May 22, 2015 3:23 PMexplained why the Comcast-TWC merger may present regulators with concerns. On the other hand, I also explained that the AT&T-DirecTV merger presented consumers with nothing but opportunities. As noted earlier this week, those opportunities have only expanded with ISP/MVPD competition and increased pressure on the programming bundle. The post-merger AT&T-DirecTV would be a tempting target that may well give some programmers an incentive to "cheat" the industry-standard distribution agreements, and finally let go of the Bundle.
But, recently, news reports have said the FCC may require AT&T to accept "interconnection conditions" as a prerequisite to granting its approval to AT&T's acquisition of DirecTV. This would be a mistake, because it would also undermine the careful restraint the Commission showed in its (still overly-broad-for-the-purpose) Open Internet Order.
In a general sense, all regulations distort economic incentives; and overly broad regulations create more profoundly-distorted incentives. Still, the FCC did show some restraint--with respect to Internet interconnection--in its ultimate Order. The Commission should decline invitations to undo its previous well-considered reservations, as it will only promote moral hazard and careless network practices by those it has been asked to "help."
Regulations Shouldn't Distort Market Discipline--Lessons from the Mortgage Crisis
Overly-broad regulations--designed to minimize one market risk--can easily distort incentives in adjacent markets (or market participants) in ways that create worse problems than the one the regulation was supposed to address. This was the message of Charles Plosser, the President and CEO of the Federal Reserve Bank of Philadelphia, as he reflected on the role of prior government regulations in contributing to the mortgage crisis.
In a speech entitled, "Responding to Economic Crises: Good Intentions, Bad Incentives, and Ugly Results," Plosser considers why we continue to see financial crises, despite the fact that each crisis inevitably brings its own new regulations. He concludes that, it's "[b]ecause the public and our lawmakers seldom recognize that attempts to insure against bad economic outcomes can sometimes be counterproductive."
Plosser (quoting economist Allan Meltzer) says, "Capitalism without failure is like religion without sin. It doesn't work." He explains that regulations cannot insure "all manner" of market participants against bad outcomes (or limit the ability of firms to take risks); because while such rules might reduce market volatility, they would also limit innovation and economic growth.
Plosser offers a number of examples where regulations undermined market discipline, making the overall system more vulnerable. For example, in the decades preceding the crisis, the government provided numerous implicit and explicit subsidies to financial firms (Fannie/Freddie) and others that became "too big to fail." By limiting these firm's risk, the subsidies gave lenders the impression that the government would always bail these firms out. Thus, those lending the money to these firms had little incentive to limit the amount of debt they allowed the firms to accept.
Plosser concludes that better regulations, and not simply more regulations, are the proper response to market failures. He cautions,
If regulation distorts incentives, it can create moral hazard problems whereby firms don't bear the costs they impose on others. Such regulations can have unintended consequences that interfere with achieving the regulations' goals.
The Commission's Invitation to Create Moral Hazard
Of course, there aren't perfect parallels between the financial system and the Internet, but there are enough similarities to draw some useful lessons. The financial markets function best when they keep money flowing to efficient uses from efficient sources. Similarly, the Internet, especially the market for Internet interconnection, has become the world's most efficient system for the routing and delivery of data traffic.
As we have explained previously (see, here and here), the market for Internet interconnection works well, and has its own market discipline, which serves consumers well. Where the financial markets efficiently reward accurate risk evaluation, the market for Internet interconnection rewards those firms that invest in the most efficient networks to provide valuable traffic routing to prospective interconnection partners.
Thus, the FCC wisely decided not to regulate Internet interconnection as a separate "service," despite being heavily lobbied to do so by a tiny minority of firms." In its recent Open Internet Order, the Commission, also wisely, declined to impose any specific interconnection obligations on ISPs, choosing to "rely on the regulatory backstop prohibiting common carriers from engaging in unjust and unreasonable practices." Order ¶ 203.
Recent events have vindicated the Commission's restraint. Some of the same firms requesting regulation have, indeed, been able to reach fair terms with large ISPs. Level 3 and Comcast, as well as Cogent and Verizon, have recently been able to reach mutually-beneficial, long-term agreements.
Unfortunately, though, a few parties, including one (Cogent) that has had found itself on the "disciplined" end of Interconnection market discipline more than any other (see, e.g., problems with Level 3, Sprint, generally, going back to AOL as a dial-up ISP), and another best known for recently gaming the Commission's own competitive bidding system, have asked the FCC to supplant competitive market discipline with extraordinary relief in the form of conditions to an otherwise pro-competitive merger. These parties have nothing to lose by asking for relief
However, if the FCC accedes to these demands, AT&T's broadband Internet consumers can only lose. Because, notwithstanding any evidence that AT&T is acting unjustly or unreasonably with respect to Cogent or Dish, these firms are asking the Commission to impose different terms on AT&T than other ISPs. It is, therefore, more than likely that the FCC--if it agreed to do so--would be imposing a weaker link (through non-competitive interconnection terms) into some retail customers' supply chain. This is no way to ensure consumers have the best end-to-end broadband Internet access. It will, however, ensure that the FCC gets more requests to regulate outcomes best decided by a more efficient market.