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July 04, 2002

MCI-WorldCom: The Cooked Books of Telecom Deregulation

[This is an op-ed based on my upcoming book, so check out the main sources here, here and here (this is the old version from 1998)]

So MCI-WorldCom cooked its accounts to hide $3.8 billion of costs in the last few years.

Big deal.

That's pretty small potatoes compared to the trillion-dollar fraud that sold telephone deregulation to the public. The raw fact is that there was no technological innovation, no enhanced business efficiency that built WorldCom, or earlier created the MCI long distance service. From day one decades ago, all the hype of telephone competition and its profits were built on shady accounting, some in the boardrooms of Wall Street, some in the regulatory halls of Washington.

Bernie Ebbers of WorldCom built his empire on the hype of the Internet, buying up spinoffs from the government, such as its UUNET Internet services division which began life as part of the Defense Department. Using soaring stock values, his company engaged in a series of company takeovers that had little to do with innovation, and much to do with financial manipulation.

And even the profits of the core Internet services were based on regulatory sleight-of-hand. Since the breakup of AT&T, the Federal Communication Commission (FCC) had given Internet providers access to local phone lines, without them having to pay the same per-minute charges as long distance companies. The reason Internet providers could provide flat fee access to the Internet at cheap prices was that they had subsidized access to local phones, paying as little as one-twentieth of long distance charges. This despite the fact that the costs for handling each kind of call were the same for the local phone company.

But this regulatory sleight-of-hand pales compared to the full-scale fraud that birthed MCI and full phone competition back in the 1970s. Like Ebbers, pioneering MCI CEO Bill McGowan was no innovator, just a master manipulator of public relations and the markets. McGowan had been trained in the lumber industry where his specialty was getting subsidies from government lands and trumpeting the results as a free market success story. In building MCI, he saw the FCC as a similar target.

The key to MCI's growth was expanding its long distance services, while escaping the responsibilities to fund local phone infrastructure that AT&T was responsible for in the 1970s. This regulatory reality would give MCI the illusion of efficiency, when the reality was of a company surviving only based on regulatory subsidies.

MCI had expanded in the late 1960s selling private microwave-based services for internal corporate communication. Its break came in 1969 when it convinced the FCC to allow the firm, after relaying a call to another city, to use local phone service to finish the connection between corporate offices in different cities. While the service was limited to calls within the same company, it was a hotly debated precedent for long distance competition that passed by only one vote. That the firm soon hired FCC Commissioner Kenneth Cox, a deciding vote on the decision, just added to the controversy.

MCI rapidly expanded its private line service from city-to-city, but could not turn a profit and was soon facing bankruptcy. So in 1974, the firm created a service it labeled Execunet that allowed firms to call other companies, essentially a long distance competitor to AT&T. When the FCC realized what MCI was up to, they ordered the company to stop. But in a surprise turn of events, a federal Appeals Court ruled in 1977, based on a complicated reading of administrative law rules, that the FCC could not restrict the Execunet service. Without a vote by Congress or approval by a regulatory agency, MCI had maneuvered to create long distance phone competition based on judicial fiat.

But MCI's real triumph was negotiating an agreement with the FCC that its fees for using local phone service would be half of that assessed against AT&T for its long distance charges. This meant that MCI could charge 20% less than AT&T with the same costs. With MCI charging so much less for phone service, the myth of the efficiency of phone competition was born.

The reality was very different. AT&T's regulated monopoly had been a paradigm of both productivity and consumer service. By 1980, monthly residential phone service had dropped in price by two-thirds since World War II, even as phone quality and the percentage of homes with phone service had risen from 37 percent in 1956 to 93 percent by 1980. Its Bell Labs was a font of technology innovation and the firm's productivity exceeded almost every other industry in the nation.

But MCI's fraudulent promotion of its own "efficiency" and its regulatory advantage undermined the Bell system and by 1983, AT&T agreed to its own breakup and the birth of full long distance competition. While "experts" hailed this bold experiment in deregulation, 64% of the public polled at the time declared the breakup a mistake as they saw their local phone bills spiking up.

Just as the supposed profits of MCI-WorldCom turned out to be based on fraudulent bookkeeping, so too were the promised advantages of telecom competition. Many commentators are worried that WorldCom's demise may also mean the end of telephone deregulation.

We can only hope we are so lucky.

Posted by Nathan at July 4, 2002 10:59 AM

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