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No. 93-531C (Senior Judge Loren Smith) ______________________________________________________________________________ IN THE UNITED STATES COURT OF FEDERAL CLAIMS _____________________________________________________________________________
AMBASE CORPORATION AND CARTERET BANCORP, Inc. Plaintiffs, and FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff-Intervenor, v. UNITED STATES OF AMERICA

______________________________________________________________________________ GOVERNMENT'S POSITION WITH RESPECT TO CROSS-MOTIONS FOR SUMMARY JUDGMENT ON DAMAGES ______________________________________________________________________________ MICHAEL F. HERTZ Deputy Assistant Attorney General JEANNE E. DAVIDSON Director KENNETH M. DINTZER Deputy Director OF COUNSEL: TAREK SAWI Senior Trial Counsel ARLENE PIANKO GRONER MELINDA HART ELIZABETH M. HOSFORD F. JEFFERSON HUGHES DELISA SANCHEZ AMANDA TATUM

DAVID A. LEVITT Trial Attorney Commercial Litigation Branch Civil Division Department of Justice 1100 L Street, N.W. Washington, D.C. 20005 Tel: (202) 307-0309 Fax: (202) 514-7969

Date: November 7, 2007

Attorneys for Defendant

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TABLE OF CONTENTS TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii GOVERNMENT'S POSITION WITH RESPECT TO CROSS-MOTIONS FOR SUMMARY JUDGMENT ON DAMAGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 I. UNDISPUTED FACTS ESTABLISH A LACK OF CAUSATION BETWEEN THE BREACH AND THE FAILURE OF CARTERET . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 AMBASE IS NOT ENTITLED TO CARTERET'S UNEXPECTED MARKET VALUE AT THE TIME OF TRIAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 AMBASE'S ESTIMATE OF UNEXPECTED CASH FLOWS CANNOT BE SUPPORTED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 AMBASE'S CLAIMS TO PREJUDGMENT INTEREST ARE INVALID . . . . . . . . . 13 AMBASE'S WOUNDED-BANK DAMAGES CLAIMS ARE INVALID . . . . . . . . . . 15

II.

III.

IV. V.

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

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TABLE OF AUTHORITIES FEDERAL CASES Admiral Financial Corp. v. United States, 57 Fed. Cl. 418 (2003), aff'd 278 F.3d 1336 (Fed. Cir. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Ambase Corp. v. United States, 58 Fed. Cl. 32 (2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 4, 5 American Capital Corp. v. Federal Deposit Insurance Corp., 472 F.3d 859 (Fed.Cir. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 American Federal Bank v. United States, 72 Fed. Cl. 586 (2006) . . . . . . . . . . . . . . . . . . . . . . . 7 California Federal Bank v. United States, 245 F.3d 1342 (Fed. Cir. 2001) . . . . . . . . . . . . . 9, 10 California Federal Bank v. United States, 395 F.3d 1263 (Fed. Cir. 2005), cert. den 126 S. Ct. 344 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Castle v. United States, 301 F.3d 1328 (Fed.Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Citizens Federal Bank, FSB v. United States, 52 Fed. Cl. 561 (2002) . . . . . . . . . . . . . . . . . . . . 2 Commercial Federal Bank v. United States, 59 Fed. Cl. 338 (Fed. Cl. 2004) . . . . . . . . . . . . . . 12 Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed.Cir. 2002) . . . . . . . . . . . . . . . . . . 14 Fifth Third Bank of Western Ohio v. United States, 55 Fed. Cl. 223 (2003) . . . . . . . . . . . . 9, 10 Fifth Third Bank of Western Ohio v. United States, 462 F.3d 1221 (Fed. Cir. 2005) . . . . . . . . 2 Glendale Federal Bank, F.S.B. v. United States, 378 F.3d 1308 (Fed. Cir. 2004) . . . . . . . . . . . 9 Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005) aff'd in part, vacated in part, and remanded, 189 Fed.Appx. 964 (Fed. Cir. 2006) . . . . . . . . . . . . . . . . . . . . 12 Granite Management Corporation v. United States, 416 F.3d 1373 (Fed. Cir. 2005) . . . . . . 2, 16 Hansen Bancorp, Inc. v United States, 67 Fed. Cl. 411 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Estate of Lillian Berg v. United States, 687 F.2d 377 (Ct. Cl. 1982) . . . . . . . . . . . . . . . . . . . . . 6 Long Island Savings Bank v. United States, 60 Fed. Cl. 80 (2004), rev'd on other grounds, 2007 WL 2685640 (Fed.Cir. 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Old Stone Corp. v. United States, 450 F.3d 1360 (Fed. Cir. 2006) . . . . . . . . . . . . . . . . . . . . . 6, 7 Sinclair Refining Co. v. Jenkins Petroleum Process Co., 289 U.S. 689 (1933) . . . . . . . . . . . . . 7 ii

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Slattery v. United States, 69 Fed. Cl. 573 (2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Southwest Investment Co. Inc. v. United States of America, 63 Fed. Cl. 182 (2004), aff'd 158 Fed.Appx. 283 (Fed.Cir. 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 4, 5 Suess v. United States, 52 Fed. Cl. 221 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Suess v. United States, 74 Fed. Cl. 510 (2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Westfed Holdinggs, Inc. v. United States, 52 Fed. Cl. 135 (2002), aff'd in part, rev'd in part, and remanded 407 F.3d 1352 (Fed.Cir. 2005) . . . . . . . . . . . . . . . . . 15

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

AMBASE CORPORATION AND CARTERET BANCORP, INC., Plaintiffs, and FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff-Intervenor, v. THE UNITED STATES Defendant.

) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )

No. 93-531C Senior Judge Loren Smith

GOVERNMENT'S POSITION WITH RESPECT TO CROSS-MOTIONS FOR SUMMARY JUDGMENT ON DAMAGES In April 2007, this Court ordered the parties to express their views on the wisdom of delaying trial pending the resolution of cross-motions for summary judgment on damages. Order dated April 13, 2007. As we demonstrate, because Ambase's damage claims are contrary to relevant case law, the Court should delay Appendix A filings and trial until the resolution of cross-motions for summary judgment on damages. Assuming these claims are resolved favorably to the United States, as we demonstrate they should be, trial will be avoided entirely or there will be fewer and less complex issues to be tried BACKGROUND In February 2007, Ambase filed a "motion for an order setting pretrial schedule," which argued that any questions relating to its claims for damages would "almost certainly focus on quintessentially factual issues . . . ." Plaintiffs' Motion For Entry Of An Order Setting Pretrial Schedule at 3. Ambase contended it would be inefficient to delay trial until the resolution of cross-motions for summary judgment on damages because its damage claims were unlikely to be

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resolved in a summary judgment proceeding. Id. Contrary to Ambase's contentions, we pointed out that many damage claims in Winstarrelated cases have been resolved on cross-motions for summary judgment on damages. See, Government Opposition To Plaintiffs' Motion For Entry Of An Order Setting Pretrial Schedule; see, e.g., Granite Management Corporation v. United States, 416 F.3d 1373, 1378 (Fed. Cir. 2005) (restitution and mitigation claims resolved on cross-motions for summary judgment on damages), Citizens Federal Bank, FSB v. United States, 52 Fed. Cl. 561, 564-66 (2002) (theories related to cost of replacement resolved on cross-motions for summary judgment on damages); Southwest Investment Co. Inc. v. United States of America, 63 Fed. Cl. 182 (2004), aff'd 158 Fed.Appx. 283 (Fed.Cir. 2005) (expectancy damages and causation claims resolved on crossmotions for summary judgment on damages); Fifth Third Bank of Western Ohio v. United States, 462 F.3d 1221, 1236-37 (Fed. Cir. 2005) (claims relating to lost leveraging profits resolved on cross-motions for summary judgment on damages). Ambase argued in reply that because its damage claims would "largely track the damages awarded in Slattery v. United States," there would be no novel issues which could be resolved on cross-motions for summary judgment on damages. Plaintiffs' Reply In Support Of Their Motion For Entry Of An Order Setting Pretrial Schedule at 2.1 Although we might have agreed with Ambase that, if it had based its claims on Slattery and Suess, few if any legal issues might be resolved on cross-motions for summary judgment on damages, it has not done so. As demonstrated by the report of Professor Charles Calomiris, Ambase's damages expert, the damage theories Ambase advances are contrary to Winstar-related

This Court in Slattery awarded as expectation damages the market value of the thrift on the date of the breach plus a market-based control premium. Slattery v. United States, 69 Fed. Cl. 573 (2006). This Court later adopted the same approach to expectancy damages in Suess v. United States, 74 Fed. Cl. 510 (2006). 2

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cases. Thus, cross-motions for summary judgment are the appropriate procedure for resolving the inconsistency of Professor Calomiris's theories with relevant law.2 ARGUMENT I. UNDISPUTED FACTS ESTABLISH A LACK OF CAUSATION BETWEEN THE BREACH AND THE FAILURE OF CARTERET Professor Calomiris acknowledges that Ambase rectified Carteret's small regulatory capital deficiency following the implementation of FIRREA by investing $50 million. May Dec. at 13. Further, he acknowledges that the United States District Court for the District of New Jersey issued a preliminary injunction in February 1991 which required the Office of Thrift Supervision ("OTS") to count goodwill, including that related to branches sold in 1990, as regulatory capital. Id. at 82. Finally, this Court has acknowledged that, because of losses on real estate investments, by the end of the second quarter of 1991, even counting goodwill as regulatory capital, Carteret was unable to comply with regulatory capital requirements imposed by FIRREA. Ambase Corp. v. United States, 58 Fed. Cl. 32, 39-40 (2003) ("Ambase I"). Professor Calomiris's estimation of Carteret's regulatory capital absent the breach as of September 1992 (the quarter immediately prior to Carteret's failure), shows that (1) "but for" Carteret would have been unable to comply with two of three regulatory capital requirements (risk based capital and core capital), and (2) that the write-downs of Carteret's real estate holdings in 1990 and 1991 vastly exceeded the amount of supervisory goodwill on Carteret's books at the time of the breach. July Supp. Dec. at 8. Professor Calomiris bases his damage calculations upon the assumption that Carteret would not have failed in the absence of the breach. If this is false as a matter of law, it will be

Professor Calomiris's declaration dated May 19, 2007 ("May Dec."), and supplemental declaration, dated July 12, 2007 ("July Supp. Dec."), are attached hereto as Exhibits I and II, respectively. 3

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unnecessary to consider Ambase's damage claims in a trial. As we will demonstrate in a motion for summary judgment on damages, the breach was immediately mitigated by Ambase's investment pursuant to the capital maintenance agreement. Ambase I, 58 Fed. Cl. At 38-40. Thereafter, before the breach could have had any substantial effect, the district court required the regulators to count goodwill as regulatory capital. Id. Between the second quarter of 1991 and the imposition of the receivership in December 1992, it is undisputed that Carteret was unable to satisfy regulatory capital requirements even counting the goodwill as regulatory capital. Id. These conditions render the assumptions that underlay Professor Calomiris's calculation of damages, namely that Carteret would have survived and prospered absent the breach, invalid. Assuming, as we will demonstrate in a motion for summary judgment on damages, that Professor Calomiris's assumptions are invalid, Carteret's failure cannot be attributable to the breach and a trial on Ambase's damage claims can be avoided. Winstar-related precedents demonstrate that causation issues, such as those raised by the Calomiris Declarations, can be decided upon cross-motions for summary judgment on damages. For example, in Southwest Investment Co., as here, the undisputed evidence indicated that the thrift's insolvency would not have been cured by the addition of goodwill to regulatory capital. 63 Fed. Cl. at 195-99. The court ruled that summary judgment was appropriate because, based upon undisputed financial information, "Louisiana was insolvent [i.e., unable to satisfy minimum regulatory capital requirements] notwithstanding the promises." Id. at 196. See also, Admiral Financial Corp. v. United States, 57 Fed. Cl. 418, 434-35 (2003), aff'd 278 F.3d 1336 (Fed. Cir. 2004) (because the thrift was insolvent with or without goodwill, it was not harmed by the breach); Hansen Bancorp, Inc. v United States, 67 Fed Cl. 411 (2005) (same). In short, like in other Winstar-related cases, the undisputed financial facts in this case indicate that Carteret was not injured by the breach. It was protected from the breach by

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Ambase's capital maintenance contributions and the district court's injunction. Ambase I, 58 Fed. Cl. at 36-38. The thrift, however, became insolvent in the second quarter of 1991 notwithstanding insulation from the breach and Ambase's mitigation efforts. Id. These facts are conceded in Professor Calomiris' report and can be demonstrated by undisputed financial and regulatory records in a motion for summary judgment on damages. July Supp. Dec. at 8. II. AMBASE IS NOT ENTITLED TO CARTERET'S UNEXPECTED MARKET VALUE AT THE TIME OF TRIAL Professor Calomiris contends that Ambase is entitled to the market value of the unexpected cash flows "but for" Carteret allegedly would have realized between the time of the breach and the time of trial (estimated to be December 2006 or December 2008) if it had survived the breach. To determine the market value of the unexpected cash flows, Professor Calomiris applies a mathematical formula (the so-called Gordon Growth Model) to estimate future cash flows upon the basis of historical earnings and a discount factor. May Dec. at 26 (1982-1988 Table 5). After estimating the alleged book value of the "but for" thrift in 2006 and 2008 (based upon estimated future cash flows), Professor Calomiris calculates the market value based upon the market-to-book ratios of alleged "peer institutions." He claims that Carteret is entitled to the market value of its "but for" equity in 2006 or 2008 which, under his preferred estimate, is more than three times the thrift's estimated market value at the time of the breach. Professor Calomiris claims that "[t]he market's predictions of Carteret's future profitability in 1988 and 1989 were, with the benefit of hindsight, unduly conservative if the breach had not caused Carteret to fail." May Dec. at 28-29 Contrary to Calomiris's contentions, the case law requires that damages relating to the loss of market value be calculated as of the date of breach and not upon the basis of ex post theories contending the market was "unduly conservative" in valuing future cash flows. See, e.g,, Estate of Lillian Berg v. United States, 687 F.2d 377, 380 (Ct. Cl. 1982) ("the date of breach is 5

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the proper date for establishing fmv"). While the breaching party might be able to foresee the loss of market value at the time of the breach, if the market at that time could not foresee future cash flows, as a matter of law, neither could the breaching party. See, e.g., Old Stone Corp. v. United States, 450 F.3d 1360, 1374-78 (Fed. Cir. 2006). In Old Stone, for example, the holding company sought, as reliance and restitution damages, over $115 million in cash and stock it had invested in the troubled thrifts at the time of the transactions. Following the breach, the holding company invested another $75 million which it raised by selling assets to mitigate the effects of the breach. Notwithstanding the mitigation, the thrift failed. The Federal Circuit, while allowing the recovery of the $75 million which was the cost of mitigation, disallowed recovery of the initial investments because the breaching party could not have foreseen the loss of future cash flows resulting from the investment of the capital. As the Court held: "[E]ven if the need for replacement capital was foreseeable, that hardly establishes that the adverse consequences alleged to flow from the need to make infusions were foreseeable." Id. at 1376. Professor Calomiris's damage theory is contrary to Old Stone because it assumes that the breaching party would have been able to foresee at the time the contracts were formed in 1982 and 1986 that cash flows between 1989 and 2006 or 2008 would have exceeded the market's estimate of the thrift's value as of 1989 by a factor of at least three. In other words, according to Professor Calomiris's assumption, while the market underestimated Carteret's profitability in 1988 and 1989, Carteret's post-1989 profitability would have been foreseeable to the regulators in 1982 and 1986. As in Old Stone, however, it is highly speculative to assume the regulators could have foreseen future developments at the time the contracts were formed that the market could not foresee in 1989. Professor Calomiris's theory, which is to "charge the offender with elements of value non-existent at the time of his offense," Sinclair Refining Co. v. Jenkins Petroleum

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Process Co., 289 U.S. 689, 698 (1933), is not permissible in contract actions. Id.; see, e.g., American Fed. Bank v. United States, 72 Fed. Cl. 586, 602-03 (the improved economy broke the chain of causation between the breach and the mitigating event). In short, Professor Calomiris's method for calculating damages is contrary to relevant case law. If his methodology is rejected on cross-motions for summary judgment, there will be no need to address at trial the extensive evidence regarding the alleged growth of thrift indices and a sample of thrifts between the date of breach and 2006 or 2008. Accordingly, addressing a motion contesting these aspects of Professor Calomiris's calculation prior to trial should simplify the trial and advance judicial efficiency. III. AMBASE'S ESTIMATE OF UNEXPECTED CASH FLOWS CANNOT BE SUPPORTED Professor Calomiris advances a lost profits claim based upon a simple arithmetic extrapolation of historical earnings using the Gordon Growth Model, without any estimates or analysis of what would have happened to the thrift on a year-by-year basis in a "but for" world, assuming Carteret had survived. Professor Calomiris uses Carteret's market value at the time of the breach as a starting point for then calculating market value as of 2006 or 2008, incorporating elements of ex post analysis and pre-judgment interest. As previously noted, Professor Calomiris purports to calculate unexpected future cash flows of "but for" Carteret by taking historical earnings and an estimated discount factor and applying the so-called Gordon Growth Model to Carteret's estimated market value as of 1989. Putting aside whether Carteret's historical earnings, which Professor Calomiris acknowledges failed to exhibit steady growth, can be used to estimate future earnings under the Gordon Growth Model, which assumes a constant rate of growth of earnings, the question of whether unexpected foregone earnings can be predicted with reasonable certainty based upon an arithmetic formula raises a pure issue of law. As the case law establishes, future unexpected cash flows cannot be 7

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demonstrated by theoretical models but, instead, depend upon contemporaneous documentation of the financial performance of the "but for" thrift. Professor Calomiris failed to identify any specific lost investment opportunities underlaying the supposed growth of earnings. Therefore, Professor Calomiris's method for estimating unexpected future cash flows is invalid as a matter of law. For example, in California Federal Bank v. United States, 245 F.3d 1342, 1349-50 (Fed. Cir. 2001), the Federal Circuit reversed the trial court's award of summary judgment on a lost profits claim because the thrift had presented substantial evidence of its assets and liabilities in a "but for" world. As the Court noted: Cal Fed presented documentary evidence to show that it sold significant assets in the wake of the breach. Its business plans and Office of Thrift Supervision documents allegedly showed its intent to invest in low risk assets that it claims have proven profitable. It provided specific documentation of 24,664 singlefamily adjustable rate mortgages worth approximately $4 billion that it claims it was forced to sell to remain in capital compliance after the breach. Cal Fed then provided expert testimony, which traced the actual post-sale performance of these loans and arrived at lost profits of $317 million attributable to these sales. Additional documentary and deposition evidence was submitted to support Cal Fed's claim that in 1993 it was forced to sell a profitable business unit, California Thrift & Loan, to meet its capital requirements. Cal Fed, 245 F.3d at 1349-50. This evidence was deemed sufficient to withstand a motion for summary judgment on damages. At trial, however, Cal Fed was unable to prove lost profits. See California Federal Bank v. United States, 395 F.3d 1263, 1267-73 (Fed. Cir. 2005), cert. den. 126 S.Ct. 344 (2005) (insufficient proof the shrinkage was caused by the breach; Glendale Federal Bank, F.S.B. v. United States, 378 F.3d 1308, 1310 (Fed. Cir. 2004) (lost profits models do not "fit comfortably with the history of these cases in the years following the breach"). Notwithstanding CalFed, in Fifth Third Bank of Western Ohio v. United States, 55 Fed. 8

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Cl. 223, 240-41 (2003), this Court awarded summary judgment to the United States on Fifth Third's lost profits claim. The thrift claimed lost profits based upon the assumption that the "but for" thrift would have been larger than the actual thrift and would have achieved the same level of profitability as had been achieved by the actual thrift. Reading CalFed as "reflect[ing] the nature and quality of evidence that the Federal Circuit ruled sufficient to withstand a summary judgment action," this Court ruled that the evidence Fifth Third proffered did not meet that standard. Specifically, Fifth Third's evidence consisted of arithmetic projections from the real world to the "but for" world based upon the leveraging of goodwill. As the Court noted: Plaintiff's model fails to account for any real-world events other than the profitability of Citizens during the 1990's before its purchase by plaintiff. Plaintiff's model ignores the presence of competitors similarly unfettered by the breaching provisions of FIRREA. But the most outstanding flaw is the assumption that the but for Bank would, even if it could, engage in the same type of activities without identifying any specific investments or opportunities, and that these activities would produce the same results (discounted to be conservative) as the actual business activities in which plaintiff engaged. The court agrees with defendant that this deficiency renders plaintiff's model speculative as a matter of fact and law. Fifth Third, 55 Fed. Cl. at 241. Similarly, in this case Professor Calomiris "fails to account for any real-world events other than the profitability of [Carteret] during the 1990's [through 2006 or 2008]." Id. To calculate foregone earnings, Professor Calomiris simply engages in an arithmetic exercise which depends upon the assumption that Carteret's historical earnings increased at a steady state and therefore unexpected future cash flows can be estimated by the Gordon Growth Model. Even assuming, however, that Professor Calomiris correctly averaged Carteret's historical operating earnings, the undisputed financial data relating to Carteret's 1982 to 1988 net after tax income demonstrates that Carteret simply did not exhibit a steady growth in income during this period.

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Instead, as Professor Calomiris concedes, Carteret's income fluctuated wildly year by year and, in many years, decreased rather than increased. May Dec. at 26. Therefore, by reference to Professor Calomiris's own data, the application of the Gordon Growth Model to Carteret is simply inappropriate. Indeed, Professor Calomiris assumes that Carteret would have been profitable each and every year after FIRREA. See Table 6, May Dec. at 28. Such an assumption, however, ignores the huge losses Carteret recorded in 1990 and 1991 because of its asset quality problems, many of which were as a result of investment decisions made well before FIRREA. May Dec. at 26, n. 59. Such an assumption has the effect of saying that every dollar of loan loss was due to the breach which even Professor Calomiris acknowledges is not correct. As he admits: "Carteret would likely have eventually suffered some of these same losses even in the absence of the Government's breach. May Dec. at 74. Even if Carteret had demonstrated a steady growth in historical earnings, the relevant case law does not regard the application of a simple arithmetic formula as credible evidence from which to estimate unexpected future cash flows. To the contrary, lost profits claims have been rejected in most Winstar-related cases because the thrift was unable to demonstrate with the required specificity the financial performance it would have enjoyed in a "but for" world. See, e.g., CalFed, 245 F.3d at 1349-50; Suess v. United States, 52 Fed. Cl. 221 at 228-30 (detailed model based upon earnings of allegedly comparable thrifts and financial projections in a capital plan unrealistic and implausible). Professor Calomiris's model is less specific than alreadyrejected models because he does not even attempt to establish balance sheets and profit and loss statements Carteret would have enjoyed in a world without the breach. Wintar-related case law simply does not support a theoretical approach to damages such as that contained in the Calomiris report. Indeed, Professor Calomiris's model is inconsistent

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with the only cases, of which we are aware, awarding lost profits. For example, in Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330, 363-64 (2005), aff'd in part, vacated in part, and remanded, 189 Fed.Appx. 964 (Fed. Cir. 2006), the thrift presented extensive evidence concerning its business plans and the performance of investment vehicles it was forced to sell because of the breach. Id. at 363-64. In this case, by contrast, Professor Calomiris simply uses a theoretical model without identifying any of the assets or liabilities of the "but for"thrift. Likewise, in Commercial Federal Bank v. United States, 59 Fed. Cl. 338, 344-51 (Fed. Cl. 2004), the thrift demonstrated at trial "the types of categories of investment opportunities that [the institution] would have exploited [in the absence of the breach]." Id. at 349, n.29. Further, both before and after the breach, the thrift demonstrated "a "record of profitable growth and average asset returns in excess of one percent [of assets]." Id. at 350. Therefore, Professor Calomiris's model has none of the indicia of reliability accepted by the courts in Winstar-related cases.3 IV. AMBASE'S CLAIMS TO PREJUDGMENT INTEREST ARE INVALID Professor Calomiris's model assumes that Carteret should reap the benefit of favorable economic conditions after 1992, and claims that Carteret's market value at the time of breach did not reflect the favorable economic conditions. According to Professor Calomiris, Carteret is entitled to damages based upon his estimate of the dividends that Carteret would have paid to Ambase ($188.7 million per Table 6, May Dec. at 28) absent the breach, plus what Carteret's market value allegedly would have been in 2006 or 2008 had it survived. In his preferred

The issue of whether the model meets the relevant evidentiary standards is separate from the accuracy of the inputs provided by Professor Calomiris. As we will demonstrate at trial, should one become necessary, Carteret did not have the financial profile prior to the breach to warrant application of the Gordon Growth Model. Further, even if it did, Professor Calomiris's estimates of Carteret's market value as of the time of breach are implausible and unsupported. Although our experts will present a persuasive rebuttal to Professor Calomiris at trial, because there appear to be differences of opinion between the experts on Carteret's financial characteristics prior to the breach, these disputed factual questions arguably cannot be decided in the context of cross-motions for summary judgment. 11

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approach, he estimates this market value by compounding "but for" Carteret's earnings net of estimated dividends at 4.2 percent per year after 1989, and then multiplying the estimated book value of the "but for" thrift as of 2006 and 2008 by the average market-to-book value ratio of "peer institutions."4 May Dec. at 25-43. Although Professor Calomiris claims his methodology is not tantamount to seeking prejudgment interest on Carteret's market value as of the time of the breach, in effect it is. That is, the methodology adjusts Carteret's 1989 market value by adding to it an annual compound interest rate of 4.2 percent which is Professor Calomiris's estimated annual rate of return for Carteret absent the breach. May Dec. at 26. Professor Calomiris contends he is avoiding the proscription on prejudgment interest by excluding estimated dividends from "but for' Carteret's annual return. Although this may lower the effective rate of prejudgment interest, it does not eliminate prejudgment interest. While it is true that lost profits between the time of the breach and the time of trial do not have to be discounted to avoid prejudgment interest, see, e.g., Energy Capital Corp. v. United States, 302 F.3d 1314, 1330-34 (Fed.Cir. 2002), Professor Calomiris does not claim "but for" Carteret's lost profits as the measure of damage but, instead, the estimated market value of "but for" Carteret in 2006 or 2008. As a matter of law, when the measure of damage is the lost market value of an asset injured or destroyed as a result of the breach, the date to measure the market value is the date of breach and not some time in the future. Estate of Berg, 687 F.2d at 380. In effect, Professor Calomiris's estimate simply adds an estimated rate of return to

Professor Calomiris's "preferred" estimate of Carteret's but-for market value of $892.1 million as of December 31, 2006 is based upon his estimate of Carteret's book value of $442.9 million as of December 31, 2006 (his $269.3 million in book value in July 1989 minus $175.0 million of goodwill amortization plus $348.6 million of "retained earnings" as of December 31, 2006 from his Table 6, May Dec. at 28). The $442.9 million is increased to $892.1 million in his Table 13, May Dec. at 41, based upon the increase in the mean market-to-book value of his "peer institutions" from 1989 to 2006. 12

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Carteret's market value of equity at the time of breach to calculate "but for" Carteret's estimated market value in 2006 or 2008. This is tantamount to adding prejudgment interest to Cartert's market value at the time of breach calculated as the estimated annual rate of earnings growth (4.2 percent) compounded net of dividends. Although the prejudgment interest impact on total book value will be less than 4.2 percent because the earnings begin with a $20.5 million base whereas the beginning book value is $269.3 million, Table 3, May Dec. at 19, the calculation results in prejudgment interest on Carteret's estimated 1989 market value.5 The facts concerning Professor Calomiris's damage calculations are not disputed and prejudgment interest claims have been decided on cross-motions for summary judgment in other Winstar-related cases. For example, in Long Island Savings Bank v. United States, 60 Fed. Cl. 80, 94 (2004), rev'd on other grounds, 2007 WL 2685640 (Fed.Cir. 2007), the thrift claimed as expectation damages the reduction in interest bearing liabilities that allegedly would have been enjoyed if lost profits had been earned in the absence of the breach. On cross-motions for summary judgment on damages, this court ruled that the claim was tantamount to prejudgment interest. Id. Professor Calomiris's claim is similar in that it seeks a return on Carteret's market value as of the time of breach computed as a function of the estimated growth of earnings net of dividends (and compounded annually). As in Long Island, whether the claim represents prejudgment interest can be resolved as a matter of law on the undisputed record. See also, Westfed Holdings, Inc. v. United States, 52 Fed. Cl. 135, 162-64 (Fed. Cl. 2002), aff'd in part, rev'd in

For example, net income between 1990 and 1991 increases by 4.2 percent or by $0.9 million ($20.5 to $21.4), whereas dividends increase by $0.3 million ($6.5 to $6.8). Table 6, May Dec. at 28. Therefore, the net increase to book value due to the earnings growth rate is $0.6 million, which results in an increase in book value of 0.22 percent ($0.6/$269.3). This demonstrates pre-judgment interest is significant though less than 4 percent of Carteret's 1989 estimated market value. 13

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part, and remanded, 407 F.3d 1352 (Fed.Cir. 2005) (interest on debt to mitigate damage determined not to constitute prejudgment interest as a matter of law). In short, Professor Calomiris's claim to Carteret's market value as of 2006 or 2008 is a claim for prejudgment interest. Eliminating the claim on the basis of cross-motions for summary judgment will necessarily reduce the complexity and duration of the anticipated trial. V. AMBASE'S WOUNDED-BANK DAMAGES CLAIMS ARE INVALID Ambase seeks wounded bank damages totaling $16.8 million which consist primarily of severance payments Ambase made to employees of Ambase and Carteret, transaction costs incurred by Ambase in seeking capital for Carteret, and costs incurred by Ambase to defend Ambase and Carteret officers and directors against administrative charges brought by OTS. In calculating wounded bank damages relating to employee payments and administrative expenses, Professor Calomiris does not distinguish between payments made by Ambase and payments made by Carteret (if any). Of course, only losses Carteret would have avoided in a "but for" world are compensable as "wounded bank" damages. Because losses that might have been avoided by Ambase, which was not a party to the goodwill contract between Carteret and the Federal Home Loan Bank Board ("FHLBB"), are not recoverable, Professor Calomiris's claim for wounded bank damages is invalid as a matter of law. Professor Calomiris justifies Ambase's claim for wounded bank damages upon the ground that the payments Ambase seeks would not have been incurred in the absence of Carteret's breach-induced weakened condition. We dispute that the payments related to the breach. More importantly for our summary judgment motion, even if the payments were caused by the breach, they are unrecoverable as a matter of law because Ambase was not a party to the contract. For example, in Granite, 416 F.3d at 1373, the thrift sought to recover costs related to a capital investment by its parent, Ford Motor Company ("Ford"). The Federal Circuit, however,

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disallowed the recovery upon the ground that Ford was not a party to the suit. Although Ambase is a party to this suit, it is not contracting party or a direct plaintiff (its suit is derivative only). Like the thrift's claim for parent expenses in Granite, therefore, Carteret's claim for expenses incurred by Ambase is not a cost incurred by a contracting party and should be denied. Similarly, in American Capital Corp. v. Federal Deposit Insurance Corp., 472 F.3d 859, 865-67 (Fed.Cir. 2006), the Federal Circuit rejected the thrift's parent's claim for the value of the thrift's equity upon the ground that "[a] corporate parent which owns the shares of a subsidiary does not, for that reason alone, own or have legal title to the assets of the subsidiary. . ." Id. at 866. Under American Capital, therefore, the parent is not entitled to recover costs incurred by the thrift because they are separate juridical entities. In this case, if only the value of Ambase's equity was reduced by the severance payments, transaction costs, and administrative expenses, only Ambase would have a claim for these costs (assuming for the sake of argument they were related to the breach). As Ambase was not a contract party and only is suing in a derivative capacity for Carteret, however, these costs are not recoverable by Ambase. In Castle v. United States, 301 F.3d 1328, 1340-41 (Fed.Cir. 2002), contract parties asserted reliance damage claims on behalf of non-parties who had invested in the thrift. The Court, however, rejected the claims on the ground that the contract parties "lack standing to assert any reliance interest on behalf of the other shareholders." Id. at 1340. In this case, Ambase, a derivative plaintiff, lacks standing to assert the reliance interest of itself, a non-party, with respect to expenditures made to third parties. In short, Ambase's wounded bank damage claims, which assume that Carteret can collect damages for costs incurred by Ambase, are both invalid as a matter of law and resolvable on cross motions for summary judgment. Resolving these claims on cross-motions for summary judgment may eliminate the need to present witnesses and documentary evidence with respect to

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approximately $16.8 million worth of claims at trial. CONCLUSION For these reasons, the court should establish a schedule for cross-motions for summary judgment on damages and delay scheduling Appendix A filings and trial until resolving those cross- motions. Respectfully submitted, MICHAEL F. HERTZ Deputy Assistant Attorney General JEANNE E. DAVIDSON Director /s// Kenneth M. Dintzer KENNETH M. DINTZER Assistant Director /s/ David A. Levitt DAVID A. LEVITT Trial Attorney Commercial Litigation Branch Civil Division Department of Justice 1100 L Street,, N.W. Washington, D.C. 20005 Tel: (202) 307-0309 Attorneys for Defendant Date: November 7, 2007

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CERTIFICATE OF FILING

I hereby certify that on this 7th day of November 2007, a copy of the foregoing "GOVERNMENT'S POSITION WITH RESPECT TO CROSS-MOTIONS FOR SUMMARY JUDGMENT ON DAMAGES " was filed electronically. I understand that notice of this filing will be sent to all parties by operation of the Court's electronic filing system. Parties may access this filing through the Court's system. /s/ David A. Levitt David A. Levitt

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EXHIBIT I

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UNITED STATES COURT OF FEDERAL CLAIMS

__________________________________________ ) AMBASE CORPORATION and ) CARTERET BANCORP, INC., ) ) Plaintiffs, ) ) and ) ) FEDERAL DEPOSIT INSURANCE ) CORPORATION, ) ) Plaintiff-Intervenor, ) ) v. ) ) THE UNITED STATES OF AMERICA, ) ) Defendant. ) __________________________________________)

No. 93-531 Judge Loren Smith

DECLARATION OF CHARLES W. CALOMIRIS OF MAY 19, 2007

Qualifications Introduction I. Carteret's Value at the Time of the Breach and the Subsequent Increase in Its Value ButFor the Breach A. Carteret Was Sold to AmBase for $266 Million in August 1988--One Year Before the Breach B. Carteret's Value Did Not Substantially Change Between the Time of Its Sale to AmBase and the Breach 1. In May 1989, a Bid of $252 Million Was Made to Purchase Carteret

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C.

D.

E.

F. G. II.

Based on the Valuation Changes in Standalone Publicly Traded Thrifts, Carteret's Market Value Could Not Have Substantially Decreased Between the Date of Its Acquisition by AmBase and the Date of the Breach 3. AmBase's Stock Price Movements Are Correlated with News Relating to the Evolution of FIRREA Before Its Passage Carteret's Market Value Was a Reflection of its Discounted Future Cash Flows, Whereas Its Undiscounted Future Cash Flows Net of Dividends from August 9, 1989 through 2008 But-For the Breach Would Have Been $406.9 Million But-For the Breach, Carteret's Value Can Be Estimated Based on the Performance and Growth of the Thrift Industry 1. The Growth in Market Values of the Thrift Industry 2. The Growth in Book Values and Market-to-Book Ratios of the Thrift Industry But-For the Breach, Carteret's Value Can Be Estimated Based on the Performance and Growth of Comparable Institutions that Survived FIRREA 1. The Growth in Market Values of Comparable Institutions that Survived FIRREA 2. The Growth in Book Values and Market-to-Book Ratios of Comparable Institutions that Survived FIRREA Damages Are Equal to the But-For Market Value of Carteret Plus Any But-For Dividends That Were Not Distributed in the Actual World Any Damage Award Should Account for AmBase's Tax Liability on the Damages

2.

Carteret Would Not Have Failed in 1992 But-For the Breach A. Carteret Had a Large Franchise Value, Both at the Time of the Breach and at the Time of Failure B. Carteret Would Have Been Sufficiently Capitalized But-For the Breach 1. Carteret Would Have Had Added Extra Capital at the End of 1992 But-For the Breach a. The Inclusion of Supervisory Goodwill in Regulatory Capital Would Have Added $139.1 Million in Extra Capital as of September 1992 But-For the Breach b. Carteret Sold Branches in 1990 as a Result of the Breach c. Carteret's Cost of Deposits Increased as a Result of the Breach, Reducing Its Capital d. Carteret Could Have Counted Supplementary Capital Towards Regulatory Capital But-For the Breach e. Carteret's Size Decreased as a Result of the Breach, Reducing Its Capital 2. Even If Carteret Had Not Had Sufficient Regulatory Capital at the End of 1992, It Could Have Raised That Capital a. Carteret Could Have Raised Capital by Selling Its Mortgage Businesses b. Carteret Could Have Raised Capital through Borrowing

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C. III.

The Breach's Negative Impact on Carteret Was Immediate in AmBase's Stock Price

But-For the Breach, Carteret Would Not Have Failed at Any Time After 1992 A. Carteret's Commercial Real Estate Portfolio Was Not as Troubled as WriteDowns Implied 1. Carteret's Writedowns Were Extremely Aggressive 2. Carteret's Commercial Real Estate Write-Downs Were Excessive in Light of the Eventual Increase in Property Values a. Carteret's Reserves Were Almost Sufficient to Cover the Difference Between the Actual Sales Value of Its Commercial Real Estate Assets and the Principal Balance of Those Assets b. The RTC Did Not Achieve Full Sales Values for Carteret's Commercial Real Estate Assets i. The Real Option Value of Liquidation Limited the RTC's Achieved Sales Value for Carteret's Assets ii. The Replacement of Carteret's Superior Management Limited the RTC's Achieved Sales Value for Carteret's Assets iii. The Minority Preference Program Limited the RTC's Achieved Sales Value for Carteret's Assets c. Commercial Real Estate Values Increased Over Time in Carteret's Markets B. Thrift Failures After 1992 Were Rare AmBase Suffered Significant "Wounded Bank" Damages as a Result of the Breach A. Turning Over Carteret to the RTC Triggered Costs Related to Employment Contracts B. Carteret Endured Costs from Selling Branches Because of the Breach C. Transaction Costs Associated with Efforts to Raise Capital D. Transaction Costs Related to Cease and Desist Proceedings

IV.

Conclusion Appendix A: Estimating the Market Value of Supervisory Goodwill A. Cash Equivalent Value of Supervisory Goodwill B. Cost of Replacement Based on a Common Stock Issuance C. Summary Appendix B: Materials Relied Upon Appendix C: Curriculum Vitae Appendix D: Expert Witness History Since 2003

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QUALIFICATIONS 1. I, Charles W. Calomiris, am the Henry Kaufman Professor of Financial

Institutions at the Columbia University Graduate School of Business and a Professor at Columbia's School of International and Public Affairs. I am the Academic Director of Columbia Business School's Jerome Chazen Institute of International Business and the Director of Columbia University's Center for International Business Education and Research. I co-direct the Project on Financial Deregulation at the American Enterprise Institute (AEI) and am the Arthur Burns Scholar in International Economics at AEI. I am a member of the Shadow Financial Regulatory Committee, a Research Associate of the National Bureau of Economic Research, and was a Senior Fellow at the Council on Foreign Relations. 2. I am Chairman of the Board of Greater Atlantic Financial Corporation, a publicly

traded bank based in the Washington D.C. metropolitan area, and a Managing Partner of Gauss Fund, LP. I served on the International Financial Institution Advisory Commission, a Congressional commission to advise the U.S. government on the reform of the IMF, the World Bank, the regional development banks, and the WTO. My research spans several areas, including banking, corporate finance, financial history, and monetary economics. 3. My recent publications include: "Bank Capital and Portfolio Management: The

1930s `Capital Crunch' and Scramble to Shed Risk" (with Berry Wilson), in the Journal of Business (July 2004); "Credit Card Securitization and Regulatory Arbitrage" (with Joseph Mason), in the Journal of Financial Services Research (August 2004); "Consequences of Bank Distress During the Great Depression" (with Joseph Mason), in the American Economic Review (June 2003); U.S. Bank Deregulation in Historical Perspective (Cambridge University Press, 2000); Emerging Financial Markets (with David Beim, Irwin-McGraw Hill, 2001); "Blueprints for a New Global Financial Architecture" in International Financial Markets: The Challenge of
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Globalization (Leonardo Auernheimer, ed., University of Chicago Press, 2000); and "Is the Bank Merger Wave of the 1990s Efficient?" (with Jason Karceski) in Mergers and Productivity (Steven Kaplan, ed., University of Chicago Press, 2000). 4. I am the recipient of research grants or awards from the National Science

Foundation, the World Bank, the Japanese Government, the Herbert V. Prochnow Foundation, and the Garn Institute of Finance. In 1995, I was named a University Scholar at the University of Illinois, where I served as Associate Professor of Finance and Co-Director of the Office for Banking Research. I am, or have been, a member of the editorial boards of the Journal of Banking and Finance, the Journal of Financial Services Research, the Journal of Financial Intermediation, the Journal of Economic History, the Journal of Economics and Business, and Explorations in Economic History. I serve or have served as a consultant or visiting scholar for the Federal Reserve Banks of New York, Chicago, Cleveland, and St. Louis, the Federal Reserve Board, the World Bank, and the governments of Mexico, Argentina, Japan, China, El Salvador, Connecticut and Massachusetts. My private sector clients have included AIG, Ameriquest, Astoria Savings, Bank of America, Citicorp, Credit Suisse, Fleet Bank, The Limited, Lloyds, UBS Securities, U.S. Trust Corporation, and Xilinx. 5. I designed (with David Beim) and teach an MBA and Executive MBA case

course on emerging market finance, which won the 1997-1998 Chazen International Innovation Prize at Columbia Business School. I have taught international banking, emerging financial markets, and advanced corporate finance at the MBA and Ph.D. levels at Columbia, as well as the MBA core course in Business Values and Ethics. I have taught Ph.D.-level courses at the World Bank and the IMF, including a course at the IMF on Emerging Financial Markets.

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6.

I earned a Ph.D. in economics from Stanford University and a B.A. in economics,

magna cum laude, from Yale University.

INTRODUCTION 7. This report considers the damages to Carteret Savings Bank ("Carteret") that

resulted from the elimination of supervisory goodwill from Carteret's regulatory capital requirements. Section I of this report establishes Carteret's value at the time of the breach in 1989 and the increase in Carteret's value through 2006 had the contractual breach in the treatment of supervisory goodwill not occurred. This counterfactual value of Carteret as of the date damages are awarded, plus any dividends received in the but-for world that were not received, plus additional "wounded bank" damages in the actual world, constitutes the damages due to plaintiffs. Section II demonstrates that Carteret would not have been seized by the Resolution Trust Corporation ("RTC") had Carteret's supervisory goodwill not been excluded from its required capital as mandated by Congress through the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"). Carteret was a healthy institution at the time of FIRREA's passage and would have survived but-for the exclusion of supervisory goodwill from its capital requirements. In Section III, I show that Carteret would not have failed in the years following FIRREA even when considering the weakest aspects of Carteret's business, its commercial real estate portfolio. In Section IV, I estimate the "wounded bank" damages suffered by Carteret as a direct result of the breach. Table 1 summarizes my lowest, highest, and preferred estimates of damages that resulted from the breach. The estimates in Table 1 are shown both before and after accounting for any potential tax liabilities on the damage award.

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TABLE 1: DAMAGES RESULTING FROM THE BREACH OF FIRREA'S REMOVAL OF SUPERVISORY GOODWILL FROM CARTERET'S REGULATORY CAPITAL
Damages Estimate Highest Lowest Preferred Damages Before Accounting for Tax Liabilities ($Million) $4,904.6 $785.7 $1,097.5 Damages After Accounting for Tax Liabilities ($Million) $8,146.2 $1,295.6 $1,814.3

I. CARTERET'S VALUE AT THE TIME OF THE BREACH AND THE SUBSEQUENT INCREASE IN ITS VALUE BUT-FOR THE BREACH 8. Carteret was a federally chartered savings and loan association that was a

successor to thrift institutions dating back to 1888.1 Prior to the breach of contract, Carteret had a consistent track record of growth. As of September 1987, it ranked as the 19th largest thrift in the United States based on deposits.2 From 1982 through 1988, Carteret grew its asset base from $3.62 billion to $6.44 billion.3 Profitability accompanied this growth. Carteret's consistent performance, as indicated by its annual income statements, demonstrates that the company was firmly established and profitable. Furthermore, activity from the financial markets showed that investors had positive expectations about the company's potential. As Figure 1 shows, in the seven years from 1982 through 1988, the last year that Carteret was an independent company, Carteret recorded net losses in only one year, 1982.

1. Carteret Bancorp Inc., 1987 Annual Report, at C-AM-A-0056661. 2. Id. 3. Carteret Savings and Loan Association, FA 1982 Annual Report, at 1 (AMB029911); Carteret Bancorp Inc. and Subsidiary, FHLB Docket #02-4702, Consolidated Financial Statements, Sep. 30, 1988 (AMB013963).

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FIGURE 1: CARTERET NET INCOME, 1982 - 1988
50 40 30 20 Million $ 10 0 1982 -10 -20 -23.2 -30 1983 1984 1985 1986 1987 1988 7.5 46.1

34.8 25.2

33.4

20.0

Sources: Carteret Savings & Loan Association, F.A., Annual Report 1984, at 26 (AMB029992); Carteret Savings & Loan Association, F.A., Annual Report 1985, at 21 (AMB030079); Carteret Bancorp, Inc., Annual Report 1987, at 1 (C-AM-A-0056662); Carteret Bancorp Inc. and Subsidiary, FHLB Docket #02-4702, Consolidated Financial Statements, Sept. 30, 1988, at 3 (AMB013962).

Carteret received income from a diverse range of recurring business activities, including financial services to individuals, households, and corporate customers.4 Carteret's development of fee-based and non-interest income revenue sources, such as residential mortgage financing,5 represented a successful strategy that strengthened the company's bottom line.6

4. Carteret Bancorp Inc., 1987 Annual Report, at C-AM-A-0056661. 5. See Carteret Bancorp Inc., 1987 Annual Report, at 43 (C-AM-A-0056697) ("Through Carteret Mortgage, Carteret has expanded its presence in the mortgage banking industry. Carteret Mortgage originates first mortgage loans, both fixed and adjustable rate and may sell a portion of such loans into the national secondary market while retaining the servicing rights thereto. At September 30, 1987, Carteret serviced $5,964,437,000 of mortgage loans for outside investors compared with $2,104,689,000 at September 30, 1986. For the year ended September 30, 1987, mortgage activities contributed $24,501,000 in loan fees and service charges to non-interest income, and an additional $9,872,000 from valuation of loan servicing retained on loans sold to investors.") 6. See Carteret Savings & Loan Association, F.A., Annual Report 1985, at 21 ("Carteret Savings, as most other thrift institutions, has assets with maturities that exceed those of its liabilities. This maturity difference or `gap', results in the Association's liabilities repricing more rapidly to changes in interest rates than do its assets. In view of the earnings limitations of its fixed-rate, long-term assets as compared to its more volatile liabilities,

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9.

As a result of its strong franchise and consistent profits, Carteret was able

repeatedly to raise capital in the open markets in the 1980s. Carteret's public stock offerings from 1983 to 1986 are summarized in Table 2. TABLE 2: CARTERET ISSUANCES OF STOCK, 1983 - 1988 Year Shares Net Proceeds Type 1983 6,820,000 $58,367,000 Common 1985 1,000,000 $11,027,000 Common 1985 892,000 $21,209,000 Preferred 1986 1,425,000 $28,671,000 Common Sources: Carteret Savings & Loan Association, F.A., Annual Report 1984, at 29 (AMB029996); Carteret Savings & Loan Association, F.A., Annual Report 1985, at 35; Carteret Savings Bank FA, Annual Report 1986, at 28. The success of these transactions indicates that both the company and investors saw great potential in Carteret's future performance. The expectation that Carteret's solid performance would continue caused AmBase Corp. ("AmBase") to explore a merger with Carteret in 1987. 10. In 1982 Carteret acquired two failing thrifts, Barton Savings and Loan of Newark,

New Jersey ("Barton") and First Federal Savings and Loan of Delray Beach, Florida ("Delray"). According to the government's internal reports, Carteret had $2.3 billion in assets and a book value net worth of $36.5 million immediately prior to the transactions.7 At the time of the FSLIC-assisted merger, Barton was experiencing "substantial and accelerating operating losses."8 Delray was in "irreversible decline."9 In connection with the transactions, Carteret recorded supervisory goodwill of $46 million and $168 million, respectively, representing the levels of insolvency of these institutions, which was counted toward regulatory capital for Carteret. Even according to early internal government reports prepared on the eve of the acquisition (before the assets and liabilities were marked to market), the government estimated

Carteret Savings adopted as a major strategy the generation of new earning assets with variable interest rates or shorter terms. A second major goal was diversification into lines of business that produce fee income. New earning assets are generated through an expansion of adjustable rate mortgage lending, diversification into commercial, consumer and income-property lending and retail financial services.") 7. S-Memo, WOR839 0347-0359 at 0347, 0358. 8. Id. at 0350. 9. Id.

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that it would have cost $42.6 million to liquidate Barton alone.10 According to those same documents, the cost to the government of Carteret's bid for Barton was $23.5 million less than the other bid and $31 million less than the estimated present value cost of liquidation.11 The cost to the government of Carteret's bid for Delray was $20 million less than the next lowest bid.12 As detailed below, Carteret lost the entirety of the value it contributed to these transactions when the RTC seized Carteret as a result of the breach. 11. In 1986 Carteret acquired two more failing thrifts, First Federal Savings and Loan

of Montgomery County, Blacksburg, Virginia ("First Federal") and Mountain Security Savings Bank of Wytheville, Virginia ("Mountain Security"). According to the government's internal reports, Carteret had $5.153 billion in assets as of March 31, 1986 and a book value net worth of $272.5 million immediately prior to the transaction.13 In connection with this combined transaction, Carteret recorded $21.7 million in supervisory goodwill that was counted toward regulatory capital. The government's internal reports show that Carteret's combined bid for the two thrifts represented a savings to the government of $5 million over the next highest bidders and $14.6 million over the present value cost of liquidation.14 As detailed below, Carteret lost the entirety of the value it contributed to these transactions when the RTC seized Carteret as a result of the breach. The government, in contrast, benefited hugely from Carteret's assumption of the liabilities of these failed thrifts.15

10. Id. at 0354. 11. WOR839 0347-0359 at 0353-54. 12. Id. at 0356. 13. S-Memo, WOR063 0879-0893 at 0879, 0887. 14. Cost Summary, WOR999 0240-0253 at 0240. 15. As noted above, the government estimated the cost of liquidating Barton as $42.6 million and the cost of liquidating First Federal and Mountain Security as $14.6 million. The government did not calculate the cost of liquidating Delray. In order to calculate an estimate of the cost of liquidating Delray, I use the ratio of the cost of liquidation as compared to the net liability assumed. For the transactions for which I have data, the ratio was 84.49 percent -- that is, the government's estimated cost of liquidation equaled, on average, 84.49 percent of the net

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A.

Carteret Was Sold to AmBase for $266 Million in August 1988--One Year Before the Breach 12. On August 4, 1987, AmBase (then known as "The Home Group, Inc.") entered

into a merger agreement with Carteret.16 The August 1987 merger agreement called for each share of Carteret common stock to be exchanged for $22.50 in cash on the effective date of the merger.17 In addition, each share of Carteret preferred stock would be converted to common stock, and each share of that common stock would be exchanged for $22.50 in cash on the effective date of the merger.18 AmBase's financial advisor, Salomon Brothers, issued a fairness opinion in support of the $22.50 cash consideration.19 13. On October 19, 1987, just two and a half months after the merger agreement, the

U.S. stock market suffered its worst one-day drop in history. On that date, the Dow Jones Industrial Average fell 22.6 percent,20 Carteret's stock price fell from $18 to $14.625 (18.8 percent), and AmBase's stock price fell from $16.375 to $13.75 (16.0 percent).21 By the end of

liability assumed. The net liability assumed in connection with the acquisition of Delray was $168 million so I estimate the cost of liquidation to be $141.9 million. This is a conservative estimate since, as I discuss below, the government does not realize the full fair market value of assets when it performs a liquidation. Therefore, I estimate the liquidation costs for all four acquisitions would have been $199.1 million. As part of Carteret's acquisition of Barton, FSLIC provided $11.7 million in assistance. See Carteret Savings & Loan Association, F.A. & Subsidiaries, Consolidated Financial Statements, Sept. 30, 1980, 1981, & 1982 (C-AM-A-0265001 ­ 041 at 005, 016). Therefore, the total avoided liquidation cost to the government was $187.4 million. Beyond the total avoided liquidation costs of $187.4 million, the government realized huge savings in not having to issue debt in this amount. Assuming the savings began at the end of the calendar year in which Carteret purchased the institutions, and using the one-year Treasury constant maturity yield compounded annually, I estimate the total savings of avoided liquidation cost plus avoided debt service equals $709 million through the end of 2007. 16. Agreement of Merger of JAM Financial Corp. with and into Carteret Bancorp Inc. at 1 , Aug. 4, 1987, (KH029240). 17. Id. at 4-5 (KH029243 ­ KH029244). 18. Id. 19. Letter from Salomon Brothers to The Board of Directors, The Home Group, Inc., Aug. 18, 1987, (AMB028576 ­ AMB028578). 20. Tim Metz, Alan Murray, Thomas E. Ricks & Beatrice E. Garcia, The Crash of `87: Stocks Plummet 508.32 Amid Panicky Selling --- Percentage Decline Is Far Steeper Than `29; Bond Prices Surge, WALL ST. J., Oct. 20, 1987. 21. CRSP, Center for Research in Security Prices. Graduate School of Business, The University of Chicago 2006.

CONFIDENTIAL MATERIALS ­ SUBJECT TO PROTECTIVE ORDER

Case 1:93-cv-00531-LAS

Document 226-2
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Filed 11/07/2007

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1987, Carteret's stock price had risen to $15.25 but had still not reached its pre-crash price.22 In the aftermath of this price decline, AmBase and Carteret renegotiated their merger agreement, and on January 18, 1988, the merger agreement was amended such that Carteret's stock would be exchanged for $19 per share instead of $22.50 per share.23 First Boston Corp., Carteret's financial advisor, issued a fairness opinion in support of the $19 cash consideration.24 Of course, the stock market subsequently rebounded after the purchase price was set in January of 1988 to levels that prevailed when Salomon Brothers issued its original fairness opinion in August 1987. 14. On August 8, 1988, AmBase completed its purchase of Carteret for $19 per share

of common stock (including preferred stock that was convertible to common stock) for a total consideration of approximately $266 million.25 The purchase price for Carteret was supported by an appraisal opinion from Kaplan Smith.26 The facts that a willing buyer paid $266 million for Carteret, and that the purchase price was supported by other financial analysts, constitute power