2nd Quarter 2002

Ground Zero of the Telechasm

Three years ago telecommunications was the shining star in Mississippi's economic firmament and Bernie Ebbers was the swashbuckling entrepreneur every would be tycoon aspired to be. No more - what a spectacular slide from the penthouse to the outhouse. Jackson and Clinton now stand at ground zero of one of the biggest wipeouts of an industry in American history. Seventy bankruptcies with at least twenty more to follow, $100 billion in telecom debt in default, over 500,000 jobs lost since its peak in late 2000 and an approximate $3 trillion loss to investors in telecom and the related industries in its food chain.

To listen to the drumbeat of politicians and media pundits one would conclude this calamity is largely the result of bubble headed investors, shady accountants, shyster investment bankers and corrupt CEOs. That works well for sound bites and headlines but it is woefully inadequate in explaining one of the great economic catastrophes of our time. As often happens with complex issues, the search for the truth and the search for someone to blame are two entirely different things. Yes, it seems certain that there was corporate wrong doing but there were larger forces at work.

Bear markets and depressions in particular sectors of the economy are almost always the result of macro forces stemming from government policy errors. Inflation, deflation, over-taxation and trade wars are four prime examples. Today's telecom depression is a direct result of deflation and a dysfunctional regulatory environment at the state and federal level.

Enthusiasm and entrepreneurship go hand in hand. The entrepreneur is the consummate promoter and risk taker, leaving the safety of tenure and secure wages to charge off across the uncertain fields of change and opportunity in the hope of helping to shape the future. Where would America be today if an overly enthusiastic Christopher Columbus hadn't sold Queen Isabella on his "pie in the sky" view of distant riches in the far off unknown? That whacky plan to sail three rinky-dink ships off over the horizon was the hottest I.P.O. of the 15th century and probably the single greatest investment of the past thousand years, both for Queen Isabella and the millions of people who flowed through the doors she cracked opened.

Alas, one dreamer's excitement is another man's irrational exuberance and if that other man is a central banker it can have a chilling impact on the first man's dreams. In the late 1990's the Federal Reserve went so far as to suggest that rising stock prices might cause inflation. With that questionable theory in hand they raised rates higher and higher, slowly and inexorably dehydrating the economy. The result was a deflation unlike anything we have seen since the 1930s. Gold dropped by 30%, farm commodities dropped by more than 30%, corporate pricing power dried up and with it profits. The only thing rising in value was the dollar, signifying of course the scarcity of the crucial unit of account.

Deflation is insidious for large issuers of debt - the product or service you are selling is likely dropping in price while your debt must be paid back with ever more valuable dollars. The biggest debt issuers in the 1990's were - you guessed it - telecom companies. Today's scurrying CEOs and CFOs are like flopping fish at the bottom of a drained pond trying to find that last puddle of liquidity. But deflation was not the only ominous cloud in this perfect storm that hit telecom. The Soviet Union proved to everyone that central planning doesn't work, but the FCC and 50 Public Service Commissions didn't seem to learn the lesson.

The Telecom Act of 1996 promised new competition and vast new opportunities for innovative start-ups. Its passage coincided with the rollout of new technologies in fiber optics, wireless and semiconductors and a new killer software application - the Internet browser. It was what pioneers, venture capitalists and investment bankers hope for but alas, it was too good to be true.

The Act's promised deregulation became in practice re-regulation. A century of regulations designed to provide cheap monopoly voice service does not go away easily. The FCC balkanized the industry as if local, long distance, wireless, cable and satellite didn't overlap and compete with each other. Some spectrum auctions ended up in court where litigation paralyzed carriers that needed to move swiftly to build out networks and generate revenues to meet business plans.

Obtuse pricing rules on the "unbundling" of local facilities resulted in diminished investments in broadband access to the home. Imagine building a nationwide Interstate highway system in record time only to find out that red tape and bureaucratic bungling had allowed the building of only a few on and off ramps. The result would be disappointing traffic growth and shortfalls in expected revenue.

Lastly, consolidation - a natural development in maturing industries - was forbidden. While Exxon and Mobil were merging to become the third largest company in the world, regulators prevented WorldCom's proposed merger with Sprint on the silly proposition that they might monopolize the Internet.

There are a multitude of lessons to take from the past five years. A few to concentrate on:

1. Deflation can be every bit as dangerous as inflation. Fortunately liquidity has greatly improved over the past year and economic indicators are very encouraging.
2. Unscrupulous executives will do unscrupulous things, especially when the going gets tough.
3. The government's regulatory environment is vitally important, and it is vitally important that they cease meddling with the most dynamic and innovative industries in the economy.
4. America's entrepreneurial form of capitalism is built on dreams - they don't all come true but they do create the future.
5. And finally, "Bubble" is a term non-dreamers use to explain what they don't grasp.

A version of this article first appeared as a column in the September 2, 2002 edition of The Clarion Ledger and is reprinted with permission.

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