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The Hidden Truth behind the Merger Block

Mises Daily: Wednesday, September 14, 2011 by

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"Sprint's financial interests are driving this lawsuit by the DOJ."

So yeah, I'm a geek. So much so that it really starts to eat into my productivity. In fact, I'm even falling behind in my geek duties. Dungeons and Dragons; War Hammer 40,000; Starcraft II I just can't keep up with it all. I haven't even finished season 3 of Battlestar Galactica yet. Yes, I know, it's a sin, but I'm trying my hardest. Really, I am!

In a way, I really can't blame my fellow geeks for not taking the time to study economics. There is a lot of material to cover. By rights, nearly everyone in America should know this stuff like the back of their hand. You would think after 12 years of public education, the masses would have learned something about how the world works. Unfortunately, most of the half-truths and lies that we learn in school are taken as dogma by most — most people I know, anyway.

On the other hand, we've been in a depression for how many years now? Is there really any excuse for not knowing this material by heart? Is there any excuse for not knowing at least how banking and interest rates work? With all the failed government programs, the trillions of dollars wasted, doesn't this at least warrant some skepticism, if not the questioning of every positive thing you've ever heard about government from your government-paid teachers?

Last spring, I wrote an article about AT&T's plan to purchase T-Mobile, the US branch of the German company Deutsche Telekom. Since then, Sprint has been lobbying the Justice Department (DOJ) to block the deal, and the geek pundits have been steadily writing editorials denouncing the merger as AT&T's attempt to restore the old Ma Bell monopoly. Being a geek myself and a regular reader of all the latest tech talk on smart phones (holding out for that blessed day when the iPhone will finally have a micro SD card slot), this was big news for me as well. At the time, it wasn't clear exactly whether or not the federal government would oppose the deal. My goal was simply to provide a free-market view of the merger in order to counteract what I saw as a large volume of writing that was tech savvy, but historically and economically ignorant.

On August 31, the US Department of Justice announced it was suing AT&T over its merger with T-Mobile. Bob Murphy wrote an excellent article for Mises Daily on the federal government's case against AT&T. He shows how the Fed's move to block the merger is not only morally wrong but also, from the standpoint of sound economic theory, completely unsound and harmful to consumers. Murphy also touches on the cold, hard fact that "the typical antitrust case is filed by the unsuccessful competitors of the dominant firms." The case of US v. AT&T Inc. is no different.

Peculiar Circumstances

Reports Bloomberg,

On the morning of Aug. 31, AT&T Inc. (T) Chief Executive Officer Randall Stephenson said in a television interview that he expected his company's bid for T-Mobile USA Inc. to get government approval by the first quarter of 2012.

An hour later, his lawyers received a call from the U.S. Justice Department and were told the government was suing to block the $39 billion transaction, a person familiar with the matter said. The suit halted the biggest deal of the year and drew a line in the sand on antitrust policy that may affect pending acquisitions.

This announcement by the Justice Department came only a day after the August 30 meeting between the DOJ and representatives from Deutsche Telekom, T-Mobile, and AT&T.

"We are deep into the analysis with the Department of Justice, and it's all the questions and data gathering you might expect," Stephenson had told CNBC's "Squawk Box" at 8:39 a.m., about an hour before the company's lawyers were advised of the complaint.

"The news caught everybody by surprise," said Steve Largent, president and CEO of CTIA-The Wireless Association, which hadn't taken a position on the transaction. "AT&T was in the middle of explaining and detailing the merger that was being proposed when the Justice Department filed," Largent said. CTIA includes AT&T, T-Mobile and Sprint Nextel Corp. among its members.

Jessica Smith, a Justice Department spokeswoman, declined to comment on the details of the meeting or the decision as did Brad Burns, an AT&T spokesman in Dallas and T-Mobile spokeswoman Anna Friedges.

The first court hearing is scheduled for September 21.

This is all very strange. Why would the Justice Department move so quickly to sue when they were in the middle of negotiations? AT&T "had offered to divest up to 10 percent of T-Mobile assets" to local providers. This sort of offer was enough to secure Verizon's purchase of Alltel in 2009, so why not now for AT&T? In the wake of the DOJ's announcement, AT&T upped it to 25 percent, and is asking for another meeting with the Justice Department to try to come to a settlement before the suit goes to court. Sales on the national market will likely be bought up by Sprint, as the purchase of those assets by Verizon, the current largest wireless provider, will likely be blocked by the feds as well.

In fact, the evidence shows that Sprint's financial interests are driving this lawsuit by the DOJ. Like AT&T, Sprint had been planning to modernize its cell-phone network. Sprint's new cell towers will be configurable to handle multiple bandwidths in addition to its current 800MHz, 1.9 GHz, and 2.5 GHz spectrum. This includes the new LTE standard, one already used by AT&T and Verizon. Acquiring T-Mobile, which also had plans to utilize the LTE standard, would help that plan along.

"With all the failed government programs, the trillions of dollars wasted, doesn't this at least warrant some skepticism, if not the questioning of every positive thing you've ever heard about government from your government-paid teachers?"

In early March of this year, it was leaked that Sprint had been in negotiations with Deutsche Telekom to purchase T-Mobile. Negotiations were on and off, as there were some disagreements between Sprint and Deutsche Telekom as to the value of T-Mobile. Deutsche Telekom has been hoping to get $25 billion, but Sprint, it seems, was unwilling to pay more that $15–20 billion. By the time the press leak occurred on March 8, it is likely that the private negotiations between Deutsche Telekom and Sprint had completely broken down. Come March 20, AT&T announced its merger with T-Mobile.

The deal offered by AT&T to Deutsche Telekom was excellent. Not only did Deutsche Telekom get the full $25 billion in cash, but it would also receive $14 billion in AT&T stock, over 8 percent of the company, as well as a representative on AT&T's board of directors. This allows Deutsche Telekom to maintain its stake in the US market while also disinvesting itself of T-Mobile, which has slowly been losing customer base to AT&T, Verizon, and Sprint. It also gives Deutsche Telekom a huge influx in cash for capital expansion and research into new technologies. Lastly, to assuage Deutsche Telekom's concern over the deal being blocked, AT&T agreed to pay a $3 billion breakup fee as well as give some of its wireless spectrum over to T-Mobile and reduce charges for calls into AT&T's network, an additional $4 billion in value.

Just days after the AT&T merger with T-Mobile was announced, Sprint issued a press release denouncing Deutsche Telekom's agreement with AT&T as monopolistic:

AT&T and Verizon are already by far the largest wireless providers. If approved, the proposed acquisition would create a combined company that would be almost three times the size of Sprint in terms of wireless revenue and would entrench AT&T's and Verizon's duopoly control over the wireless market. The wireless industry moving forward would be dominated overwhelmingly by two vertically integrated companies with unprecedented control over the U.S. wireless post-paid market, as well as the availability and price of key inputs, such as backhaul and access needed by other wireless companies to compete.

In the wake of the DOJ's press conference over its suit filed against AT&T in US District Court, AT&T's stock dropped over 4 percent and Sprint's stock went up by over 9 percent. Deutsche Telekom's stock dropped as well. Sprint's response was ecstatic:

The DOJ today delivered a decisive victory for consumers, competition and our country. By filing suit to block AT&T's proposed takeover of T-Mobile, the DOJ has put consumers' interests first. Sprint applauds the DOJ for conducting a careful and thorough review and for reaching a just decision — one which will ensure that consumers continue to reap the benefits of a competitive U.S. wireless industry. Contrary to AT&T's assertions, today's action will preserve American jobs, strengthen the American economy, and encourage innovation.

It's clear that Sprint is benefiting greatly from this while at the same time getting its revenge at AT&T and Deutsche Telekom, but how does the Justice Department factor into all this? Why is it filing this suit on Sprint's behalf? As it turns out, representing Sprint in its negotiations with Deutsche Telekom was none other than Goldman Sachs Group Inc.

Goldman Sachs is known to be the most politically savvy public-private corporation in the United States, netting $12.9 billion in the government's TARP bailout of AIG, a measure that was supported by both President Bush and Senator Obama. Goldman Sachs was by far Obama's biggest campaign contributor during his 2008 presidential campaign, donating close to 1 million dollars. It's also no secret that his administration is filled to the brim with Goldman Sachs employees. Press Secretary Jay Carney denies any involvement from the White House. Even if Goldman Sachs puppet Obama didn't directly order the Justice Department to stop negotiations with AT&T, Goldman likely had something to do with Sprint's public call for the DOJ to block the merger. These sorts of corrupt backroom political deals are the historical norm.

How AT&T Got Its Monopoly in the First Place

Not only is government itself a monopoly on the use of violence; it is often the stated goal of government legislation to create more monopolies. An example of this is government patent law. A patent grants an inventor an exclusive monopoly over a particular idea for a limited time. The justification for this is to create an incentive for invention and technological advancement. It is the defense of so-called intellectual property that causes technological stagnation.

Alexander Graham Bell was granted his patent of the telephone in 1876. From 1876–1894, the Bell Company filed some 600 lawsuits to defend some 900 patents and keep competitors out of the market. During this time, only about 270,000 telephones were produced. When the patents expired, by the end of 1894, over 80 competing companies had already grabbed 5 percent of the market. By 1900, that number grew to over 3,000, capturing 51 percent of the market. By 1906, the number of telephones in the Unites States had grown to a vast network of 6 million.

When Theodore Vail returned to AT&T as its president in 1907, the number of telephones owned and leased by AT&T had fallen from 100 percent to 55 percent. AT&T was not as economically efficient as its smaller competitors.

According to AT&T's official history,

Vail wrote in that year's AT&T Annual Report that government regulation, "provided it is independent, intelligent, considerate, thorough and just," was an appropriate and acceptable substitute for the competitive marketplace.

Theodore Vail believed that "the telephone by the nature of its technology would operate most efficiently as a monopoly providing universal service."

In AT&T's 1917 annual report, Vail makes the case for a single-monopoly system. "A combination of like activities under proper control and regulation, the service to the public would be better, more progressive, efficient, and economical than competitive systems."

World War I, as in so many other areas of the economy, gave the federal government the excuse it needed to nationalize the telephones. In 1918, "for reasons of national security," a government commission headed by Postmaster General Albert S. Burleson was placed in charge of the nation's telegraphs and telephones. Vail was appointed by Burleson to manage the telephones. His friend Newcom Carlton, president of telegraph giant Western Union, would manage the telegraphs. Long-distance rates were standardized nationwide.

Under a free-market system, rates vary based on population density. People living in urban areas are charged less, because operating a telephone system in a city is much cheaper. The higher population density allows for a much more efficient system. Rural areas, where the population is much lower with people living in remote and hard-to-reach areas, are much more difficult and expensive to provide phone services to. Thus, people living in the country are charged more than those who live in the city. The upside to this is that the high prices paid by consumers in the country for phone service attracts investment to those areas and helps spur the growth of new communications infrastructure.

"These sorts of corrupt backroom political deals are the historical norm."

When rates became standardized, the government fixed their rates according to average costs, and city callers were charged the same rates as country callers. Those who lived in urban areas had to pay much higher rates, while those living in rural areas paid less. Because the vast majority of those owning a telephone lived in the city, the extra profit gained from overcharging urban areas more than made up for the loss incurred in the more remote areas. US long-distance rates went up an average of 20 percent. These rates remained in force years after nationalization ended in 1919.

They didn't have to remain in force for long. States began to expand the authority of their own regulatory commissions. By 1922, 40 of the 48 states had imposed a regime of statewide rate averaging. This policy of rural subsidization, while intended to expand service to these areas with the ultimate goal of extending telephone services to every American, resulted in the stagnation of growth in the rural areas. Rural telephone service had been made artificially unprofitable. Not only did this discourage investment and expansion by city-based telephone companies; it also served as a barrier for smaller, local phone companies who could neither compete with the artificially low prices nor subsidize those rates with profits from denser areas.

During this period of increased regulation on the state level, many state and federal officials began to openly argue that it would be much more efficient if telephones were operated under a single, unified system. The telephone industry was viewed as a "natural monopoly." Multiple telephone services operating in a single area were deemed a "duplication of investment" and a waste of resources. Various state regulatory agencies refused to allow telephone companies to construct new telephone lines in areas already served by another carrier. They also encouraged companies to exchange and consolidate their networks in order to increase efficiency.

These policies not only caused the rise of telephone monopolies within large geographical areas; they also served to stunt the growth of the phone industry in the United States. Were it not for state-imposed price controls, it's likely that wireless coverage for cell-phone networks would be much greater today outside of cities, and AT&T would not be suffering the very problems that moved it to purchase T-Mobile in the first place. Also, the Radio Act of 1927, which nationalized the entire electromagnetic spectrum, would ensure that the development of cell-phone technology would be crippled for decades.

The Great Depression saw the rise of vast new government agencies to regulate the economy. This includes the Communications Act of 1934, which created the Federal Communications Commission. Telephone providers were now required to get a license to operate in the United States from the FCC. This barrier to entry secured Ma Bell's place as the de facto government-sanctioned telephone monopoly in the United States. All this, according to the Communications Act, was

for the purpose of regulating interstate and foreign commerce in communication by wire and radio so as to make available, so far as possible, to all the people of the United States a rapid, efficient, Nation-wide, and world-wide wire and radio communication service with adequate facilities at reasonable charges.

Telephone ownership in the United States would not even reach 50 percent until 1945, with near-universal ownership not being achieved until the 1970s.

LvMI Hardside Briefcase

Reality Check

Sprint — like AT&T in 1907, unable to compete efficiently as its competitors on the free market — has decided to manipulate the coercive powers of government violence to get its way. Filing suit just seven days after the DOJ, Sprint is seeking to enhance its financial position under the guise of public service. The current lawsuit against AT&T is Sprint's way of striking a blow at a company that is able to outcompete it in both closed corporate negotiations and the wireless market as a whole.

Those supporting the federal government with their written opinion are in both a state of historical ignorance and political naïveté. If this lawsuit succeeds, it will be just another case of government hindering the rise of consumer living standards. What's more, it would be a tragic blow to the cause of freedom if the general public is once again fooled into supporting antitrust litigation on behalf of corporate interest. What geeks and everyone else must learn is that the only way to end the current depression and usher in a new era of economic progress and technological innovation is to free the market from the regulatory stranglehold of the state. Better yet, we could abolish the state completely.