The Deal of the Century

by Coll, Steve;

  To be sure, the “surviving” AT&T will never go belly up, and probably will never fail to pay its shareholders a healthy dividend, at least not in any business future imaginable in 1985. The company’s intercity phone network and dominant position in the long-distance market will generate billions in annual revenues for the rest of this century and well into the next. But Charlie Brown’s entrancing vision of an unbridled AT&T racing into the technology-driven “information age,” competing with the likes of IBM and Wang and Data General and others for dominance of the “global information village” imagined by popular academic futurists such as Marshall McLuhan, John Naisbitt, and Alvin Toffler, has already been clouded by muddled realities, and there is much evidence that his company’s boundaries will continue to shrink, rather than grow, in the decades ahead. McGowan and MCI, on the other hand, lacking any guarantee of long-term profitability, once again face the possibility of financial difficulty, and while the vista is familiar to McGowan, this time there will be nothing to grab onto if he falls. It is quite possible—some would argue it is more than likely—that the final landscape of the Bell System breakup will include a bankrupted MCI and an AT&T returned to its original state as a regulated, albeit smaller and less effective, telephone monopoly.

  The source of this specter lies not in anyone’s crystal ball but in the history of U.S. v. AT&T. Precious little in that history—the birth of MCI, the development of phone industry competition, the filing of the Justice lawsuit, McGowan’s deceptive entry into regular long-distance service, the prolonged inaction of Congress, the aborted compromise deals between Justice and AT&T, the Reagan administration’s tortured passivity, the final inter-intra settlement itself—was the product of a single, coherent philosophy, or a genuine, reasoned consensus, or a farsighted public policy strategy. Rather, the crucial decisions made in the telecommunications industry during the 1970s and early 1980s were driven by opportunism, short-term politics, ego, desperation, miscalculation, happenstance, greed, conflicting ideologies and personalities, and finally, when Charlie Brown thought that there was nothing left, a perceived necessity. The point is, if anyone had emerged triumphant from that embarrassing history in how not to make public policy, it would have been a phenomenal accident. And no one did. Not telephone consumers, not AT&T, not MCI.

  Consider, for example, the plight of William McGowan in 1985. Fifteen years earlier, the MCI chairman could not have dreamed that his legal and political guerrilla war against the phone company would go so far, would actually lead to the complete breakup of the world’s biggest corporation. If he had dreamed it, he might have awoken in a cold sweat. Before the breakup, MCI was paying $235 per line, per month for access to AT&T’s local exchanges. That was the price negotiated under the so-called ENFIA agreement of 1979. The cost to AT&T for the same access was well over $600; the difference supposedly reflected the superior access enjoyed by AT&T. After the breakup, as the first step of a process that was to lead to fully equal access, and more significantly, equal payments by MCI and AT&T, MCI’s per-line, per-month price rose to $330. When it did, the company’s profits fell precipitously for the first time since McGowan won the right to sell Execunet service. MCI’s stock, which had been selling at well over $20 per share, fell to under $7 per share. From the beginning, MCI’s profits, its discount prices, indeed its very reason for being, derived from its cost advantage over AT&T—an advantage that was marketed to consumers in the form of lower long-distance prices. But McGowan’s cost advantage was not the result of superior technology or innovative processes. It was artificial. It resulted from government regulation, not free market forces. Once the operating companies were separated from AT&T’s long lines, the rationale for MCI’s so-called deep discount evaporated. In theory, MCI and AT&T would both pay the same price for access to local exchanges by the year 2000—somewhere in the neighborhood of $500 per line, per month, or more than twice what MCI had paid in the early 1980’s when it blossomed into a billion-dollar corporation. If the move toward equal access proceeded on schedule, MCI would most certainly face difficulties. In 1984, there were 96 million long distance subscribers in the United States. Ninety million of them were AT&T customers; MCI had 1.7 million, good for second place. Given the immense costs of constructing, financing, and maintaining a nationwide communications network, it would be simply impossible for MCI or any “other common carrier” to survive equal access with so paltry a market share. McGowan’s hope was that once customers were offered a truly equal choice among long-distance carriers—a chance to vote for ten digit, “dial one” service from MCI, AT&T, Sprint, or whomever the customer pleased—AT&T’s immense market power would dissipate. That process will not be complete until 1990 or beyond, but so far, AT&T is holding steady with more than 80 percent of long-distance revenues, even in those areas where “elections” have been held so that customers could freely choose their long-distance carrier. The fact is that unless Congress intervenes and decides for political reasons to prolong the other common carriers’ artificial deep discount, AT&T will find itself alone in the basic long-distance market by the end of the century. These days, McGowan and his lawyers and lobbyists are once again swarming around the FCC and the Capitol, this time urging lawmakers and legislators to delay the very thing that MCI publicly sought throughout the 1970s: equal and fair competition with AT&T. And they have a potent argument. If Congress allows equal long-distance competition, it risks putting a group of companies with $6 billion in plant and 350,000 employees out of business.

  Bill McGowan is nearing the end of the tightrope he has walked since MCI was first authorized by the FCC to sell private line service in 1969. According to attorneys close to MCI, McGowan hoped to survive the cash crunch engendered by the rising cost of equal access by using the $1.8 billion antitrust judgment he won from AT&T in 1980 to expand his network and finance an aggressive marketing campaign to win new long-distance customers. As it turned out, though, the $1.8 billion was reversed on appeal, and in 1985 a new trial was held to reconsider the damages MCI was entitled to because of the FX and other controversies during the early 1970s. At the new trial, MCI sought over $15 billion, but a Chicago federal jury awarded the company less than $300 million—a major victory for AT&T. Immediately after that verdict, McGowan approached computer giant IBM and offered to sell out 30 percent of his company for cash. IBM agreed, although its vice-chairman emphasized that it would not provide “deep pockets” for McGowan over the long run. The “strategic alliance” between MCI and IBM, as well as mounting political pressure in 1985 on the FCC and Congress to preserve artificially the other common carriers’ deep discounts, has probably guaranteed that MCI will remain solvent until at least 1995. But there are few in the telecommunications industry who doubt that McGowan’s day of reckoning is rapidly approaching.

  AT&T, too, has been rocked by one crisis after another in the post-divestiture world, although, unlike MCI, it faces no danger of financial difficulty. In 1985, the price of access to the divested operating companies’ local exchanges was draining away 60 percent of AT&T’s revenues. Regulation by the FCC, which was supposed to begin to disappear after the breakup, was more pervasive than ever. Western Electric, renamed AT&T Technologies, Inc., was still desperately struggling to adjust to a competitive world, and its telephone equipment market share, which had been steadily eroding before the breakup, took a nose dive. The company’s overall profits in 1984 ran a full $1 billion short of projections, and its annual rate of return was substantially below the 12.75 percent allowed by the FCC. Fourteen thousand employees were laid off or asked to retire early as part of a breakneck plan to pare costs. And the company showed no signs of racing off into the profitable information age with the Bell System’s family jewels, Western and Bell Labs. AT&T’s much ballyhooed new computer products, introduced in 1984 and 1985, were plagued by technical problems and flopped in the marketplace. To gear up for a second try, the company decided to shut down four factories and cut its production costs by 25 p
ercent. But as its position in the computer and equipment markets continued to deteriorate, Wall Street analysts began to question loudly whether a century-old monopoly could learn to compete before it was too late.

  “AT&T did not get anything that they bargained for,” says one government lawyer prominently involved in the breakup. “If they thought they were going to get peace in their time, they got a worse war. If they thought they were going to get deregulated, they were stupid and naive. Now they’ve got these operating companies out there draining their capital and they don’t have sufficient money to do all the things they want to do.”

  By contrast, the divested operating companies, declared by so many in 1982 to be facing a bleak and unprofitable future, flourished in the first years after the breakup. Fear that the companies would founder without unlimited long-distance subsidies allowed them to raise prices for local service, while at the same time AT&T and its long-distance competitors continued to pay billions for access to local exchanges. Protected by state regulators and boosted by the favorable decisions made by Judge Greene in the summer of 1982, profits for each of the seven basic operating companies exceeded projections in 1984 and continued to grow in 1985. Whether that unexpected success reflected the benefits of a temporary overreaction by regulators and politicians concerned about the operating companies’ future, or whether it was a true indication of the companies’ financial health, is a question that will not be answered for decades.

  Irving Kristol, the former socialist turned neoconservative editor of The Public Interest, once commented that U.S. v. AT&T was less a conventional antitrust case than a “modern day variant on classical Marxist class warfare theories,” because it was fundamentally a struggle for power between a class of bureaucrats in the government—lawyers and technocrats in the Justice department, the FCC’s common carrier bureau, and in Congress—and the class of bureaucrats who ran the nation’s phone system, the one million employees of AT&T. Certainly it is true that the government lawyers and bureaucrats at Justice and the FCC were not driven to break up the phone company by any clear, coherent vision about how a decentralized telecommunications system would work better than the existing one. The Justice lawyers, for example, never seriously believed that the operating companies would ever be divested, and until it became a necessity as the case was about to go to trial, they spent very little time drawing up plans for how the nation’s phone network would be managed if they won their case. Instead, the government lawyers were driven by the conviction that AT&T was “unregulatable,” as Walter Hinchman, the former common carrier chief, always put it. With McGowan playing every angle, MCI was unleashed, nurtured, protected, and defended by the FCC and Justice because, in the words of Hinchman’s predecessor, Bernie Strassburg, “AT&T was getting so big, so fast.” Competition was a means for the government lawyers and bureaucrats to wrest power away from AT&T, to regain control over the phone company. Judge Greene, a former government lawyer himself, indicated clearly, from his jokes about “the well-oiled machine” to the harsh language of his September 11 opinion, that it was AT&T’s size and power that troubled him above all.

  Thus it should come as no surprise, as Ken Robinson and Dr. Paul MacAvoy, dean of Rochester University’s graduate school of management, have pointed out, that the “result of the settlement was not to facilitate deregulation,” as the academic ideologue Bill Baxter said it would be, “but was rather to reduce AT&T to more regulatable dimensions.” Baxter believed that U.S. v. AT&T was fundamentally a case about ideology and economic theory. But events in the telephone industry since the 1982 settlement announcement have made it plain that Kristol’s view of the case as “class conscious” war between rival bureaucracies is a far more accurate description. Broken into eight pieces, the political power of AT&T’s one-million-strong telephone bureaucracy, so disastrously overplayed by John deButts during the 1976 Bell Bill fight with Congress, has faded. Whereas AT&T was once able to present its resources and power in a unified front against the government, it has now been broken into two factions with separate and often conflicting interests: the local operating companies and the “surviving” AT&T. Judge Greene, for one, has accumulated great autonomy and influence by mediating disputes between the two rival factions, who only a few years earlier were pooling their immense capital resources to thwart his will in court. The FCC, similarly, will wield far more control over AT&T’s fortunes during the late 1980s and early 1990s, as it decides the crucial issues of long-distance equal-access payments, than it ever did during the 1960s and 1970s. In those days, there was little the commission could do to affect the phone company’s profits but impose an ever-higher limit on AT&T’s rate of return. In stark contrast to that era of Bell dominance, AT&T was forced in 1984 to file an “emergency petition” with the FCC asking for relief from certain regulations for fear that its annual rate of return would fall below 5 percent and jeopardize the company’s standing in the financial community. The FCC granted the request, but the point was made. AT&T, so long despised by commission staffers for its high-handed arrogance, was on its knees at last.

  Chapter 36

  Epilogue

  There were moments in the first months after the settlement of U.S. v. AT&T was announced when it seemed that the breakup of the Bell System would be paralleled by the demise of George Saunders’ ebullient personality. After a decade of relentless hard work, passionate oratory, desperate connivance, and uninterrupted dedication, Saunders had come away with nothing—or less than nothing, since his efforts had resulted in the destruction of his client. Some trial lawyers, imagining themselves as mercenary professionals emotionally unattached to the fortunes of their clients, might have accepted that the settlement was beyond their control. But Saunders was not like most lawyers. It seemed to his partners and colleagues that Saunders’ very soul was inexorably linked to the spirit of the Bell System. There were times after the settlement when he seemed moody, sentimental, angry, devastated, as if he was mourning the loss of a close companion.

  But there was more to it than that. After the $1.8 billion defeat in the MCI trial, Saunders had approached U.S. v. AT&T seeking vindication for himself as well as his client. When Charlie Brown made his fateful decision to surrender to Justice, he snatched that vindication from Saunders in the most categorical manner imaginable. Some felt that after the trial before Judge Greene, Saunders began to tire of the great telephone litigation wars, as if the demonic flame that had driven him to fight and scratch and claw on AT&T’s behalf since the early 1970s had dimmed or been snuffed out. Perhaps it was simpler than that: perhaps after so much work and frustration, he had had enough of it all. But he could not let go of it, either, and that turned out to be a fortunate thing.

  During the second week of May 1982, five months after the settlement announcement, the trial of Southern Pacific v. AT&T got under way before Judge Charles Richey in U.S. District Court in Washington. Southern Pacific was the parent of Sprint, the discount long-distance company that had cautiously followed McGowan and MCI into the intercity services market. The case was nearly an exact duplicate of the MCI lawsuit that had resulted in the $1.8 billion trial verdict, which in turn closely mirrored Justice’s suit against the phone company—many of the same documents were entered and many of the same witnesses testified in all three trials. Saunders had thrown himself into preparations for the Southern Pacific case almost as soon as the settlement with Justice was announced, and the work had provided an important distraction for him. By the time the trial began, Saunders seemed restored to his old self, at least in the courtroom, railing in his hours-long opening statement about how there was no doubt Sprint “was a creamskimming operation.”

  The six-month trial was held in a courtroom very near to Judge Greene’s in the district court building on Constitution Avenue. From the beginning, Richey seemed more sympathetic to Saunders’ arguments than had either Greene or Judge Grady from the MCI trial in Chicago. Saunders pressed the same arguments he had made in the MC
I and government cases. He cross-examined the same witnesses in more or less the same way. He entered the same documents. And when it was over, he had won, for the first time, a stunning victory.

  “The FCC’s introduction of competition in the long-distance market has been and will be shown to be contrary to the best interests of millions of Americans,” Judge Richey wrote in his December 1982 opinion dismissing the entire case. “Every action complained of in this case could have or should have been handled by the appropriate regulatory bodies.… The court believes that the antitrust laws were never intended to destroy an essential public utility such as we have here.”

  Beyond offering some vindication to Saunders and AT&T, Richey’s decision provided compelling evidence to many observers that the judiciary ought not to become involved in economic policy making. Here were two judges in the same court building, Greene and Richey, whose opinions about the telecommunications industry were diametrically opposed. Greene, by virtue of the case he drew, reshaped the entire telecommunications industry; Richey, by the lot of the same draw, was able merely to dismiss a private antitrust suit while sniping at Greene’s decision in his final opinion.

  For Saunders, victory begat victory. The $1.8 billion MCI verdict was set aside by a federal appeals court, and a new trial for damages, in which Saunders was not directly involved, resulted in a much smaller award. Saunders continued to try private antitrust cases for AT&T, though his breakneck pace eased somewhat. To preserve his health, he gave up cigars and occasionally checked himself in for six weeks at a Santa Monica, California, health camp, where he would quit drinking, eat nutritious food, and jog serenely along the shores of the Pacific Ocean. Once released from camp, Saunders seemed to return to many of his former vices, but when he ran himself down, he returned to California to be reinvigorated.