Maybe you have already seen the piece, "Strike Up the Broadband," in the January 26 edition of the Weekly Standard, but I just read it tonight. (I know--I should have better things to do on a Saturday night than reading another article about broadband!)

The author says all the right things about how the FCC needs to quickly clarify its Triennial Review Order broadband rules, for example, by declaring that the ILECs to not have to unbundle new fiber facilities to apartments buildings and businesses. The author sums up by concluding: "Leaving broadband trapped in a regulatory morass skews the incentives for deployment, ultimately hurting American consumers (fewer products) and workers (fewer jobs). It is time for the FCC to keep its promises and bring broadband regulation into the 21st century."

Well, we here at PFF have been saying much the same for six or seven years now. What struck me about the Weekly Standard piece is the author--Jay Lefkowitz. Jay is now a Washington lawyer, but until a few months ago, as the author tag indicates, he was "head of the White House Domestic Policy Council." Wouldn't it have been nice if, in his capacity as Domestic Policy Council chief, Jay had been able to get the Bush Administration to articulate the same deregulatory broadband policy he now articulates and to convey the Administration's support for such a policy to the FCC?

Yep, it would have been. But better late than never. Maybe, from the outside, Jay can phone home and convince the Administration folks that what he says in his article is true--that "the opportunity for a new boom is just around the corner" if only the regulators will implement meaningful regulatory relief.

PS--Whatever you do, do not tell my wife I was doing this on Saturday night.

I recently published an article "Today Linux, Tomorrow the World?" in the ezine TechCentralStation. The piece discussed the phenomenon of open source software, with particular focus on the effort by some (called "leftist academics" by me, but feel free to substitute a more neutral term if you like) to extend the model to the production of other types of intellectual creations.

One thing I have learned in writing about the topic of open source is that it usually produces intense flame wars. This effort is an exception, so far; I did get objections, but they were uniformly thoughtful and courteous, and they made some excellent points.

Attached here are my capsule descriptions of the comments, together with responses. At the end, the comments are attached in full. The names have been removed, however, since we have not sought permission to disclose them.

We look forward to more dialogue on this important topic.

You only have to visit Texas once to know how proud the natives are about their state, their music, their bar-b-que and just about everything in Texas.

The Texas Public Policy Foundation is wrapping up a big two-day legislator orientation session that covered a raft of issues from taxation and education to water and telecommunications policy. Ray Gifford was in Austin to speak on the telecom issues with Cato's Adam Thierer and Bruce Fein. While Adam and Bruce duked it out over federal unbundling requirements, Ray stayed focused on local and state law concerns. Hint: The imperative for retail rate deregulation and the elimination of in-state rate distortions that result from regulation were central to his presentation. If your interested in what he covered, this paper is an excellent primer.

State representative Phil King moderated the panel. King is Chairman of the House Regulated Industries Committee and we'll look forward to working with him as the debate heats up in the heart of Texas.

Adding to Randy's posting regarding the triennial review oral argument this morning (see two postings, below):

Delegation - As Randy indicated, Judge Edwards appeared to be skeptical of the FCC's broad delegation on switching (and thus, UNE-P), stating that all of the cases the FCC relied on in its brief on delegation were "inapposite" and that the Telecom Act provides the states with a narrow, limited role. Judge Edwards also insinuated that the FCC saw the triennial review as a "headache" and wanted to send it somewhere else. Additionally, Judge Williams questioned whether aspects of NARUC's argument on delegation were ripe for review.

Obviously, it's dangerous to predict how judges view a case based upon oral argument. But this line of questioning, including several other questions from the panel about what the proper remedy should be if the delegation were held to be unlawful (no easy issue, to say the least), has to look ominous from the state...uh, well at least the NARUC, perspective. And given the complexity of the case, I would be surprised to see a decision come out as quickly as some have been hoping for (i.e., February or March). In short, the possibility that states will conduct a healthy portion of their mass market switching proceedings, only to have their authority to do so struck down, appeared to increase today.

Hot cuts - this portion of the TRO probably won the runner-up award for argument time. Judge Randolph questioned the evidentiary value of the FCC's hot cut analysis, where it appeared to base its findings on "assertions" and "statements" made by commenting parties. Judge Williams probed the parties on questions such as scalability, the batch hot cut process, and whether switches are more like airplanes or dams.

Otherwise, Judge Williams drove the debate almost single-handedly on the other issues raised today, including aspects of the impairment standard, the interplay between sections 251 and 271 (and the appropriate pricing methodology), investment incentives (the FCC's counsel declining to concede that TELRIC rates have been falling), EELs, broadband, special access, etc. etc.

In August 2002 the Missouri legislature passed a law to guide municipalities' entry into the telecom market. Among its features, the legislation calls for an annual report from the MO PSC to the legislature on the economic impact of municipal telecom. When the report becomes available online, a link will be posted here.

There is some variance with the Missouri data collected in a survey done by The Progress & Freedom Foundation. In all, we found 19 municipalities engaged in telecommunications activity while the PSC only reported 15. The PSC found one more municipality offering Internet service, 10, than we did in October when we reported nine. The discrepancy can probably be attributed to a difference in definition: At PFF we count public utilities, like power and water, as inherently governmental entities while the state only looked at cities and other political subdivisions. In all, there was startling consistency between the reports.

More on the methodology: The PSC mailed questionnaires to 640 municipalities and received 340 responses. Then, a more detailed questionnaire was mailed to municipalities that indicated their participation in the telecom marketplace. Self- reporting was critical to the data collection and may result in a slight bias toward under-reporting in the state's survey or inconsistency in the application of certain definitions.

Roughly half of the municipal telecom providers report that revenues don't meet costs. The City of Albany reported, "it sold its Internet operation to a private entity because its Internet operation was too resource-intensive." In a telling note, the report summarized that "some cities view the provision of data transmission services as a means of increasing revenues" and that there "appears to be a demand for higher speed data transmission capabilities" in rural areas of the state.

Kudos to the legislature for requiring an economic impact statement on this flashpoint in the telecom sector. The report from the PSC is a well-documented survey of the landscape with up to six appendixes, but sadly does not really assess the economic impact of this type of municipal activity.

Well, I just sat through the two and a half hour oral argument before the DC Circuit reviewing the FCC's August 2003 Triennial Review Order. With the usual disclaimer that what is said at oral arguments is sometimes not a good predictor of results, here are two quick impressions:

1. The three judge panel, especially Judges Edwards and Randolph, seemed very concerned that the FCC violated the 1996 Telecom Act by delegating too much decisionmaking authority to the states to determine whether "impairment" exists for network bundling purposes. I'm not certain the court will reverse on this point, but the chances look pretty good it will. Never one to say, "I told you so," I'll merely point you to my piece, "A Call for Real Federalism," published in Legal Times in March 2003. There, commenting on the FCC handing over to the state PUCs too much authority, I said: "In the end, such a misuse of federalism, properly understood, leads to unsound communications policy making. And the bet here is that it will lead to yet another defeat in the courts for the FCC's network sharing rules." (Apart from the legal issue, to understand why, as a policy matter, telecommunications networks are changing in a way that renders the traditional state regulatory role much more problematical, see Doug Sicker's "Delocalization" paper released yesterday by PFF.)

2. On the impairment issue itself, Judge Williams did most of the tough questioning, seemingly trying to figure out a way--consistent with the statute's ambiguity--to rule that the FCC is still tilting too far in the direction of too much mandatory unbundling. Judge Williams clearly believes--as do I--that excessive unbundling is a disincentive to new investment by both the ILECs and CLECs. What is less clear is whether there is an effective remedy that Judge Williams and his colleagues can envision themselves imposing under the statute as currently written that will require the FCC to materially further restrict unbundling. I don't think the court wants to get itself in the position that Judge Greene was in after the AT&T breakup of overseeing the intricacies of the telecom industry. And I doubt the Supreme Court will allow the DC Circuit to put itself in that position.

What a pity that Judge Williams was not one of the key drafters of the 1996 Telecom Act or the FCC Chairman leading the effort to draft the initial overly regulatory unbundling rules. Oh well, he probably would not have wanted to trade in his robes!

Anyway, and importantly, the court didn't give any overt indication that it is inclined to reverse the FCC's elimination of the unbundling mandate for new fiber and packet-switched facilities, that part of the TRO order that is more future-oriented than the circuit-switching part. Assuming the FCC makes some important clarifications on reconsideration that allow ILECs more broadly to roll out new fiber without the unbundling obligation hanging over their heads, it looks like the positive deregulatory step the FCC took regarding new facilities will probably stand up in court.

PS--I didn't stick around for the post-argument spin, but I suspect, as was the case in New Hampshire after the results were reported last night, the spin out of the war rooms of all of the contesting parties, whether CLECs, ILECs, the states, or the FCC, was: "We won because...[fill in the blank here yourself]."

According to Tuesday's Wall Street Journal, Harris Interactive just released a poll finding that three-quarters of adult Americans believe downloading music from the Internet and reselling it is wrong, but that downloading for personal use in "an innocent act." Interpretation of this finding is clouded by Harris Interactive's decision to ask a single question combining both of these issues. It is not clear whether the results are mainly attributable to the agreement that downloading and reselling is wrong or agreement that downloading for personal use is OK. (In addition, the survey did not distinguish between unauthorized P2P downloads and downloads from the rapidly growing authorized online music services.)

Further complicating interpretation is the fact that nearly two-thirds (64 percent) agreed that "musicians and recording companies should get the full financial benefit of their work." How companies and artists could be expected to obtain full value if free music downloading is permitted was not covered in the survey.

Since many Americans engage in P2P downloading for personal use, it is not surprising that they would like to think the activity is innocent. The price is right. But if unauthorized P2P transfers are treated as innocent, many consumers will opt for free content, free-riding on the increasingly small number of paying customers who foot the bill for content creation. The availability of high quality content will suffer. Consumers as a group will be better off under a regime that protects rights in content and thereby promotes the development of legitimate markets in digital content. (For more on market approachs, see the recent study by Professor Robert Merges.)

Everyone who follows the IP business knows about RIAA v. Verizon -- the D.C. Circuit ruling that section 512(h) of the DMCA does not empower a copyright holder to lay a subpoena on an ISP demanding the identity of an unauthorized P2P music downloader, unless it has already filed formal legal action against an unknown "John Doe."

It turns out that the issue is not closed. RIAA subpoenas are also being litigated in the 4th and 8th Circuits, and in those venues the industry is arguing that the D.C. Circuit was wrong. The cases are still at the trial level, or at preliminary stages of appeal, so briefs are not yet available, but the crux of the RIAA's argument can be found in the opinion of the district court that was reversed by the D.C. Circuit. Also, the industry has not yet decided whether it will seek rehearing en banc or Supreme Court review of RIAA v. Verizon.

An analysis of the issues, written before the D.C. Circuit decision, is here. Many experts were surprised by the D.C. Circuit decision, so the other circuits could come to a different conclusion.

This one is going to dive deep into regulatory arcana, so run for the exits (or the back button now).

Verizon is none too happy about a recent NH PUC Order setting its cost of capital in the state. Indeed, Verizon is "shocked and troubled," emotions not easy for a corporate entity to muster.

The New Hampshire Order goes through a discounted cash flow analysis of Verizon New Hampshire to arrive at an average weighted cost of capital of 8.2% (see page 70 of the Order). This figure is the product of Verizon's imputed capital structure, estimating the cost of long- and short-term debt, along with the cost of equity. The pressing question now: Who cares?

First of all, Verizon cares. The decision on its cost of capital forms the kernel for all its wholesale and retail rates in New Hampshire. A higher cost of capital leads to higher rates; conversely, a lower cost of capital leads to lower rates. For Verizon, a lower cost of capital makes them less likely to invest in New Hampshire, particularly if the regulator-set rate is below its actual cost of capital. CLECs care, but in the opposite direction. A lower cost of capital makes for lower wholesale rates. Paradoxically though, the CLECs' presence and competitive threat to Verizon is the very thing that would tend to inflate Verizon's cost of capital. A low cost of capital is associated with Verizon's former status as a regulated monopoly.

Consumers, meanwhile, want the right cost of capital. Call it the Goldilock's principle: a too high cost of capital assumption leads to artificially high rates; a too low cost of capital assumption leads to low rates, but also reduced investment -- and the short-term pleasure of artificially low rates will be more than offset by the long-term effects of reduced investment.

But what is the right answer for the cost of capital? Like many regulatory determinations, the process pretends to a rigor and precision that is just not there. You can express DCF analysis mathematically (this page has a good discussion of DCF analysis, which has much wider application than just the regulatory sphere). But the big decisions arrive in estimating the discount rate and other forward-looking assumptions that predict the risk that a given firm faces. These numbers are by no means clear. Indeed, they are particularly difficult to estimate in a dynamic market like communications where the technology, market definitions and players are in great flux.

DCF analysis is therefore so plastic that it allows illegitimate concerns to drive the analysis. Thus, if the desire is "low rates" then arriving at a low average weighted cost of capital is a way to do it. And this is the problem. The inability to make any analytically rigorous input assumptions allows secondary concerns to predominate. Do I want to induce entry --even artificial entry -- into the market? Then derive low wholesale rates that will make entry attractive. Cost of capital assumptions are just the ticket, too, for they plug into the rate formulas at an elemental level and hence cascade through the rate structure. However, it is very difficult to say definitively that the NH PUC decision is wrong. It looks low. It uses some questionable assumptions, to be sure, but there is enough indeterminacy in the analysis that it is on the outer bounds of defensible-ness.

DCF analysis, like so much rate setting, is an exercise in analytic futility. And I know of what I speak. In 2002, I set a cost of capital for Qwest of 9.55% here. I am not denying it must be done, but you don't want to do it very long, and regulators need to be conscious of the effects and incentives they face when making these exceedingly difficult decisions.

This brings me to my final point about the difference between regulatory versus market supervision of an industry. When regulators get something wrong, those errors will be durable and difficult to reverse. Decisions will be made in New Hampshire -- by Verizon and by CLECs -- based on this remarkably low cost of capital. Reliance interests will congeal around this and -- if it was erroneously low -- it will be difficult for the NH PUC to back out of it, for they will be raising rates if they do.

In contrast, markets use DCF analysis to value companies and decide whether they are worthy of investing in or not. Erroneous DCF analysis in a market leads to an investor losing money, a disciplining effect that tends to concentrate the mind. Furthermore, investors' incentives to get DCF analysis "right" are strong. Do it right, you make money; do it wrong, you lose money. Contrast that to regulators' incentives where low-balling the cost of capital yields lower rates, but the negative effects are foisted off on the company and its shareholders. [Mind you, low rates issuing from an accurate assumption of the cost of capital are a good thing. Mistakenly low estimates of the cost of capital slowly desiccate the company you are regulating.]

Verizon, of course, has choices where it can allocate its capital, and this will provide the long-term discipline to the NH PUC and other regulators tempted to reach unrealistic cost of capital assumptions. Verizon will invest where it gets the best return. NH may not be that place.

The Cato Institute has just posted a piece by Professor Robert Merges of the University of California-Berkeley entitled Compulsory Licensing vs. the Three `Golden Oldies': Property Rights, Contracts and Markets. The accompanying press release says: "America's creative energy and entrepreneurship are known the world over. Property rights, contracts and voluntary markets have played a primary role in the development of our vibrant industries. . . . . Merges argues that these, the 'building blocks of all creative endeavors,' are just as relevant in the digital era as ever, and, in fact, underpin the conditions for 'future growth and diversification' in intellectual property."