The FCC, Net Neutrality and the Future Enrons of the Internet

America’s largest Internet service providers, which own most of the network backbone, have decided that Internet content providers such as YouTube are using too much bandwidth, and becoming too rich, and now the ISPs are demanding a bigger piece of the pie. Amid surprisingly little public debate, the ISPs have engaged in a focused campaign to lobby Congress and win court cases with the goal of stripping the government of any meaningful authority to regulate their price structures or data-routing policies.

The question that remains is whether the government will have the authority, or even the will, to regulate the ISPs and the future of the Internet. If Republicans in the House of Representatives have their way, the battle will be over before it ever really begins, with the ISPs emerging as undisputed victors.

The House voted early Saturday morning to pass H.R. 1, the federal budget bill for 2011. The bill included an amendment, H.AMDT.80, sponsored by Oregon Republican Greg Walden, which defunds any attempt by the Federal Communications Commission to regulate ISPs. The amendment was approved by a vote of 244 to 181, along party lines.

The vote on Rep. Walden’s amendment is the latest in a string of skirmishes over the regulation of the Internet. In December 2010, the FCC passed a set of rules giving itself limited authority to regulate Internet service providers. The FCC rules were an attempt at compromise, and they specifically deregulated wireless Internet providers, which are increasingly important. Some consumer groups said they were toothless, and several ISPs even cautiously supported the rules.

But Rep. Walden’s amendment will block the implementation of those rules if the budget passes the Senate and is signed into law by President Barack Obama.

Philosophically, Walden and the ISPs pushing for deregulation are following in the footsteps of Enron, Lehman Brothers, Bear Stearns, Citigroup, JPMorgan and the rest of the modern financial services industry.

Enron, the disgraced and defunct energy trading firm, lobbied for the deregulation of the U.S. energy market, and argued that the company should be allowed to enter into private agreements to sell energy and create complex derivatives based on speculative investment positions.

Similarly, Wall Street firms demanded and were granted unlimited freedom to create unregulated private contracts which evolved into “toxic assets,” including collateralized debt obligations and credit default swaps, which nearly destroyed the global economy in 2008.

Now, the ISPs are demanding the right to enter into private agreements with anyone who connects to the Internet, from any location in the world, on any pipeline. These private agreements would not only apply to the direct customers of the ISPs, but would include any parties identified by the ISPs as special users. The agreements could also allow ISPs to slow or block data traffic that the providers deemed to be burdensome or unacceptable.

For years, the largest owners of the Internet’s infrastructure, including Verizon and Comcast, have lobbied strenuously against almost all regulations, saying that private companies must be free to set prices and route Internet data traffic based on market conditions.

Both companies have also turned to the courts, suing to strip the FCC of the authority to regulate the Internet. They have also argued that they should have the right to slow or even block data that interferes with their priority traffic. Some ISPs, including Comcast and Level 3 Communications, have engaged in semipublic battles over the flow of data traffic. And some ISPs have considered the possibility of a “metered” Internet, where consumers would be charged based on their daily usage.

More extreme possibilities have been explored, including surcharges for individual Web pages, higher prices for video streams, on-demand payments for various features, and the “deep inspection” of customer data streams to prioritize traffic.

Consumer advocacy groups, some media companies and the FCC have pushed for various forms of regulation, saying that consumers must be protected from price gouging and the quasi-monopolistic telecommunications market, in which most consumers have only a handful of choices for Internet access.

Both sides of the debate have laid claim to the phase network neutrality. Internet service providers have said neutrality is defined by the ability of private companies to structure their services according to market conditions. Consumer groups have defined network neutrality in terms akin to the “common carrier” concept applied to telephone companies since 1934, saying that consumers should be able to pay for an open pipeline, without worrying about surcharges or interruptions based on disputes between pipeline providers.

In truth, this issue is not simple, and both sides have some valid points.

Three primary arguments are made by the champions of the free market and deregulation. First, they say, it is expensive to run a large Internet backbone, and new technologies such as YouTube are dramatically increasing pipeline requirements. Second, some data traffic is more important or time-sensitive, and ISPs, not government regulators, are best positioned to assign priorities to data traffic. Third, the government cannot be trusted to regulate the Internet, and any government regulation could lead down a slippery slope of government censorship and control.

Certainly, these arguments should not be dismissed too quickly. Internet backbones are very expensive. Some network applications, such as video games and videoconferencing, do need special priority to function properly. And recent headlines from China to Egypt have proved that governments will manipulate the Internet to the detriment of their own peoples.

On the other hand, it’s important for the debate to be grounded in reality, and the U.S. Internet system, as it exists today, is anything but a free market. The sponsor of H.AMDT.80, Rep. Walden, might need a refresher on that point. In a release cited by The Washington Post, he said, “We all want an open and thriving Internet. That Internet exists today. Consumers can access anything they want with the click of a mouse thanks to our historical hands-off approach. …”

Republicans and libertarians may claim that the Internet evolved in a perfect free market, but that is wrong at best, and a lie at worst, when one is considering the ISP backbone. Indeed, the U.S. ISP system has more in common with traditional monopolistic utility companies than a free market.

The facts are clear. A very small number of companies control the critical hubs and cross-country lines within the United States. Most U.S. consumers have only one to four choices of broadband providers for their homes or businesses. And the ISP system itself grew out of government-sponsored university and military projects, and it has always been governed by quasi-governmental organizations such as ICANN.

Moreover, huge multinational conglomerates have successfully lobbied to restrict many consumer freedoms on the Internet. The music, film and software industries have spent countless millions to ensure that consumers, content providers and even ISPs must follow complex and extremely restrictive copyright and trademark laws.

In short, the Internet has done just fine despite already being regulated, and there is no reason to think it could not thrive with a few additional reasonable rules applied to the business practices of the large ISPs.

So, what should be done?

The debate, assuming there is still room for one, should start with a look at the incentives built into the system. How can society incentivize private companies to provide fast, reliable Internet service to consumers and businesses? That seems like a simple enough proposition.

One possibility is a 21st century version of the Glass-Steagall Act. Under such a system, ISPs would be allowed to have only “one” customer: a client who would connect directly to them for Internet access. The ISP would be allowed to charge any reasonable price for this network connection, with the price being based on the speed of the connection or the amount of data transferred. But the ISP would be blocked from owning any media companies. And the ISP would also be blocked from imposing any surcharges based on individual usage preferences (e.g. which website or video the user was viewing). In other words, the ISP would be forced to function like the telephone companies of the 20th century. They would supply the line. The customer would “fill” it. How could this possibly be fair? Well, again, the ISPs are effectively monopolies, and perhaps should be treated as such. Let them do one thing, and one thing well.

Another possibility is to set up different rules for average Internet consumers and large companies such as Google. Under this vision, consumers would be protected by the FCC or some other government regulator. Large companies, such as Verizon and Google, would be free to enter into whatever complex private agreements they choose. Ideally, such a system would include some sort of regulator that could ensure that markets were marginally competitive, much as the TV networks were regulated in the 20th century. The danger of this system is that it would resemble the banking system right before the collapse of the economy in 2008, but it might be a more stable model when applied to the Internet than to money.

A final possibility is that the Democrat-backed FCC rules might not be so bad after all, at least as a starting point.

According to a Washington Post story, the FCC has said its rules are designed to protect consumers, and may not apply to the largest Internet pipelines, which are already governed by secret, private “peering” contracts. (Data traveling across the Internet almost always passes through several “peered” networks before terminating in the homes and businesses of consumers.)

Congressional Democrats have also offered reasonable defenses of the FCC rules, with Rep. Edward Markey issuing the following statement: “The [FCC] rules make three simple promises. One, to consumers: that we can visit any website we want using any service we want on any device we want. Two, for innovators: that they can create tools without getting permission from the government or the company that the consumers use to get online. Three: that we put a cop on beat, to make sure that both sides are doing what they’re supposed to and to be a neutral arbitrator. That’s all they do.” I think Rep. Markey is oversimplifying it a bit, but the rules could be massaged until they were that good.

In any case, as of this week, the Republican-led House of Representatives has voted against any government regulation of the Internet backbone. This is a mistake, and it is a position driven by dirty money, blind ideology, or both. For his part, Walden has said that his next action will be pushing for a joint resolution permanently blocking the FCC’s Internet rules. (The Congressional Review Act of 1996 allows Congress to overturn rules and regulations issued by the executive branch.)

On the other hand, it would be foolish to give the FCC unlimited authority to muck up the freedom of the Internet. I think — I hope — we are smart enough to find a compromise solution.

Derek Lazzaro is an attorney and university administrator in Los Angeles. He studies and writes about free speech issues, U.S. national security, the 2008 financial crisis, real estate, and technology.