Local-loop fiber optics stymied by the Fifth Amendment

Aug 1st, 1996

Local-loop fiber optics stymied by the Fifth Amendment


Regional Bell operating companies want financial compensation for the full cost of the copper plant that remains in their local telephone loops and plan to achieve their goal by invoking the U.S. Constitution`s Fifth Amend ment. People think of the Fifth Amendment as protecting an individual`s right against self-in crimination. The public is used to seeing Congressional investigations in which individuals refuse to answer questions on the grounds that they may incriminate themselves. As expected, the telephone companies will use the law in a different way to counteract a portion of the Telecommunications Act. The companies argue that in certain conditions the Act lets government confiscate telephone company property. They assert that confiscation is contrary to the Fifth Amendment, which says, "...nor shall private property be taken for public use, without just compensation."

The property in question is the telephone network`s local loop, the so-called last mile composed of copper and carrying customers` telephone calls from their premises to the companies` switches, where the call is routed to its destination. The copper loop may eventually be replaced by a fiber optics loop, but that will not be anytime soon. When copper loops were installed, they had a life of approximately 40 years. Today, the loops have 10 to 20 years of life left. Supposedly, the only way to speed up their retirement is to allow the companies to recover the full cost of the local loop. For example, if the loop costs $4000 to build and its life is 40 years, the cost recovered each year is $100, and the company waits 40 years before replacing its copper loop with a fiber one. The wait could be shortened if the $4000 were recovered in 20 years, which means doubling the annual cost from $100 to $200.

The example depends on the company being a monopoly: No company can wait to deploy new technology if the delay allows competitors to take away business. Will telephone companies lose business if they insist on recovering the full cost of the copper loop before deploying new technology? Professor Ron Choura of Michigan State University`s Department of Telecommunications does not think so: "There is no real competition, and the needs of the customer are not a factor in what the monopoly companies provide. All they are interested in is how to squeeze profit out of the obsolete [copper] twisted-pair network."

The incumbent local telephone companies want their cost recovered through interconnection charges, the fees that competitors pay to connect to a local customer. For example, if AT&T were to use any portion of a local company`s network to provide local service to consumers, then AT&T would pay an interconnection fee, which has two economic purposes: It allows the local companies to recover the loop`s full cost, and it gives competitors an incentive to build their own local networks.

These subjects were discussed recently at a public meeting hosted by the Federal Communications Commission, which invited 20 prominent economists to examine the issues. Jerry Hausman, economics professor at the Massachusetts Institute of Technology, said, "I think the real potential worry is that the Ilecs [local telephone companies] may decide to charge too little and [therefore] deter entry of facilities-based competition." Carl Shapiro, professor of economics at the University of California, Berkeley, had a different opinion: "We know in a competitive market that if you have invested in technology, and competitors are able to enter with new technology...you have to depreciate...in an economic sense.... That leaves open the possibility that certain investments have been made that are inefficient and would typically not be recovered..." Other opinions ranged from total support of the companies` claims to total opposition. The economists agreed with an unidentified speaker, who said: "I think it would be a little self-aggrandizing for economists to think that this is primarily an economic issue. I think the legal issues are going to weigh far more heavily." William Taylor, an economist with National Economic Research Associates, said, "The Telecommunications Act does not directly address [the compensation issue].... On the other hand, [the Act] does not obviate the Fifth Amendment prohibition against confiscation."

Taylor accepts at face value the companies` position, but there is more to it then meets the eye. In the parlance of the legal community, the Fifth Amendment`s phrase, "...nor shall private property be taken for public use, without just compensation," is called the "takings clause" and confiscation is called "a taking." The companies argue that "just compensation" means recovering the full cost of the loop; anything less is a taking.

Proponents of the local telephone companies are linking the takings clause with the Telecommunications Act. In his recent article, "When Competition Amounts to Taking" in the National Law Journal, Gregory Sidak of the American Enterprise Institute publicly advocates the telephone companies` position: "It is easy to cheer the arrival of competition. ...The transition from regulated monopoly to competition...is not free.... Competitive entry and interconnection mandated by [the law]...may cause a taking.... Deregulation without...the appropriate setting of interconnection prices...transfers income from utility shareholders to their customers and competitors." This reasoning establishes a role for economic analysis in the assessment of the takings argument, to wit: If the Telecommunications Act is transferring income between groups, is that transfer always a one-way street, or does the income move both ways? The price of telephone company stock increased 35% to 60% last year. This increase is directly caused by the Telecommunications Act. In addition, the market value of the companies` stock is nearly three times the stock`s book value, despite the financial write-off of the telephone companies` assets. Clearly, shareholders have benefited from the Act because it has directly increased the value of their holdings. The precondition required to invoke the Fifth Amendment--economic loss--is absent and may prevent the telephone companies from successfully pressing their claim to compensation.

The recent history of Fifth Amendment cases is presented in Private Property and the Limits of American Constitutionalism, authored by Professor Jennifer Nedelsky of the University of Toronto. Nedelsky examines several cases in federal and state jurisdictions and draws two important conclusions that apply to the telephone companies` view of the takings clause. The courts have interpreted the takings clause to mean that government may take private property only for public use. If the intended use is not public, then government has no authority to take private property. Because interconnection is a private use for competitors, the companies may argue that interconnection cannot be mandated by law and may be established only voluntarily by the companies. Nedelsky suggests this tactic would not be effective because, "in practice, `public use` has long been defined broadly.... The determination of what constitutes public use is left largely to the legislature." Under the Telecommunications Act, interconnection could easily be defined as a public use. Nedelsky emphasizes that the most important issue is "whether those who lose as a result of the redistribution of property bundles ought to be compensated."

Physical invasion of property

However, if there is no loss, there is no compensation. The companies hope to sidestep this problem by relying on the idea of "physical invasion" of property, a legal concept advocated by the current head of the U.S. Supreme Court, Chief Justice Renquist, who wrote, "[Where there is] an identifiable segment of property...the effect of [government regulation] on the holder of the property is indistinguishable from the effect of a physical taking." From Renquist`s statement Nedelsky infers: "The task of judicial defenders of property is to make regulation appear like [physical] invasion." She also says that Renquist`s phrase, "an identifiable segment of property," allows any piece of property, no matter how tiny, to be treated by itself, as if it were not part of a larger whole. In the legal community, this separateness is called "conceptual severance." Nedelsky says this concept means that "every regulation of any portion of an owner`s [property]...is a taking of" the property. Nedelsky concludes: "Conceptual severance could mean that virtually all economic regulation would require compensation."

Nedelsky published her book in 1990, and it may have been a conceptual source for Sidak`s article. He takes her advice and makes the Telecommunications Act look like physical invasion of a telephone company`s property. He says, "Deregulatory...policies can work a taking in several ways. For network industries the most important of these is mandatory interconnection...at specified prices, which constitute a government-ordered, physical invasion of the property of the incumbent regulated firm." When this language is joined to the concept of "conceptual severance," the telephone companies` legal assertion becomes clear: The courts must view interconnection as an economic loss, and the courts cannot balance this loss against the broader gains that have already accrued to the companies` stockholders. This is Renquist`s "conceptual severance" in action: It prevents the judiciary from summing economic losses and economic gains to arrive at a net amount to assess the Telecommunications Act`s "takings" --only losses matter.

If this principle is applied to the Telecommunications Act, many negative results are likely. It relieves the local telephone companies of all risks they may have suffered as the telecommunications industry transitions from monopoly to competition. Interconnection prices will be higher than they would otherwise be, and fiber optics is not likely to enter the loop anytime soon. The "takings" issue also demonstrates a failure of the legislative process because all knowledgeable people involved with the making of the Act knew the "takings" issue was imminent, but no one wanted to deal with it, preferring to let the courts handle it. Congress passed the Act to remove telecommunications policy from the jurisdiction of U.S. District Court Judge Harold Green, who presided over AT&T`s divestiture and its subsequent legal actions from 1984 to 1996. It is ironic that Congress and the telecommunications industry are once again placing into the hands of the judiciary a major policy decision about the nation`s communications infrastructure. q

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