GDP grew five 
percent, which sounds -- on a per annum rate, which 
is quite significant.  In the second quarter this 
year, GDP grew at 1.3 percent.
		Let me just say that the five percent 
sounds impressive, but the initial bang coming out 
of the gate, as you come out of a recession, is 
always large as firms try to replace their depleted 
inventories.  So that number is always biased 
upwards.
		Unemployment, however, has remained 
stable in the current economic situation.  Output, 
however, is rising faster than employment, so we 
still have overall productivity growth in the 
economy -- about 1.2 percent.
		Corporate profits have recently, just 
recently, turned around overall with one notable 
exception.  Profits are up 8.8 percent, if we 
analyze second quarter over second quarter from 
2002 to 2001. So these indicators seem to suggest 
that we're actually going through a pretty healthy 
recovery, nothing exceptional, but pretty much 
average.
		However, leading indicators, which 
economists sometimes use to predict what's going to 
happen into the future, have declined in the last 
three months.  So some people fear that we might 
have a relapse into another recession because of 
this -- it's very unusual to have leading 
indicators decline for three consecutive months.
		Okay.  Next slide, please.
		So looking forward, what are the 
economic forecasts?  The CBO, Congressional Budget 
Office, estimates that for year 2002, annual year, 
we'll have -- calendar year -- we'll have a 2.3 
percent GDP growth rate, which is of modest 
significance.  Beyond that, looking into 2003, they 
estimate a three percent GDP growth rate.
		Beyond that, in the 10-year time 
horizon for the 2002-2012 timeframe, the CBO 
estimates a 3.2 GDP growth rate.  The BEA, by 
comparison, projects a growth rate of non-farm 
industrial production of 3.4 percent.  So similar 
numbers.
		So just to put that in historical 
perspective, during the boom years of the 1990s, 
GDP grew at a rate of 2.9 percent from '91 through 
to '95, and 3.8 percent from '96 to 2001.
		Okay.  Inflation has pretty much been 
vanquished.  It's about 1.7 percent for this year 
and expected to be about 2.4 percent next year.  So 
there are no significant concerns about inflation 
in the intermediate horizon.
		Unemployment, as I mentioned, is 
projected to be 5.9 percent for 2002, and the same 
for 2003.  So unemployment has risen from its all-
time low that we had a few years ago when it 
actually touched four percent, but that is 
historically an unprecedented low number.  Even 
though 5.9 percent is coming out a recession, as a 
historical average it's not too bad.
		Okay.  Next slide, please.
		This slide covers some of what I just 
talked about in much more detail.  You can see that 
nominal GDP -- that's in dollar terms, not taking 
out inflation -- in 2001, it was a tad over $10 
trillion.  Forecast for this year is $10.429 
trillion and for next year $10.912, almost $11 
trillion.
		Forecasting out 10 years, the CBO 
projects that average over the 2008-2012 time 
horizon that GDP will up to $17 trillion a year.  
As I mentioned, the nominal GDP growth, which is in 
dollar terms, not taking out inflation, is for 2.6 
percent this year -- sorry, 3.4 percent this year, 
4.6 percent next year.
		The unemployment rate is stable at 5.9 
percent.  If we look down at the bottom, we can see 
that the three-month Treasury bill rate is at 
1.7 percent.  That's forecast to be 2.9 percent 
next year.
		It's interesting to note that the 10-
year T-note rate is at 4.9 percent at the moment, 
so we've had a much steeper yield curve than we've 
had in the last couple of years.  The flattening of 
the yield curve essentially meant investors became 
rather unworried about risk.  That steepness of the 
yield curve is an indication that that's no longer 
the case.
		Okay.  Next slide, please.
		This next slide puts it into a 
pictorial perspective.  We can see where we've been 
and where we're projected to go in terms of real 
gross domestic product.  If you look at the top 
left-hand chart, you'll see that in this last 
recession, though we had an overall -- we didn't 
actually get a year-over-year negative return on 
GDP.  So even in 2001, there was still very small 
growth, .3 percent.
		So the economy never actually 
contracted over a full year.  So it was in that 
sense, for the economy overall, rather mild.
		And, similarly, you see a similar 
description of the events in the unemployment rate 
and also in the treatment of interest rates in the 
other charts.
		Next slide, please.
		So let's try and disconnect supply from 
demand and analyze the relative importance of these 
two components in what's going on in the economy.  
So as I mentioned, real personal income has not 
fallen.  It did briefly in 2001, but it's back 
where it was.
		Consumer demand remains high.  However, 
we have anemic business investment, and capacity 
utilization remains low.  So if we look at the 
supply side of the equation -- next slide, please 
-- currently, industrial capacity, as of last 
August, is at 76 percent.  It's been flat for the 
last three months.  So even though the economy is 
growing, our use of capacity isn't really growing. 
 A year ago we were at 76.4 percent, so we haven't 
really moved anywhere in a year.  
		Just to put these numbers in 
perspective, the long run average over the last 20 
years of the industrial capacity has been at 81.9, 
82 percent, so we're well below average.  The all-
time low was 71 percent in 1982 and 85.4 percent in 
1988-'89.
		Capacity overall is still growing in 
the economy.  That means there's still investment 
in capacity.  Last year it actually grew at one 
percent.
		Okay.  So that's on the supply side.  
Let's look at the demand side.
		Next slide, please.
		The next slide charts the real change 
in final demand in the economy.  As you can see, it 
plummets in recessions.  In the last recession, 
again, it plummeted, but it didn't actually go 
negative.  Consumers have demand as being 
incredibly resilient.  It has partially recovered, 
but it's not back to the gangbuster years as it was 
in the growing four percent, five percent 
consistently in the 1990s.
		But it's interesting to note that it 
never actually went negative.  We never actually 
had a shrinking of final demand.
		Okay.  So what's going on overall?  
Let's look at the sectors in a little bit more 
detail in the next slide, please.
		So what's growing?  Well, actually, the 
service sectors generally are growing in the 
economy at quite a rapid clip.  So services are 
growing in particular health care; parts of the 
entertainment industry are growing.  In addition, 
some areas of construction are growing, originally 
fueled by the housing boom and now more recently 
fueled by a government building boom.  And, of 
course, the federal government is growing as a 
sector of the economy.
		Next slide, please.
		What are the significant lagging 
sectors?  Well, notably, the telecommunications.  
Telecommunications has been suffering from 
extensive overcapacity, and it's so lagging the 
rest of the economy in terms of returning.  In 
addition, information technology is also lagging.  
And in terms of production, high tech industrial 
production, the firms that make the inputs into the 
network is the area of production which has the 
lowest capacity utilization in the economy 
currently.
		The financial sector is partially 
rebounding, but it hasn't been rebounding in terms 
of profitability.  It lags the rest of the economy, 
the other industrial sectors.
		Next slide, please.
		So just quickly, what are the potential 
problems looking forward?  Well, the big one is the 
wealth effect, that we've had this massive decline 
in the stock market, but it doesn't seem to have 
affected consumer behavior, which is quite an 
anomaly.
		So if consumers ever decide to stop 
spending because of this massive decline in their 
personal wealth, that could lead to another 
recession.  Things are recently more complicated by 
the dock worker strike on the west coast, which 
stops about $1 billion of trade a day.  And as the 
economist Dennis Robinson said in the 1930s, "Trade 
is the engine of growth."
		In addition to that, we have potential 
complications with the Mideast, which might affect 
the budget situation and the price of oil.  Trade 
issues also loom on the horizon, steel tariffs, 
export tax policies, and agricultural subsidies, 
which have led to the possible threats of trade 
confrontations between Europe and the U.S., which 
would also be negative impact on growth.
		So, finally, let's turn around.  What 
are the reasons to be cheerful?  
		Next slide, please.
		As I mentioned, the economy has 
actually been growing since third quarter 2002.  
And if we extrapolate from the start of this year, 
it's growing at an annual rate of about 3.8 
percent, which is higher than expected.
		Unemployment seems to be stable right 
at the moment at 5.8 percent, which is a bit lower 
than expected.  Personal income is close to an all-
time high, and consumer expenditures are resilient.
		So, in conclusion, the recession was 
significant.  There is a classic overcapacity 
situation, but personal income has remained stable. 
 Non-financial sector profits are recovering, but 
the stock market decline and financial conditions 
create substantial uncertainty as to how robust the 
recovery is.
		Thank you.
		CHAIRMAN POWELL:  Thank you very much, 
Simon.  
		I think now we'd like to turn to and 
introduce Rob Gensler.  Rob is the Vice President 
and Portfolio Manager for T. Rowe Price.  He joined 
the firm in '93 with seven years of previous 
investment experience.  Rob is President of the 
Media and Telecommunications Fund and Chairman of 
its Investment Advisory Committee.
		Welcome, Rob. 
		Rob will give us an overview of 
financial industry basics.
		MR. GENSLER:  Right.  Thank you, Kevin, 
Kathleen, Michael, and Michael.  I'm somewhat 
struck.  I'm flattered by the invitation, but I'm 
struck by some of your comments that we're 
supposedly the experts.
		If you look at our results in the 
investment community, I would hardly call us 
experts where the average telecommunications fund 
is down over 50 percent year to date, and that's 
after being down 40 percent last year and down 35 
percent the prior year.  That makes a three-year 
run that's rather daunting.
		So as the tallest of the munchkins, 
I'll speak for the industry.  But I would never --
		(Laughter.)
		-- claim to be an expert so to speak.
		It's interesting, though, that we do 
set the rules, not we the telecommunications 
investor, but really the portfolio managers that 
invest in diversified industries, both growth and 
value.  Okay.
		And the buy side, not the sell side, 
the buy side, the actual investors of people's 
money in mutual funds, in pension funds, in 
institutional funds, actually have the daunting 
task of investing.  The sell side, Wall Street, is 
somewhat like the vendors in a shoe store trying to 
tell you whether to buy wing tips or penny loafers. 
 We have to figure out which one and at what price 
we want to do that.
		And the rules change all the time based 
on cashflows, based on indices that we're trying to 
keep up with.  And, unfortunately, I'd have to say 
that we share in some of the blame of the bubble.  
It's not just regulators.  It's not just industry. 
 It's a bit of everything, and we're in there, too. 
 
		And we've changed the rules of 
engagement from one of hopes for growth and revenue 
growth, okay, to free cashflow, return on invested 
capital, earnings per share.  The income statements 
matter.  The balance sheets matter.  And we keep 
moving down through the traditional financial 
metrics that somehow we left out and lost out in 
the late '90s.
		The funds flow today is actually okay. 
 Pension funds still get money into them from their 
employees by definition, whether defined benefit or 
defined contribution.  Okay?  And in the defined 
benefit they actually -- many companies will have 
to start putting money back into them again, 
because the overfunding status is going away.
		The mutual fund industry still has 
money flows coming into it, although a very 
different nature of flows than a few years ago.  
The flows are more into value funds and less into 
growth funds.  But overall, the flows are still 
modestly positive.
		And in spite of times when the fixed 
income funds have gotten most of the money 
throughout the summer, we're back to the point 
where equity funds are actually getting modest 
money, although the high-yield funds, which were a 
great funder of the whole telecom bubble, have 
changed their attributes.
		If you recall in high yield, over 30 
percent of their new money was going into the 
telecommunications industry at its peak.  But when 
we talk about reinvestment and investment in 
telecommunications, there's really two forms that 
one always has to remember.  It's not just the buy 
side or the investment community.  But it's really 
the rules we set for the industry, and, therefore, 
their reinvestment rate.  
		This is what percentage of revenues get 
reinvested into capital spending, what percentage 
of sales, and this could be true in any industry.  
It would be R&D or investment or CAPEX.  And in 
traditional days in telecom, it was about 20 
percent of revenues got reinvested, and it peaked 
in the high 30s in the United States, peaked in the 
high 20s to 30 percent elsewhere in the world.
		And right now, with the lack of growth 
that we see, many investors, myself including, are 
demanding, almost imploring, managements to give 
the money back, pay higher dividends, buy back 
stock, pay down debt, etcetera.  If we don't see 
prospects for growth, the money doesn't get 
reinvested.  
		So it's more this reinvestment rate, 
the percentage of sales spent on capital spending 
now, that is the problem, in terms of your 
question, about fostering investment.
		Then, actually IPOs or secondaries or 
high yield, which may not come back for some time, 
but if the -- that investment rate is now below 20 
percent of sales.  It's looking like it's headed to 
15 percent of sales.  And, quite frankly, as the 
typical investor, I'd be happy if they didn't 
reinvest anything and if they gave it back.  But 
that's another story.  Okay.
		If I move on -- and I apologize for 
this.  This is not a slide I gave you, but it sort 
of strikes to your question, is:  what is our 
investment process, and what do we look for, and 
how has this changed?  And it's really not that 
different at other families than it is at T. Rowe 
Price.  
		We look at near-term fundamentals, 
long-term growth outlook, pricing power, margin 
outlook, structure of industry -- is it getting 
better or worse?  Is it fractured?  Product cycles 
-- are they mature, etcetera?  Balance sheets, free 
cashflow, return on invested capital, and oh, by 
the way, valuation.
		I can submit this slide later.
		But the intriguing thing is if I go 
through each of these, many of them are areas that 
they are bleak or they are problematic, but there 
is nothing this Commission can do per se.  You 
know, the near-term fundamentals are bleak because 
of the economy.  Okay?  
		But the long-term growth outlook is 
troubling because unit demand is very good.  Okay? 
 Units of consumption in telecom are growing 
nicely, but there is no pricing power at all.  
There is rate regulation, both retail and wholesale 
rate regulation.  So we get to a point where we 
have good unit growth but very little revenue 
growth, okay, in an industry.
		And the margin outlook is actually 
negative for the industry.  We have a product mix 
shift from fixed wire line to wireless and data.  
Okay?  This is akin to transportation a hundred 
years ago where we migrated out of rails into 
airlines and trucking and autos and etcetera, and 
we need to do something where the core business is 
shrinking.
		And we're regulating that core business 
as if it was the money for everything else and it 
was the, you know, monopoly.  And we have new 
competitive businesses that are far lower in 
margin, and it causes a problem for the investment 
community of how to look at it.
		Structure of industry has nothing to do 
with this Commission.  It's more an antitrust 
issue, and it's more the companies and their social 
issues about whether or not they'd like to merge or 
not.  But by luck of the draw in the United States, 
we have a fractured industry.  In many other 
countries of the world, you have much more 
integrated providers who can get scale of scope, 
better margins, etcetera.
		Product cycles are maturing.  Nothing 
anyone can do about that.  Balance sheets are 
actually getting better, which is at the heart of 
your issue of investment.  We want better balance 
sheets.  We want the money returned in terms of 
paying down debt, etcetera.  It's a nice thing for 
the investors.
		Free cashflow -- well, most of the 
industry hasn't had any but is getting modestly 
better.  Return on invested capital is getting 
better as well, and valuations -- well, at least 
they're intriguing, but we don't know, because the 
whole public market, remember, has traded down to 
about 15 times earnings.  
		And value investors, which are the only 
investors that really want to touch any 
telecommunications funds -- stocks, are really, you 
know, looking at many, many names that are trading 
at eight to 12 times earnings.  So in spite of the 
fact that we think these valuations are so low, and 
why wouldn't people invest, if I go to my 
diversified value managers, they say, "Well, I've 
got about 10 other names, or 20, or 50, or 100 
names I could buy that have less regulatory issue, 
less margin issue, less pricing power issue, less 
structure of industry issue, less long-term growth 
issues, better trading at similar valuations."
		Okay.  So, again, I'm sorry I don't 
have that slide.  I can submit it later.
		We then move to the slides I do have, 
where -- I don't know how I get to a slide, but 
this was sort of the historic.  You know, we had 
for four or five years the best of times.  This is 
all old news, so I'm going to -- you know, but we 
thought it was easy.  Investors as well.  Okay.  
Companies, regulators, we all share in the sort of 
exuberance.  I definitely will take part of that 
blame.
		But if we move on to the perfect storm 
of '01-'02 -- next slide, okay -- and this is, 
again, all old news in a sense, but I'd like to try 
to focus on this in the next slide, of what we can 
do better.  You know, we do have maturing product 
cycles.  Nothing we can do.  Weak economy -- 
nothing we can do, although that will get better 
hopefully sometime in my investment horizon.
		Okay.  Overcapacity due to the binges 
-- that will get better.  Difficult regulation, 
which I'll talk about in the next couple of pages, 
pricing powers collapse, revenue growth disappears, 
margins decline, etcetera.  One wonders why we have 
any money still left in telecom when I look at 
this.
		But the intriguing thing is the 
structure of industry is getting better.  And also 
intriguing, if you would split the 
telecommunications industry into wire line, 
wireless, and the cable industry, just to throw in 
for sort of another network infrastructure 
business, the cable industry is still investing.  
Wireless is still investing, although I would 
proffer to say that both the investment rates will 
go down in the next couple years.
		But it's really the fixed wire line 
business that has cut its investment rate the 
sharpest.  First, the CLECs went away, but then the 
incumbents have shut down their investing.  And 
it's intriguing that that's the most rate regulated 
part of the three.  The rate regulation in cable 
isn't there, and they are investing to try to get 
scale of scope.
		In wireless, although it's fierce 
competition, the investment still goes on.  And I 
just want to point out that it seems different in 
terms of the outcomes.
		If we go to the next page, the -- yes, 
this page.  Just to say that the telecom equipment 
problem which you're talking about, will CAPEX -- 
that's the capital spending -- minus 15 percent in 
'01, minus 30 percent in '02, minus another 10 or 
15 in '03, much of this is because we're demanding 
free cashflow and better returns on investment.  
Much of this is the investment community demanding 
results, because we don't get growth and we're not 
getting any pricing power.  So we want the money 
back.
		It's poor balance sheets getting 
better.  Wireless has no profits, and cable has 
negative free cashflow.  So the wireless and cable 
that I said are better investors today probably 
directionally are only a year or two behind.
		If we go to the next slide, sort of 
continuing issues for investment -- and some of 
these I want to talk about and think how they're 
different in other places of the world.  Okay?  
		The first, the fixed voice product 
migration to wireless and data is true everywhere. 
 This is just a fact of life in the industry, and 
it's actually a good thing.  We're getting new 
products.  We're getting new competition.  But we 
can't ignore it when we think about regulation.  
Okay?
		And we have a fractured structure of 
the industry.  We have three or four long distance. 
 We have four geographic local providers.  We have 
six wireless.  We have five technologies in 
wireless.  So it's a bit of a mess, I'm sorry to 
say.  
		It's a lot better in a lot of other 
countries, and we who move money around the world 
are actually investing more in telecommunications 
internationally than we are domestically.  Okay?  
Because although it suffers from .1, low growth and 
product migration, but we have more stable industry 
structures that at least foster reasonable returns 
on capital.
		We also have intermodal competition.  
That's the new modes of data and wireless competing 
with wire line, and even cable competing and then 
cable modems.  But we have a structure of 
regulation that's predicated on intramodal 
regulation -- UNE-P trying to foster a competitive 
environment in fixed wire line, okay, and many 
other areas where we're looking at these as if they 
were silos as opposed to areas competing with each 
other.
		Okay.  We have deregulated competitive 
growing product lines, wireless.  Even broadband is 
somewhat deregulated, although the terms of 
regulation are slightly different.  But we have a 
declining core business, the fixed line/wire line 
business, that's heavily regulated.  And maybe 
that's the money that we need, the profits from 
that, that would go into the new product lines.
		You know, we had a social contract in 
this country, the local with somewhat lower rates 
and everything else had higher rates, and there was 
an implicit cross-subsidy that went on.  But the 
new -- the higher rates in long distance and all 
these other areas have come down due to 
competition, but that implicit social contract, 
which might be made more at the state PUCs than at 
the Fed, hasn't really been reexamined or changed.
		So we also, with the states, have 
retail rate regulation, as well as wholesale rate 
regulation.  I'm not sure you can -- I mean, I'm 
not smart enough to get them right.  I'm not sure 
anybody is in terms of the interplay of new 
competitors picking off incumbents predicated on 
where they just pick and choose to, you know, hit 
on the existing regulation.
		And, obviously, this is not your 
problem.  It's just a fact of life.  We've got 
state PUCs versus FCC.  I don't have any advice on 
what you do with that.  That's a third rail I don't 
want to touch.
		Thank you.
		CHAIRMAN POWELL:  Thank you, Rob.  That 
was an outstanding overview, very insightful.
		I'd like to move now to Robert Konefal, 
who is from Moody's Investors Service.  He's the 
Director in the Corporate Finance Group at Moody's. 
 He directly manages the ratings group that covers 
investment grade telecommunications, media and 
technology companies in the United States, Canada, 
and Central and South America, since April 1998.
		Welcome.
		MR. KONEFAL:  Thank you.  Good 
afternoon, Mr. Chairman and Commissioners.  On 
behalf of Moody's, I am pleased to appear before 
you today regarding steps toward recovery in the 
telecommunications industry.
		We appreciate the opportunity to share 
our views with the Commission regarding the current 
state of the industry and the near-term outlook 
under the existing framework.  As a rating agency, 
we do not take opinions on particular policy 
issues, but, instead, we analyze the current and 
long-term ability of companies to service their 
debt.
		With respect to our assessment of the 
ability of telecommunications companies to meet 
their debt obligations, we believe that a 
distinction should be made between the long 
distance, local, and wireless subsectors, because 
there are notable differences in the credit quality 
and outlook.
		Let me start by discussing Moody's and 
its role in the financial markets, and then provide 
our views on the outlook for ratings of 
telecommunications companies for the next 12 to 18 
months.
		Moody's is the oldest rating agency in 
the world.  Our roots can be traced to 1900 when 
John Moody & Company first published Moody's 
Investor Service focused on rating railroad bonds. 
 As early as 1924, Moody's was rating nearly every 
bond in the U.S. bond market.
		Although Moody's rates a wide range of 
debt obligations, the heart of our service lies in 
rating long-term bonds, for which we have nine 
primary debt rating categories.  Investment grade 
ratings range from a high of Aaa down to a low of 
Baa.  Speculative grade ratings range from Ba to C. 
 Overall, Moody's ratings are designed to provide a 
relative measure of risk, with the likelihood of 
credit loss increasing as the rating decreases.  
And over time our default studies have shown that 
ratings effectively distinguish bonds with higher 
credit risk from bonds with lower credit risk.
		It's equally important to note what our 
work at Moody's does not include.  A rating is 
neither a buy nor a sell recommendation, nor is it 
a seal of approval.  Rather, our ratings reflect 
Moody's opinion of the relative creditworthiness of 
a fixed income security.  Furthermore, just as we 
do not insure the bonds we rate, we do not audit 
the financial information provided to us.
		Now let me turn to Moody's analysis of 
the telecommunications industry.  It will likely 
not surprise the Commission that our outlook for 
the next 12 to 18 months for all segments is 
negative.  However, we see the degree of negative 
pressure as most severe for long distance carriers 
and more modest for local exchange carriers and 
wireless companies.
		The question hanging over this hearing 
is:  what steps can the Commission take to put the 
telecom sector on the path to recovery?  That is an 
important topic, and I'm confident that others will 
have specific, although perhaps conflicting, policy 
recommendations to accomplish that goal.  
		But it is important to realize that a 
number of forces acted together to put the industry 
in its current state.  Beyond the government 
regulation, other factors include new competitors, 
technological advances, and the larger forces at 
work in the economy.  We believe that all of these 
forces will play a role in the future of the 
telecom industry.
		Moody's notes a number of current 
concerns for the sector.  Capital markets are weak, 
making debt refinancing more challenging.  
Expectations for strong growth, particularly in 
wireless and data, have fallen short.  Competition 
is fierce, not only within segments but across 
them, as wireless substitution is becoming an 
increasing factor affecting local long distance 
service.  Massive overinvestment has led to a glut 
of capacity and overextended balance sheets.
		Finally, free cashflow generation is 
marginal in relation to debt loads, and in some 
cases still negative. 
		In the past year, we have downgraded 
companies with large long distance businesses -- 
AT&T, WorldCom, Sprint, and Qwest -- by multiple 
notches.  AT&T and Sprint are now rated low 
investment grade, Qwest is rated speculative grade, 
and WorldCom, of course, defaulted.
		Looking at the local carriers, we 
recently placed the Bell Companies -- SBC, Verizon, 
and BellSouth -- under review for downgrade.  
However, the magnitude of the downgrades will 
likely be very modest.  As for wireless, most of 
the large operators carry negative outlooks but are 
not currently under review.  Near term, we expect 
the Bell Companies and the other ILECs to remain 
the highest rated companies in the sector by a 
significant margin.
		Before I address each of the 
telecommunications industry segments, I want to 
underscore our role in the financial markets.  
Moody's does not advocate policy positions, nor 
does it have a preference on the outcome of a 
rating, a particular regulatory issue, or a 
marketplace event.
		Our job is simply to evaluate a company 
as best we can with available information, and, if 
that information materially changes, to reevaluate 
the company for a possible rating change.  With 
that caveat in mind, I will now address specific 
industry sectors.
		Looking first at the long distance 
sector, the future is not bright.  We expect 
further declines in revenues and operating income. 
 The market share losses by the big three long 
distance carriers will continue to decline due to 
Bell entry and increased wireless substitution.
		The weakness in the debt and equity 
markets is most pronounced for long distance 
companies.  After a period of large scale 
investment, carriers are cutting back investment in 
infrastructure dramatically.  The impact of the 
WorldCom bankruptcy is also unclear.  WorldCom 
customers may move their business and benefit 
stronger carriers like AT&T and Sprint.
		Pricing, after years of sharp decline, 
may stabilize.  But we expect RBOC entry to keep 
the pressure on the long distance industry.
		Finally, the prospect for consolidation 
among long distance carriers we believe is low.  
With so much excess long haul capacity, a 
horizontal merger does not make sense.  A long 
distance local combination makes more sense if it 
was to be permitted, but the performance and debt 
problems of long distance carriers may prove to be 
a deterrent.
		Next we turn to the ILECs.  Our outlook 
for this sector is brighter, but still one that we 
rate as modestly negative.  ILECs remain dominant 
in their markets despite access line losses.  The 
key development is that UNE-P resale, cable 
competition, and wireless substitution collectively 
are now having a notable impact on the RBOCs' 
performance.
		Looking out over the next 12 to 18 
months, we expect a continued flat trend in 
revenues, operating income, and free cashflow.  We 
believe the ILECs will continue to suffer further 
decline in market share to AT&T and possibly CLECs 
coming out of bankruptcy.  We also expect the ILECs 
will continue to invest heavily in new facilities, 
focusing on DSL and long distance.
		As Section 271 approvals are granted, 
we expect the Bells to achieve a significant share 
of the consumer long distance market and a smaller 
but meaningful share of the business market.  
		Next to the last, I will return to 
potential competitors in the local market, the 
CLECs and the cable operators.  It is perhaps 
telling on the state of the CLECs that Moody's has 
withdrawn coverage of many of them because they 
have defaulted, filed for bankruptcy, and are not 
any longer issuing debt.  But questions remain as 
to what happens when CLECs emerge from bankruptcy 
with their debt loads dramatically reduced.  CLECs 
will still need new capital, which will be very 
difficult to obtain.  
		However, some CLECs built substantial 
facilities-based networks and could still be a 
legitimate threat in certain cities.
		Another competitive force is the cable 
industry.  To date, cable companies have focused on 
upgrading their networks to offer digital video and 
high-speed internet access and are winning the 
battle against the ILECs' DSL product, a lead we 
expect cable to maintain for some time.
		Longer term, we believe cable 
represents a threat to the ILECs in voice 
telephony.  Only AT&T broadband and Cox are 
actively offering it now, but others may do so as 
IP technology improves.
		Finally, turning to wireless, the 
outlook for this sector is also modestly negative. 
 In their favor, subscriber growth is still strong, 
although it is decelerating and is resulting in 
solid revenue and operating income growth.  Most 
operators, however, still have negative free 
cashflow because the investment needs remain so 
high.
		While average revenue per user has been 
relatively stable, pricing plans are granting 
subscribers more and more minutes, which affects 
network and spectrum usage, and ultimately capital 
expenditure.
		As the Commission is well aware, 
wireless operators spent heavily to build digital 
2G networks.  These investments have not yet 
generated a positive return on the invested 
capital.  Now we find them investing heavily in 2.5 
and 3G platforms, which limits their ability to 
generate positive free cashflow in the near term.
		In our view, CDMA operators have the 
less expensive, less complicated migration path, 
while TDMA operators face a more challenging and 
expensive migration path that requires an overlay 
of GSM technology.
		Furthermore, the success of 3G services 
is far from assured.  In the long run, we do not 
believe that markets can support six operators and 
would anticipate either consolidation, if that was 
permitted, or attrition.
		In conclusion, we respect that the 
Commission is well aware of the state of the 
industry, and we thank you for allowing us to share 
our views on the various industry subsectors.  As 
the environment affecting the industry changes in a 
material way, we will review all available data 
regarding ratings of debt instruments to determine 
whether any changes are warranted.
		Thank you, Mr. Chairman, and 
Commissioners.
		CHAIRMAN POWELL:  Thank you, Robert.
		I'd now like to introduce Barry 
Nalebuff, the Milton Steinbach Professor of Yale 
School of Management.  He's a co-author of the book 
Co-Opetician.  His first book Thinking 
Strategically:  The Competitive Edge in Business, 
Politics and Everyday Life is a popular business 
school text.  It has been translated into seven 
languages and was a best seller in Japan.
		A consultant, as well as a scholar, Mr. 
Nalebuff applies game theory to his work with 
Fortune 500 clients and in antitrust litigation.
		We welcome you, Professor.
		PROFESSOR NALEBUFF:  Thank you, Mr. 
Chairman, fellow Commissioners.
		I'm an outsider to this business.  I 
worked on the first spectrum auction, but since 
then I haven't advised any companies in this 
industry.  Therefore, allow me to apologize in 
advance for my bluntness.  It's partly my nature, 
and it's also the fact that I don't know where the 
minefields are.
		Could we have the slides?  Thank you.
		What I intend to talk about today is, 
first, what to do about broadband, then what to do 
about local competition, or lack thereof, and, 
finally, come up with a few recommendations.
		Next slide, please.
		The problem with broadband is simply 
there aren't any good killer applications.  We had 
one.  It was called Napster, and it was 
unfortunately illegal.  There are some other ones 
that have come in place, whether it be Morpheus or 
Linewire, but in general we don't have any 
application that everybody thinks they must own. 
		Korea has had some success.  They have, 
of course, population density where 40 percent of 
people live in high rises, and the big application 
that has worked there is online video games.  Boy, 
that's something we need more of in the United 
States.
		(Laughter.)
		So we don't have any existing ones, nor 
is it clear that there are any obvious applications 
coming up in the future.  I read a report from 
Brookings which said there would be $500 billion in 
productivity gains from broadband.  I think if you 
believe that, I have dot com stocks to sell you.
		(Laughter.)
		They talked about, in a Department of 
Commerce report, Biotech as a source of future.  
Well, they said that Merck has four terrabytes of 
data that you could perhaps want to download, not 
at home.  I don't think you're going to even want 
to download that at your office.  
		And more than that, it's not that 
you're going to take this four terrabytes of data 
and use it, you're going to ask some computer 
somewhere to do something with it.  Very little 
instructions you're going to be sending back and 
forth.
		They talked -- and also, of course, the 
people that are using this are academics or in 
business.  They are already on broadband.  
		Health -- they talked about online 
assessments of cholesterol and enzyme levels.  
Again, you don't have to send a whole lot of 
information back and forth.  Phone lines will work 
for that. 
		Robotic surgery -- yes, I doubt this 
will be done from home.
		(Laughter.)
		And hospitals, they already have 
access.
		Homeland security doing biometric 
information at airports -- well, one, that 
technology isn't ready.  But, two, it's not as if 
airports aren't already wired for high-speed 
access. 
		And then, my personal favorite, under 
the new hopes and new possibilities, they talked 
about video e-mail helping millions of illiterate 
Americans challenged by instant messaging.  Can I 
respectfully suggest that it would be better to 
teach these people how to read rather than getting 
them to do videoconferencing with high-speed 
broadband?
		So I think that there is no prognosis 
that we have some great application that's about to 
happen that we should be all excited about, and 
that's okay.
		Next slide, please.
		Remember, we do not have a chicken and 
egg problem.  The fact is there are 24 million 
people who have access to it at home, plus 
countless millions more who have access to it at 
work or at school.  And so if there is some great 
application that's ready to go, people can find it. 
 That's a big enough market out there for people to 
make the applications for.
		Moreover, we don't have any urgency.  
Seventy-five percent of people say they're happy 
currently with their dial-up.  When it was given 
away in Georgia, only 29 percent of the people 
signed up for broadband.  So it's not as if you 
have a screaming demand for this.
		Now, I do actually have some 
suggestions for industry here, if they actually 
want to make this happen.  Guess what?  Get some 
content.  Murdock figured this out with Sky TV.  He 
went and got sports.  Nintendo got Super Mario.  
Sega got Sonic the Blue Hedgehog.  What you need is 
good content, and the content that people want is 
obviously movies and music.
		And guess what?  Only a billion CDs 
were sold last year and a billion movie tickets.  
So you could buy all of the movie tickets and the 
CDs and give them away at a cost of about $5 
billion.  And if you think it's $5 billion to 
justify $100 million of investment to get demand, 
this is pretty cheap.
		You could even start a little cheaper 
by buying old TV shows and old movies, and that 
would probably cost less than a billion.  So to put 
this in context, if you're looking for a killer 
app, we kind of know what it is.  It's movies and 
music, and it's not that expensive.  And it doesn't 
need to be subsidized.  The industry can do it all 
on their own.
		We had a Field of Dreams strategy where 
people built it hoping the demand would come, and 
they were wrong.  They were way wrong.  That's 
okay.  It's there.  It's not going anywhere.  And 
when the demand comes up, we'll have the capacity.
		Now, that leads me to respectfully 
disagree with the conclusions from the Department 
of Commerce Office of Technology Policy, which they 
say, "Actions to accelerate demand are justified 
and valuable."  I don't think so.  I think they're 
neither justified, nor valuable.  We have all we 
need to make demand happen today.
		Next slide.
		Turning to the lack of competition, 
local competition, I think it's an obvious 
statement but bears repetition that incumbents 
dislike competition.  Nobody likes competition 
except consumers.  And we see that they don't like 
competing with themselves.  Every time you put out 
a DSL line, you're probably losing a second phone 
line, so the marginal revenue is relatively low.
		My best example of that is Pagoo and 
Callwave, two companies that came up with a clever 
idea that if you're online and your phone is busy, 
they have your message delivered to them, which is 
then e-mailed to you.  And so you can get a message 
while you're online saying that somebody is 
actually trying to speak to you on the phone.  
		This is a great application.  It 
actually allows you to be online without having to 
have a second phone line.  And, of course, the 
phone companies don't like that.  And so, 
therefore, they did nothing.
		Now, this is the type of customer 
service application that we should have the Bell 
Companies inventing.  It's sort of embarrassing 
that it takes small startups to come up with these 
type of services.
		It's also important to recognize that 
the benefits of competition don't go to the 
competitor.  For the most part, entering into long 
distance is not going to make you a lot of money.  
The benefits go to the customers.  We've seen the 
status quo actually is not impressive.
		In a report I read by Bob Hall and 
Professor Lehr, local prices are up nine percent, 
while long distance prices are down nine percent.  
So recognize that there isn't a lot of gain from 
entry in competitive market, and the more 
competitive the market is the less gain there is 
for entering.  It's kind of one of those paradoxes. 
 So if you succeed in making the market 
competitive, don't expect a lot of entry.
		There is a question of whether or not 
adding competition will lead to more investment.  I 
think I come down on the view that it does because 
that's the only way to protect yourself.  But 
whether it does or it doesn't to me is secondary.  
		The important point is that there will 
be gains to consumers who will get lower prices, 
and there's plenty of investment that's already 
taken place.  Meanwhile, the consumers have not 
gained enough from competition.
		One possibility is that wireless is our 
hope.  But here I'm not impressed either.  
Basically, pricing is just a disaster.  Most of the 
money that's made is done by fooling people.  The 
majority of people are on the wrong plan.  Does 
anybody in this room have an idea how much they pay 
per minute for wireless?  I venture the answer is 
no.
		And the reason is is because you can't 
take how much you spend per month versus -- divided 
by minutes.  I know I pay between five and 10 cents 
a minute for long distance.  Nobody has an idea for 
wireless. 
		If you talk more and you go over your 
minutes, it's 35 cents.  So initially it's 10, and 
then up to 35.  We have incredibly complicated 
wireless pricing, and that's one of the things 
that's cutting it back from being more competition. 
 So let me turn to my conclusions.
		One more slide, please.
		The Energy Star program was a terrific 
program to help people understand how to do 
refrigerators.  Basically, you could understand 
what you would pay in electricity, and, therefore, 
know it's worth paying extra money for a high 
efficiency refrigerator.
		We should have the same type of 
voluntary Energy Star pricing for wireless, where 
all phone companies are required to report the 
average amount paid by customers on each plan per 
minute and how much they pay per plan.  Just 
because you are on a $39 plan doesn't mean on 
average people pay $39.  So giving information 
stickers telling people how much they pay.
		Secondly was you put more pressure, not 
less pressure, in terms of opening up local 
markets.  No reason to relax antitrust, and we 
should find ways to reward entrants, because they 
are actually not going to be the big beneficiaries.
		And, finally, the biggest productivity 
enhancer of our communication structure these days 
is e-mail, and e-mail is drowning in spam.  And 
this is a simple solution that I believe exists, 
which is to put small postage on e-mail.  And, in 
essence, that postage can be denied when people 
actually are happy to have gotten that message.  
You can have open gates to anybody who is a non-
spammer, a dot edu, an AOL.
		But, basically, figuring out how to 
make the things that we have today work better is, 
I believe, where our priorities should be.
		Thank you so much.
		CHAIRMAN POWELL:  Thank you, Professor.
		Now I'd like to introduce Professor Hal 
Varian, who is the Dean of the School of 
Information Management and Systems at the 
University of California, Berkeley.  He is also a 
professor in the Haas School of Business, professor 
in the Department of Economics, and holds the class 
of 1944 professorship.
		Professor Varian has published numerous 
papers in economic theory, industrial organization, 
financial economics, econometrics, and information 
economics.  He authored two major economics 
textbooks.  His recent work has been concerned with 
the economics of information technology, the 
information economy, co-author of the best-selling 
book on business strategy Information Rules -- a 
terrific book, by the way.
		We're happy to have you with us.
		PROFESSOR VARIAN:  Thank you.  So I'm 
going to give a fairly quick talk, because some of 
the points have already been mentioned.  I want to 
-- first slide, please.
		I want to talk about the problem, the 
current situation, some possible resolutions, and 
then conclude.
		Next slide.
		Well, there's two dimensions to the 
problem.  One is the supply side.  We've heard 
about that.  Excessive investments during the late 
1990s, there were new entrants, it's just as cheap 
to put in 266 strands of fiber as 24.  Some people 
say this was dumb.  It wasn't so dumb.  It was just 
that the incremental cost was very low, and each 
individual company has certainly found it in its 
interest to add this capacity.
		At the same time, we saw dramatic 
increases in switching speed, and wavelength 
division multiplexing came along, which increased 
the supply of existing bandwidth, and we've ended 
up with this glut in long haul fiber.  Although 
it's important to emphasize that there are some 
other areas of the network that are still poorly 
served.  For example, there are many customers 
complaining about not being able to get access to 
sufficient metro level fiber capacity.
		Next slide.
		Meanwhile, on the demand side, we saw 
much less demand than forecast.  CEOs were going 
around telling us that internet traffic was 
doubling every 90 days.  Well, if you think about 
it, that means 16 times a year, that means 256 
times in two years.  It just doesn't compute.  
There's a nice paper by Andrew Lisko at the 
University of Minnesota, who has tried to track 
down the source of this urban legend.
		Although it was true that for many 
years -- in fact, even this year it's likely true 
the internet traffic is doubling every year.  
		But video on demand, dramatic takeoff 
of broadband of the home, ubiquitous 
teleconferencing, and other promised applications 
never materialized.
		Next slide, please.
		So the result, of course, is that for 
many firms in the industry that total cost, 
including that sunk cost, exceed the revenue.  
That's not viable.  So we have to find out some way 
to increase revenue or decrease cost.
		Next slide.
		Well, what about the revenue side? 
		Next slide, please.  Thank you.
		There are some unattractive options.  
We could have price supports.  There is a long and 
sordid history of that in regulated industries.  I 
don't think it will fly today.  We could change 
merger guidelines to allow sufficient oligopoly 
power to push prices up.  I know there are some in 
the industry that are arguing this point.  I don't 
think it's a very attractive solution.
		The attractive option, of course, is to 
try to encourage new services that can cross-
subsidize those losses on legacy investment.  So 
there's no silver bullet, as we heard before, but 
there may be a lot of little BBs.  
		And I mention one here -- camera 
equipped cell phones.  This year, 37 percent of the 
cell phones sold in Japan have cameras.  It's the 
big fad.  Docomo charges 40 cents a photo to host a 
photo on their web server, and people can have a 
lot of fun taking pictures of each other and 
sending them back and forth.  And I saw some 
numbers that said the average user of a cell phone 
-- of a photo equipped cell phone spends $11 more a 
month on service than other users.  So it is a 
revenue source that's attractive.
		I'm going to mention another such 
source in the next slide.  Residential broadband 
won't bail us out.  We just heard Barry's view, and 
I agree completely with everything he said.  We ran 
a project called INDEX, Internet Demand Experiment, 
back in 1998, and we -- that was the only 
controlled experiment of how much people were 
willing to pay for broadband.  
		At that time it was 128 kilobits per 
second service.  We had about 100 users.  They were 
university people, prime -- early adopters of 
technology.  We found that there was a very small 
willingness to pay for broadband with the 
applications then available, and the one exception 
was we did find that home office workers and 
telecommuters had a high -- much higher willingness 
to pay.
		And one of the things I urged the ISPs 
to do was to put together a home office package 
with some virtual private networking, a deal with 
Kinko's, a deal with FedEx, do some market 
segmentation, and charge a premium price for the 
users that had a higher willingness to pay -- 
straight MBA 101 stuff.
		Now that was pre-Napster, pre-KaZaA, 
but the point still holds.  Those are not viable 
services on which to build an industry, and there 
is some demand for broadband, of course, but it 
saturates at about 15 percent.  And it should say 
internet households there -- 15 percent of 
households currently use the internet at current 
prices.
		Next slide.
		So what you need are compelling 
applications.  Copyright violations are the killer 
app, but they're getting killered.
		(Laughter.)
		You need a lower price.  Twenty-five 
dollars is a great price point.  There is 
substantial demand at that point, but something 
significantly more than $30 just doesn't work. 
		If you look at Korea, we all know 
that's the most broadband intensive country in the 
world, but why is that?  Well, they sell DSL light 
at $23 a month.  So, of course, the price point is 
there, and it's much more attractive from a cost 
point of view.
		And if you look at prices in the U.S., 
they're going the wrong direction.  They're going 
up.  Last year price -- average price of 
residential broadband has gone up from $50 to $55. 
		Next slide.
		What about reduced costs?  Well, you 
could try to reduce operating cost.  That's great. 
 But how do you do it?  You could reduce fixed 
cost, and what that really means is mark those 
fixed assets to market.  That's the polite way of 
saying it.  That's what economists say.  But, of 
course, the more popular term is bankruptcy.
		Shareholders lose, bondholders lose, 
but the public gets cheap telecom.  And Larry White 
is going to say more about this, so I will defer 
further discussion until he gets to it.
		Next point.  There is one caveat I want 
to raise about bankruptcy, and that is the 
possibility of competitive bankruptcy, and the idea 
there is that if competitors cut costs by doing 
bankrupt, then I want to as well.  
		People have compared the telecom glut 
of the 1990s and 2000 with the railroad glut in the 
1890s, and competitive bankruptcy was endemic at 
that time.  There were more miles of track laid in 
1880 than in any other decade in U.S. history, and 
in 1890 there were more miles in bankruptcy.
		We already heard Robert Konefal talk 
about the CLECs.  When they go bankrupt but the 
capacity is still there, it gives them a cost 
advantage when they come back.  And so if you 
happen to be a surviving CLEC, it's in your 
interest to go bankrupt.
		This could be an interaction with 
corporate organization, bundle losers into a 
subsidiary, and then put it into bankruptcy.  So 
these are not reasons not to engage in financial 
reorganization, but I think it's important to 
recognize you will probably get more of it than you 
expect.
		Last slide.  What can the FCC do?  Try 
to reduce transactions costs of financial 
organization.  Give clear guidelines for asset 
transfer.  Perhaps you can explicate the process in 
some way.  We've got some of the world's experts on 
options working for the FCC.
		But be warned about this point -- that 
there will probably be more financial 
reorganization than you might anticipate, just 
looking at the numbers, if it confers a competitive 
advantage.  And it's better to recognize those 
losses sooner rather than later.
		So we can skip the summary.  I've 
already said it.  Thank you.
		CHAIRMAN POWELL:  Thank you, Hal.
		Now I want to introduce Kim Wallace, 
who is the Chief Political Analyst and Managing 
Director, who joined Lehman Brothers in May of 
1994.  As Lehman Brothers' chief political analyst, 
Mr. Wallace directs the firm's Equity Research U.S. 
political analysis group responsible for analyzing 
legislative and regulatory events important to 
investors.  He focuses on macroeconomic policy, 
telecommunications, antitrust, trade policy, and 
the financial services industry.
		Welcome, Kim.
		MR. WALLACE:  Thank you.  Good to see 
you again, Michael, Commissioners.
		I have a prepared text that you have 
before you.  I won't read from that.  It'll save us 
some time and some considerable redundancy.  The 
colleagues before me have done a good job of 
covering the landscape.
		My group and I live on that third rail 
that Rob was talking about -- policy analysis.  
Staying away from what ought to be done is, 
unfortunately, not something that we have a luxury 
to do.  Obviously, we aren't advocates.  We merely 
look at what the policy process may issue, and then 
help institutional investors think through what 
might be their position afterward.
		As such, I'll speak from the three 
slides that I've prepared, and if you could put up 
the first one.
		You know, looking back may help us 
understand a little bit of why we got there and 
where we may need to go in the future.  If you look 
at the three drivers of the telecom boom in the 
late half of the last decade, they were tied to 
three phenomena -- capital formation, 1995 through 
1999 was the last leg of a 20-year bull market.  
		Technology developments in the 1990s 
were spurred by both productivity developments and 
then capital formation, giving more money to some 
of those good ideas, and some of that money to very 
bad ideas.
		And then lastly, and I think as 
importantly, were the rules changes.  From 1995 
through 1997, the European Union, the United 
States, and the WTO, all of those rulemaking bodies 
changed their rules and telecommunications policies 
-- one sector, other sectors, but especially 
telecommunications -- in order to spur competition 
and to increase choice, not just within their 
sovereign areas but across the world.
		Those drivers are still at work today. 
 Obviously, they have gone to other places in some 
regards, particularly when it comes to capital 
formation.  But when the return comes to the 
telecommunications industry, those three drivers 
will still be there.
		Investors talk about certainty 
constantly.  Those of us in the capital markets 
look for certainty.  That's the best way to put a 
value on any asset, if you know what certainty is 
going to go around it, whether it's event risk or 
risks that are endemic to that asset.
		However, when it comes to 
telecommunications policy, that becomes difficult 
because of strategic defensive maneuvers made by 
the several players in the marketplace.  So that 
certainty coming off the desk of the FCC isn't 
really certainty anymore until it comes off the 
desks of some justice somewhere.
		As much as we would like certainty, 
it's very difficult to drive down to that level as 
long as that system is still in place.  And I don't 
see that system going away any time soon.
		The bottom half of the slide has been 
covered by my colleagues before me.  I won't go 
into it.  But there are several contributors to the 
industry's decline.  One could argue I think 
reasonably that policymaking isn't one of them.
		Certainly, people who are in a bad way 
right now from a balance sheet perspective can 
point to any number of policies or policymakers 
that they would like to have difference with, but 
understandably there are macroeconomic and 
microeconomic forces in telecommunications that are 
in line before you all, in my view.
		Next slide.
		Because there are so many players, and 
most of those players are well funded at least when 
it comes to the policymaking process, they all have 
access to you and to the policymakers on Capitol 
Hill, and for that matter the judicial system.
		It is highly unlikely that the 
legislature -- Congress -- is going to be able to 
make new law anytime soon to significantly affect 
policymaking, which means the job will fall on you, 
your brothers and sisters at the state level, and, 
of course, the ever-present courts.  
		That's not to say that the legislature 
didn't have its day.  The 1990s were very active, 
and we'll go through some of that in a minute with 
the 1992 Cable Act, the '96 Telecommunications Act, 
and then, of course, the 1999 Satellite Home 
Viewers Act.
		The legislature put its stamp on the 
telecommunications industry, and, as I said before, 
here in the U.S. it was consistent with what we saw 
around the world, or at least in the Western world 
-- that is, competition, or at least pro-
competitive policies, and then choice for 
consumers.
		Competition and choice will likely 
continue to dominate your decisions, because those 
models obviously are the best.  The difficulty, of 
course, for a participant in the industry is that 
as you all search for perfect competition, if you 
will, that since the drive down the value of the 
commodities of the people in the marketplace sell. 
 There is going to be a give there.  It's hard to 
tell what that is sitting here today.
		The last point on this slide that I'd 
make is that as terrible as the situation is for a 
lot of the players in the telecommunications 
market, it's very likely, as many people have said 
before me, to change significantly until the 
macroeconomic conditions of the country and the 
world do, and that includes the investment 
decisions of both businesses and individuals.  It 
doesn't look like we are there yet.  Certainly, it 
does look like policymakers have taken some steps 
to move that forward.
		Next slide, please.
		One of the things we attempt to do with 
institutional investors is to take policies made 
and put them on a map, if you will, so that we can 
build a road sign for people as to the signals you 
all and others are sending about investment 
opportunities, and, for that matter, risks.
		If you look at some of the points on 
this slide -- and, obviously, this is selective.  
There were several other actions taken by the 
Commission, taken by the legislatures at the state 
level, and by Congress that aren't on here.  
		But if you look at these five or six 
acts that were taken in the two decisions by the 
Supreme Court, it's very clear this trend toward 
competition and consumer choice has been decided 
upon by the three branches of the government and is 
very unlikely to change.  Those signals have been 
sent throughout the markets.  And although on a 
temporary basis people would blame some of those 
signals for bad decisions made, as many have said 
before me, some of those decisions came because 
perceptions were unrealistic about the signals that 
had been sent.
		I would just close by saying the 
lessons learned, or at least the desired result, 
for robust facilities-based competition, you end up 
with a platform whereby there is wireless 
performers, obviously there will be wire line 
performers, and those wire line performers will 
operate off of a telephony network, as well as the 
cable network.
		It's hard to see how it could get much 
better than that if your end goal is competition 
and consumer choice.
		I'll stop there.
		CHAIRMAN POWELL:  Thank you very much, 
Kim.
		I'd now like to welcome Lara Warner.  
She's a director at Credit Suisse First Boston in 
the Equity Research Department.  She joined the 
firm in April of 2002.  Ms. Warner covers the cable 
television industry.  She was ranked the top up-
and-comer analyst by her clients for coverage of 
the cable industry by institutional investors in 
2001.
		Welcome, Lara.
		MS. WARNER:  Thanks very much.  
		Just to put it in perspective, I'm the 
shoe salesman selling the wing tips to Rob down at 
the end of the table.
		(Laughter.)
		I'd go for the penny loafers, Rob, just 
to be clear.
		Thank you very much for having me here 
today, and I have lived on many sides of this 
debate.  Prior to covering cable, I actually was in 
the telecommunications industry, both at a 
corporate level as well as on the Wall Street side, 
and have watched this process now for many, many 
years, and would just like to give my perspective, 
most of which has been mentioned by my colleagues, 
but with particular focus I think on the consumer 
side of this debate.
		We've talked a lot about the 
overinvestment, much of which had to do with the 
business telecommunications industry.  So as I go 
through, I'll try and point out more of a consumer 
perspective.
		I would agree, obviously, that the 
capital markets played a very large role in terms 
of overfinancing this industry, and I would argue 
that, really, very little of it had to do with the 
fault of any policymakers.  I recall that, you 
know, we used to use the term "Build it and they 
will come," and I think many networks were 
constructed in anticipation of facilities-based 
competition, although much of that was for the 
business market.
		On the consumer side, I think you saw a 
fairly rational buildout of the wireless networks 
based on demand, and cable networks were, in 
essence, built out:  a) because they anticipated 
competition, but b) because we also had fairly easy 
access to capital.
		I would summarize and say that we, as a 
capital market structure, no longer assessed risk 
appropriately, and that was really our main issue. 
 We've talked a lot here today about the fact that 
we were very good on the supply side.  We were not 
very good on the demand side.  
		We assumed the pie was dramatically 
expanding, but we actually did some work that 
suggested that on the consumer side, even though we 
had significant adoption of narrow band, wireless, 
and broadband, much of that was fueled by the 
dramatic reductions we saw in the last five to 
seven years on the long distance side of the 
business.
		And if you look at the way consumers 
spend across all services and communications on a 
monthly basis, they've been pretty consistent in 
terms of how much they've been willing to spend 
every year.  So that market was not expanding as 
dramatically as we thought.
		So today the stocks are down at lows 
for both telecom and cable, and I think what you 
see is the market anticipating more and more head-
to-head competition, with probably a more critical 
assessment of risk and maybe overassessment of the 
risk.
		Cable stocks are down due to satellite 
competition.  RBOCs are down due to impending 
cable, wireless, and IXC competition, and so on and 
so forth.
		And I think it's fair to ask what has 
changed.  My view is that, you know, obviously 
these threats of competition existed before.  The 
difference is our mentality as a capital market 
structure.
		Number one, I think this is very key.  
The market is really unwilling to believe in future 
cashflows from new services until they appear.  
When companies talk, even particularly on the cable 
side, about opportunities for new services using 
existing broadband capacity, I think generally the 
response by markets has been lukewarm at best, 
because we don't believe anymore in things like 
videoconferencing and other new applications until 
we see how consumers literally adopt those 
services.
		I think, therefore, we believe there is 
little to no expansion right now of the industry 
pie.  And, consequently, given all players in the 
industry are incumbents right now, they all have 
something to lose.  So, consequently, I think many 
people believe that competition is viewed as a zero 
sum game broadly across the industry today.
		So how can you, as the FCC, improve the 
situation?  I think, first of all, in terms of the 
stock prices, it's important to recognize that your 
goal of introducing competition, I would argue, 
runs contrary to market wishes.  
		If we're totally honest, the market 
does not like competition introduced into a 
regulated industry -- I think we touched on this 
earlier -- because it does threaten returns in the 
short term, and so I would caution you to take our 
reactions and at least sift through them a little 
bit given that fact.
		I think also that the lack of certainty 
has only exacerbated the situation, and this is 
probably an area where you can help.  As we listen 
and, frankly, are buffeted by the rhetoric on both 
sides of the fence, whether it's from the incumbent 
long distance players, the cable operators, or the 
RBOCs, they all have their unique position as to 
who wins, who is right, and we are not able to 
assess it in the abstract and independent eye of 
the market in terms of competition.
		So one certainty is very important, and 
as soon as possible I think would also be something 
I'd underscore.
		Secondly, in terms of the balance 
sheets, I would argue there is very little you can 
do here as well.  The industry has stalled the 
investment cycle, as we have heard repeatedly, and 
I would say we've put the industry on a proverbial 
diet.  
		I think the challenge is right now that 
basically what's left for these companies to do is 
make very hard decisions around their business, cut 
back capital spending, sell off non-performing 
businesses, generate free cashflow, pay down debt, 
and at that point I think you'll see the markets 
much more open to incremental investment by the 
industry.  But, again, very little I think that you 
can do in terms of that process today.
		That leads me, really, to the third 
question, which is, how do you encourage investment 
and return us to a growth industry?
		And I would argue that while the 
markets don't like it, history seems to say that 
competition is the only really factor that drives 
investment over time.  We saw it in the cable 
industry as they upgraded their networks, the RBOCs 
deploying DSL, and you may one day have a cable 
industry that is spurring on the RBOCs to think 
about how they may run their consumer business on a 
more efficient basis.
		And, obviously, the UNE-P debate has 
hit a nerve in this area.  I just want to make a 
couple of comments on this topic, and I think this 
is a really large challenge for all of you, which 
is whether your goal is competition today or 
facilities-based competition down the road.
		I can say, I don't know which one makes 
sense from your perspective, but the timing, I 
believe, is going to be very different.  In my 
opinion, the market will be reticent to fund any 
additional capital for facilities-based 
competition, because if you look at the slides 
we've been seeing, we did fund quite a bit of 
facilities in the marketplace on both the business 
and consumer side.
		As it relates to cable, which is 
something we've been pretty focused on, I think 
while telephony is an opportunity that cable will 
not turn away from, because it, frankly, is their 
largest opportunity for growth, they face the 
similar challenge of needing to pay down debt in 
the near term to really give themselves the 
flexibility to fuel incremental investment.
		I would also point out that while that 
process may take several years, they are being, 
frankly, threatened by a competitor in their core 
business -- the video business.  And so as a cable 
operator, I think the challenge in three to four 
years when you do have incremental capital is:  
where will you deploy it, and in what size and 
scope?  Particularly if your core business remains 
under threat as it represents the vast majority of 
your revenues.
		We are also waiting for IP telephony, 
which I think is clearly a technology path that has 
taken a lot longer than anyone thought, and that's 
something we continue to wait for, frankly, before 
investing incrementally.
		So, in summary, I would say what the 
market needs is certainty, the ability to see 
resulting competition proceed in the market, and 
let us judge the results versus being buffeted by 
the rhetoric and projections of all the companies 
that are involved today.  So your challenge, I 
think, is, again, provide certainty, let the 
companies compete, and let the markets determine 
which management teams innovate and, therefore, 
survive.
		Thanks.
		CHAIRMAN POWELL:  Thank you very much.
		Finally, I'd like to introduce Larry 
White, who is the Arthur Imperatore -- did I 
pronounce it right?  Professor of Economics at New 
York University Stern School of Business.
		During 1986 to 1989, he was on leave to 
serve as board member, Federal Home Loan Bank 
Board.  And during 1982 to '83, he was on leave to 
serve as Director of the Economic Policy Office of 
the Antitrust Division, U.S. Department of Justice.
		Welcome, Larry.
		PROFESSOR WHITE:  Thank you.  Thank 
you, Mr. Chairman, Commissioners of the FCC.
		When you're the last person on an 
impressive panel like this, you often worry there 
are no good lines left.  Well, I'll try just to at 
least leave a few.
		Next slide.  Oh, okay.
		We've already heard the basic reasons 
for why we're here today -- a large expansion of 
capacity, a lot of investment, technological change 
compounding this, much slower growth than was 
expected, the slowing of the economy that Dr. 
Wilkie talked about earlier, and then, on top of 
that, the corporate governance and accounting 
revelations.
		There are no magical, painless 
solutions.  As Commissioner Copps said earlier, 
there is no silver bullet.  But I think there are 
three important principles that the private sector 
and the public sector should adhere to.
		Next slide, please.
		The first is acknowledge and recognize 
the losses and the pain, and then move on. 
		Second, follow good antitrust 
principles. 
		Third, do not delay efficiency-
increasing developments in spectrum allocation and 
usage.
		Next slide, please.
		Those losses are there.  They have to 
be absorbed by someone -- the owners/shareholders, 
first, then the lenders/creditors.  And that's the 
way it should be.  Sooner and faster is better.  
That way companies and markets can then recognize 
true prospective marginal costs, and we can get the 
lower prices, expanded demand, greater utilization, 
greater economic efficiency.
		Next slide, please.
		Delay is going to stretch out the pain, 
but not avoid it.  Let's all remember:  investors 
do not deserve a return.  They make risky 
investments.  Often they succeed.  Sometimes they 
lose, and that's the way it ought to be in a market 
economy.
		And to prop up losing investors is to 
privatize the gains, socialize the losses, and this 
is a recipe for inefficient decisions and 
inequitable outcomes.
		Next slide, please.
		Sizeable bankruptcies already exist.  
There are possibly more to come.  But it's 
important to remember they do not mean the 
shuttering of a company, so long as the company has 
prospective value.
		I read in The Wall Street Journal last 
week that I believe 360 Networks looks like it's 
going to be emerging from bankruptcy as a going 
concern.  And bankruptcies provide resolution for 
people, for companies, for customers, for 
suppliers, and then everyone can move on.
		Now, I know it's not a lot of fun, and 
it's not a perfect process.  There can be glitches, 
but it does provide resolution. 
		Now, just so you don't think we're all 
just one big happy family here, I want to take a 
little bit of issue with what Hal Varian -- not 
what he said, but what he wrote down on one of his 
slides about the problem with bankruptcy, about 
competitive bankruptcy.
		I don't think you need -- you want to 
look at it as a problem.  It's simply there.  And I 
think the really important point here is simply 
that the logic of marginal cost pricing is going to 
will out in any kind of competitive process.  And 
that's really what's going on.
		Bankruptcy allows that marginal cost 
pricing to happen a little bit faster, but it's 
going to happen anyway.  And, again, sooner is 
better than later.
		Next slide, please.
		How did talk about the 19th -- oh, can 
we get the next slide?  There we go.
		The 19th century railroads -- he's 
right on the mark there.  There was overbuilding, 
and not as much demand as was expected, 
bankruptcies.  We had surviving railroads, and the 
railroad industry went on for the next half century 
to be the center of transportation for passengers, 
for freight, and even today 100 years -- over 100 
years later is central to freight transportation.
		Next slide, please.
		A more recent example that I lived 
through, and my back side is plenty scarred from 
the experience, the savings and loan debacle.  We 
now recognize that it was excessive commercial real 
estate investments and inadequate safety and 
soundness regulation in the early 1980s that 
brought on the crisis, resulting in overbuilt, 
overpriced commercial real estate.  See-through 
office buildings were a common phrase in sunbelt 
cities as of the mid-1980s.  And we had many 
hundreds of insolvent savings and loans.
		Next slide, please.
		There was a lot of political pressure 
at the time to go slow, give time the opportunity 
to let conditions turn around.  And there were 
fears that selling commercial real estate would 
only depress prices further.
		But markets weren't going to be fooled. 
 They already knew there was the real estate 
overhang, and that that was going to have a 
negative effect on prices, and delay would have 
allowed more risk-taking by insolvent savings and 
loans and a continued overhang of real estate.
		Next slide, please.
		The cleanup of insolvent savings and 
loans took too long.  But when it did finally get 
underway, it proceeded expeditiously.  
		The Resolution Trust Corporation, the 
RTC, did move expeditiously to dispose of 
commercial real estate that it inherited from the 
insolvent S&Ls.  And rapid actions allowed both 
sectors -- the S&Ls and commercial real estate -- 
to emerge stronger and sooner.
		A current example -- next slide.  There 
we go.  The Japanese banks.  After the Japanese 
stock market and real estate market bubbles popped 
in the early 1990s, the government of Japan should 
have forced banks to acknowledge losses, should 
have dealt expeditiously with insolvent banks, and 
should have found new owners for insolvent banks.  
And then the Japanese banks could have resumed 
their proper lending role to the Japanese economy.
		Next slide.
		Unfortunately, instead, the Japanese 
government dithered.  When actions have been taken, 
they have been too little and too late.  Japanese 
banks remain saddled even today with bad loans on 
which they have not yet fully recognized losses.  
The banks remained moribund and reluctant to lend, 
and the Japanese economy remains stagnant.  And 
this is not a pattern to be followed.
		Just at least once a week, sometimes 
twice a week, we see headlines in The Wall Street 
Journal, The New York Times, about the stagnant 
Japanese economy, the stagnant Japanese banks.  Now 
they're going to do something, and they don't do 
it, and they're paying a large price for that.
		Next slide, please.  Next slide.  Oh, 
okay.  Yes.  There we go.  Okay.
		My second major point -- follow good 
antitrust principles.  As the Chairman indicated 
earlier, some consolidation is warranted, but 
financial difficulties are not a good excuse to 
abandon sound antitrust principles.  The Department 
of Justice-FTC, horizontal merger guidelines, 
provide sensible guidance to permit efficient 
combinations and to avoid the creation of market 
power.
		Slack antitrust standards, by 
comparison, for other regulated industries -- for 
example, the railroad and airline industries -- 
mergers there with slack standards have had 
unfortunate outcomes.
		Next slide.
		My last point.  Don't delay efficiency-
increasing developments for spectrum.  Substantial 
improvements continue to be possible.  They can 
come about through improved technologies and 
through improved regulation and deregulation.  And 
don't delay them because of feared effects on 
fiber-optic cable, because the efficiency 
advantages are important to have regardless.
		Spectrum auctions carried out by this 
Commission for the last decade are a good start.  
But they're only a start.  They don't go nearly far 
enough, because they don't apply to nearly enough 
spectrum.
		The right way to proceed is to think of 
spectrum as property to propertyze the spectrum, to 
deal with the public aspects in a property system 
just the way we deal with the public aspects of 
real estate.  There is room for government.  There 
is room for the private sector in real estate.  The 
same is true for the spectrum.
		And so last slide, please.  Next slide. 
 Yes.
		Again, my three major points.  
Acknowledge and recognize the losses and the pain 
and move on.  Follow good antitrust principles.  
And do not delay the efficiency-increasing 
developments in spectrum allocation and usage.
		Thank you very much, Mr. Chairman, 
Commissioners.
		CHAIRMAN POWELL:  Thank you very much, 
Professor White.
		I'd like to note a monumental 
achievement.  We finished exactly on time.  That's 
what you get when you've got a panel committed to 
efficiency and productivity, I guess.
		We now will have a period in which 
we'll hopefully have a productive dialogue.  And I 
would suggest to my colleagues that, rather than 
just going in order that the floor is available to 
anyone who might have a question, and just feel 
free to jump in at any moment that it moves you.
		Does anybody have a question they'd 
like to start with?
		COMMISSIONER ABERNATHY:  Actually, I 
have a question based on all of the discussion that 
we had today.  And my experience in this industry, 
it's always been that the telecom industry was 
capital-intensive, and this was driven by 
investment in new technology and new capacity.  
		And yet now, according to a number of 
you, there is really no growth expected for any of 
the industry, whether you look at local or long 
distance or broadband.  And this is due, 
apparently, to lack of access to capital and the 
level of competition and no expansion of the pie.
		So, then, my question would be:  if 
there's no more infrastructure investment, at least 
in the near future as you see it, does that mean 
that regardless of what we do with pricing, we're 
not going to see infrastructure investment for at 
least -- it won't stimulate that?  And if it won't, 
maybe we should do it anyway, because it's the 
right thing to do.
		But what else is there?  Does that mean 
that in order to stimulate it, maybe we shouldn't 
even be thinking about infrastructure investment?  
Maybe we should be thinking more along the lines of 
mergers.  But then, what does that do to the 
competitive environment?
		So those are my questions.
		MR. GENSLER:  Can we just answer or --
		COMMISSIONER ABERNATHY:  Yes.
		MR. GENSLER:  I would actually differ 
with one of your premises.  I think there is good 
unit growth and unit consumption in many areas.  I 
mean, fixed wire line is shrinking, but everything 
else is growing.  I think pricing gets to the heart 
of it.  And without proper pricing, the returns on 
capital aren't good enough.
		And, you know, the system of wholesale 
pricing on UNE-P gets at part of the issue, but 
even rate rebalancing, which in many parts of the 
world they let happen.  
		Now, we have this issue with state PUCs 
where no one would get reelected at that level if 
they ever let a rate rebalance happen.  But 
separate from that issue, many parts of the world 
find ways to get around this and give, you know, 
price cap regimes with rate rebalancing, and you 
get investment if the prices get closer to, you 
know, what would be needed for proper reinvestment 
rates.
		COMMISSIONER ABERNATHY:  But I thought 
you had said that the goal, really, what you were 
pushing for right now was you want them to decrease 
debt and get more of the revenues back out into the 
economy, into the investment community.  But that 
seems to be inconsistent with the decision to 
invest in infrastructure.
		MR. GENSLER:  Absolutely.  But what we 
have is, you know, you have a product migration 
from a very heavily regulated but shrinking fixed 
wire line to competitive wireless data, etcetera.  
And you have a mix shift going to lower margin, 
lower returns on capital.  
		That's just a natural product 
migration, but then we sit and we sort of treat the 
corpus, which is shrinking, as if it can pay for 
everything else, and we give it low rates that 
aren't allowed to change and wholesale rates that 
make it even harder.  It makes it hard for those 
companies to think about having enough capital to 
reinvest in the new product lines.
		PROFESSOR VARIAN:  To answer your 
question a bit more peripherally, I would say that 
if you've got an excess of pie, then invest in ice 
cream.  There are still a lot of complementary 
services that could be very valuable, particularly 
if there is very cheap telecommunication services.
		I mentioned there is still something of 
a shortage in some places of metropolitan fiber 
service.  But if the long haul network is there, 
and very competitively priced, I think the 
investment funds will be forthcoming to pay for 
that.  What you really want to look at, on a going-
forward basis, will the money be there for the 
complementary services that can really utilize this 
inexpensive telecommunication?  I think they will 
be.
		PROFESSOR WHITE:  I would second that.
		COMMISSIONER COPPS:  Let me ask a 
question, if I could.  I was both hugely fascinated 
and hugely frustrated by the discussion on 
competition.  I think a couple of the speakers at 
the outset said nobody likes competition.  
Certainly, the market doesn't like competition.  
Least of all does it like the facilities-based kind 
of competition to which a number of us would like 
to see an evolution toward.
		Yet as Mr. Wallace pointed out, and as 
the rather clear commitment of the country as 
expressed by three branches of government, that we 
are going to have competition in the United States. 
 So I don't know quite where that leaves us.  It's 
kind of the irresistible force meeting the 
immovable object.
		But I would certainly appreciate having 
some little guidance on how we might extract 
ourselves from a dilemma of this magnitude.  And, 
really, is it unrealistic investor expectations 
that's the culprit here as much as anything else?  
Are those expectations at historically 
unprecedented levels?  Is that a problem that we're 
dealing with?  Or feel free to --
		MS. WARNER:  I'll just take a first 
stab.  I'm sure there will be others.  I mean, my 
personal view is we are, I think, at somewhat of a 
stalling point in terms of how to resolve this.  
Part of the issue is, obviously, that the incumbent 
businesses in telecommunications appear to be to 
many investors the only place in which there is an 
opportunity for return.  
		And so I would say that while markets 
generally -- markets don't like competition, and, 
frankly, if competition occurs slowly in this 
market, we all have an opportunity to make, you 
know, better returns or at least more manageable 
returns over the next few years as competition 
arrives.
		I think the challenge is for 
facilities-based competition that we believe that a 
lot of the capital we invested in the last five 
years was facilities-based competition, and that's 
why we are sitting here with, you know, several 
networks, many of which are in bankruptcy.
		So in terms of spurring on incremental 
facilities-based competition, you know, it's not 
clear to me that the market will tolerate that.  I 
think we'd prefer to see how the existing structure 
works out.  And maybe to Commissioner Abernathy's 
question, maybe it is a matter of structural 
solutions first, given we've got facilities and 
capacity out there before, you know, we really can 
move on in terms of incremental investment.
		PROFESSOR WHITE:  Let me -- I'd like to 
address that as well.  And I think here is where 
leadership by the Commission and by all branches of 
government are really important.  I say this as a 
former chief economist at the Antitrust Division.  
I know the Chairman, as a fellow alum of the 
Antitrust Division, I truly believe would share 
this.
		The markets may not like it, but that's 
the market's problem.  And the public good, the 
public interest in greater competition, really 
ought to trump anything else.  And that's what 
leadership ought to be all about.
		CHAIRMAN POWELL:  Let me just exercise 
a privilege and throw a gloss on this.  I think 
it's wrong to say markets don't like competition.  
Markets like winners, and markets function very 
effectively in many very competitive markets.  I 
think that is too gloomy as sort of a binary 
choice.  
		I mean, I think that the greater 
concern here is people are struggling to find 
winners and struggling to see paths for different 
classes of companies in different markets to find a 
path to success or victory.
		I mean, money flows all the time into 
people who are entering competitive markets, if 
they think they have an advantage, a competitive 
advantage, a differentiated product, something that 
will allow it to gain market share.  So let's not 
-- I'd like to sort of take issue a little bit at 
the idea.
		You know, competitors don't like 
competition all the time.  But I think markets are 
fairly agnostic.  As long as there's an opportunity 
to get a return on that investment, they'll take 
it, even in a competitive market.  I just thought 
I'd --
		MR. WALLACE:  And recent history bears 
it out.  If you look at the financial services 
industry and the telecommunications media industry 
broadly from 1994 through 1995, highly competitive 
in new ways that people didn't understand, and yet 
returns across the board were good for many, and 
the winners really won.
		In terms of the leadership and the 
structure for regulation, Justice Kennedy probably 
hit it on the head in the 1994 and 1997 decisions 
in FCC v. Turner.  If there's a bottleneck created 
by one entity in terms of distribution, content, or 
their ability to control prices in that market 
disproportionately, that's something that ought to 
be regulated.  If you don't have the bottleneck, 
market forces are probably taking care of it for 
you.
		PROFESSOR VARIAN:  I have one brief 
comment on your phrase "historically 
unprecedented."  I don't think there's anything 
that's historically unprecedented.  We've seen, of 
course, booms and busts continually -- the 
railroads in the 1840s and 1880s, the radio boom in 
the 1920s.
		There was at the time the famous 
euphoria of 1923, which compares almost exactly to 
the internet euphoria of 2000, PC software in the 
1980s.  1907 to 1910 there were over 300 companies 
that entered the automobile industry, and then they 
were winnowed out in the first part of that decade.
		So continually, whenever you have booms 
in technology, you'll see something that captures 
the public imagination, a big investment boom, and 
not a bit of an overhang.  And I think the lesson 
that Larry raised was the most important thing to 
remember, that typically it's better to recognize 
those losses sooner rather than later.  Don't drag 
it out, don't try to pretend they aren't there, and 
move on.  That's what has worked in the past, and I 
think that's what's going to work now.
		CHAIRMAN POWELL:  One of the things 
that I think is always missing in this kind of 
discussion is, you know, competition is not some 
infinite concept.  Markets try to find a point of 
equilibrium on the right number of competitors and 
the right space, so that producers continue to 
produce and consumers continue to purchase.
		We all cite to historical examples from 
tulips to railroads to airlines.  But there has 
been a growing sort of recognition that there is an 
aspect of network industries that just tends to 
scale in scope, that just has to be accounted for 
as a matter of effective policy.  
		You know, people cite the railroads, 
but then -- let's say, how many of them are there. 
 Let's cite the airlines.  Now let's talk about how 
many of them there are still not turning profits.  
You know, let's cite the telegraph and its 
experience from 80 to one, and then to telephones, 
which produced a government embracing of one.
		Can any of you -- I know, you know, how 
you've written about this.  Others -- is there some 
additional qualification because of the necessary 
nature of a networked industry?
		PROFESSOR VARIAN:  Well, I would say 
the important characteristics are to look at the 
scale economies on the supply side and the demand 
side.  So if you have an industry where there are 
large scale economies, cost advantages in 
production, you are going to see a relatively small 
number of competitors.  And, of course, we saw that 
in the automobile industry.
		If you have an industry where there is 
very large demand side economies of scale, so that 
there is -- more valuable to connect to the largest 
player, then you'd expect to see a relatively small 
number of players there.  
		I think there absolutely will be 
continued consolidation in the telecommunication 
industry, but -- and, in fact, it's possible that 
market forces alone would take you all the way to a 
monopoly player.  But I think that there is a role 
for policy in stopping somewhat short of that 
purely competitive outcome, in my opinion.  The --
		CHAIRMAN POWELL:  How do you know where 
it is?
		PROFESSOR VARIAN:  How do you know 
where it is?  Well, I think economists generally 
would agree that one and two are too small, and 
three is getting there, and five looks pretty good.
		(Laughter.)
		PROFESSOR NALEBUFF:  Let me add to 
that.  I think it's the case that, in particular 
for telecom, they have done a very bad job with 
product differentiation, that for the most part I 
don't have any idea what network I'm using, how 
it's -- what's traveling over where, and that it 
actually doesn't have to be that way.
		In fact, my discussion about the lack 
of transparency in wireless pricing I think is one 
of the reasons why we have incredibly high churn in 
the United States, that basically people don't like 
their wireless carriers because they constantly 
find their bills to be higher than they expect them 
to be, and they don't understand it.
		So my view is that the lack of service 
innovations is actually remarkably little.  Think 
about how much better computers are 20 years -- 
today compared to 20 years ago versus how much 
better telecommunications is.  So they have the 
curse of low marginal cost and high excess 
capacity, which is a recipe for losing money.
		But at the same time, the antidote to 
that, some product differentiation and some 
customer loyalty, is something they've failed to 
achieve.  And that's their own problem.
		MR. KONEFAL:  I would offer a couple 
more thoughts on it.  I guess, first off, telecom 
is, by definition, a very capital-intensive 
industry.  It requires very patient capital.  It 
takes a long, long time for that return to be 
earned.  
		And in those markets that are very well 
developed, there is already an incumbent.  And in 
the more nascent markets, like wireless -- and I'm 
sort of using time horizon rather liberally here -- 
but the wireless area or the data area, where there 
isn't really a front runner, the opportunity for 
success at least has more realistic teeth to it 
than in areas where there's already a very dominant 
incumbent.
		COMMISSIONER COPPS:  Is patient capital 
an oxymoron?
		(Laughter.)
		MR. KONEFAL:  Excuse me?
		COMMISSIONER COPPS:  Is patient capital 
an oxymoron?
		MR. KONEFAL:  It is these days.
		(Laughter.)
		COMMISSIONER MARTIN:  I wanted to ask 
-- I seem to sense a tension between some, I 
thought, of the panelists.  And I just want to be 
sure I understand.  There was a lot of talk about 
not giving up on competition on the one hand, but I 
think that, really, the distinction or the 
challenge for us is the degree to which we 
recognize the intermodal competitions occurring and 
how that impacts our intramodal regulations.
		And that's -- so I think we can all 
agree on the competition principles.  But I think 
that we have another level in our questions of what 
we're -- what issues we're facing and the 
challenges that we're dealing with.  
		And I heard Rob talking about, for 
example, some of the concerns he had with the 
wholesale pricing market and the potential wrong 
signals that I think it was sending.  I think I 
heard Rob say it.  
		But then I also heard Lara and Larry at 
the end talking about the importance of continuing 
to focus on intramodal competition because of their 
doubts about facilities-based competition because 
of the investment that has already occurred there.
		And so I'm wondering, is there 
unanimity on that question?  And where should our 
focus be?  Because that's where I think the real 
challenge is for us is that when everyone talks 
about don't give up on competition, or that's going 
to be ultimately what drives additional resources, 
infrastructure, and services, but the degree to 
which we recognize the intermodal platform to 
platform competition that's occurring, or whether 
we continue to have as a point of emphasis the 
intramodal, that I think for me is the real 
question.  And I was wondering if each of you could 
comment on which direction and how much of a degree 
do you think we need to recognize that going 
forward.
		MR. GENSLER:  I may as well start, 
since I brought it up.  My biases are clear -- is 
that intermodal competition is a wonderful thing, 
and it's here to stay and it's actually one of the 
great things that has happened in telecom in the 
last 10 or so years.
		And if we continue to think of it as if 
they are just individual silos, and there's not 
cross-correlations and cross-subsidies and cross-
effects, it gets to Michael's question about 
networks and how we regulate networks.
		Well, a network business inherently has 
cross-subsidies and cross-costs that are just very 
hard to capture in any one business product line.  
And if we ignore the intermodal, it's at our peril 
when we're trying to incent some small market share 
player in an intramodal way as if it's the only 
competition.  And we ought to embrace the fact 
there's intermodal, that there's broadband, there's 
wireless, there's fixed line, and work -- use that 
to work to our advantage and competition would be a 
great thing in that way.  If we try to niche each 
mode to death with little policies, you just drive 
investment away.
		CHAIRMAN POWELL:  If anybody else has 
any --
		MR. KONEFAL:  I guess I would say that 
intermodal is actually critical in the sense that 
for each of the companies that are feeling pressure 
on their core businesses, their opportunity to 
perform their way out is through entering into, if 
not developing rather aggressively, other modes of 
business.
		PROFESSOR NALEBUFF:  I'd like to 
challenge the question in the sense of I don't care 
if there's less investment.  We've had too much 
investment.  Our problem is not getting more 
investment.  Actually, the goal of competition is 
to bring down prices, and that's actually something 
that needs to happen and hasn't happened. 
		And so if it increases investment, 
that's great.  But if it doesn't, I can live with 
that for a while.  We've had plenty of that.
		MS. WARNER:  I guess I'll answer, and 
I'll answer this from my cable perspective at the 
moment.  Cable obviously spent over $80 billion in 
the last six years building out networks, although 
now they're finding themselves with somewhat of a 
constrained capital environment themselves.
		One way you might want to think about 
this is:  what if cable had access to existing 
networks?  What would that do?  And I think you can 
look at it two ways.  One is, from my perspective, 
you would probably view that as positive.  
		You'd have an opportunity for the cable 
industry to get into the telephony business, for 
example, without putting capital up front, proving 
they could actually scale in that business, and 
then putting capital behind it. 
		And I do believe over time companies 
are incented to put capital behind it, particularly 
the cable industry.  The bad thing is that they 
would clearly stop facilities-based competition.  I 
would argue they don't have a lot of luxury to do 
that in the near term, but clearly they would stop 
facilities-based competition.
		So it depends on what your ultimate 
goals are, but I would say, as an investor, as 
cable investors would probably, you know, look 
positively on that opportunity, but they are the 
market attacker.  You know, they are not the 
incumbent.
		And I think you can't have this 
discussion without recognizing that, you know, 
there is a significant part of this that is wrapped 
around the fact that a large amount of market cap 
in the industry is in the incumbents.
		PROFESSOR WHITE:  Let me jump in here, 
and I think you ought to do both, that you just 
can't think of it as a dichotomy.  You've got to do 
both.  To use I think a good analogy, to think 
about transportation.  Yes, trucks versus rail is 
important, but also rail versus rail and trucks 
versus trucks is also important.  And just you have 
to do both the inter and the intra, and you can't 
just focus on one or the other.
		PROFESSOR VARIAN:  I think if you went 
back to 1995 and told Congress that if you vote for 
this bill, this 1996 bill, by 2002 almost every 
household in the U.S. will have access to cable, 
wireless, and copper for local telephone service, 
and satellite will be competing intensely with 
cable, and fixed wireless will begin to be 
deployed, they would say, "Fantastic.  That's what 
we want to vote for."
		So, actually, in my opinion, the 
current situation has been much more successful 
than one might have thought it would have been five 
years ago.  And somehow the cost of that success is 
the fact that you're seeing a lot of incumbents 
facing profit problems.  That's the nature of 
competition.
		MR. WALLACE:  And that success will 
become more evident, again, when macroeconomic 
conditions change.  But, you know, unfortunately 
for you all, you don't have the luxury of waiting, 
nor do you have the luxury of choosing which one to 
get behind, because intermodal is here.  The assets 
are there.  It's unlikely they're going to be 
ripped out of the sky or the ground anytime soon.  
Someone will use them.
		And intramodal is a rule that you're 
stuck with.  Until some level of competition exists 
that meets the '96 Act level, or threshold, you've 
got to provide both.  I don't see that it's an 
either/or.
		COMMISSIONER COPPS:  One of the 
mandates we operate under here is to encourage the 
delivery of comparable telecom services at 
comparable prices in both urban and rural America, 
and to all consumers in America.  And I don't know 
how you would define the place of rural America in 
the business plans of some of the companies that 
you deal with.
		But I'd like to ask a question that I 
ask a lot of the business people that come through 
my office, and I guess a wealth of diversity in the 
response.  Do you think that without incentives and 
without stronger universal service commitments on 
the part of the government, that market forces on 
their own are capable of leading to this kind of 
comparable telecom service at comparable prices 
across both rural and urban America?
		PROFESSOR VARIAN:  I believe it would 
not.  I believe that the cost would reflect prices 
under a market system, and I think that if it's 
more expensive to serve a given area, it's going to 
be more costly to consume that service.  I actually 
grew up on a farm.  I'm one of the few people 
around who can say that these days.  But we paid a 
lot less for parking on the farm --
		(Laughter.)
		-- than I do now, and the fact that we 
might have to pay more for cable or for telephone 
service doesn't seem to me to be unreasonable.
		COMMISSIONER COPPS:  Well, this is 
another one of those areas where we have a 
legislative mandate and the irresistible force 
meeting an immovable object that I talked about.
		CHAIRMAN POWELL:  I'd like to ask a 
question, but I can't resist being a little 
cantankerous about a couple of points.
		(Laughter.)
		Professor Nalebuff, I don't think I 
agree that investment is irrelevant, for no other 
reason than I don't think competition drives prices 
down.  I think competition drives prices to their 
economically efficient levels.  And if those are 
below -- if those are below that mark, it will 
drive prices up.  
		And that will be just as logical in an 
economic system as the -- the reason I say this is 
because this is an important part of the problem we 
have in the telecommunications sector, because as 
long as we have, to carry on from Commissioner 
Copps' point, a major political and public policy 
mandate about universal service, and as long as we 
have massive amounts of public funds used to 
subsidize those rates, the competition question is 
not a simple matter of, you know, free reign.  
		And trying to continue to encourage 
investment is critical to continue to maintain the 
viability of a network that is priced at retail, 
below its costs on average.  I think that makes an 
important public policy problem.
		I guess I also think it's an important 
public policy problem from another universal 
service standpoint, which is certainly the country 
would allow companies to fail.  But at some level, 
it wouldn't tolerate it.  At some level of critical 
services and critical infrastructure, we would 
insist on carrier of last resorts or a reference to 
the social contract that I think Rob talked about.
		And one of the biggest public policy 
problems for decades in telecom is to somehow 
continue to stimulate investment to maintain the 
quality of the network at a level of reliability, 
because 911 or something is not fungible.
		But I wanted to kind of change the 
discussion a little bit to pick up on some of the 
themes I heard.  One of them was about technology, 
and in some ways I don't know that we talked enough 
about that.  
		I remember being at a conference -- 
indeed, I think one sponsored by Haas -- in which I 
heard a very chilling thing which I think has now 
come home to roost by a major CEO of a major 
information company.  He says, "I have a major 
problem that I've never seen before, and I don't 
know how to deal with.  If I don't tell my 
engineers and physicists to do anything, they're 
going to show up in my office in a year and tell 
me, 'Guess what, boss.  I just tripled your 
capacity and cut your price in half.'"
		And he said, "You don't understand.  
From a business point, that means I have only two 
options.  One, I have to cut prices 50 percent for 
what I'm delivering, or I've got to come up with 50 
percent more value to do with the same network I 
did before, and neither of them is an attractive 
proposition to me."
		He said, "And what scares me, this 
looks like forever."  And that as long as the 
technology curve keeps disrupting that equation, 
you know, he says, "The products I sell I can't ask 
Ford Motor Company to throw everything out every 
year and start over."  And that's a real challenge.
		To me, this is a real serious secular 
component that I think is part of the story about 
what happened.  I don't remember -- one of you said 
I don't think they made a really bad mistake and 
made some rationality in the number of strands they 
were -- I think Hal said investing.  But what they 
really didn't count on is the degree to which 
technology would disrupt that choice.
		But even though the market is down and 
grade magazines like the industry standard aren't 
reminding us of the Technology Modifications every 
week, even while we sit here, the microprocessor 
chip is still doubling.  Even while we sit here, 
the prices and capacity of memory continue to be 
cut.  The capacity increase is cut.
		But technology is really not interested 
in this discussion and continues to be this sort of 
massive secular and disruptive change that I think 
policymakers are going to have to struggle with, 
businesses are going to struggle with, and I'd even 
be willing to challenge industry to struggle with, 
because I'm not so sure that traditional measures 
of supply and demand and projections are going to 
hold up in a market of this sort of unpredictive 
disruptions, and that we're all sort of in this 
soup of, how do you deal with dynamism forever.
		John Chambers often says you've got to 
get used to being a declining cost business for the 
rest of your life.  This is not a comfortable place 
for a CEO.  I would submit it's not a comfortable 
place for regulators either who tend to hope for 
stable assumptions.  And I'm not so sure I think 
investors now are waking up to the cold fear of 
that.
		Does anybody -- I mean, this is a very 
open-ended question, but I think it's important one 
-- have any sense of the degree to which that 
technology, that secular component, is a part of 
the fear of the investment equation?  And is there 
any sense of how the money and the markets will 
grapple with it on a going-forward basis?
		Rob, do you want to start or -- or 
Robert?
		MR. GENSLER:  I'll start.  You know, 
this is something -- I've covered the industry 
eight years, and we've always known about as a 
declining cost.  But what makes it even more 
troubling, because this is just a fact of life, is 
when you deal with TELRIC pricing, by definition 
you are always giving new entrants the ability to 
lease the incumbent's network at forward-looking, 
best practice type costs, which is wonderful policy 
in its abstract, but in reality of this declining 
cost you will always definitionally have stranded 
costs.
		And TELRIC, combined with UNE-P, it's 
sort of scary, you know, as opposed to, yes, it's 
declining costs, and I've got enough -- remember, 
if I have enough scale and scope that I have a 
market share advantage, the little nitchy player 
only has an advantage if they can load their 
network.  This is the great fallacy of a lot of the 
big networks that were built.  They were unloaded, 
so their efficiencies were terrible.
		Okay.  But if they can load them and 
resell everyone else's at a forward-looking, 
declining cost that the incumbent actually by 
definition can't have because they have their 
stranded plant, it's very disturbing.
		MR. KONEFAL:  I mean, without question, 
the telecom vendors are on their backs suffering 
even more so than the service firms are.  
Practically speaking, not all telecom investment is 
running to zero.  It is differential.  It is 
probably most dramatically cut back in the long 
haul, where the overcapacity issue is the greatest.
		It is less so in the metro and the 
local networks, as well as the wireless networks.  
I mean, the vendors, at least for now, are riding a 
couple trends.  One is that there is still a fairly 
substantial investment need there, and the other is 
that while revenues are unquestionably under 
pressure, traffic is continuing to grow.  And at 
some point you absorb the capacity.
		So it's not a -- sort of a ready-quick 
answer, but at some point there's going to need to 
be investment in plant.  And, furthermore, we would 
-- we also seem to be talking about investment in 
the offensive sense of the term.  There really is, 
in some respects, a defensive need to invest.
		If the cable industry, for example, did 
not invest as much as it had over the past five 
years, it might be a different ball game with DBS. 
 But they were prompted to invest by that 
competitive threat.  They have invested heavily 
there. 
		CHAIRMAN POWELL:  We are over time, and 
I don't want to risk, if anybody particularly has 
flights or something -- if you can stay, I would 
propose just 10 more minutes to make sure we 
haven't -- we have certainly exhausted questions.  
Is that agreeable to you all?  If you need to go, 
just let us know and we'll -- but that's only 10 
more minutes, seven more minutes from now.
		Kevin, did you --
		COMMISSIONER MARTIN:  Well, I wanted to 
follow up on the questions that -- or the issue 
that Hal Varian had brought up on the competitive 
bankruptcy.  And I notice that you talked about it 
and highlighted that as a concern.  There was some 
discussion as to whether or not it should be a 
concern, but I also wanted to ask -- even if it 
was, I didn't notice you highlighted anything we 
could do about it.  
		And so that was  -- was it just you 
were flagging an issue that that could be a real 
problem?  But I didn't know if there was any 
suggestions that anybody had.  Even if we agreed it 
was a concern, is there anything we could do?  And 
I know others thought maybe we shouldn't even be 
worried about it, but I didn't know if there was 
anything you thought.
		PROFESSOR VARIAN:  Well, I mean, it's a 
concern only in the sense I think you should be 
aware of it.  It's not that there is some magic 
cure that will eliminate that possibility.  
		But if it -- if the bankruptcy is seen 
as the solution, which I think it is certainly part 
of the solution, and financial organization has to 
be undertaken, I think you will see more weak 
companies than you can forecast now, because there 
will be an advantage to seeking that particular 
route.
		I don't think that that's something 
that we should say that's not a reason to allow 
that movement, as Larry indicated.  But I think 
it's just a fact of life.  We've seen it before, 
historically.  And it's something we have to be 
aware of when we go into this.
		PROFESSOR WHITE:  Let me just follow 
up.  Again, it is not a problem.  If you think it's 
-- there is a problem, it is the fact that we have 
low marginal costs and high fixed costs.  That's 
the issue.  But competitive markets are going to 
drive prices to marginal or close to marginal costs 
in any event.
		This issue of the bankruptcy of one 
company causing other companies to perceive 
conditions as unfair, as Hal just mentioned, that 
goes back at least a century.  The railroads 
complained that one company's bankruptcy made 
problems for them.  A decade ago airlines were 
complaining that one company's bankruptcy created 
problems for them.
		But that's all driven by this low 
marginal cost phenomenon, and that's just a fact of 
life.  We all have to live with it.  You have to 
live with it.  But that's why you're paid such 
handsome salaries.
		(Laughter.)
		COMMISSIONER ABERNATHY:  Yes.  One area 
that we've touched on briefly but not in great 
detail is spectrum, and the fact that we do a lot 
of spectrum allocation here.  And how should the 
current market conditions, if at all, affect how we 
put spectrum up for auction?  Which is the 
preferred method these days of licensing spectrum.
		MR. WALLACE:  I think the first rule is 
to be certain of what you're auctioning and the 
delivery.  And that, you know, said directly is to 
have a lot more certainty around the process and 
the timing of the end of the process.
		COMMISSIONER ABERNATHY:  Okay.  Anybody 
else?
		COMMISSIONER COPPS:  Let me ask, Mr. 
Konefal, I think you made some comments about 271 
applications and business activity and competition 
coming out of that.  We hear a lot from the 
companies, the regional Bells, about loss of 
competitive lines and all of that.  
		How do financial analysts look at it -- 
if it's a tradeoff, if you will, the ability to go 
into a section with 271 and offer long distance 
vis-a-vis the losing of the lines to competitive 
carriers, or to wherever?  Do you -- from the 
standpoint of the financial viability of the RBOCs, 
how do you assess that?
		MR. KONEFAL:  I guess, first off, I'll 
highlight that the RBOCs are quite strong companies 
in their own right.  I think you frame it 
accurately.  There's a tradeoff here.  They are 
definitely feeling some of the impact of, you know, 
losing lines to competition.  But the long distance 
opportunity is a meaningful one.  I think Lara was 
saying, or someone else on the panel was saying, 
that it is a huge opportunity.  
		And the tradeoff is rather difficult to 
scale right now, but it is certainly a meaningful 
opportunity on the part of the regional Bells to 
pick up long distance.  So there's going to be an 
offset, and it's probably a significant one.
		COMMISSIONER COPPS:  You also mentioned 
-- and I thin one of the other panelists did, too 
-- about the competitive local exchange carriers 
who will survive.  Do you have any judgment on how 
many of them are going to survive?
		MR. KONEFAL:  It's not clear what form 
it's going to take.  It's -- under the current 
construct where you have, you know, the bifurcation 
still of local from long distance, as I mentioned 
in my remarks, the long distance carriers are 
feeling the pain the most.  
		And so in that respect, it's a bit more 
difficult to make the call on that segment of the 
market.  Whereas, if, you know, the segmentation if 
you will of the wire line side of the market was to 
remain in place, the regional Bells and the other 
independent LECs are pretty solid companies.  
		They're all rated in the single A or 
Baa categories.  And so that, in our mind, is a 
pretty strong view that they are among the ones 
that will be the long-term survivors.
		MR. GENSLER:  Commissioner Copps, if I 
could answer sort of both questions.  I don't know 
how many will survive, but I know what type.  Okay. 
 And it's to your 271 question.  The reason it's so 
important for the RBOCs is so that they can have a 
bundled service offering.  Okay?  Because they all 
have network costs and SG&A costs that are -- and 
many times the serving of a customer is more than 
just the network cost.
		And if you can't have a scale of scope 
in your product offering, you lose.  And whatever 
CLECs come out of the ashes, I'm convinced they 
will be companies that have a full scope of 
product.  We made the mistake in the late '90s of 
thinking there would be a disaggregation of the 
network, a disaggregation of the product offerings. 
 And we even had companies spin off their wireless 
companies, which in hindsight I think was very 
foolhardy.
		We will return to a day where you have 
scale of scope and product as well as network and 
offerings, and it's those companies that will have 
the better returns.
		MS. WARNER:  Can I just make a comment 
that maybe gets to the Chairman's question earlier, 
which is scale and how many players.  I think it's 
important also to recognize a couple of things Rob 
just said.
		Number one, network costs many times 
are dwindled by the costs of SG&A, selling, 
provisioning, billing, and caring for these 
customers, particularly on the consumer side over 
time.  And I think that, you know, as it relates to 
how many players, while certainly new competitors 
can come in and offer bundled services, etcetera, 
it takes them significant amounts of fixed capital 
to put in place things like care centers, billing 
capability.
		You know, AT&T, at its best, is 20 
percent SG&A.  On a very scaled company, it's been 
proven I think that building a network and not 
having the capital to, in essence, care for that 
customer doesn't work.  
		So certainly I agree that scalability 
on both sides is going to be important, but I also 
believe that, you know, there is a very large 
number of customers that you have to have before 
you can really generate returns on both the network 
side as well as on the, you know, day-to-day care, 
particularly of the consumer customer.
		CHAIRMAN POWELL:  Well, thank you.  I'm 
not going to hold you all any longer.  I think it's 
been an extremely productive discussion, and I 
appreciate you all joining us for this. 
		I would simply like to emphasize that I 
heard some themes that I think this Commission has 
often pointed to and will continue to be guided by, 
a lot of questions about acting quickly to help 
with the question of regulatory certainty.
		One way or the other, whatever the 
judgments to make them, make them boldly and make 
them quickly, and the market will adjust to 
whatever they are.  At least they will digest it as 
a positive if it's a clear direction, well 
signaled, and well written, and it will be guided 
by that.
		I think we also hear that competition 
is still an imperative.  It always has been.  I 
don't think there's been any suggestion -- I think 
in the regulatory world -- of abandoning 
competition.  I think that Commissioner Martin sort 
of hit on it.
		It's a continuing struggle for what the 
balanced environment for that is -- that is, 
healthy and productive and long term and 
sustainable -- and I think that's -- we've always 
underestimated how difficult a question that is, 
particularly in an attempt to create it 
regulatorily, with all the kinds of things that 
have existed in the monopoly system.
		And I think we've heard some long-term 
prospects for new technologies.  It's always 
important to be guided by making sure that those 
have breathing spaces and opportunities for new 
revenues that offer new sources of cross-
subsidization for a high fixed cost network.  
		So I think we learned something, or 
certainly emphasized points, and I appreciate it.
		And with that, I'd like to adjourn the 
meeting and thank everyone for their participation. 
 Thank you.
		(Whereupon, at 4:17 p.m., the 
proceedings in the foregoing matter 
were adjourned.)

















  
 

 
 


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