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ENCOURAGING CAPITAL FORMATION IN

KEY SECTORS OF THE ECONOMY

HEARING

BEFORE THE

SUBCOMMITTEE ON

DOMESTIC MONETARY POLICY, TECHNOLOGY,

AND ECONOMIC GROWTH

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

APRIL 18, 2002

Printed for the use of the Committee on Financial Services

Serial No. 107–66

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

SUBCOMMITTEE ON DOMESTIC MONETARY POLICY, TECHNOLOGY,

AND ECONOMIC GROWTH

PETER T. KING, New York, Chairman

JAMES A. LEACH, Iowa, Vice Chairman

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

RON PAUL, Texas

STEPHEN C. LATOURETTE, Ohio

DOUG OSE, California

MARK GREEN, Wisconsin

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

CAROLYN B. MALONEY, New York

BARNEY FRANK, Massachusetts

GREGORY W. MEEKS, New York

BERNARD SANDERS, Vermont

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

MAX SANDLIN, Texas

CHARLES A. GONZALEZ, Texas

MICHAEL E. CAPUANO, Massachusetts

RUBE ́ N HINOJOSA, Texas

WILLIAM LACY CLAY, Missouri

MIKE ROSS, Arizona

(III)

C O N T E N T S

Page

Hearing held on:

April 18, 2002 ................................................................................................... 1

Appendix

April 18, 2002 ................................................................................................... 33

WITNESSES

THURSDAY, APRIL 18, 2002

Alexander, Anthony J., President and Chief Operating Officer, FirstEnergy

Corporation ........................................................................................................... 5

Glenchur, Paul, Vice President, Schwab Capital Markets, Schwab Washington

Research Group .................................................................................................... 18

Kuhn, Thomas R., President, Edison Electric Institute ....................................... 4

Levin, Blair, Managing Director and Telecommunications and Media Regulatory Analyst, Legg Mason Wood Walker, Inc. ................................................ 20

Mitchell, Bryan J., Chairman and CEO, MCG Capital Corporation ................... 13

Trabandt, Charles A., Vice President, Charles River Associates, Inc. ................ 7

APPENDIX

Prepared statements:

Alexander, Anthony J. ...................................................................................... 34

Glenshur, Paul (with attachment) .................................................................. 86

Kuhn, Thomas R. .............................................................................................. 39

Levin, Blair ....................................................................................................... 93

Mitchell, Bryan J. (with attachment) ............................................................. 72

Trabandt, Charles A. ........................................................................................ 52

(1)

ENCOURAGING CAPITAL FORMATION IN KEY

SECTORS OF THE ECONOMY

THURSDAY, APRIL 18, 2002

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON DOMESTIC MONETARY POLICY, TECHNOLOGY, AND ECONOMIC GROWTH, COMMITTEE ON FINANCIAL SERVICES, Washington, DC.

The subcommittee met, pursuant to call, at 10:00 a.m., in room

2128, Rayburn House Office Building, Hon. Peter King, [chairman

of the subcommittee], presiding.

Present: Chairman King; Representatives Oxley, Grucci, Capito,

Biggert, J. Maloney of Connecticut, C. Maloney of New York and

Clay.

Chairman KING. The hearing will come to order. Today, the Domestic Monetary Subcommittee continues its work which began

last year to examine economic growth issues and the steps that

Congress can take to help facilitate that needed growth.

I would like to welcome our distinguished guests from the energy

and telecommunications sector. Clearly, the segments of the economy you represent drive a very large percentage of U.S. industrial

capacity and are catalysts for a variety of other business activities.

I recognize that because your respective industries are identified

as critical infrastructures for purposes of national security, much

of your post 9–11 focus has been on security and fail-safe systems.

That, added to the climate brought about by the most recent corporate failures, has surely raised some degree of uncertainty, which

is generally not conducive to capital formation.

Because you have driven so much of the economic growth in the

past decade, in this critical recovery period, I believe the relevant

question in the context of encouraging growth is what hurdles your

respective industries face that detract from your ability to raise

capital and, in turn, spur growth in your sectors. I look forward to

receiving your testimony and any recommendations you may make

to help Congress better understand what it can do to break down

existing barriers to capital formation and improve investor confidence.

With that, I would now like to recognize the Ranking Member of

the subcommittee, who works very closely with me, my friend from

New York, Ms. Maloney, for any remarks she may have. And the

Chair would also note that your full statements will be included in

the hearing record, without objection.

Thank you.

Mrs. Maloney.

2

Mrs. MALONEY. I thank the Chairman, my colleague from the

great State of New York, for calling this hearing. We are meeting

today in this subcommittee today to discuss capital formation and

the unique challenges facing the energy and telecommunications

sectors, specifically.

During the 1990s, our Nation enjoyed an unparalleled period of

economic prosperity that included exploding values in the equity

markets. Investment in the internet and telecom greatly increased

as staples of the new economy. However, in the past few years, the

sector has become a poster child for the dot-com collapse and the

devaluation of the Nasdaq.

While it is appropriate to review Government policies that affect

these two sectors, my belief is that clearing up the questions about

the accounting practices of these two sectors and the recovering

economy will have the most significant impact in pumping investment back into them. The SEC is currently conducting inquiries

into the accounting practices of a number of energy and telecom

companies. Given the explosion of Enron and Global Crossing, we

can hardly expect investors to rush back into these sectors until

these issues are resolved.

While capital raising in the entire economy has waned in the

past 2 years, the economy in general is now improving faster than

many had anticipated. Economists can rightly point to the resiliency of consumer spending for preventing a harsher period of recession.

In the fourth quarter of 2001 alone, new data indicates that the

GDP grew 1.7 percent, powered by a 6.1 percent increase in consumer expenditures. Spending by business on fixed capital dropped

for the fourth consecutive quarter, this time by 13.8 percent. However, business spending on computers and computer related devices

increased for the first time since the end of 2000.

While preliminary estimates will not be available until the end

of the month, forecasters believe that economic growth continued to

increase during the first quarter of this year. The recovery has produced little evidence that the excess capacity of communications

equipment has substantially narrowed to the point that demand

will increase substantially anytime soon.

Capital formation also continues to be affected by adverse longterm interest rates. The Fed reduced interest rates 11 times last

year, after raising them the previous 2 years. But long-term interest rates remain high, partly as a result of the return of massive

Government deficits.

The Congressional Budget Office’s projection of the baseline

budget surplus for 2002 through 2011 was $5.6 trillion a year ago.

But it has dropped to just $1.7 trillion in the last report, a drop

of nearly $4 trillion. The president’s recent budgetary proposals

would further reduce the projected surplus to less than $500 billion

over those same 10 years and would result in a projected deficit of

almost $200 billion in 2002 through 2006.

There is little doubt that this return to deficits will have a major

impact on all aspects of the economy, including energy and telecom.

I think all Members need to keep these grim statistics in mind as

we vote on the issues before us.

Chairman KING. Thank you, Mrs. Maloney.

3

I now recognize the Chairman of the Full Committee, the gentleman from Ohio, Mr. Oxley.

Mr. OXLEY. Thank you, Mr. Chairman.

I welcome our witnesses to today’s hearing, which is really about

the health of the U.S. economy. Capital investment is the fuel that

feeds America’s economic engine, and while consumer spending has

been cited as the recent hero, ultimately, it is capital investment

by business that drives our economy, allowing companies to grow

and innovate.

One of the early goals I set as Chairman of this committee was

to use our unique forum to promote overall economic growth. Capital formation has been a long-standing interest of this committee.

Last year, the Oversight and Investigations Subcommittee held

a hearing on regulatory barriers to capital formation, and today,

the Domestic Monetary Policy, Technology, and Economic Growth

Subcommittee turns its attention to two specific industries, energy

and telecommunications. These are two capital intensive sectors

that traditionally have saved a rebounding stock market. But this

time, they seem to be lagging behind.

We have seen investor confidence shaken by the dramatic fall of

companies like Enron and Global Crossing. Enron cast a shadow

over the electric power industry, even though retail customers were

virtually unaffected by its collapse. As for the telecom and technology sectors, by all accounts the current state of investment is

quite grim.

What I believe has gone unnoticed is that Enron and Global

Crossing are not representative of their industries as a whole. After

all of the media coverage of recent months, it is time to bring back

balance to the picture. Congress also needs to identify ways that

it can promote growth in these markets, because that is what attracts capital.

I believe the CAARTA bill passed by our committee this week is

one key to enhancing investor confidence. Why should people care

about what Congress does about capital formation? When capital

becomes more expensive for utility companies, costs go up for consumers. When telecommunications firms cannot raise adequate

capital, the market becomes less competitive, and consumers are

denied choice.

We have seen this happen in the telecom sector. In fact, lately,

many companies have found that even the commercial paper market is extraordinarily stingy which leads to higher financing costs.

We have two excellent panels to discuss the state of capital formation in their industries. I would particularly like to welcome the

President of the Edison Electric Institute, Thomas Kuhn, an old

friend; the President and Chief Operating Officer of FirstEnergy,

Tony Alexander, who comes to us from Akron, where FirstEnergy’s

headquarters is based.

I look forward to this morning’s testimony, Mr. Chairman, and

I yield back.

Chairman KING. Thank you, Chairman Oxley.

I would like to now welcome the witnesses who are here this

morning. As Chairman Oxley said, we have Mr. Thomas Kuhn, the

President of Edison Electric; Mr. Anthony J. Alexander, the President and Chief Operating Officer of FirstEnergy Corporation; and

4

Mr. Charles A. Trabandt, the Vice President of Charles River Associates.

We will start with Mr. Kuhn. I would ask each of the witnesses

to try to keep their statements to approximately 5 minutes. We are

not going to be banging gavels on people, but we would like to keep

the statements to roughly 5 minutes, and your full statement will

be, without objection, included in the record.

Mr. Kuhn.

STATEMENT OF THOMAS R. KUHN, PRESIDENT, EDISON

ELECTRIC INSTITUTE

Mr. KUHN. Mr. Chairman, Congresswoman Maloney, Chairman

Oxley, and Members of the subcommittee, I am Tom Khun, President of the Edison Electric Institute. EEI is the association of U.S.

shareholder-owned electric companies and industry affiliates and

associations worldwide. I very much appreciate the opportunity to

testify before you today on this very, very important subject with

respect to capital formation in the electric utility industry.

The electric utility industry is one of the most capital intensive

industries in the country. Our $872 billion worth of assets represent about 9 percent of the assets of all businesses in this country.

Electric companies have been through an enormous change over

the last 10 years as they make the transition from vertically integrated regulated monopolies to diverse companies operating in

competitive markets. The past year brought additional financial

challenges for the electric industry, starting with the California

electricity crisis, continuing with the terrible events of September

11th and the resulting economic downturn, and ending with the

collapse of Enron.

Enron has brought much greater scrutiny to the energy industry.

But I would like to emphasize that Enron’s collapse was a financial

story, not an energy story. Electricity supply and delivery were not

disrupted and prices remained stable. Nevertheless, Enron did deal

a blow to investor confidence that, at least in the short term, has

affected the cost of capital for energy companies.

More generating capacity is definitely needed to meet the demand for more electricity. Electricity and the economy grow on almost a one-to-one basis.

Congress can remove a tax impediment to building more generation by shortening the depreciable lives of generation facilities.

Other barriers to investment in generation are the Public Utility

Holding Company Act and uncertainty in environmental policy.

Competitive wholesale and retail electricity markets place more

demands on a transmission grid that was not designed for such

purposes, resulting in dramatically increased congestion in the

transmission area. According to the Federal Energy Regulatory

Commission, transmission bottlenecks cost consumers more than

$1 billion over the past two summers alone. Yet largely due to regulatory uncertainty and inadequate returns, investment in transmission is decreasing rather than increasing.

Transmission investments in 1999 were less than half of what

they had been in 1979. Maintaining transmission adequacy at its

5

year 2000 level would require a quadrupling of transmission investments during the current decade.

FERC should be given authority to help site new transmission

lines with appropriate State participation. PUHCA should be repealed, because it acts as a barrier to the formation of interstate

independent transmission companies. And financial incentives, including higher rates of return and other appropriate innovative

pricing mechanisms, are needed to attract capital to fund investments in transmission expansion.

Congress should shorten the depreciable lives of property used in

the transmission and distribution of electricity. To efficiently meet

our Nation’s energy needs, the electric industry requires the same

ability that other industries have to more rapidly depreciate assets

for Federal income tax purposes.

As part of H.R. 4, the energy bill, the House last summer approved a reduction in depreciable lives for gas distribution facilities

to 7 years. Facilities in other capital intensive industries, such as

pulp and paper mills, steel mills, automobile plants, and even cigarette manufacturing plants, are depreciable over 7 years. All this

is in stark contrast to the 15 or 20-year depreciable lives for electric generation, transmission, and distribution facilities.

The Federal tax code also should be amended to defer taxes on

the sale, and eliminate taxes on the spin-off, of transmission facilities for transmission-owning companies that seek to join FERC approved regional transmission organizations, as contained in H.R. 4,

the energy bill that passed this summer. In this time of historic

change in the electricity industry, it is critical that Congress continue to pursue measures that will promote capital investment in

the electric industry, which will encourage the development of

badly needed generation and transmission facilities.

Thank you again for allowing me the opportunity to testify today.

I will be glad to answer any questions you might have after the

other panelists have finished.

[The prepared statement of Thomas R.. Kuhn can be found on

page 39 in the appendix.]

Chairman KING. Thank you, Mr. Kuhn.

Mr. Alexander.

STATEMENT OF ANTHONY J. ALEXANDER, PRESIDENT AND

CHIEF OPERATING OFFICER, FIRSTENERGY CORPORATION

Mr. ALEXANDER. Good morning, Mr. Chairman and Members of

the subcommittee. My name is Tony Alexander, and I am president

and chief operating officer of FirstEnergy, based in Akron, Ohio.

FirstEnergy is a registered public utility holding company. Our

seven electric utility operating companies comprise the Nation’s

fourth largest investor owned electric system, based on serving 4.3

million customers in Ohio, Pennsylvania, and New Jersey.

Encouraging capital investment in the Nation’s electric system is

critically important, because maintaining an affordable, reliable

supply of electricity with a strong network to produce and deliver

it is essential to our economic growth. With the development of

competitive electricity markets, utility companies no longer have

the obligation to build generating capacity and recover those costs

through utility rate-making.

6

Instead, the competitive market will determine if and when capacity is built. This fundamental change in the manner in which

electricity supplies will be developed has a significant impact on

capital formation in the industry.

Investments in the energy industry, particularly in generation

assets, must now compete with every other capital requirement in

the market, and that means it is essential that regulatory, tax, and

other burdens do not discourage investment in this sector. In fact,

generating facilities should be treated like other competitive businesses.

I believe there are several ways to encourage needed investment

in this segment of our industry. First, Government should provide

more favorable tax treatment for generation assets. Shorter depreciation periods would free up capital for reinvestment in energy

markets and make those markets more attractive to new investors.

The current 20-year depreciation periods for generation assets

are outdated and far longer than for other capital intensive industries. It makes sense that electric generating facilities have tax

treatment similar to other capital intensive industries. Tax credits

are another way to attract capital to the energy industry.

Second, the industry needs a greater degree of certainty with respect to future environmental regulations governing generating facilities. Potential investors in generation need to know what the

regulatory future holds. Without good prospects for solid returns,

they will not tie up capital for new or expanded facilities.

Third, the Government needs to support competitive energy markets by allowing those markets to develop unimpeded. That includes ensuring that wholesale electricity prices are market based.

Artificial price caps or pricing subject to refund will only serve to

stifle competition and create barriers to investment.

In addition to generation, the competitive electricity market also

depends on an adequate transmission system. Even though transmission is still regulated, utility companies are being required to

turn over control of their transmission assets to third parties.

There are limited options available that will encourage investments in assets over which the owner will have no control of operations, pricing, or expansion. One way, however, is to remove barriers to divestiture by reducing the current tax liabilities for the

sale of transmission assets.

Another is through so-called participant funding, which requires

that new investment in transmission be paid for by the party requesting the expansion. And, finally, rate-making allowances that

produce sufficient returns will allow the owner to make needed investments in the transmission network.

In order to create and support the kinds of markets that were

envisioned when States and the Federal Government promoted

competition, we first need to ensure that the steady and growing

capital requirements of the electric industry are met. Only with an

adequate supply of electricity produced from diverse sources that

include coal, nuclear, natural gas, and renewables and the proper

system to deliver it can customers be assured of reliable and reasonably priced electric service.

7

Thank you for the opportunity to share my views on this important topic. I would be more than willing to answer any questions

you might have after the other panelists have spoken.

[The prepared statement of Anthony J. Alexander can be found

on page 34 in the appendix.]

Chairman KING. Thank you very much, Mr. Alexander.

Mr. Trabandt.

STATEMENT OF CHARLES A. TRABANDT, VICE PRESIDENT,

CHARLES RIVER ASSOCIATES, INC.

Mr. TRABANDT. Good morning, Mr. Chairman, Congresswoman

Maloney, and Chairman Oxley. Thank you for the opportunity to

testify before the subcommittee today on this important subject of

capital formation in the energy industry.

My testimony reflects my experience as Vice President of Charles

River, advising electric utilities recently, as well as 8 years as a

Managing Director in the energy and power group at Merrill

Lynch’s investment banking division, where I worked on capital

formation for energy and utilities around the world, and 8 years as

a commissioner at the FERC, working on these similar issues.

At the outset, I would commend this subcommittee and the full

Financial Services Committee for bringing a specific focus to the

critical capital formation considerations in the context of the ongoing congressional debate about our national energy policy and the

reactions to the Enron situation. I have been asked to testify today

about the impact of recent developments in the electric power industry, including the situation in California and the collapse of

Enron, and my prepared testimony provides some considerable detail on those matters.

I generally support the recommendations made in Mr. Khun’s

testimony and also Mr. Alexander’s testimony with regard to action

that can be taken by Congress to facilitate capital formation. As

Tom’s testimony demonstrates, there is a critical need for capital

investment in the Nation’s electric infrastructure, which requires

both investor confidence and assured access to capital markets

going forward.

The Federal Energy Regulatory Commission, FERC, in Order

2000 sought to address that need by providing structural and regulatory flexibility for independent for-profit transmission companies

or so-called transcos. That flexibility has spawned a new generation of proposed transcos in every region of the country with participation by investor-owned utilities and some public power entities, including Mr. Alexander’s FirstEnergy Company, which has

provided considerable leadership in that area.

It is clear from a business and financial perspective that a properly structured for-profit business model could access capital markets for equity from financial and strategic investors and for investment grade debt to maintain, upgrade, and expand the transmission infrastructure. I cite in my testimony a deal between the

Alliance Transco LLC with National Grid USA as the proposed

managing member as one example of the types of commercial business arrangements that can be negotiated with significant infrastructure investment.

8

FERC policy initiatives should be formulated in a manner to facilitate such arrangements in the emerging energy markets. FERC

also has initiated an ambitious program for establishing four or

five regional transmission organizations across the country which

will implement a uniform market design now under development

on a national basis. This effort is intended to materially advance

competition in wholesale electricity markets over the next 2 years

and will be a significant response to the difficulties in California.

The recent Supreme Court decision in the Order Number 888

case is seen as solidifying FERC’s authority under the Federal

Power Act to pursue the new policy. And just yesterday, the chairman of the Tennessee Valley Authority announced an agreement

with major southeast and midwest utilities to support a seamless

eastern electricity market that would run from the Atlantic to the

Rockies and from the Gulf Coast to the Canadian border. That is

a big step forward in the FERC plan and should advance the

wholesale markets.

While FERC pursues a more robust competitive wholesale market under Federal law, State authorities still maintain predominant jurisdictional control of State retail competition policies and

programs. As a practical matter, the nationwide drive toward retail

competition at the State level, which New York was one of the pioneers of, has stalled precipitously as a result of regional differences, the events in California, and Enron.

Seventeen States now have some form of competition for retail

customers while other States have essentially slowed significantly

or stopped all together movement toward retail competition. Perhaps the best hope for supporters of retail competition would be

FERC’s success in advancing truly competitive wholesale markets

across the country, as they have set out to do over the next 2 years.

The competitive wholesale market has continued to function reasonably well despite the Enron collapse, with no interruption in

physical supply and with no excessive price volatility or spikes, albeit it during a winter season of very mild weather and with very

low demand on both the industrial and commercial sides as a result of the economic slowdown.

Nonetheless, the many issues surrounding Enron have negatively

affected a number of our energy companies and caused a loss of investor confidence that must be addressed to assure needed access

to capital markets for infrastructure investments. Many companies

have already taken decisive action in the form of comprehensive recapitalization plans now being implemented to respond to credit

quality and accounting challenges.

Somewhere in the vicinity of about $10 billion has been raised

over the last couple of months as part of those recapitalization

plans. But, as Mr. Oxley said in his opening statement, some companies have also experienced great difficulty in obtaining capital

because of credit quality concerns and because of the reticence of

many investors today.

But assured access will only be restored when there is a greater

degree of regulatory certainty regarding the Enron related issues.

This committee’s leadership on accounting reform legislation which

you reported Tuesday is a positive step forward, and, hopefully,

other committees in Congress will follow your example to take

9

measured and carefully considered action with regard to the goingforward practices in the industry.

I would respectfully urge Congress, the Administration, and Federal regulatory agencies to strive to complete the Enron reviews in

a timely manner and adopt any clearly needed reforms with carefully considered and measured actions which will support competitive energy markets. At the end of the day, greater regulatory certainty in all forms of regulation and an increased degree of stability for the industry will be required for assured access to capital

investment for the critical national energy infrastructure needs

that Tom Kuhn laid out.

Thank you, Mr. Chairman, for this opportunity to testify. I look

forward to questions.

[The prepared statement of Charles A. Trabandt can be found on

page 52 in the appendix.]

Chairman KING. Thank you, Mr. Trabandt.

We will have votes coming up on the floor in several minutes.

With that, I will yield my time right now to the Chairman of the

Full Committee, Mr. Oxley.

Mr. OXLEY. Thank you, Mr. Chairman. I appreciate that courtesy.

Mr. Kuhn, the Financial Services Committee just recently passed

our legislation addressing accounting and appropriate disclosure

issues raised by Enron. Just in general, what are your thoughts in

terms of the approach that our committee took? There were folks

who were less than enthusiastic about our approach, in the media,

for example, and I am wondering, from your perspective, what tone

you would recommend that the legislation take.

Mr. KUHN. Mr. Chairman, I think basically what I have pointed

out on Wall Street and elsewhere—and I think there is a general

consensus—is that Enron was a business and a financial situation,

not an energy situation. So I commend you and the committee for

approaching the Enron situation from an overall business perspective and looking at it from the standpoint of accounting practices

and disclosure rules that would apply to all businesses. I think that

is the approach that definitely should be considered and looked at.

There are some specific issues in the accounting area with respect to the energy industry that we are addressing with FASB and

with the SEC and with the rating agencies and with Wall Street.

We have a very aggressive program at EEI right now to bring our

companies together to review all our accounting practices and disclosure practices, to look at best practices, and to deal with these

things on a going-forward basis.

But I believe your approach was right on target in terms of looking at the situations from a broader based business standpoint,

from doing things that make sense to do as a starting point. I know

there are thousands of ideas out there that are very regulatory in

nature, and I would just urge you to cautiously, as you have done,

make sure that they are addressing the problem, the absolute problems, and not re-regulating in a way that I would think would hurt

competitive markets or hurt financial markets in general.

Mr. OXLEY. Well, Chairman Greenspan testified here last month,

and one of the things that he emphasized was the ability of the

capital markets to fix problems within its system. And you pointed

10

out the fact that your member companies are re-examining a number of issues, including their auditing and their accounting procedures.

That is obviously happening all over the corporate world, because

it is demanded by the shareholders and by the boards of directors.

So you could be congratulated for your leadership in that area. I

think it is critically important.

Let me turn to Mr. Alexander. I know that the repeal of PUHCA,

which has been an issue that has been around for, I guess, as long

as I have been in Congress—some say that because of Enron,

PUHCA should be retained, maybe even strengthened, even though

the SEC continues to support conditional repeal.

I know what you are going to say, but I need to hear you say

it, anyway, in regard to PUHCA and what effect it would have on

FirstEnergy, specifically.

Mr. ALEXANDER. The industry position, obviously, is that the

Holding Company Act has outlived its usefulness in connection

with the way the industry is going right now. It is a very highly

regulatory driven Act being applied to an industry that is trying to

deregulate.

And as such, it really does not fit, and it is an impediment to

some of the things that the industry would like to do, and it tends

to slow down your ability to raise capital in a timely way if you

are a holding company. Those things need to get addressed, either

by the SEC in the way it applies the Holding Company Act, or by

repealing the Act and finding other means to maintain some regulation over the parts of the industry that require it, generation not

being one of them any longer.

Mr. OXLEY. Let me ask you this, then. If we assume that the status quo maintains, and that is at the end of the day, Congress is

unable or unwilling to repeal PUHCA, is it your testimony that the

SEC could, on its own initiative, amend or change the PUHCA to

make it more realistic in today’s world?

Mr. ALEXANDER. I do not think the SEC can amend it. They can

apply it in a way that allows transactions to be completed in a

more timely way—financing transactions—instead of perhaps a

year or longer—or mergers, instead of being the last one to go, they

could start addressing the regulatory side to try to speed up their

processes so that, yes, it is a regulatory burden, but as long as that

burden does not delay transactions from being completed or financing from taking place in a timely way so you can take advantage

of market opportunities, then that is something the agency can

deal with and should be dealing with today.

Mr. OXLEY. Thank you.

Mr. KUHN. Mr. Chairman, if I could add to that——

Mr. OXLEY. Yes.

Mr. KUHN. Obviously, with an interpretation by the SEC and a

great deal more work from lawyers, sometimes you can get to the

same conclusion. But, basically, what the existence of PUHCA does

is it discourages a lot of investment in generation and transmission

from companies that do not want to become subject to the Holding

Company Act, also.

So you have players that might want to make investments in

generation or transmission that otherwise will not make them.

11

That impedes capital investment that is critically needed in the industry right now.

Mr. TRABANDT. Mr. Chairman, I would also add that the Circuit

Court of Appeals recently reversed an SEC decision in the AEP

merger case, specifically because it found that the SEC had been

too loose in its interpretation of the law. And I think that is a good

example of where repeal is probably not only the best solution but

the only really good solution for purposes of allowing financial

transactions to go forward.

Second, I would offer that as an investment banker, I actually

went out to recruit investment in a major transmission company

that FirstEnergy and 9 other utilities were trying to form. And we

were repeatedly told by both strategic partners and financial investors that they were unwilling to make the investment, which would

translate directly into infrastructure development, because they

would become subject to PUHCA’s requirements.

And on Wall Street, those requirements are a major disincentive

and PUHCA it does have a material effect on the ability to raise

capital from these types of industrial undertakings.

Mr. OXLEY. Speaking of raising capital, obviously, the whole

issue with competitive markets has put a strain on transmission.

Let me just ask all of you, in your view, is investment in upgraded

transmission systems keeping pace with demands being placed on

our system?

Mr. KUHN. Mr. Chairman, the very simple answer is no, it is not,

and transmission is the most vulnerable part of our system. Under

wholesale competition, the number of transactions that are

occuring on the transmission system are growing exponentially.

Basically, the transmission system was built to interconnect

neighboring utilities. So you might almost make the analogy that

it was kind of a country road.

Now we want to create with competition a super highway, and

the transmission system definitely needs to be upgraded to deal

with all these additional transactions on the transmission system.

Last year, the Federal Energy Regulatory Commission study

showed that more than $1 billion was lost by consumers over the

last two summers because of congestion in the transmission system.

We desperately need additional investment in the transmission

system. We need higher returns on investment for transmission.

We need to decrease the depreciable lives of transmission assets.

I think these things would help greatly in terms of getting much

needed investment in the transmission area.

Mr. OXLEY. Mr. Alexander, what has been your specific situation

with FirstEnergy in regard to transmission?

Mr. ALEXANDER. Well, Mr. Chairman, we have obviously continued to invest in our transmission system, although it is more and

more difficult to make business decisions, because you do not really

control the asset ultimately. Ultimately, this asset is going to be

controlled by someone else, and they are really making the capital

investment decisions that are going to have to be made when we

actually get into operating regional transmission organizations.

Transmission across the entire system needs to be improved and

upgraded to allow for these literally thousands of transactions that

12

the system was not designed or built to accommodate. And as long

as we are going to continue down the path of deregulated competitive generation business—now, years ago, when a utility built a

power plant, it built its power plant and then it built its lines to

get that power into its system. Now, you can go to a power plant,

any place you choose, and someone else’s responsibility is to build

those lines, and you might not be building it to the area where

those lines are primarily directed. They may be directed to some

other market.

So the entire spectrum of transmission has to be looked at totally

differently as we move more and more toward competitive generation markets. And the system is just not there on the transmission

side at this point to allow for all of the transactions that people

would like to make.

There are thousands of transactions that are made on a daily

basis. Let’s not discount the transmission system we have today,

because it is a very good system. It allows for a lot of transactions,

but not all of them.

Mr. OXLEY. Thank you.

Mr. Trabandt, you have had, obviously, some experience on Wall

Street. You were at FERC. You were a consultant to the energy industry. What is your take on this whole issue regarding transmission?

Mr. TRABANDT. I think it is very important, Mr. Chairman, in

that regard to focus on something that Tom’s testimony pointed

out, and that is we need an enormous amount of new generation

in the country. Much of the financing that is being done now is to

connect new power plants to the grid, rather than to deal with the

issues surrounding the upgrading and improvement and reliability

of the existing system as it is today, which, as Tom said, is not designed for a market operation.

So we really do have what is tantamount to a potential crisis in

that part of the industry today that needs to be addressed. I think

what is very important—and I think our respective testimonies focused on this, perhaps in somewhat different ways—is that regulatory policies at FERC definitely need to establish incentives in

terms of the rates, terms and conditions that are going to be established for transmission service so that there is a proper return for

investment.

Today, there is not an incentive to invest in transmission as a

general matter. We have a couple of examples where there were investments in so-called merchant transmission lines, but so far, no

one has successfully built one of those because of the inherent concerns with the returns and the financing associated with them.

So, I think that it is quite important that regulatory policies, the

tax policies, and the general overall energy policy maintain a focus

on this. I think it is important that Mr. Bush’s national energy policy that was released last year really did highlight this issue. The

issue has tended to be overtaken by California, Enron, and other

things. But I think capital formation for investment in the transmission sector is critically important for the country.

Mr. OXLEY. Thank you.

Thank you, Mr. Chairman.

Chairman KING. Thank you, Chairman Oxley.

13

Ms. Maloney has had to leave. She does have a series of questions which we will submit to the witnesses in writing, and if you

could get back to her within the next week or 10 days, that would

be greatly appreciated.

As for my own questions, actually, everything has been answered. Your statements are comprehensive, and your dialog with

Mr. Oxley has really touched on all the questions I would have

asked.

We have to go vote. We will be in recess until about 11:10.

Mr. Chairman, unless there are further questions, I think we can

excuse this panel at this time.

So I want to thank you for taking the time to be here. We certainly appreciate your cooperation and your assistance, and you are

excused. Thank you for being here.

The hearing stands in recess until 11:10, at which time we will

have our second panel.

[Recess.]

Chairman KING. The hearing will come to order. I want to welcome our second panel today and thank them at the outset for taking the time and trouble to come down here and give us the benefit

of their knowledge and wisdom and their insights.

I would like to welcome Mr. Bryan Mitchell, the Chief Executive

Officer of MCG Capital; Mr. Paul Glenchur, Director of Schwab

Capital Markets; and Mr. Blair Levin, Managing Director of Legg

Mason. I would ask each of you to make an opening statement. If

you can possibly keep it to roughly 5 minutes, that would be appreciated.

We are not going to be pulling the plug on anyone, but if you

could keep it to 5 minutes, it would be appreciated. In any event,

your full testimony will be incorporated into and made a part of the

record.

So, with that, I would ask Mr. Mitchell to make his opening

statement.

STATEMENT OF BRYAN J. MITCHELL, CHAIRMAN AND CEO,

MCG CAPITAL CORPORATION

Mr. MITCHELL. Thank you, Mr. Chairman. I appreciate it and

thanks for giving me the opportunity to express my thoughts in

front of your subcommittee.

I wanted to give you a brief description of the background of our

company so you can put into context our comments. Our company

is a publicly traded solutions-focused financial services company

that works with high growth small private companies. We assist

those companies in prioritizing their opportunities and managing

their risks of growth.

We apply an expert activist investment philosophy to these companies, and we do that by focusing on very specific industry sectors

in which we invest. We develop financial, operational, and regulatory expertise in these marketplaces, and we actively apply that

knowledge to support these companies.

The basic investment thesis of our company is to trade upside for

a less speculative, more stable path to value creation, and it is that

bias that we bring to the discussion today. As a bit more background, our company has an investment portfolio today of about

14

$675 million. A little over 25 percent of that investment portfolio

is in the telecommunications industry, and the remainder is in

media, information services, and technology.

Our company, in the fourth quarter of last year, completed a $240 million IPO and issued $265 million worth of investment

grade bonds to support our investment activities in the telecom sector and technology sector. And we have had our basic investment

philosophy validated, in our view, by the capital markets by completing those capital transactions in December of 2001 in a very

difficult capital market environment.

I think the last point I would make around our background is

that we have been active in investing in telecommunications for

over 10 years, and we have deployed over $2 billion of capital and

over 200 transactions in that time period. And our basic approach

is to assess the fundamentals of growth markets and identify the

path to cash flow and profits, which ultimately create significant

enterprise value.

It is the assessment of that critical path to cash flow and profitability that I would like to focus on as it relates to assessing capital

formation in the telecommunications industry. Our focus in the

space has been really in a range of different service providers, long

distance, niche markets, prepaid services, conference calling, the

hospitality industry, integrated services such as the local long distance data bundling models that are out there and messaging models, and, ultimately, and I think most importantly, for the purpose

of this testimony today, is in the UNE-P CLEC area.

The basic framework that we have brought to bear as it relates

to investing in telecommunications companies is identifying companies that are able to acquire customers that have high net present

value. And inherent in the telecommunications business is a cost

to acquire a customer, the marketing, the provisioning costs, that

is in excess of the current period, that current month’s revenue

stream. It is inherently a negative cash flow investment proposition.

So what we look to identify is the predictability of the future revenue streams of that customer and the gross profit margin in fulfilling the particular service that that customer procures that generates positive cash flow in the out periods, that when discounted

to a present period, exceeds the cost of acquiring that customer.

And I think in this framework, as you build that critical mass of

customers, you can then look to take the next step in terms of stepping up the return on investment curve by building facilities in

which the gross profit margin increases as you push forward.

Now, when we initiated our activity, in particular, in the local

services marketplace, we did that based on what we deemed to be

a very favorable regulatory environment related to the Telecom Act

of 1996, a significant price-value proposition for a very large universe of consumers, where the greatest value proposition of deregulation was to the advantage of small businesses and residential

customers, of which there are very many. The basic belief was that

smaller competitors can significantly out-perform by being better at

the basics, as it relates to what a customer sees, the customer service, the billing clarity, the pricing policies, the provisioning elements of the business.

15

And, lastly, we felt that the Telecom Act of 1996 provided a terrific framework for encouraging innovation. I think within the context of the Telecom Act of 1996, the Act really provided for three

basic entry strategies for competitive telephony.

The first was a total service retail model, which essentially was

a retail minus, the regional Bell’s price minus a percent. And, essentially, your new entrance came in as marketing and billing

agents for the incumbent providers of telephony.

The facilities model, which is also obviously one more, involved

a significant PP&E investment, very sizable capital expenditures,

and essentially made use of some elements of the public switch network. The last model which we have focused in on is the UNE-P

or network elements recombined.

If you think about the basic framework of the Act, it was designed to allow the key elements of completing a phone call to be

unbundled and procured by the competitive infrastructure. In the

three components, there is really sort of seven specific components,

but they basically roll up into access, switching, and transport of

a telephone call.

What the UNE-P model represents is a cost-plus approach rather

than a retail-minus, and it is that cost-plus approach that allowed

those entrants to generate a reasonable return on capital that

could facilitate additional flows of capital into that marketplace.

Now, each one of those components that were envisioned by the Act

has a very significant and meaningful position, and, clearly, the

Act was very well thought out in that regard.

The total service resale model presents a low-cost entry strategy.

Your investment capital is primarily to acquire customers.

The sort of customer acquisition model is a critical element in

that regard, and there is a fairly low gross profit margin which creates a long timeframe for return on investment. In other words,

you burn money to build a pool of customers, you get this critical

mass of paying customers, and then you go about the capital expenditure investment to generate a profit margin. That is a fairly

long path, given the lack of return on capital while you are acquiring the critical mass of customers.

The other model, which has been obviously very notorious for its

impact on sort of the trouble in the markets, is a sort of build it

and they will come—the facilities based model. Now, obviously,

there are significant entry costs. There is a significance reliance on

favorable access terms, which I think is very important and was

expressed effectively in the Telecom Act of 1996.

There is, however, also a very long scaling timeframe. There is

high gross profit margins upon reaching scale, but you have got to

get your plants built, and then you have got to acquire those customers. Both of those cost a lot and do not throw a lot of return

back on the capital that you invest. And as you ultimately load

your network, that is when the gross margins begin to kick in.

And, lastly, I think the facilities framework is really designed to

serve the higher margin larger users out there, the large corporate

users or the very concentrated, from a population density perspective, users in the market.

The last entry element, UNE-P, really does present to some extent the best of both, with a little bit of extra. We think it provides

16

a low-cost market entry point. It is a customer acquisition entry

model.

It has a much shorter payback on customer acquisition, because

there is sufficient gross profit margin associated with buying the

network elements at a cost basis rather than a retail-minus basis,

so that you can generate a gross profit margin with about 20,000

or 25,000 access lines. That allows you to continue to propagate

with profitability new customer acquisition, which ultimately allows you, I believe, to step into the facilities framework.

The capital expenditures associated with this model typically

focus on customer centric issues. Most customers in the marketplace do not feel that the existing infrastructure is not effective at

completing their calls. They feel more along the lines of ‘‘my bill

is confusing; the pricing mechanic does not make sense; I need

service and it takes a long time; I call customer service and I do

not get that.’’

So from our perspective, the basic building blocks of building a

competitive framework involve serving those sort of front and center customer issues up front, and we think that this framework is

supportive of that.

And then, lastly, by being able to unbundle the network and then

recombine those network elements, it gives innovative firms that

have built a critical mass and are generating returns the opportunity to create product and service innovations by bundling hardware and software with the existing network elements to create enhanced services, things like unified messaging or follow-me calling

or enhanced conference calling services or enhanced voice mail

services. And this innovation, which has been really lacking from

the incumbents, is really the biggest promise of telecom deregulation.

Then, lastly, I think what UNE-P represents is the stepping

stone to the higher margin facilities based business model. So as

I look at what Congress did in 1996, I think there was an enormous amount of brilliance embedded in the Act.

But, I think it is essential that Congress continue to support all

three elements of the Act, the resale model, which creates ubiquity

in the marketplace; the UNE-P component, which allows for a stepping stone to profitability through quicker cash flow and quicker

profitability, which at this point is really what the capital markets

are looking for—they do not like that long-term horizon of capital

burn before they begin to see a return on their capital, and I also

think it creates a very effective service platform for the average

customer, the small user, the person who has eight lines in his

business or 12 lines in his business rather than the large Fortune

500 companies—and then, lastly, the facilities strategy to serve the

most complex customers and generate the highest margins.

I think the three together will facilitate capital formation. And

I think that leads to someone sort of saying, ‘‘Well, boy, it all seems

to be so well thought out and works so well—what happened?’’ It

sort of begs the question: Why are we in the position that we are

in?

I think that one of the strengths and one of the weaknesses of

the economy is its willingness to speculate for gain, to drive lots

17

of capital into circumstances to create the upside. And I think the

capital market simply went for the brass ring.

If you think about it, it is a $200 billion-plus revenue marketplace, and to secure 20 to 30 percent of that from the monopoly

market to a competitive market represents $40 billion to $60 billion

at a two to three times multiple on revenue. That is $180 billion

of market cap that was available to be created. There was a pentup gold rush into that market cap model, and everyone went for

the highest margin business model, the facilities based model.

I think the capital markets ignored a bit a more rational step

framework that was established in the Act through total service resale, UNE-P, and then facilities based advocacy. So I guess the

question is what sort of point of view do I have as it relates to how

we perpetuate or reinvigorate capital formation in the space.

The question is, also, is there still a reason to force the incumbents to keep open all three entry strategies, and we believe very

emphatically yes. We think it is a central theme to capital formation in the marketplace, and we think through the FCC’s triennial

review proceedings, which are underway, the results of that will

really, I think, determine the outcome.

From a public interest perspective, we do not think people are

going to build the Novo networks to serve the small guy. And competitive telephony, as it is configured today, will allow all to benefit

as each strategy has an opportunity to flourish over time.

I think my second point would be that what Congress can do to

facilitate flows of capital is to continue to hold the incumbents to

cost studies that allow for buy rates on the public switch network

elements that can support margin and that will perpetuate capital

inflows.

Then, lastly, I would say that enforcement is a critical issue.

And, in fact, rather than lessening the terms of the Act, I think the

terms of the Act need to be more fully embraced. It is important

to note, in my view, that old monopolies die hard, and as such, enforcement mechanics should not be undermined.

I think the Tauzin-Dingell bill appears to create a protected safe

harbor for the Bells to invest in next generation networks that will

not be subject to open access as provided for in the Telecom Act of

1996. And I think that would be a dangerous precedent and deleterious to capital formation in the telecommunications industry.

Again, I would like to thank you for the opportunity to speak before the subcommittee, and I would be pleased to entertain any

questions anyone might have.

[The prepared statement of Bryan J. Mitchell can be found on

page 72 in the appendix.]

Chairman KING. Thank you, Mr. Mitchell.

The subcommittee has been joined by Congressman Grucci, who

does have a particular expertise in this area, and he will be asking

questions later. But now, I would like to ask Mr. Glenchur to give

his opening statement.

18

STATEMENT OF PAUL GLENCHUR, VICE PRESIDENT, SCHWAB

CAPITAL MARKETS L.P., SCHWAB WASHINGTON RESEARCH

GROUP

Mr. GLENCHUR. Thank you, Mr. Chairman and Members of the

subcommittee. It is my pleasure to discuss with you issues related

to capital formation in the telecom market.

As the vice president of Schwab Capital Markets, Washington

Research Group, I work with a staff of analysts that examine the

regulatory, legislative, and political factors affecting investments in

various industries, including telecom, technology, energy, health

care, financial services, and international trade. We work with institutional investors to address their concerns in these areas.

I would like to say at the outset, however, that today’s comments

and views represent my own, not those of Charles Schwab and

Company or Schwab Capital Markets.

It was only a couple of years ago that the telecom and technology

markets were ablaze. Equity values soared and capital investment

was flowing into these sectors.

But as we all know, telecom and technology have suffered a meltdown. Telecom carriers, pursuing a land rush mentality, assumed

substantial amounts of debt to build and expand the reach of their

networks.

The bursting of the internet and dot-com bubble undermined a

major portion of the customer base for telecom service providers.

Revenue struggled to keep up with debt service obligations. We

have seen numerous bankruptcies and threats of more to come.

The investment community obviously suffered along with the

telecom carriers. They were enthusiastic about the promise of

telecom competition and the migration to new and exciting data

services over upgraded networks.

To a great extent, investors believed that expanding telecom networks to allow flexible configuration of services to customers in all

major metropolitan areas offered the greatest potential upside in

the new telecom environment. But building networks in all major

cities required the assumption of huge amounts of debt.

A variety of factors pressured the revenue growth of upstart

telecom service providers. Competition for high volume business

customers led to disruptive pricing as carriers attempted to achieve

revenue targets regardless of profitability.

Internet service providers struggled and went out of business,

disconnecting service or cutting back demands for service. Regulatory actions also were involved in affecting the projections of competitive local exchange carriers.

The economic slowdown worsened a difficult situation. The expansive revenue growth anticipated from new data services failed

to materialize. Meanwhile, debt burdens continued to squeeze upstart carriers. Investors pulled back, refusing to invest additional

money in telecom service providers. Suddenly, the emphasis was on

cash flows rather than the reach of a provider’s network.

As illustrated by the last couple of years, it is difficult to make

a business work when it requires massive up-front capital investment and entails substantial customer acquisition and retention

costs. Ongoing regulatory battles between incumbent and competiVerDate 11-MAY-2000 09:28 Sep 05, 2002 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 C:\DOCS\79320.TXT HBANK1 PsN: HBANK1
19

tive carriers also have increased regulatory uncertainty in the sector.

At this time, there is little growth in the telecom industry. Without profit growth, there are few incentives to invest.

But despite the downturn in the industry, there is room for optimism. A necessary shakeout will mean inevitable consolidation and

the survival of carriers with the most sustainable business models

and financial structures.

New data services and other offerings will continue to leverage

upgraded telephone, cable, and wireless networks. But the healing

process will take time.

Carriers are reluctant to assume additional debt, a factor discouraging industry consolidation. Meanwhile, the burden of maintaining networks and upgrading them to add capacity or provide

new services remains a costly exercise at a time when adoption

rates for new services lack visibility. But technology is forcing the

migration to new service models.

Telephone carriers face competitive pressure from wireless substitution, IP telephony, and instant messaging. Broadcast and cable

operators face a fragmented audience among numerous video offerings that pressures traditional advertising models. Commercial

wireless service providers are making critical investments in data

services.

Although futurists may be excited about today’s telecom opportunities, reluctant investors fit the ‘‘once burned, twice shy’’ characterization. They want to see killer apps that drive penetration rates

for new services. The pendulum has swung from irrational exuberance to abject pessimism.

History teaches, however, that we tend to overestimate change in

the short run, but underestimate change over the long run. And,

hopefully, the melt-down represents the first part of that equation.

As Washington considers legislative or regulatory proposals to

jump-start the telecom economy, some level of caution is warranted. Major initiatives lead to the inevitable legal challenges in

Federal court and the results are unpredictable. The resulting uncertainty can actually discourage capital investment.

Moreover, legislative and regulatory actions cannot force changes

in human behavior. As noted above, there is genuine excitement

about the potential of new technologies and high bandwidth services. What is not clear is how consumers will embrace these new

capabilities over wireline and wireless networks.

What is the value proposition for these services? We do not need

100 megabits a second for e-mail. Consumers and business are

struggling with this question today. We must be realistic in our expectations of what Government policy will accomplish.

Thank you, Mr. Chairman.

[The prepared statement of Paul Glenchur can be found on page

86 in the appendix.]

Chairman KING. Thank you, Mr. Glenchur.

Mr. Levin, please.

20

STATEMENT OF BLAIR LEVIN, MANAGING DIRECTOR, TELECOMMUNICATIONS AND MEDIA REGULATORY ANALYST,

LEGG MASON WOOD WALKER, INC.

Mr. LEVIN. Thank you very much, Mr. Chairman, Ranking Member Maloney, Members of the subcommittee. I am Blair Levin,

Managing Director of Legg Mason. I am an analyst, and in that

role, I advise institutional investors about the impact of Government policy on telecommunications and media companies.

Let me start by saying that I think the telecom situation is different than the energy situation in a very critical aspect. Telecommunications went through an historic change in the last 5 or

6 years.

Every industry that has gone through an historic change has

seen a cycle of over-investment and then a retreat from the market.

This was true of the railroads in the 1800s, and it was true of the

auto industry in the early 1900s, and it was true of the computer

chip industry and the computer industry.

That does not mean that these industries, all of which are critical to the success of our economy, are fundamentally flawed. It

just means that when you have change, you have enormous investment, because, as the first speaker mentioned, there was a brass

ring to be grabbed, and now the market is obviously retreating.

I think as an indication of the fundamental health, but the problem of the industry—the revenues in the telecom industry last year

grew at a rate of 7.5 percent, ranking as one of the highest among

industries. But the profits of the industry dropped about 52 percent, and that is obviously very problematic.

Mr. Chairman, I think you asked the right question by asking

what are the hurdles that need to be overcome so you get the appropriate level of investment. Let me say I think that first, there

are three preconditions to investment in the telecom industry.

The first is competition, because without the opportunity for competition, you do not have investment in new entrants. Also, traditionally, the incumbents do not invest as much, and, certainly,

there are a lot of examples which I cite in my written testimony

that as competition starts to come online, you have both investment in competitors as well as more investment by the incumbents

in upgrading our networks.

Second, I think there needs to be a growth opportunity in both

revenues and profits. Mr. Glenchur talked about that, and I think

that is absolutely right. None of us in this room are going to invent

those killer apps, but, nonetheless, we have to make sure that the

companies realize they can get the benefits of inventing those killer

apps.

Third, there has to be, as Chairman Oxley mentioned, innovation

in the marketplace. There have to be new kinds of goods and services. And here, there is a particular problem in telecommunications, because there is a tension between innovation in the networks themselves and innovation at the edge of the networks. I

think we have to make sure that the delicate place is balanced, so

that both investments kind of make sense, because that is what

really drives the kind of innovation that increases consumer welfare gains as well as the economy.

21

In making sure that those preconditions are met for investors, I

think Government itself faces three challenges, first, to make sure

that there is a balanced policy. All the policy debates center around

the question of what are good incentives for investments.

But it turns out there is a lot of tension between facilities based

investors or those who want to lease networks, between certain

kinds of facilities based investors. It is much easier to say than to

do, but the simple truth is—and my written testimony goes into

some examples of this—we need to make sure that all different

kinds of investors have an opportunity to see revenues and profits,

because otherwise, we will not get the kind of competition and innovation that America needs.

Second, we need to rationalize the revenue streams in telecom.

One of the things that makes telecom different than these other

sectors—which I noted earlier as going through historical cycles—

is that it is very heavily regulated. And we need to, when possible,

have the market sending the right pricing signals.

In my testimony, I talk a little bit about the problems of retail

rate setting and universal service and the very complicated Federal-State jurisdictional battles that still, I think, give the market

problematic signals and lead the market to underinvest in the sector, because they cannot tell where the market really is and where

the growth is going to be and whether they should invest in a company who, unfortunately, may really depend on a regulatory regime

for their profits.

The third thing is we need speed and certainty in decisionmaking. The others have talked about that, and my written testimony goes through some examples. But again, I think the Congress

did a very good thing when it passed the 1996 telecom act by telling the FCC to get a number of decisions made within a very short

period of time.

But we have the ironic situation where the Congress asked the

FCC to establish the pricing rules within 6 months, which it did.

And now 6 years later, the courts have still not finally addressed

the question of what is the appropriate pricing regime. So I go into

some concrete proposals for how to speed up that decisionmaking

and how do you make it more certain.

There is a limit to what Government can do. Obviously, as Mr.

Glenchur mentioned, consolidation and other market forces are

going to return this sector to a greater sense of profitability and

make it more attractive to investors.

But, nonetheless, I thank the subcommittee for giving me this

opportunity to testify, and I think that the Government does have

a very critical role to making sure that capital formation in the

telecom industry improves over the next 3 years.

Thank you very much.

[The prepared statement of Blair Levin can be found on page 93

in the appendix.]

Chairman KING. Thank you, Mr. Levin.

I want to thank each of the panelists for their testimony. I have

one question I will ask at the start, and then I will turn it over

to Mrs. Maloney and then to Mr. Grucci.

22

I will ask the three of you to comment on this. To what extent

do you see the issue of access lines being a capital deterrence, and

how does this issue affect the decisions of Wall Street analysts?

Mr. LEVIN. Could you just clarify on the question of access lines?

I am not sure I know what you mean.

Chairman KING. Actually, the last mile, basically, we are talking

about.

Mr. MITCHELL. Oh, OK. I will start. I think that having open access to last mile is absolutely critical and essential to building any

kind of a competitive framework. And the buy rates on that last

mile need to be constructed in a way that the companies that are

competing can generate a reasonable profit margin so they can

cover their costs and generate a return on capital.

So capital will form up to acquire customers and create—the first

part of the competitive infrastructure, in my view, is a critical mass

of customers to make prudent ROI judgments on, in terms of investing in expanded facilities.

Mr. GLENCHUR. The last mile is obviously the whole critical part

of this debate, and in terms of what we ought to do to reform

telecom regulation. Whether it is for phone connections or it is for

broadband connections, it is the great advantage that incumbents

have, whether it is the Baby Bells, the incumbent phone carriers,

or cable operators, having that direct connection with the customer.

Unlike the infrastructure for long distance, the barriers to entry

in terms of coming into the local market are pretty substantial. It

is much more costly to invest in the local infrastructure to solve the

last mile problem or to offer competitive alternatives. And that is

why we have seen so many of the telecom meltdowns that we have

seen and the bankruptcies and the pending bankruptcies. So this

is a very, very difficult challenge.

I would also say that beyond just that connection, you are looking at a lot of advantages that incumbents have in terms of brand

identity, constant contact with the customer, and entrenched customer relationships, which has raised the acquisition cost for a lot

of upstart carriers or those who would enter this market to try to

offer that alternative. And it takes time to try to overcome those

hurdles, to find the right business model and financial model to

make a business case for entering this market. But it is the great

challenge, and it is really at the heart of the difficulties the industry faces today.

Mr. LEVIN. I would certainly echo that. I think it is notable that

a great deal of the investment that occurred in the post–1996 environment went into the long-haul side, and prices have dropped dramatically, performance has improved dramatically in the long haul

networks. But we did not see the same kind of investment or improvements in price and performance in the last mile.

On the other hand, I think that more and more, there are beginning to be last mile substitutes, whether it be on the wireless

side—I think we are going to see more cable CLECs in the efforts

over the next year. So, obviously, we want to see more improvements in the performance of that last mile, but I would be cautious

about making any dramatic changes in the policy at this point in

time, because I think that could hurt investment into the last mile

at this point more than help it.

23

Chairman KING. Mrs. Maloney.

Mrs. MALONEY. I just would like to ask the panel to react to

what Mr. Kuhn said earlier. In his statement, he made a point that

he was trying to distinguish Enron’s practices from those engaged

in by other energy companies in order to restore investor confidence in the whole industry.

But several other energy companies, including counter parties to

Enron, have announced that the SEC has opened inquiries into

their accounting practices. So, basically, the point is we are trying

to get more investor confidence into energy companies and telecom

companies. But how can we get that investor confidence when all

of this is being announced, whether it is Global Crossing or Enron

or whatever.

Global Crossing was a telecommunications company, was not it?

It was not in energy. It was in telecommunications.

So as long as that cloud is out there with Global Crossing and

alleged accounting practices in other telecommunications companies, for then Enron—that was totally an energy company. How

can we get investors to come back with confidence and put their

capital there when this cloud is out there?

Mr. GLENCHUR. I think that is right. It is another burden to have

to overcome at a very difficult time in the industry. They are burdened with substantial debt, and we have seen the bankruptcies,

and we are probably going to see more of those. What is positive

is some of the companies are working out of bankruptcy, and that

is favorable.

But if you look in the telecom industry, it is not just Global

Crossing. You have seen questions raised with respect to

WorldCom, Qwest. You have seen the SEC opening an inquiry in

Adelphia, a cable company, now, raising questions about off-balance sheet debt.

And these are problematic, because it increases the due diligence

that one must perform with respect to potential transactions in this

sector, in terms of what kind of debt you are going to assume in

doing a deal, as well as whether you have a good sense about the

scope of the burdens that you may be taking on. It actually may

have somewhat of a chilling effect on the ability to see consolidation take place that might ease some of the troubles in the sector.

Mrs. MALONEY. Well, energy projects are often financed and held

through special purpose vehicles, the so-called SPEs, that do not

appear on the books of the sponsoring companies. How frequently

is this type of financing vehicle used in the telecommunications industry? Doesn’t the telecommunication industry use these SPEs in

their accounting practices?

Mr. MITCHELL. From my perspective, there is not nearly as much

frequency in that regard. The sort of accounting issues that, I think

are more prevalent in the telecommunications industry are sort of

bartering arrangements and sort of income recognition issues more

so than moving things off of the balance sheet so they cannot be

seen.

I think that this kind of issue of accounting policy and accounting framework tends to be highlighted in industry sectors where

there is a lot of growth, which creates a lot of investor interest and

creates an opportunity for people to engage in perhaps less savory

24

activities. But I think, to some extent, it is a separate and distinct

issue to the underlying construct of profitable business models.

Is there the ability to develop, and is there a supportive framework from a regulatory perspective for the formation of profitable

business models. And, you know, I think telecom is plagued with

its share of accounting issues, but I think the bigger issue in

telecom is companies that investors invested in that did not make

money, and they knew it did not make money when they invested

in it. And the task of making money was so extended that it created investor indifference and, ultimately, investor dissatisfaction,

which then created a lot of pressure on the leverage side of the

houses, as was mentioned by Paul.

Mrs. MALONEY. I think the first and best thing that we could do

as a Nation to get people to invest capital in telecommunications

is to restore confidence that the businesses are well managed.

When someone reads about a Global Crossing, it is not fair to say

that every company is the same. It certainly is not. Most companies

are honest, hard working, and doing a great job.

But we need to restore investor confidence. I think that is probably the biggest thing we could do to get people to start investing

capital back into telecommunications.

So I would like to ask what the industry is doing to assure investors that these off balance sheet entities do not conceal additional

liability or losses. And what is being done by the industry to weed

out overly aggressive or misleading practices?

Obviously, the best thing that could happen for telecommunications is that there is not another Global Crossing, there is not

another scandal, you could say, of sort of misleading investors. And

Government is trying to do their role. We have had extensive

markups on bills that increase oversight. The SEC is trying to do

their role. But what is industry doing to weed out aggressive or

misleading practices?

Mr. LEVIN. I would like to answer that with two comments. First,

I think we need to make a distinction between misleading investors

in what one might think of as a conscious way, where you do not

reveal information you should reveal—clearly, this was the case in

Enron. Based on press reports—and I want to emphasize based

solely on press reports, it appears to be that Adelphia was engaged

in off book accounting.

But that is very different from what I think is the major problem

facing telecom, which is the business models did not live up to expectations, primarily because of mis-estimations of supply and demand. So there were a number of companies that went into the

long-haul business. The demand did not increase as much as they

had anticipated. There was much greater supply. Prices dropped.

That is a more normal problem, but I think that that is more of

the problem in the telecom sector than some kind of misleading.

And, second, let me say to the extent that there is misleading,

I have got to tell you that the market reacts just like Washington.

In other words, when there is an issue, everybody goes and focuses

on that issue. And I can assure you that as soon as Adelphia came

out with their statement that they had been borrowing money that

had not been revealed, every single cable company was immeVerDate 11-MAY-2000 09:28 Sep 05, 2002 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\79320.TXT HBANK1 PsN: HBANK1
25

diately asked by every single analyst, OK, tell us what you have

too.

So I think that the market is self-correcting in some ways. That

is not to say there is no further Government role necessary. But

the market is now, I think—well, Mr. Glenchur stated that we

have gone from irrational exuberance to some kind of over-pessimism.

We have also, as analysts—it used to be that the job of the analyst was to search for the great new thing which would bring huge

upside. Now, I think analysts are very focused on what is the missing thing that actually I can discover that reveals that there is

enormous downside. So I think the marketplace is reacting by

searching for those kinds of problems.

Mrs. MALONEY. Well, then, what can we do to help you? What,

specifically, could Government do to help with capital formation for

telecommunications? I mean, I see it as investor confidence. You

say that is adjusting. When all these scandals are out, investors

pull back. But if that is adjusting, and that is not a problem, then

what could be done?

Mr. MITCHELL. I think the first step is private capital formation.

I think you need to distinguish sort of private equity and large institutional funds that invest in companies separate and distinct

from the individual investors maybe through their mutual funds or

whatever.

From my perspective, I think there was great brilliance in the

Telecom Act of 1996, and I think that it would be a mistake to sort

of throw the baby out with the bath water. We have to recognize

that frequently, in the economy, particularly around substantial

growth sectors—and I think Blair mentioned that telecommunications revenue growth is still up substantially—there is a proclivity to over-invest, to create speculative fervor around these

growth sectors.

I think when that happens, the markets do correct themselves,

and what we do not want to do is over-respond from a regulatory

perspective. Let’s look at the brilliance of the stepped business

models toward inevitable profitability that was established in the

1996 Act, and let’s make sure we enforce those provisions and hold

people, particularly the incumbents, to the critical metrics of reasonable buy rates and open access and do not find ways for them

to avoid open access on the data side and keep it open on the voice

side, because at the end of the day, data and voice are the same

thing. It is bits and bytes. And so it is just sort of voiding the old

monopolies’ desire to protect themselves and make sure we stay

true to the original framework of the Act.

Mr. GLENCHUR. I think that Blair stated this pretty well, that

the investment community will be a disciplinarian for the market,

and you are seeing companies having to respond to that. The ‘‘build

at all costs’’ model has been discarded, and now you will see competitive carriers with tighter geographic focus, more customer segmentation.

You have seen the models adapt to the change in the capital environment. The capital markets are brutal, and they are forcing

discipline on the market.

26

At the same time, we still have a very, very expensive infrastructure build-out ahead at a time when we really, again, do not know

how fast or how deeply these new services that will be offered and

enabled by this infrastructure investment will be taken up by consumers, which still makes it speculative and risky. But I think it

is good now that we are seeing the hype come out of the market,

the concept investing come out of the market, and fundamentals

like cash flows and profits are reemphasized, and that is painful.

But that process did self-correct, and I think it is good to let that

begin to run its course from a financial and business standpoint.

There are broader policy issues that I know Congress has debated

that regulators are looking at that affect various regulatory incentives in the market, and those are worthwhile debates to have. But

I think that, in general, we are seeing the healing process, and we

need to make sure that nothing is done to interfere with that.

Mr. LEVIN. I would just echo those comments again to the extent

that there are folks who are deliberately not revealing information

that they should have revealed or that we need to change the rules

to make sure they reveal that information. That is certainly an appropriate role for the Government and the SEC with the capital

markets.

Mrs. MALONEY. Isn’t it a criminal offense not to reveal the information that you have debt that you are not really—to lie, basically,

to lie to your auditor? Isn’t that a criminal offense?

Mr. LEVIN. I am not an SEC lawyer, and I think there are always questions—obviously, there are a lot of questions about what

needs to be revealed and what is not. And I think that that is at

the heart, obviously, of a lot of the investigations of Andersen. I

think those are very legitimate and important questions for this

subcommittee and, really, the entire Government to look into.

But I do make a distinction, and I think it is an important distinction, between those players who were withholding information

and those players who simply guessed wrong. They did not guess

wrong because they were not smart and did not work hard. They

guessed wrong because markets are unpredictable. So I want to

make sure we do not punish them, because if we punish them, then

people will not invest in new innovative companies that, I think

bring a lot of value to this American economy.

Mrs. MALONEY. Thank you.

Chairman KING. Thank you, Mrs. Maloney.

Congressman Grucci.

Mr. GRUCCI. Thank you, Mr. Chairman. It seems to be a New

York issue here. We have all New York representatives.

My question goes along the lines of competition and bringing

competition into the marketplace. How can we encourage young upstart companies to get into the telecom industry, and can they access capital to do so? How can we help in creating the environment

for capital to grow so that it can be accessed by these new startup

companies?

I guess we will go down the line. If anyone wishes to answer that

first, that is fine with me.

Mr. MITCHELL. Well, Congressman, that is exactly what my company does. We are in the business of financing private companies

with $5 million to $25 million of capital to support creation of what

27

we hope to be, in the long run, a larger and ultimately perhaps

public companies.

And from our perspective, our company has been rewarded by

this fundamental cash flow discipline that we have applied to investing in this space to our ability to raise over $500 million in December of 2001 to re-deploy back into this market, so that the capital market, sort of on a wholesale basis, had, I think, a firm stepby-step process of building moderately profitable to very profitable

businesses with good visibility on profits and cash flow. And I

think the Act has built a framework for that, and I think continued

access to the network elements on an unbundled basis is a very important part of constructing a profitable business model and a business model that will then perpetuate innovation.

I think the first issue is is there a framework that you can go

out and negative spend to acquire customers in the context of nearterm profitability as you gross up your customer base. And the facilities build model, straight up, does not provide that.

The amount of capital you need to spend to get the facilities and

the amount of negative burn that needs to occur to get the customers puts profitability so far off that the capital markets have

said, ‘‘I just do not have the tolerance for that long view of things,

in terms of return on investment.’’

My personal view is I think that the Act has developed a good

framework for that, and it is sort of making sure the buy rates

make sense and making sure you can get those individual network

elements for the facilities guys for access, for the UNE-P guys for

access, transport, and switching, and, ultimately, for resale guys a

reasonable access to the overall network at a reasonable price.

Mr. GRUCCI. Does anyone else wish to answer?

Mr. GLENCHUR. Yes, I would just say briefly that, again, I think

that the competitive market for telecom services, the competitive

carriers and the upstart carriers—I mean, they are trying to overcome a very difficult financial climate, and the capital markets are

generally not open to them at this point, at least not as much as

they were. I think a lot of the hype and the concept has come out

of the investing, and there is discipline being imposed on the market as they explore the kinds of models that will work and the

kinds of financial structures that will be sustainable, and that is

a good process.

Eventually, as you see the consolidation and the shake-out, some

players emerge who have the right approach, as the third or fourth

generation competitive local exchange carrier going forward. So I

think that healing process is critical here, because that will be

something that all investors will want to know about and will have

questions about and will demand answers, in terms of what kind

of model a carrier has to compete, given today’s climate.

I also think it is important for the FCC to continue to enforce

the rules that Congress has established, provisions for competition—the FCC implements and enforces them. As the commission

explores changes in this area, obviously, that creates some uncertainty in the market, and that is another difficulty to overcome.

But to the extent that the rules——

28

Mr. GRUCCI. Congress starting to go on, and I want to get a second question in, and we will start with Blair, if he wishes to answer this.

Chairman KING. Congressman Grucci, you can have as much

time as you want.

Mr. GRUCCI. Thank you, Mr. Chairman.

The next question I wanted to ask is are there restrictions and

impediments that put the smaller companies at a disadvantage

over the bigger companies? Is there some kind of regulatory relief

or regulatory assistance that might make it more appetizing to invest in a small company if, indeed, they had access to that kind of

help?

Second, the Tauzin-Dingell bill was designed to bring competition

into the field. I would like to hear all of your responses as to

whether or not you are seeing that. Do you think that will grow,

and do you believe that we ought to bring the cable companies into

that loop where they are also covered under the Tauzin-Dingell

bill?

Blair, why don’t we start with you?

Mr. LEVIN. I suspect Mr. Mitchell could answer the question

about small companies better than I, but let me make a couple of

quick observations and then talk about your other question. I think

there is a distinction between—telecom is really a big player game,

and when you are talking about running these huge networks,

huge data pipes, huge voice pipes, you really need scale.

There are a number of small telecom companies in this country

that are in, geographically, generally rural areas. And I think there

are certain things that Congress is considering in terms of regulations to limit the restrictions on them. But that is different than

saying that a small CLEC can arise in Long Island or in New York

and really compete with the big guys.

Going back to your earlier question, after the 1996 Act, we saw

hundreds of new companies form. In some sense, they acted as an

enormous success in terms of generating a lot of interest in

telecom, and a lot of capital was invested. But what we have seen

is that it is a big player game, and we just have to accept that that

is the economics of the business.

On the other hand, a lot of the best things that have happened

have been at what we think of as the edge of the networks, with

new applications and innovations. And I think it is important that

the people who—whether they be things like e-mail or instant messaging or file sharing or whatever—that those folks have access to

the networks, so that they can make money off of bringing those

innovations into the marketplace.

On the other hand, we want to make sure the big guys have incentives to invest in faster and faster networks. And that is the

tension which I talk about in the written testimony, but I think it

really calls for a certain kind of balanced policy where you really

have to get into the weeds of the details of the policy. But that is

the goal that we ought to shoot for, where everybody has an incentive to invest in all parts of the network.

In terms of the Tauzin-Dingell bill, I do not have any particular

comments to make as to whether it is a good or bad idea. I think

it goes to an earlier point I made, which is, yes, it is about investVerDate 11-MAY-2000 09:28 Sep 05, 2002 Jkt 000000 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 C:\DOCS\79320.TXT HBANK1 PsN: HBANK1
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ment, and, very frankly, if the bill were to pass, I would say the

obvious thing to investors, which is invest more money in Bells, invest less money in CLECs and IXCs.

I do not think the bill will, in at least the short and medium

term, affect the fundamental competition between cable and DSL,

because that competition, in my opinion, has a lot more to do with

the fundamental economics of providing broadband services, and

that goes to the economics of the networks. And I have read a variety of different studies, but just roughly speaking, I think the cost

for the Bells to provide a DSL services is, in rough order of magnitude, 30 to 50 percent more than the cable companies providing

a cable modem service.

You can really play with the numbers, because so much depends

on how many people you are serving. But my point is there are economic reasons that cable is beating the Bells that really have nothing to do, in my opinion, with regulation.

So I would just make that obvious observation, that it really depends on where you want the investment to go. But if you take the

point——

Mr. GRUCCI. If you wanted the investment to bring competition

into an area, how would you encourage that to happen?

Mr. LEVIN. Well, I think there are a number of things. For example, I think that one of the constraints on competition today is that

a lot of cities have regarded their rights of way as a money-making

opportunity. So they either tax or have some kind of fees on companies that, in my opinion, hurts competition.

If a new CLEC wants to come in and put in pipes under the

ground, obviously, the city has a right to get reimbursed for direct

costs, and, obviously, there are problems for cities of digging up

streets. I am not saying the cities have no rights here.

But on the other hand, if the city is essentially saying, ‘‘We have

a scarce resource, a right of way, which we should treat—and we

should kind of, shall we say, auction it off, or we should try to

make money here,’’ I think that is an impediment to competition.

I am delighted to see that a number of people, such as the NTIA

director, Nancy Victory, have recently said that this is a big problem.

Also, several States have taken action to prevent local Governments from using the rights of way in that way. But, frankly, a

State-by-State approach is much too slow, and I think Federal action may well be warranted to make sure that all facilities based

competitors have a right to the right of way.

Mr. GRUCCI. Just on that issue, I used to be the supervisor of a

township of 450,000 people, and we did have franchise agreements

with a cable company on Long Island. I almost shudder to use this

word in this town, but it is an infinitesimal amount of revenue that

came to the municipality as compared to what the gross revenues

of the cable company were.

For our municipality, it was probably less than $2 million a year

in franchise agreements, and I know that they made tens of millions of dollars in gross receipts from just my township alone.

While that may certainly add to the cost of the final product, which

is what the consumer pays for, I do not believe that is driving away

competition, because anybody would have the rights to that area.

30

The lease agreements would be open to anyone who wishes to come

and lease that space, the right of way.

I am concerned with these giant companies coming in, and if you

are saying that we have to accept the fact that this may only be

a game for the big players, then what happens when, as in the accounting industry, the big eight went to the big six which went to

the big five which is going now to the big four. I mean, what do

we end up with, one cable company throughout the entire country,

one telecommunications company throughout the entire United

States?

I do not think that would be good for the consumer. They would

end up paying the brunt of all of that.

Mr. GLENCHUR. Well, fortunately, the FCC is in the process now

of looking at how consolidation in telecom and in media—well, primarily in media—will impact the idea of having all voices brought

down to a small number, and whether it has impacts on the diversity of viewpoints and localism and the extent to which, historically, the FCC’s effort to protect that has worked, and they are

looking at that very issue. And I think maybe by the end of the

year, we will have a better sense about how this kind of consolidation, as we go to fewer players and larger players, will affect those

very issues.

Mr. GRUCCI. The issue that I am concerned with is how it affects

the consumer. Let me just say locally—because that is the issue

that is the topic of today—we have really one cable company that

provides access to the TV stations, other than a dish or an antenna, and a dish is the real small guy in the marketplace trying

to be a player.

There is a war going on now between the two top guys in the Yes

network and cable company, and as a result, the consumers are

being denied the ability to watch Yankee baseball games. And

while I am not a huge fan of sports—I enjoy watching it—there are

those who are, and they cannot access that unless they now go out

and get a completely different system for their homes. And that is

my fear, that if you end up with one or two companies where the

consumers can go for this kind of service, they are ultimately going

to bear the high cost of that new service.

Mr. MITCHELL. Well, I think your point, Congressman, is right

on—and I would suggest that, in fact, you can create a very viable

business model around serving Long Island, Westchester County. I

invest in companies that do exactly that—60,000 customers in

Westchester County, and why those customers come to work with

my little CLEC that does not have enormous levels of facilities and

all this pipe and what-not—they come because we have clearer

bills, which might be less expensive.

When they call to get another line put in their house, we respond

on the phone immediately. We come out and provision that line in

5 days in a very reliable fashion.

Basic consumer facing service improvements are enough for a lot

of customers to make a decision to change from the regional Bell

to a competitive player. And that basic initial building block, if you

can do it profitably, will allow you to build the cluster of customers,

like one of my companies that has 60,000 customers in Westchester

County, and then we can take a look at whether or not we should,

31

in fact, be investing in additional facilities that allow us to bring

more innovation, broadband services, and other things.

We have got a profitable cluster of customers, and that makes

me, as a capital investor, much more anxious to look at making additional investments of capital into that company. I think the Act

has a provision for that, and I think what we have to be very careful about in the Tauzin-Dingell bill is the opportunity for the entrenched historic monopoly businesses to find a safe harbor in data

and broadband, which actually can serve as sort of the next generation voice network as well, and sort of leave behind to that small

customer service innovator that wants to become a product innovator an antiquated system or an antiquated methodology.

And if you give them the safe harbor, they will take it. There is

absolutely no doubt about it, and——

Mr. GRUCCI. Isn’t that what happened with the cable companies?

Didn’t they find a safe harbor in the Tauzin-Dingell bill?

Mr. MITCHELL. I am less able to speak to the issues in TauzinDingell relating to cable than I think—and telecommunications.

But I think the same concept applies.

Mr. LEVIN. Could I just real quickly give the——

Mr. GRUCCI. Sure.

Mr. LEVIN. The question about media ownership, in particular, I

think is one that really needs to be on the radar, because the

courts have significantly undercut the FCC’s ability to actually regulate in this area. But I think it is worth noting that this debate

over the S network—there is a certain kind of—the marketplace is

working to a certain extent. A cable company is not carrying it, one

satellite company is not carrying it, but the other satellite company

is.

In fact, in the most recent quarterly results of Direct TV, they

had a big increase in subscribers, and a lot of people think it has

to do with the fact that a number of people chose to get the S network, and they want to do it. I think that, you know, it is an interesting question, which I am sure the folks at the Department of

Justice and the FCC will look at. If you allow the two satellite guys

to merge, then what happens to that competitive dynamic for programming?

So that is a very important question. I generally tell investors

what I think will happen in the world, whether or not it is a good

thing or a bad thing. You obviously have to worry about what is

being served in the public interest here.

I would just say that I think these issues of ownership are incredibly important and deserve an awful lot of study. And we have

to be very careful, because, in fact, I think both the telecom industry and the media industry have delivered an awful lot of benefits

to American society, both in terms of providing a diversity of viewpoint as well as economic growth.

Mr. GRUCCI. Thank you, Mr. Chairman. I appreciate your indulgence and your generosity with the time.

Chairman KING. Thank you, Mr. Grucci. I think you went a bit

overboard, though, in being such a strong advocate for the

Yankees, especially since the Mets are doing considerably better

than the Yankees lately, and I think your constituents, even

32

though they elected you, are still too enlightened to get that excited

about the Yankees when the Mets are the proper alternative.

Ms. Capito, do you have any questions?

Ms. CAPITO. Thank you, Mr. Chairman. I have no questions.

Chairman KING. We have votes coming up in the next several

minutes. Do any of you want to comment on any of the points that

your fellow panelists made this morning? I am not trying to look

for a fight, but is there anything you want to add or amplify on

a point that was made by one of your fellow panelists?

Mr. GLENCHUR. I would only say, again, that with respect to

what we need to do, in terms of Tauzin-Dingell or any other regulatory efforts to modify the competitive landscape, the rules that

players will compete under, that we just be very, very cautious

about how much unpredictability that can create and how expectations about the future have to adjust and whether it actually deters

investment in the sector. I think that those are not easy questions

to answer, but I think that we do need to be cautious about that.

Chairman KING. I want to thank the witnesses for their testimony. You have gone above and beyond the call of duty. We greatly

appreciate it, and I speak for myself and the Ranking Member, Ms.

Maloney, and the other Members of the panel.

I also want to note that a number of Members may have additional questions for the panel, and, without objection, the hearing

record will remain open for 30 days for Members to submit written

questions to witnesses and to place the responses in the record. So

ordered, and, with that, the hearing stands adjourned.

Thank you very much.

[Whereupon, the hearing was adjourned.]

(33)

A P P E N D I X

April 18, 2002

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