As most of you know, the FCC will implement its first-ever incentive auction for wireless spectrum. In this auction, television broadcasters will (hopefully) offer for sale—and wireless carriers (among others) will offer to buy—spectrum in the 600 MHz band. The FCC will serve as the auctioneer. It’s all voluntary. How much spectrum gets traded depends on the prices offered by the wireless industry and the prices required by the broadcasters. Ideally, the auction will transfer a significant amount of spectrum to the mobile wireless industry and generate lots of revenue with which to buy stuff (like a new public safety network, E911 upgrades, and a needed injection into the bloated federal budget).

In addition to maximizing spectrum transfers and revenue, the Obama Administration and the FCC have added the manipulation of market shares in the mobile wireless industry to the auction’s goals. According to recent press reports, the FCC is considering a plan to favor Sprint and T-Mobile in the auction in the hope that adding low-band spectrum to their holdings will improve their reputation with customers and have an effect on industry competitiveness. To allegedly promote competition in the sector, the Commission plans to reduce competition in the auction, limiting the number of licenses the nation’s two most consumer-favored wireless carriers, AT&T and Verizon, can acquire.

Considering what AT&T and Verizon have contributed to action proceeds in the past, it’s a risky move by the Commission. Recognizing the likely adverse revenue impacts of restricting the two big bidders, the Commission is thinking about ways to soften the blow. (After all, while the government appears to want Sprint and T-Mobile to get spectrum, it’s not the case they want them to get it too cheaply.) So, in an attempt to have their cake and eat it too, it appears the agency has concocted a two-part plan for the auction.

In the first stage of the plan, the agency will allow the two larger providers to bid on all licenses in the auction, thus driving up prices. But once a set revenue target is reached, AT&T and Verizon will be blocked from further bidding on much of the auction’s licenses. In effect, AT&T and Verizon are being asked by the FCC to operate as shill bidders.

In the second stage of the plan, by restricting AT&T and Verizon to limited amounts of spectrum, the FCC hopes the two will fight aggressively for what’s available to them, inflating the price for those licenses. This idea comes from economic research suggesting that spectrum set-asides, whereby established carriers can’t touch many of the licenses, can improve overall auction revenues by forcing the larger players to fight over a limited amount of spectrum. If the fight is nasty enough, then the higher revenues from the established firms bidding will be sufficient to offset the lower revenues from the spectrum set aside for the agency’s hand-picked winners. Note, however, that in order to have the intended revenue effect from the set-aside, either AT&T or Verizon will have to walk away from the auction with nothing.

AT&T’s no fool. In a recent filing, AT&T indicated to the FCC it may sit the auction out. Doing so would almost certainly spell disaster for the auction. First, the FCC needs AT&T and Verizon to bid up prices on all licenses early, just before the restriction kicks in. Second, the FCC needs AT&T and Verizon to duke it out over the limited amount of spectrum they are permitted to acquire, thereby pumping up revenues. Without AT&T, neither part of the plan has much chance of success. AT&T’s active and broad bidding in prior auctions carries a lot of weight, driving up prices for what it buys and what it doesn’t buy. In the AWS-1 auction, AT&T paid only 10% of the auction’s revenues, but was responsible for 37% of total proceeds via its indirect influence on final prices. In the 700 MHz auction, AT&T paid big bucks for the B Block. AT&T’s departure is obviously a serious threat: not only will AT&T’s absence cost the agency one of its shill bidders, but the revenue-enhancing cage match between AT&T and Verizon doesn’t happen.

FCC Chairman Tom Wheeler says AT&T is full of it. On this matter he recently stated, “I find it hard to believe that somebody who has advocated so forcefully about why it is absolutely essential that they have spectrum like this would pass on the opportunity…. I have a hard time envisioning this once in a lifetime opportunity for this kind of beachfront spectrum being something that people throw up their hands and walk away from.”

Apparently, Chairman Wheeler sees this as one helluva game of chicken.

With all due respect, I think Chairman Wheeler misses the point. For this little scheme of his to work, either AT&T or Verizon must walk away from the auction empty handed (or effectively so) after a period of aggressive bidding. The spectrum will be auctioned as 5×5 MHz blocks. As noted by AT&T in its filing, “in each market where the restrictions attach to at least two carriers, at most only one restricted carrier could emerge from the auction with a 10×10 MHz allocation.” In a 60 MHz band plan (five 5×5 MHz blocks, which would imply a highly successful auction), AT&T and Verizon could be limited to three blocks.  As such, only one party can walk away with a 10×10 MHz block, leaving only a 5×5 MHz block for the other which has little to no value. So, it’s not that AT&T is throwing up its hands and walking away from beachfront spectrum; it’s that AT&T recognizes that by the plain design of the auction, the opportunity to win sufficient spectrum at non-inflated prices is very low. The beachfront property Wheeler is offering is, in essence, sitting next to an anchovy-processing plant (which, as I can personally attest, can really put a damper on one’s vacation plans). Furthermore, it’s not clear what licenses AT&T and Verizon will be permitted to bid on. If they can’t get spectrum in the urban markets where their networks are most congested, then there’s really no point in showing up.

If AT&T is a no show, and I can imagine a scenario where it’s not worth participating, then the success of the auction is in serious jeopardy since the FCC’s plan depends on the company to drive up prices on two fronts. Reckoning the risk, perhaps the agency will will back down from this dangerous game of chicken and propose rules where AT&T and Verizon both have an opportunity to acquire spectrum.