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Re: Principles for Encouraging the Development of Secondary Markets for Spectrum, Policy Statement (rel. November 27, 2000); Promoting Efficient Use of Spectrum Through Elimination of Barriers to the Development of Secondary Markets, WT/ET Docket No. 00-230 (rel. November 27, 2000).

Markets and government regulation are not complete strangers. Mutual contempt has bred an all too asymmetric familiarity. Regulations change, and markets, by necessity, adapt instantaneously. The converse, however, is not true.

It is difficult to find a market in which all applicable regulations have not been reflected; their effects on the market--for good or ill-- are implicitly counted. By contrast, it is rare to find a regulation that directly and reasonably accounts for its effects in one market, much less all markets. Thus, even a casual observer should pause when a government agency writes a regulation with the word "market" in its title. What is at work here? A regulation based on familiarity with markets, or--all too familiarly--a regulation based on contempt for markets?

I am happy to report that the items today reflect more the former than the latter, and for this, the Office of Engineering Technology and Dale Hatfield along with Tom Sugrue and his Wireless Telecommunications Bureau deserve enormous credit. Indeed, these items are conceived from the all too obvious--and all too often ignored--observation that markets for spectrum rights are not working well. Buyers complain. Sellers complain. And the common refrain is that FCC rules are costly, cumbersome, and do more harm than good for spectrum markets. Even with the progress made by these items, much more needs to be done. These are but the first infant steps when giant steps are ultimately needed, particularly to remove the shadow of regulatory uncertainty from spectrum markets.

Clarifying lease arrangements

The items today do much to clarify Commission rules and policy regarding leasing arrangements for spectrum rights, and this newfound clarity and certainty will reduce one significant area of regulatory uncertainty. There remain some issues surrounding rental or leasing arrangements that are unresolved by today's items, but surely the additional clarity in Commission policy is a positive step.

Some may observe that secondary markets for spectrum are alive and thriving. Indeed, every year the FCC processes thousands of license transfers, the consummation of secondary markets for spectrum rights. In many if not most instances, these licenses are transferred from one party to another in exchange for some form of consideration as a result of a contract. Yet, the mere existence of a secondary market for spectrum rights does not imply that the market functions particularly well. Complaints about the license transfer process at the FCC are legion. As I have often noted, the license transfer process at the FCC is seriously flawed with delays, discriminatory treatment of applicants, unwritten rules, and other problems. (1) The unpredictable, dysfunctional, and possibly unlawful license transfer process at the FCC burdens secondary markets for spectrum rights. The process discourages some potential market participants, and leaves many participants disenchanted.

Even if the FCC were to move to timely, nondiscriminatory, transparent, carefully crafted, fully lawful rules for license transfers, secondary markets for spectrum rights would still not be as vibrant as they could be. This is because Commission policies in many areas militate against transactions for spectrum.

Despite all of the good that comes from today's items, they do not, in my view, go nearly far enough. Markets for spectrum rights labor under a multitude of regulations, only a few of which are meaningfully reviewed or addressed, in these items. In the remainder of this statement, I describe broad areas where markets for spectrum rights are hampered.

What makes a market

Markets are simply means by which buyers and sellers exchange for mutual benefit goods, services, or bundles of rights. Markets facilitate exchanges in all societies, both primitive and modern. In primitive societies, many transactions may be based on barter exchange at one point in time. In modern times, transactions can be quite subtle and complex involving complicated contractual arrangements that occur over long periods of time. All market transactions, both simple and complex, have many rules--either explicit or implicit, and these can be summarized in three broad categories:

1. Property or exclusivity rights The parties to a transaction should agree on what is being exchanged. In a simple transaction involving simple property, this might mean a good or service without much description or qualification of the rights associated with the good or service. But for many goods and services, the precision with which associated rights are defined determines the value of the good or service. One example of the importance of associated rights is spectrum. The extent to which excludability or property rights are defined and associated with a spectrum license determines the value of the license.

Much like land or many other forms of property, the right to exclude others from the use of spectrum is important to the value of spectrum. The use of spectrum with most current technologies is congestible. Different, uncoordinated uses of spectrum in the same band and location are likely to conflict and interfere with one another. The value of access to spectrum is directly related to the exclusivity rights of that spectrum, both for current and future use. On the other hand, limitations on the uses to which property may be used diminish the value of the property, including spectrum. Under FCC rules, there are limitations on the uses of practically all spectrum licenses.

2. Contract or transaction rights When a good or service is bought or sold, the rights of the buyer to transfer the good or service to a third party may be restricted. To the extent there are restrictions, however, those are usually agreed upon at the time of the transaction. For FCC licensees, except for those limited leasing arrangements described in today's items, these transactions must be approved by the Commission.

3. Enforcement and liability rules In most sophisticated contracts, the means to enforce the contract and the liability rules for failure to perform under the contract are explicitly stated. For FCC license transfers, enforcement and liability rules between private parties are difficult to write and to implement because the FCC is an intermediary in all transactions.

Uncertainty and markets

Demand and supply conditions in a market determine prices, and perturbations in demand and supply conditions lead to corresponding changes in prices. Even market participants with complete information on their current and future excludability rights, contract rights, enforcement rights, liability rules, and the other bundles of rights associated with goods or services in a market understand that prices are not constant forever. Buyers and sellers make transactions with expectations that prices will change, although perhaps not with shared expectations of price movements. At least in competitive markets, neither buyers nor sellers believe that any market participant has the power individually to influence market conditions. Future market volatility as the result of changing demand and supply conditions is assumed to be an unpredictable exogenous event. This volatility in a competitive market where buyers and sellers have complete information on their current and future bundle of rights reflects the common usage of "market uncertainty."

For this common usage of "market uncertainty," firms will be more or less inclined to participate in a market depending on the firm's degree of risk aversion specifically to market uncertainty. Some firms like more risk; others like less. Some firms can insure against risks in one market with offsetting risks in another market while others cannot. Market uncertainty affects transactions and the distribution of assets in a market, but those outcomes are rationally assumed to be competitively neutral, not favoring one class of firms over another, except perhaps those that can--or those that believe they can--better insure against market risks than others. In any event, government agencies can do nothing to remove this form of market uncertainty.

There is a different form of uncertainty in markets that is independent of the market uncertainty of changing demand and supply conditions. This uncertainty is regulatory uncertainty, or incomplete information about future regulatory outcomes. There are many possible categories of regulatory uncertainty, but the three categories for transactional rules -- property, contract, and liability -- are convenient. Where market participants are unsure about current and future property rules, contract rules, and liability rules, not only will asset values fall but participants will be discouraged from transactions.

If the future outcomes of property rules, contract rules, and liability rules are believed to be random events, uninfluenced by any market participants, it is conceivable that regulatory uncertainty can be consistent with a competitive market. In practice, however, regulatory rules are the product of regulators who participate in spectrum markets often as sellers of spectrum, and always as intermediaries for all license transfers. Where sellers and intermediaries have the power to change regulatory rules, the competitive paradigm for regulatory uncertainty vanishes. Moreover, many other market participants actively lobby regulators, obviously in the belief that regulators can be persuaded one way or another. Again, where regulatory rules are influenced by market participants, regulatory uncertainty is inconsistent with the competitive paradigm.

As with market uncertainty, regulatory uncertainty affects the distribution of assets in a market. Many firms may simply avoid markets with substantial regulatory uncertainty. Unlike market uncertainty, it is difficult to insure against regulatory risk in one market with offsetting risk in another market. While some firms may believe they have the power to influence regulators, and therefore they may broaden their portfolio of assets subject to regulatory risks, other firms may view a portfolio of such assets as non-diversifiable risk.

FCC actions increase regulatory risk

The FCC has taken many actions that increase regulatory risk particularly by changing the property, contract, and liability rules that apply to licensees. These include consideration of and adoption of rules that limit the rights of licensees to exclude others from using or interfering with licensed spectrum. Examples include consideration of sharing of spectrum for DBS licensees, changing interference protection for FM radio broadcasters, absence of protection for WCS licensees, and forced relocation for certain licensees.

Although there are perhaps more examples of the FCC relaxing use restrictions, there are some examples where the Commission has considered and adopted more restrictive limitations on spectrum use. Examples include new public interest requirements on broadcasters.

Commission practice regarding license transfer transactions are also ever changing. (Formal rules rarely change because there are few formal written rules on license transfers.) Outside parties simply do not know how license transfers, whether simple or complex, will be treated at the agency.

Finally, liability rules for interference change. Most licensees are assigned a license that is defined by geographic location, a spectral band, power limits, and other restrictions. While licenses sometimes delineate explicit protection from a small number of identifiable sources of interference, the FCC rarely makes explicit the interference protections to be afforded licensees from all other potential sources of interference. When legal but creeping interference increases in a band, liability rules implicitly are relaxed. When interference standards for broadcasters change or underlying noise levels for ultrawideband technology are modified, so too do associated liability rules and their enforcement.

Erosion of these property, contract, and liability rules ultimately increase regulatory risk, diminish the value of spectrum licenses, and discourage participation in spectrum markets. These adverse regulatory effects develop independent of the steps we take today to provide greater clarity for leasing of spectrum rights by licensees.

Frustration of parties with the FCC

Every business day, the FCC hears entreaties from many private parties concerning spectrum. Some want to acquire bundles of rights to spectrum. Some want to sell various rights associated with spectrum. Others want to facilitate (or to interfere with) the transfer of a spectrum license from one party to another. In the ordinary course of business for other commodities, buyers and sellers meet in markets, markets that may develop anywhere in America. For spectrum, all markets pass through the FCC in Washington.

Market transactions typically occur when all parties to the transaction are at least as well off as a result of the transaction. Buyers and sellers come to the FCC not because we make transactions less complex or more certain; they come here because, by law, they must. Buyers and sellers have some divergent interests, but, after their experiences at the FCC, all parties repeat common themes: (1) impatience with our process in which delays are the norm; (2) puzzlement at our complex rules and the unknown range of possible outcomes; (3) fear of the unknown likelihood of each unknown result; and (4) frustration at the absence of effective remedies for outcomes they perceive as unfavorable.

While the Commission today calls for a more active secondary spectrum market, it largely misses an opportunity to define the property, contract, and liability rights associated with a spectrum license. Absent a clear definition of the rights of its licensees, secondary markets cannot reach their full potential. Regulatory uncertainty is rampant at the FCC as evident by the types of questions regulated entities pose: What are the range of possible rights associated with a spectrum license? What is the likelihood associated with each outcome? Will the Commission change those rights unilaterally? What protections do licensees have from interference? What certainty do licensees have that the Commission will not seek to relocate them or ask them to share with other potentially interfering users? What remedies do licensees have for bad outcomes? How long will FCC proceedings last? The answer to each question seems to vary by proceeding.

Even more troubling is the Commission's reluctance to answer these questions at all. For example, there is reluctance to explain why we contemplate sharing arrangements in some bands of spectrum and not in others. Similarly, we refrain from defining interference protections because we want the "discretion" to alter those rules later on. Yet to the extent the Commission wants to continue to change, eliminate, or overrule its decisions about the scope of licensees' rights, the Commission must accept as a consequence of increased regulatory uncertainty that secondary markets will not flourish. Few want to buy something that cannot be defined. Licensees can only sell what they have - yet the FCC is reluctant to define exactly what "spectrum usage rights" these licensees have.

A Pig in a Poke

Much wisdom rests in an old country saying: "Don't buy a pig in a poke." Narrowly, the expression admonishes a potential buyer to have responsibility for diligence before purchasing a good or service. More broadly, the expression means that a person should not blindly enter into situations without having some knowledge of the possible outcomes, the likelihood of those outcomes, and any remedies that might be available for bad outcomes. Where the range of possible outcomes is unknown, the likelihood associated with any outcome is unknowable, and remedies for bad outcomes are unavailable, individuals should be wary.

One can look around America, in urban canyons and in country fairs, and still not find a market for a "pig in a poke." It is not for the difficulty of supply; while difficult, putting a pig in a bag is not impossible. There is no market because no one wants to buy one, and it is consumer demand--not the ease of supply--that creates a market.

Few markets have products where the range of possible outcomes is unknown, the likelihood associated with any outcome is unknowable, and remedies for bad outcomes are unavailable. If there is such a pig-in-the-poke market, it is generally the market--and more particularly the secondary market--for spectrum rights and all of the regulatory uncertainty associated with it.

The Commission's consensus goal of a vigorous secondary spectrum market will only be achieved if we are prepared to answer the difficult questions associated with clearly defining exactly what rights a spectrum license creates. The process will be difficult, but the resulting benefits make it our necessary course. Ultimately only through free market evolution will spectrum-based services ever keep pace with consumer demand and technological change. Thus defining spectrum usage rights is a challenge that we have no choice but to accept.

1     See e.g. Statement of Commissioner Furchtgott-Roth, Concurring in Part & Dissenting in Part, Applications of Ameritech Corp., Transferor, and SBC Communications, Inc., Transferee, For Consent to Transfer Control of Corporations Holding Commission Licenses and Lines Pursuant to Sections 214 and 310(d) of the Communications Act and Parts 5, 22, 24, 25, 63, 90, 95, and 101 of the Commission's Rules, CC Docket 98-141 (rel. Oct. 6, 1999).