The Fine Print: How Big Companies Use Plain English to Rob You Blind

by David Cay Johnston

  “The focus of U.S. transportation policy in the nineteenth and twentieth centuries was on extending the benefits of transportation to more locales and to more citizens,” said Gerald McCullough, a University of Minnesota economist who studies railroads. But the Staggers Rail Act has shifted that priority. Its stated purpose is to promote “a safe and efficient rail transportation system” and the Intermodal Surface Transportation Efficiency Act, which created the Surface Transportation Board, has as its goal a system that is “economically efficient.” But in practice a switch has been effected as the board focuses more on the welfare of railroads than the customers or the larger economy they serve.

  The evidence of a lack of competition in the rail marketplace is more than anecdotal; the numbers tell the same story. In 1978, two years before Congress adopted the Staggers Rail Act, the railroads actually were highly competitive, with thirty-six big lines known as Class I railroads. The industry and Staggers said this robust competition did not produce enough profits, an argument that ran counter to the traditional thinking that the economy thrives on competitive enterprise. Once the Staggers Rail Act took effect, the number of Class I railroads quickly shrank and, by 2004, there were just seven Class I railroads.

  Economists have a simple technique for measuring whether an industry is competitive or tending toward monopoly. It is called the Herfindahl-Hirschman Index, or HHI. The formula squares the market share of each company, then adds up the squares. It’s easier than it sounds. In an industry with one firm that has 100 percent market share, the HHI score will be 100 x 100 or 10,000. Or, if fifty firms each have 2 percent of the market, then the score would be 200 (2 x 2 = 4; 4 x 50 = 200). On the Justice Department scale, scores up to 1,000 indicate competitive markets, while scores higher than 1,800 are seen as solid evidence that competition is weak to nonexistent.

  In 1978, when America had thirty-six Class I railroads, the HHI score was 589, indicating robust competition. By 2004, however, just seven remaining Class I railroads meant the HHI score had soared to 2,263, reinforcing what was already obvious: little competition survived in the marketplace. Although the text of the 1980 Staggers Rail Act cites competition four times as the goal of the law, the effect has been the opposite.

  (To say that there are seven Class I railroads is also misleading. Twin duopolies, one west of the Mississippi River, the other east, dominate rail freight hauling. In the West there are the Union Pacific and Warren Buffett’s Burlington Northern Santa Fe. In the East there are CSX and Norfolk-Southern. As long as each of the big players elects not to cut prices to take major customers away from its rival, these duopolies function as price-inflating, profit-making machines to the detriment of the overall economy.)

  Another look over our shoulder at the not-so-distant past is informative. In the nineteenth century, the Grange movement of yeoman farmers arose mostly in response to railroads charging such high prices for poor service that family farms could not survive. Grain traders, millers and others have been treated no better by the railroads today, but protest is muted in our time in large part because politicians are insulated from popular dissent by the nature of our campaign finance and voting systems, which require huge infusions of cash that come from a small but very rich segment of the public. Therefore the voices politicians hear are those of the rich and of lobbyists whose concerns are underwritten by larger interests.

  There is another thing that the railroads became much more adept at after the Staggers Act and its false promise of competition. From 1978, just before passage of the Staggers Act, to 2004 the amount of freight moved per worker grew sixfold, a reflection of the fact that many workers were being laid off. No doubt increased labor productivity is good for railroad profitability; very likely it would be good for the economy as a whole if it added overall to economic efficiency. But in cutting their workforces, the railroads pushed goods onto the highways, which today means less efficient burning of fuel and more trucks around you when you go to work or drive your family on a vacation down an interstate highway.

  Let’s take one more look back. So ruthless were the nineteenth-century railroads that, as the reformer Henry George wrote in his 1879 book Progress and Poverty, railroad monopolists approached the burghers of small towns “as a robber approaches his victim.” The railroads demanded whatever would make them richer, threatening to move their line a few miles this way or that to compel submission. You can still visit the ruins of once-thriving little towns in the Great Plains that became ghost towns because the town fathers dared to resist the demands of railroad barons.

  Jumping to our time, railroad ownership is more concentrated than in 1887 and the abuse of power as great or greater. The subtitle of Henry George’s book is as apt now as then: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth.

  5…

  In Twenty-ninth Place and Fading Fast

  It sounds like you don’t want any competition down there in Glasgow.

  —Judge Ronald Meredith

  5. A 1999 television commercial encapsulated the telephone industry’s promise of the future along the Information Superhighway. A grizzled salesman drops his bag in the sparse lobby of Roy’s Motel and Café, then asks the unaccommodating young woman at the front desk about amenities.

  “What kind of rooms you got?”

  “King size.”

  “You got room service?”

  “Donuts and coffee,” replies the young woman, not bothering to look up from her book.

  “Got entertainment?”

  As the camera closes in on her lips, she says, “All rooms have every movie ever made in every language, anytime, day or night.”

  Astonished, the aging man asks “How is that possible?” As his words die away, the camera shifts outside to the windswept Mojave Desert, where an old Route 66 highway sign morphs into the logo of one of the Baby Bell telephone companies. In voice-over, the actor Willem Dafoe answers the question. “Could your business use the bandwidth to change everything? Ride the light. Qwest.”

  Qwest was just one of the telephone companies that shaped the promise of connecting us to the World Wide Web, even from fleabag motels in the middle of nowhere. In legalese, the companies represented the same thing—universal access—in formal regulatory filings with the government.

  To fulfill this promise, the telephone companies said they needed money to upgrade the medium, namely the copper wires that had been used since the first commercial telephone call was placed in 1878. The best new technology now was cables made from bundled strands of glass, thinner than a human hair. While the biggest copper cables carried four thousand conversations, AT&T said its fiber-optic cables could handle more than a million calls simultaneously. Experts on telephone economics calculated that this new technology meant the cost of calls would fall by 99 percent or more.

  There was just one problem: Who was going to pay for the creation of the new network? The telephone companies and the cable television firms set about getting that money. The obvious source was customers, and in the two decades from 1992 to 2012 state and federal regulators approved many rate increases and ended price regulation for many services. Bruce Kushnick, the former telephone industry consultant who gave us a lesson in chapter 1 about our telephone bills, estimates that $360 billion moved from the pockets of customers to AT&T, Verizon and the runt of the Baby Bell family, Qwest, which in 2010 was acquired by CenturyLink.

  That almost incomprehensibly large number was calculated using something much smaller: Kushnick’s own heavily footnoted reports based on company disclosures, which, in turn, led him to company reports and disclosures to regulators. When you do the long division, Kushnick’s estimate works out to a toll of $3,300 paid by every household in America to access the superfast electronic highway. In fact, based on the public statements of numerous telecommunications industry leaders about the cost, customers paid more than enough money to finance a fiber-optic system. And that $360 billon would have
been enough to pay off 45 percent of what Americans owed on credit cards in 2010.

  On the plus side, that cash was also enough to speed the development of two national cell telephone systems, owned by AT&T and Verizon, which is what they told regulators the rate increases helped them do. On the downside, however, the industry now cautions journalists that the term Information Superhighway is best not used anymore. That they want us to regard the term as archaic terminology is not surprising, because its use is a reminder of their unfulfilled promise. The high-speed data lanes in most of America are among the slowest electronic highways in the world; in many places in the United States, the promised highway has yet to materialize at all and, under current policies, never will.

  The telephone industry says Kushnick’s $360 billion figure is wrong, but the industry also declined to provide documentation or an alternate figure. This is a common tactic employed by public relations executives. Kushnick may be off only in the rounding and publicists can say that his estimate is wrong. But Kushnick’s estimate comes from his meticulous analysis of disclosure documents filed with the Securities and Exchange Commission and other regulatory agencies. Typically when an estimate is seriously flawed (perhaps off by 20 percent or more), providing a figure would discredit the source. On the other hand, Kushnick’s estimate might significantly understate how much extra money people paid for an electronic highway they did not get. It seems very likely that Kushnick’s numbers are uncomfortably close to the truth.

  Coming up with a reliable range of figures on telephone, Internet access and cable costs used to be easier because the FCC and state utilities regulators collected and disclosed revenues, costs and profits reported by the companies. But the telecommunications companies persuaded Congress and the state legislatures to change the laws to free them from reporting basic economic figures to regulators. The last big federal audit found record keeping that was appalling. Identical pieces of equipment were valued at next to nothing in one office and at thousands of dollars in another. In 2007 the FCC stopped collecting some key data, making its subsequent reports much less informative.

  Reducing required reporting to government sounds like a good idea if you think data collection makes companies inefficient. But keep in mind all those statements by politicians—especially those who affiliate themselves with business—that government should be run like a business. Corporations collect and analyze mountains of internal data to understand their operations. To set policy, to keep the competitive playing field level and the regulated field fair to investors and customers alike, government also needs lots of reliable data.

  When companies have this data internally and regulators do not, it creates what economists call an asymmetry, meaning one-sided knowledge. Asymmetry creates regulatory blindness. One-sided information lets the companies game the system for their benefit because it obscures what policy makers understand. Lack of information makes already cautious regulators even more hesitant, and it emboldens companies, strengthening their confidence that conduct they want to keep private is likely to remain unobserved.

  Without basic data, state and federal legislation will be shaped by the information the companies choose to make available, information that will focus on company needs rather than the needs of customers. The result must be—and is—laws and regulations written to the detriment of millions of people, especially captive customers.

  Regulation of prices acts as a proxy for customers where no market exists because of monopolized industries or where market competition is minimal, as with our national telephone duopoly of AT&T and Verizon. Prices are not the only concern, either. Access to service, quality of service and resolution of disputes are also important issues, as more Americans are discovering under the new rules—and many more will once AT&T and Verizon achieve one of their basic goals: to enhance profits by shedding unwanted customers, a goal they were in sight of in 2012.

  Even in a market where more than one telephone service is available, competition is not robust. Many people can chose Internet calling via unregulated services such as Skype and Vonage if they buy broadband Internet access, which may well come from AT&T or Verizon. People can also switch to cell phones, where AT&T and Verizon also dominate. AT&T and Verizon also own traditional landline systems that are legal monopolies. Through one technology or another, the AT&T–Verizon duopoly controls more than 60 percent of the telephone business in America.

  Any competition between telephone companies and cable companies is illusory. Verizon announced in 2008 that it would stop building out its FiOS (fiber-optic system) once it reaches about 16 million of America’s more than 100 million households. In New Jersey, for example, a state law that Verizon drafted says it must run FiOS past homes and businesses in seventy cities, but it is not required to actually wire every property for service. Verizon has no plans to wire the rest of the state. Instead, it has made deals with Comcast to sell its services using Comcast cables. Verizon said it anticipates similar deals with other cable providers to sell over their systems.

  The cross-marketing deal Verizon and Comcast made is not competition, but the start of a cartel. It is much closer to the intertwined corporate ties that dominate the economies of Japan and South Korea than the American ideal of competitive markets. It reinforces the economic interests of telephone and cable companies by not extending lines to rural areas or poor neighborhoods and not wiring apartment buildings where few people could afford the new services.

  Cable companies jacked up prices, too. Since 1995, average cable prices have been rising 2.6 times faster than the cost of living, reaching an average of almost $53 a month for basic, no-frills service in 2009, FCC reports show. Some cable companies are not content with annual price hikes. Comcast raised prices twice in ten months in 2011 and 2012 on its 1.8 million Boston-area customers. Service that cost $58 in 2009 came to almost $67 in early 2012, increasing at more than twice the rate of inflation.

  The strongest evidence that the cable companies exert monopoly power to raise prices comes from a survey of prices for basic service plus the most commonly purchased extra features such as handheld remotes and premium channels like HBO. In 2008, the worst economic year since the Great Depression, when the national economy shrank and millions lost their jobs, cable prices rose. What is more astounding is that, for the first time in decades, there was no inflation that year. A dollar was actually worth 3.6 percent more in 2009 than in 2008. But the cable companies raised prices 5.9 percent that year, according to a survey that the FCC relies on. That’s a real price hike of 9.5 percent.

  Of course, the FCC figure may be wrong, too, as it might understate actual increases. According to SNL Kagan, a market research firm, the average cable television bill in 2011 was $78, almost double the $40 price in 2001 and significantly higher than the FCC figure. Had the price just increased at the rate of inflation it would have gone up only $11, not $38.

  What do these prices mean? In 2010 half of all workers made less than $507 a week, according to Social Security Administration wage data. After taxes, then, a single person at the median wage had to work for two full weeks, plus most of the following Monday, just to make enough, after taxes, to pay the annual cost of cable service.

  While cable prices rose sharply from 1999 to 2010, the median wage, adjusted for inflation, was essentially flat during those twelve years. That means cable television consumed a growing share of people’s incomes, leaving them less money to buy other goods and services. Because they are monopolies or part of a duopoly in most localities, the cable companies leave the consumer with a simple choice: submit to cable-company pricing or go without the service.

  LET’S GO TO GLASGOW, KENTUCKY

  One community unwilling to submit to monopoly pricing was a small Kentucky city whose name recalls the Scottish heritage of its early settlers. Cable service wasn’t merely a convenience for the 15,000 people in Glasgow, as the nearest broadcast stations are across the Tennessee border in Nashville, ninety-five miles away, too f
ar for TV signals to carry over the air. But Glasgow residents complained of poor service and high prices from their monopoly cable provider, Telescripps (later acquired by Comcast).

  The Scots have a proverbial reputation for being thrifty. After all, Scotsman Adam Smith first identified and explained market competition in his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations. So perhaps it is not surprising that there was popular support in Glasgow for creating competition by building a city-owned cable system. In 1987 the Kentucky town built its own broadband system, spending $10 million (in 2012 dollars), about $667 per resident. Once municipal cable became available, prices plummeted. The cost of basic service dropped by half; the cost of a handheld remote fell from $4.95 a month to under a buck.

  The handheld-remote charge illustrates how modern price gouging works. Cable companies typically just provide one when signing up a customer. Many people assume the company-owned remote is required to change channels to avoid getting up to push the tiny buttons on the cable box, but in fact you can buy your own remote at an electronics store for under $10 retail. Remotes are so inexpensive that most companies don’t require their return with the cable box when service is cancelled. However, the remote the cable company rents you comes preprogrammed, while a remote you buy retail involves some setup.

  Telescripps charged nearly $5 a month for the remote, generating an annual profit on devices in the range of 2,000 percent. Telescripps’ charge was high, but even at the seventy-five cents a month some cable companies charge today for a remote channel changer, the annual profit remains several hundred percent annually.