Anthony J. Pennings, PhD

WRITINGS ON DIGITAL STRATEGIES, ICT ECONOMICS, AND GLOBAL COMMUNICATIONS

The Telecom Crash of 2002

Posted on | September 27, 2015 | No Comments

One of the economic history’s most fascinating questions will deal with the stock market advances during the eight Clinton-Gore years, especially those in the Internet and telecommunications sectors. During their tenure in the 1990s the stock markets boomed, and the investments created the lowest unemployment in years as well as contributed significantly to the budget surpluses. Even Alan Greenspan’s speech on December 5, 1996, in which he questioned when the “irrational exuberance” of stock purchases, merely marked the beginning of the historical “bull run” that would end with the Telecom Crash of 2002.

Billions of electronic dollars moved through newly computerized stock markets into established and new technology companies as the economy roared forward on a record pace. ECNs (Electronic Communication Networks) such as Island were approved by the SEC for matching buyers and sellers and created a much-needed trading facility in the hectic new environment. While most people participated primarily through institutions providing mutual funds, 401Ks, and pension funds; day trading emerged through the Internet to provide a more direct interface to the financial markets. The American investment economy had not seen such universal participation since the 1920s when radio companies such as RCA set the pace of speculative investing.

NASDAQ went from 675 in January 1993 to 2,796 at the end of January 2001 (a 414% increase), although it hit a high of 5132 in March of 2000. The DJIA went from 3,370 to 10,887 (323%) during that same period with a high of 11,497 in December 1999. The Dow dropped from 8,883 to 7,539 in August of 1998 after the Asian and Russian financial crises, but managed to recover quickly.[1]

Any “information superhighway” would need a legislative framework within which it could be built. A major element of this new regime was the rewriting of the basic telecommunications law. Central to the administration’s economic success was changing the Communications Act of 1934. Written and passed as part of the New Deal, its aim was to curb the abuses of monopoly while ensuring the development and availability of efficient and nationwide broadcasting, telegraph, and telephone services. The Act authorized separate monopolies in each of the communications sectors: radio broadcasting, telegraphy, and telephony (this list would grow to include cable TV, satellites and wireless) subject to the FCC rulings on appropriate prices and services. Within the new regime, a new framework was needed that allowed digital convergence among these separated sectors.[2]

The Clinton Administration and its appointed FCC Chairman, Reed Hundt, worked with the Republican-controlled Congress to pass the Telecommunications Act of 1996. It was an awkward piece of legislation, but one which allowed the FCC to create a new environment for the Internet and e-commerce to grow. For instance, it required telcos to allow other companies to lease their network for interconnection purposes at regulated rates. It lead to a large number of ISPs offering low-cost Internet access. The legislation had lot of political pork; in particular, the broadcast networks were bought off by giving them free spectrum for future offerings of digital television.[3]

Part of the Act broke open the segmentation that had separated the different sectors. Subsequent to the Act, companies could invade the other’s turf. It removed barriers to entry to the once protected monopoly-controlled sectors. For example, broadcasters could move into broadband and carriers could offer content. It also allowed consolidation of different media companies, creating a new frenzy of mergers. AT&T for example, made major multi-billion purchases of Media One and TCI to become a cable behemoth after they invented cable modems for broadband delivery along with television services. AOL, by far the largest ISP, merged with Time-Warner in an attempt to cross pollinate between the “old economy” and the “new economy”.

In the wake of the Telecommunications Act of 1996, investors poured some $2 trillion dollars into the telecommunications industry.[4] Enron, Global Crossing, Tyco, Winstar, and Worldcom were a few of the companies that attempted to position themselves on the forefront of the telecommunications revolution. Enron, primarily an energy company, bought and built a 15,000-mile fiber optic network throughout the US and set up a new division, Enron Broadband Services to manage the network. Enron also attempted to create a spot market for its bandwidth capacity services as well as other carriers, ISPs, and major users with leased lines. Global Crossing, led by Michael Milken protégé Gary Winnick, built an extensive fiber optic network including a substantial international portion. In addition, it also took over Frontier, a Rochester NY based telephone company. A major conglomerate, Tyco, also made major investments in international optical IP networks including a major hub on Oahu, Hawaii.[5] Worldcom incorporated telecom competition pioneer MCI and became the largest Internet backbone service in the world through its purchase of Internet provider UUNET. The investments in the telecommunications sector dramatically increased the speed and scope of its digital transmission capacity, transforming it into the major conduit for worldwide Internet traffic.

The newly deregulated environment heated the battle for broadband access to the home. The FCC’s longstanding distinction between basic and enhanced services allowed a new breed of ISPs to connect to home computer users from local toll sites for unlimited time periods. But the Bell companies retaliated with services including ISDN and then DSL and would eventually work the system to gain control over most local ISPs.

Competition from cable television and the satellite industry was looming. New modems and switching capabilities allowed the cable companies to use their high-bandwidth coaxial and fiber optic facilities to provide high-speed access to the Internet. Satellite television services developed new compression techniques that not only allowed many more channels to be broadcast but with encryption techniques that allowed for individual subscriber services. But satellites still suffered the signal delay that made it difficult to provide interactive services from a spacecraft located over 36,000 kilometers above the earth. Although all three were moving towards the use of IP networking, cable television had the advantage of moving into broadband Internet service with its legacy infrastructure which would soon include voice-over-IP (VOIP) telephone sets.

After Al Gore had wrapped up the Democratic nomination on Super Tuesday, March 7, 2000, NASDAQ reached a high of over 5000. But in April prices began to fall although the Dow, the top 30 oligopolies, continued to rise throughout the summer. November’s election was extremely close with Gore winning the nation’s overall vote, but Bush narrowly winning the Presidency by Electoral College, taking Florida’s 29 electoral votes by a mere 537 popular votes after a controversial Supreme Court decision.[6] From the NASDAQ’s high of over 5000 in March of 2000, it quickly declined over 3000 points by the time the Bush administration settled into their new offices less than a year later.

With the new presidency, tech stocks fell to earth. The “new economy” was over, and the “old economy” had retaken Washington DC. President George Bush and most of his immediate staff (Cheney, Evans, Rice) were veterans of the oil business. The new administration represented a new set of economic values and geopolitical priorities. The NASDAQ continued to fall while the Dow-Jones Index of 30 established corporations climbed even higher, surpassing the 11,000 mark again in February 2001.

The telecommunications industry went into steep decline. The first revelation came with the meltdown of Enron, a company that was consistently listed in the top 10 of the Fortune 500. Heavily burdened by its junk bond debt, Enron desperately sought new ways to raise cash including putting together an 18,000-mile fiber optic network.[7] One of its schemes embraced the Internet in an interesting but futile attempt to create a trading environment for bandwidth as it had for natural gas spot contracts. But it was too little, too late. Enron Online made its first trade in December 1999 as the markets were at their peak, and Enron was trading near $90. It would soon wind up as the largest bankruptcy in history and destroy accounting giant Arthur Andersen in the process. But not before FORBES would tout Enron as “The Most Innovative Company in America” for the fifth year in a row.[8]

As the Worldcom case would show, many companies started to engage in illegal accounting techniques after the markets faltered. In late June 2002, CNBC reported that Worldcom had been discovered to have accounting irregularities dating back to early 2001. Nearly US$4 billion had been illegally documented as capital expenditures. Worldcom had registered $17.79 billion in 2001 “line cost” expenses instead of the $14.73 billion it should have reported. The result was that it reported US$2.393 billion in 2001 profits instead of showing what should have been a $662 million dollar loss. Shares dropped quickly. Although the stock had already fallen from its 1999 high of $64 a share to just over $2, it soon dropped to mere pennies before the stock stopped trading.[9] Other companies such as Qwest and Tyco further reduced the vestiges of the general public’s confidence in the stock market, and particularly its telecommunications companies.

The stock markets continued to decline as new corporate scandals were revealed. It finally reached into the DJIA during mid-2002. The “Dow”, representing mainly the stalwarts of the old economy, would maintain its strength during the new administration’s early years. It would dip below but return to highs over 10,000 intermittently until the summer of 2002 when the corporate scandals were exposed. Bush’s SEC chief, Harvey Pitt, failed to gain the confidence of investors and eventually resigned. The Wilshire Total Market Index fell from $17.25 trillion on March 24, 2000 to $10.03 trillion on July 18, 2002. By August, 2002 over $7 trillion of stock values had dissipated. Particularly hard hit were the tech sectors.

Telecommunications services, which had accounted for 7.54% of the Wilshire Total Market Index at the end of March, 2000 saw its total value fall to only 3.63%. Information technology fell from 36.2% to 15.01% and even Microsoft saw its market capitalization fall from $581.3 billion to $276.8 billion. Finally, Congress passed the Sarbannes-Oxley Bill in August requiring all corporate CEOs to sign off on their company’s books. The fall abated, but at a cost of trillions of investor dollars from IRAs, mutual funds, individual investments, and pension funds.[10]

Notes

[1] Stock figures for both the NASDAQ and DJIA are from Yahoo! Finance, the “poor man’s Bloomberg”. They indicate monthly figures and may represent the daily or weekly highs. Greenspan “irrational exuberance” information from Daniel Gross’ (2000) Bull Run: Wall Street, the Democrats, and the New Politics of Personal Finance. New York: Public Affairs. p. 19.
[2] Information on Communications Act of 1934. Martin, J. (1976) Telecommunications and the Computer. (2nd Edition) NJ: Prentice Hall. p. 31.
[3] Republican Bob Dole was a particularly vocal critic of the spectrum giveaway.
[4] BUSINESS WEEK, (2002) “Inside the Telecom Game”. Cover Story, August 5, 2002. Pp. 34-40.
[5] An article by John Duchemin on the Honolulu Advertiser’s website chronicled the travails of the Tyco telecommunications hub in Wai’anae. The 38,000 square foot center went unused when the telecom market collapsed. August 13, 2002.
[6] The USA operates its Presidential elections with an electoral college system. People don’t elect the President directly but when a candidate wins a state, a determined number of electoral votes go to that candidate. The system keeps any one section of the country from dominating the country.
[7] We see Michael Milken’s mark who was a consultant to Lay and helped him fend off Irwin Jacobs and other potential corporate raiders, but at the price of a incurring huge debt. See Peter C. Fusaro and Ross M. Miller’s (2002) What Went Wrong at Enron. NJ: John Wiley & Sons.
[8] Fusaro, P.C. and Miller, R.M. (2002) What Went Wrong at Enron. NJ: John Wiley & Sons. p. 172.
[9] Worldcom figures from THE NEW YORK TIMES, Friday, June 28, 2002. pp. C1-C6. Articles by Michael Wilson and Leslie Wayne.
[10] Feaster, S.W. (2002) “The Incredible Shrinking Stock Market: More Than $7 Trillion Gone,” NEW YORK TIMES. July 21, 2002. p. 14 WK.

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AnthonybwAnthony J. Pennings, PhD is the Professor of Global Media at Hannam University in South Korea. Previously, he taught at St. Edwards University in Austin, Texas and was on the faculty of New York University from 2002-2012. He also taught at Victoria University in Wellington, New Zealand and was a Fellow at the East-West Center in Honolulu, Hawaii during the 1990s.

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    Professor and Associate Chair at State University of New York (SUNY) Korea. Recently taught at Hannam University in Daejeon, South Korea. Moved to Austin, Texas in August 2012 to join the Digital Media Management program at St. Edwards University. Spent the previous decade on the faculty at New York University teaching and researching information systems, media economics, and strategic communications.

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