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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.

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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 powerful evidence of the value of Carteret just one year before the breach. 15. In addition, AmBase secured a credit agreement of $300 million from Chase

Manhattan Bank in June 1988 for the specific purpose of funding the Carteret acquisition. Carteret's common stock was used as collateral for this credit agreement.27 The fact that Chase

22. Id. 23. Appendix D, Jan. 18, 1988 (AMB068044 ­ AMB068045). 24. Carteret Bancorp Inc. May 18, 1988 Proxy Statement, at F-1 ­ F-2. 25. Carteret Bancorp, Inc., 1989 Annual Report (C-AM-A-0394532); The Home Group, Inc., 1988 Annual Report (Form 10-K) at 9 (C-AM-A-0395940); Home Group Announces Completion of Carteret Acquisition, PR NEWSWIRE, Aug. 8, 1988. 26. Kaplan, Smith & Associates, Inc., Acquisition Valuation: Carteret Bancorp, Inc., Morristown, New Jersey Valued as of August 8, 1988 at Table I-1 (Jan. 18, 1989) (CAM4411095) [hereinafter KAPLAN SMITH VALUATION REPORT] 27. Minutes of the Meeting of the Board of Directors of the Home Group, Inc. (May 20, 1988), at 5-6; The Home Group, Inc., Credit Agreement, Dated as of June 10, 1988, The Chase Manhattan Bank (National Association) as Agent; Letter from Bruce W. Bean, Sr. Vice President & General Counsel, The Home Group, Inc., to the Banks Party to the Credit Agreement Referred to Below & The Chase Manhattan Bank (National Ass'n.) as Agent, Aug. 8, 1988; Letter from Richard R. Butler, Vice President, Chase Manhattan Bank, N.A., & Mark S. Thorum, Director, Chase Manhattan Capital Markets Corp., to Jack R. Plaxe, Sr. Vice President, Chief Financial

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Manhattan Bank specifically requested that Carteret's common stock be used as collateral for the credit agreement further substantiates that Carteret was a significantly valuable property at the time of its acquisition by AmBase, just one year before the breach. Furthermore, the fact that Chase Manhattan, in its role as a sophisticated bank that was very familiar with regulatory capital requirements, was confident to make the loan to AmBase to purchase Carteret demonstrates that there was little doubt about the health and survivability of Carteret as an institution before the breach. 16. The sales value of $266 million is a conservative estimate for the value of Carteret

as of August 8, 1988 because of two obligations forced upon AmBase by the Federal Home Loan Bank Board as conditions of the merger.28 The first obligation was a regulatory capital maintenance agreement (RCMA). As part of the RCMA, AmBase promised to infuse Carteret with up to $50 million in capital if Carteret ever fell out of compliance with its regulatory capital requirements.29 AmBase also agreed to a limit on the dividends that Carteret could distribute.30 This obligation is a real put option with positive value.31 If Carteret ever fell out of compliance with its regulatory capital requirements, the government would exercise its real option to "put" the cost on to AmBase of infusing sufficient capital into Carteret. The value of this put option was relatively low at the time of the sale because the ex ante probability of Carteret falling out of

Officer, & Treasurer, The Home Group, Jan. 25, 1988; The Home Group, Inc., FSLIC Amendment No. 1 to Application H-(e) 1, at 14 (AMBNP026545); The Home Group, Inc., FHLB Application H-(e) 1, at 7 (FAM0010011). 28. Federal Home Loan Bank Board, No: 88-657, Aug. 5, 1988, at 3 (AMB009232). 29. Stipulation and Agreement, Aug. 8, 1988 (ANB009226 ­ ANB009229). The RCMA was amended after the merger, but AmBase was still required to provide up to $50 million in capital if Carteret's regulatory capital did not meet defined criteria. See Exhibit C, Regulatory Capital Maintenance/Dividend Agreement, Nov. 28, 1988 (AMBNP001430 ­ AMBNP001440). 30. Id. 31. For a primer on financial options, see JOHN HULL, OPTIONS, FUTURES, AND OTHER DERIVATIVES 6 (Prentice Hall, 6th ed. 2006). Under a put option, the seller agrees to buy back the commodity or instrument at a strike-price, which is specified in the terms of the option. Id. The buyer has the right, but not the obligation, to exercise the put option at the strike price. Id. Because the put option provides a form of price insurance to the buyer, the buyer pays a premium to the seller for the value of having the put option. Id.

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regulatory capital compliance was low. However, the real put option eventually became valuable as the government's breach resulted in Carteret's falling out of regulatory capital compliance, and AmBase was required to contribute $50 million.32 As a conservatism, I do not attempt to quantify the value of this put option. 17. The second regulatory requirement in the transaction was related to AmBase's

sale of Imperial Premium Finance to Carteret for $65 million as part of AmBase's purchase of Carteret. To appease the Federal Home Loan Bank Board, AmBase was required to cover any potential loss on a future sale of Imperial Premium Finance through August 9, 1991.33 Again, this requirement was a real put option with positive value. Specifically, the strike price of the option was $65 million, equal to the sale price of Imperial Premium Finance to the buyer, Carteret. If the value of Imperial Premium Finance fell below $65 million before August 9, 1991, a value that would have been revealed had Carteret attempted to sell Imperial Premium Finance before August 9, 1991, Carteret would have had the option to, in effect, sell Imperial Premium Finance back to AmBase at $65 million, with AmBase sustaining the loss in value. Ultimately, AmBase paid $12.5 million to satisfy this obligation.34 As with the first option, I do not attempt to quantify this option. However the presence of both of these options indicates that the $266 million sales price is a conservatively low estimate of the value of Carteret as of the date of its sale to AmBase.

32. AmBase Corp. v. United States, 58 Fed.Cl. 32, 38 (2003). 33. Federal Home Loan Bank Board, No: 88-657, Aug. 5, 1988, at 7 (AMB009236); Agreement, Aug. 1988 (AMB009202 ­ AMB009203). 34. AmBase Corp. v. United States, 58 Fed.Cl. 32, 38 (2003).

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B.

Carteret's Value Did Not Substantially Change Between the Time of Its Sale to AmBase and the Breach 18. Once AmBase acquired Carteret, Carteret ceased trading as a standalone public

company and became part of AmBase's portfolio of companies, which included The Home Insurance Company, Gruntal Financial Corp., USI Re, Inc., Commonwealth Insurance Company, and Sterling Forest Corporation.35 Because market values for Carteret are not explicitly observable between the date of its sale to AmBase and the date of the breach, I estimate Carteret's market value at the time of the breach by examining any bids for Carteret during that year, the financial statements of Carteret and AmBase, the performance of other publicly-traded thrifts, and changes in value of AmBase's publicly traded common stock. 1. 19. In May 1989, a Bid of $252 Million Was Made to Purchase Carteret In May 1989, two former directors of Carteret, General Alexander Haig and Harry

Jacobs, among others, offered to purchase Carteret for $252 million.36 Mr. Jacobs and General Haig were intimately familiar with Carteret because Mr. Jacobs served on Carteret's board from 1984 to 1988, and General Haig was on the board from 1986 to 1988. Mr. Jacobs was the former Chairman of Prudential-Bache Securities and remained a senior officer there at the time of his bid for Carteret. As explained in my declaration of July 14, 2006, AmBase experienced a

35. Home Group Announces Completion of Carteret Acquisition, PR NEWSWIRE, Aug. 8, 1988. Carteret had $47 million in pretax earnings in 1989. AMBASE 1989 ANNUAL REPORT, at 21 (C-AM-A-0394701). The Home Insurance Company was AmBase's American insurance division and Commonwealth Insurance Company was AmBase's Canadian insurance division. Both concentrated on larger insurance policies requiring underwriting expertise. Id. at 11 (C-AM-A-0394691). Together they had $168 million in pretax earnings in 1989. Id. Gruntal Financial Corporation was AmBase's investment division, offering many of the same services as the largest investment firms. Id. at 27 (C-AM-A-0394707). It accounted for $14 million of AmBase's pretax earnings in 1989. Id. U.S. International Reinsurance Company was AmBase's treaty and facultative reinsurance division. Id. at 17 (CAM-A-0394697). It had pretax earnings of $23 million. Id. Sterling Forest Corporation was the major real estate holding of AmBase. Id. at 31 (C-AM-A-0394711). The AmBase 1989 Annual Report did not report pretax earnings for Sterling Forest Corp. 36. Letter from Robert B. O'Brien, Jr., Carteret Savings Bank, to George T. Scharffenberger, AmBase Corp., Aug. 29, 1990, at 2 (KH089941).

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significant negative abnormal return in late May of 1989.37 As my declaration makes clear, this drop in valuation was causally connected to the breach. As I discuss later in this report, other events related to FIRREA had already occurred by the May 1989 bid, such that the May 1989 bid would have included some discount in accounting for the possibility of supervisory goodwill being removed from regulatory capital as a part of FIRREA. Thus, the May 1989 bid is a conservative measure of the non-breach-effected value of Carteret. In the aftermath of the negative impact on Carteret's value of the news about FIRREA, the potential acquirers modified their bid by the end of May to include only the Florida branches.38 The modified bid was rejected. 20. The fact that a bid of $252 million was made for Carteret in the midst of

uncertainty over the future treatment of supervisory goodwill demonstrates that Carteret's market value as of May 1989 would have been greater than $252 million but-for the breach. 2. 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 Because market values for Carteret are not explicitly observable between the date

21.

of its sale to AmBase and the date of the breach, I estimate Carteret's market value at the time of the breach by examining the change in its book value between the date of its sale to AmBase and the breach, and the change in market-to-book ratios for other publicly-traded thrifts over the same time period. 22. As reflected in the Kaplan Smith valuation opinion produced for Carteret

regarding its sale to AmBase, Carteret's book value (equal to its assets less its liabilities) was

37. Declaration of Charles W. Calomiris of July 14, 2006, at 87-89. 38. Letter from Robert B. O'Brien, Jr., Carteret Savings Bank, to George T. Scharffenberger, AmBase Corp., Aug. 29, 1990, at 2 (KH089941).

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$306 million at the time of the sale, leaving Carteret with a market-to-book ratio of 0.869.39 At that time, Carteret's assets included existing goodwill of $192.9 million--equal to 63 percent of Carteret's book value.40 23. Carteret's book value decreased by 11.6 percent (from $306.0 million to $270.5

million) from the time of its sale to AmBase in August 1988 to June 30, 1989, the last quarterend date before the breach occurred with FIRREA's passage.41 The decline in book value included a net decrease in Carteret's goodwill of $7.8 million (from $192.9 million to $185.1 million),42 $22.867 million of dividends declared between August 8, 1988 and December 31, 1988, and $1.275 million of dividends declared in the first quarter of 1989.43 Therefore, 90 percent of the decline in book value from July 31, 1988 to June 30, 1989 ($31.9 million of the $35.5 million) was attributable to dividend distributions and goodwill amortization. Based on Carteret's goodwill amortization schedule from August 1989, Carteret's total goodwill was amortized at a rate of $1.254 million per month in 1989.44 Therefore, I estimate that Carteret's book value as of July 31, 1989 was equal to $269.3 million (equal to Carteret's $270.5 million book value from June 1989 minus $1.254 million in goodwill amortization). 24. The mean market-to-book ratio of the 46 thrifts with data available from

Compustat as of July 31, 1988 and as of July 31, 1989 changed from 0.589 as of July 31, 1988,

39. KAPLAN SMITH VALUATION REPORT, supra note 26, at Table I-1 (CAM4411105). 40. Id. at Table I-1 (CAM4411104). 41. Id. at Table I-1 (CAM4411105); Carteret Bancorp Inc. and Subsidiary, Consolidated Statements of Financial Condition (June 30, 1989) (CAM4470985). 42. Id.; Carteret Savings Bank, FA, Thrift Financial Report, June 30, 1989, at Q-1 (AM050308). 43. Carteret Bancorp Inc. & Subsidiary, Consolidated Financial Statements (Dec. 31, 1989) (C-AM-A0394516); TFR data. 44. Goodwill Amortization Schedule (Historical), August 1989 (CAM5300023). This figure includes $984,932 in monthly amortization of supervisory goodwill and $268,657 of monthly amortization of non-supervisory goodwill. Table A1 shows amortization of supervisory goodwill based on amortization schedules from August 1989 and December 1989. Table A9 shows amortization of total goodwill from those same schedules.

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to 0.633 as of July 31, 1989 (an increase of 7.4 percent).45 Carteret's market-to-book ratio as of the time of its sale to AmBase was 0.869. Assuming Carteret's market-to-book ratio increased at the same rate as the average thrift, then its market-to-book ratio would have been 0.934 as of July 31, 1989. Given my estimate of Carteret's book value of $269.3 million on July 31, 1989, and the assumption that Carteret's market-to-book ratio increased at the same rate as the average thrift, I estimate that its market value was $251.4 million (equal to $269.3 million times 0.934) on July 31, 1989, just before the breach. This market value just before the breach was only 5

45. Compustat. I define a firm in Compustat as a thrift if its NAICS code is 522120 (Savings Institutions). I define a company's market-to-book ratio in Compustat in any given month to be equal to its market value at the end of the month divided by its stockholder's equity at quarter-end for the given month. The Compustat database did not include book value data for many of the thrifts for which it contained market value data for the late 1980s and early 1990s. In order to increase the sample of thrifts in the analysis (especially for the later comparison when I only consider thrifts that existed as standalone public companies from 1989 to 2006), I supplemented the Compustat data with book value data from TFRs. The Compustat database and the TFR data do not share a common identifying variable that allows a perfect match between companies in Compustat and thrifts in the TFR data. In order to manually match observations from Compustat and the TFRs, I first identified all thrifts with month-end stock prices in every month from July 1989 to December 2006 in Compustat. I then manually matched the names and locations of those companies with the names and locations of thrifts in the TFR data. To ensure that this process did not result in any mismatches (such as matching a thrift from the TFR data to a unitary thrift holding company owning multiple thrifts from Compustat), I collected annual reports, 10-Ks, and 10-Qs for the potentially matched Compustat companies. I compared the assets and stockholders' equity from these filings with the assets and equity reported in the TFR data for 1988 and 1989. If the differences between values for both assets and stockholder's equity between the two data sources (TFR data and SEC filings) were no more than 10 percent in 1988 or 1989 for a given thrift, then I included that thrift in my sample. Therefore, if a successful match was made, and the book value for the company was not present in Compustat, I used the thrift's equity from the TFR data as the company book value when estimating market-to-book ratios. The companies for which I used TFR data in 1988 and 1989 in any marketto-book ratio analysis consisted of: Ameriana Bancorp (only 1989 TFR data used due to an acquisition in September 1988), BankUnited Financial Corp., Elmira Savings Bank FSB, FMS Financial Corp., First Financial Holdings Inc., Harleysville Savings Financial Corp., Independence Federal Savings Bank, Parkvale Financial Corp., Washington Fed Inc., Washington Savings Bank FSB, and WSFS Financial Corp. See Ameriana Bancorp, SEC Form 10-K, Dec. 31, 1989; Bankatlantic Financial Corp., Annual Report, Dec. 31, 1988; Bankatlantic Financial Corp., Annual Report, Dec. 31, 1989; Bankunited, A Saving Bank, Annual Report, Sept. 30, 1989; CCNB Corp., Annual Report, Dec. 31, 1988; The Elmira Savings Bank, FSB, SEC Form 10-Q, Sept. 30, 1988; The Elmira Savings Bank, FSB, SEC Form 10-Q, Sept. 30, 1989; First Financial Holdings Inc., Annual Report, Sept. 30, 1988; First Financial Holdings Inc., Annual Report, Sept. 30, 1989; FMS Financial Corp., SEC Form 10-K, Dec. 31, 1988; FMS Financial Corp., SEC Form 10-Q, June 30, 1989; Harleysville Savings Bank, PASA , Annual Report, Sept. 30, 1988; Harleysville Savings Bank, PASA, Annual Report, Sept. 30, 1989; Independence Federal Savings Bank, Annual Report, Dec. 31, 1989; Northeast Bancorp, Inc., Annual Report, Dec. 31, 1988; Parkvale Financial Corp., Annual Report, June 30, 1990; Peoples Bancorp Inc., SEC Form 10-Q, June 30, 1988; Peoples Bancorp Inc., SEC Form 10-Q, June 30, 1989; Sovereign Bancorp Inc., Annual Report, Dec. 31, 1989; Trustco Bank Corp. NY, Annual Report, Dec. 31, 1989; Washington Federal Savings & Loan Association, Annual Report, Sept. 30, 1988; Washington Federal Savings & Loan Association, Annual Report, Sept. 30, 1989; Washington Mutual Savings Bank, Annual Report, Dec. 31, 1988; The Washington Savings Bank, F.S.B., SEC Form 10-K, July 31, 1989; Washington Mutual Savings Bank, Annual Report, Dec. 31, 1989; The Washington Savings Bank, F.S.B., SEC Form 10-K, July 31, 1990; Star States Corp., SEC Form 10-Q, June 30, 1988; Star States Corp., SEC Form 10-Q, June 30, 1989.

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percent lower than Carteret's market value of $266 million at the time of its acquisition by AmBase. Table 3 summarizes this calculation. TABLE 3: CARTERET'S MARKET VALUE AS OF JULY 1989 BASED ON MARKET-TO-BOOK RATIOS OF PUBLICLY TRADED THRIFTS
[1] [2] [3] = [2] / [1] [4] [5] [6] [7] = [5] - [6] [8] [9] = ([8] - [4]) / [4] [10] = [3] × (1 + [9]) [11] = [5] × [10] Dollars in Millions Carteret Book Value as of 7/31/1988 Carteret Market Value as of 7/31/1988 Carteret Market-to-Book Ratio as of 7/31/1988 Mean Market-to-Book Ratio for Thrifts as of 7/31/1988 Carteret Book Value as of 6/30/1989 Goodwill Amortization from 7/1/1989 - 7/31/1989 Carteret Book Value as of 7/31/1989 Mean Market-to-Book Ratio for Thrifts as of 7/31/1989 % Increase in Market-to-Book Ratio for Thrifts from 7/31/1988 to 7/31/1989 Carteret Market-to-Book Ratio as of 7/31/1989 Carteret Market Value as of 7/31/1989 1988 $306.0 $266.0 0.869 0.589 1989 $270.5 $1.3 $269.3 0.633 7.4% 0.934 $251.4

25.

The estimate of Carteret's market value as of July 31, 1989, is a conservative

measure of Carteret's market value at that time but-for the breach. As I explain later in this report, the market value for AmBase (and Carteret) was negatively affected by news related to FIRREA's developments in Congress in the months leading up to its eventual enactment in August 1989. Carteret was already operating in a breach-affected world in July 1989 because much of what would be in the final version of FIRREA (including the breach) was known by the market. It is difficult to determine the latest date at which Carteret's market value was not tainted by the breach. The end of July 1989 is a very conservative estimate of this date given that it is only nine days before FIRREA's enactment. 26. The estimate of Carteret's July 31, 1989 market value of $251.4 million is

conservative because the decrease in Carteret's book value is largely due to the dividends paid and goodwill amortization, which are viewed by the market as favorable reasons for a decrease in book value. Although dividends decrease a firm's book value, dividend payments have been

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found to have a positive effect on the market value of the firm. For example, research by Professors Amy Chang, Praveen Kumar, and K. Sivaramakrishnan of the University of Houston tested the validity of the dividend-signaling hypothesis.46 Specifically, the dividend-signaling hypothesis states that dividends can be used to convey information about future earnings, and the authors find evidence to support this hypothesis.47 They find that the relationship between dividend changes and future earnings is strongest for firms that have the highest marginal net benefit from signaling.48 Therefore, to the extent that the dividends that Carteret paid were perceived by the market as a positive signal of future earnings, the valuation estimate presented above is conservative. 27. Furthermore, goodwill amortization has much less than a dollar-for-dollar effect

in reducing the market value of an institution. In my previous declaration, I estimated that the market value of Carteret's supervisory goodwill would have been between $45.9 million and $49.0 million as of December 6, 1993, when the face value of goodwill would have been $128.3 million.49 Using a similar methodology (see Appendix A), I estimate that the market value of Carteret's supervisory goodwill was between $63.3 million and $69.0 million as of August 9, 1989, when the face value of that goodwill was $169.3 million. Based on these estimates, the ratio of the market value of supervisory goodwill to the book value of supervisory goodwill was between 37.4 percent and 40.8 percent. Because a decrease in the balance of goodwill reduces book value more than market value, the market-to-book ratio will increase. In Carteret's case,

46. Amy Chang, Praveen Kumar & K. Sivaramakrishnan, Dividend Changes, Cash Flow Predictability, and Signaling of Future Cash Flows (Nov. 15, 2005), available at http://ssrn.com/abstract=881511. 47. Id at 1. 48. Id at 25. Firms with the highest marginal net benefit from signaling tend to be firms with relatively unpredictable cash flow. Id. 49. Declaration of Charles W. Calomiris of July 14, 2006, at 69-84, 108-113.

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goodwill amortization (supervisory and non-supervisory) accounted for $7.8 million of the $35.5 million decrease in book value between July 1988 and July 1989. 28. Approximately 90 percent of the reduction in Carteret's book value from July

1988 to June 1989 was attributable to dividends and goodwill amortization. Reductions in book value due to dividend payments and goodwill amortization have much less than a dollar-fordollar effect on market values. Indeed, given the positive signaling effects of dividend payments, reductions in book value experienced by Carteret from July 1988 to July 1989 could have increased its market value. Furthermore, because the mean market-to-book ratios for all other thrifts increased from July 1988 to July 1989, and because that mean is depressed by the negative effects of the breach on many of those other thrifts, it is reasonable to assume that Carteret's market-to-book ratio also increased over this time span, resulting in a market value in a but-for world at the time of the breach that could not have been substantially lower than Carteret's market value at the time it was acquired by AmBase, and arguably would have been higher. 3. 29. AmBase's Stock Price Movements Are Correlated with News Relating to the Evolution of FIRREA Before Its Passage Between the date of AmBase's acquisition of Carteret on August 8, 1988, and the

date of FIRREA's passage on August 9, 1989, AmBase's stock price increased from $13.00 to $15.625--an increase of 20.2 percent.50 However, as events unfolded regarding the evolution of FIRREA through Congress, the market reaction to those events can be seen in negative movements in AmBase's stock. 30. FIRREA passed the House of Representatives on June 15, 1989, and the Senate

on June 21, 1989, but in the weeks leading up to its passage, there was substantial uncertainty

50. CRSP, Center for Research in Security Prices. Graduate School of Business, The University of Chicago 2006.

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about whether FIRREA would pass and what provisions it would contain. During the spring of 1989, as Congress debated FIRREA, the thrift regulators, thrifts potentially affected by FIRREA, and market participants responded to its prospective passage. The costliness of FIRREA to thrifts that maintained supervisory goodwill depended not only on whether supervisory goodwill would be phased out but on the details of how such a phaseout would be enforced. Those details, in turn, were not known in advance but rather evolved during the Congressional debate. 31. Tracking what exactly constitutes news is difficult given all the different

legislative proposals put forth while FIRREA was debated in Congress. In addition, news events close to the date of a bill's passage are often less significant signals to the market than earlier events because much of the uncertainty over what the bill will include has been removed through earlier debates. 32. An important example of one of these earlier debates that had a material impact

on the final provisions of FIRREA was an amendment offered by Congressman Henry Hyde ("Hyde amendment") on May 24, 1989 in the House Judiciary Committee.51 Had it passed, this amendment would have required a lengthy regulatory review process before an institution could be prevented from counting supervisory goodwill towards regulatory capital. As reported on the front page of the New York Times, this amendment was defeated on May 24 by a 17-17 tie as FIRREA passed through the House Judiciary Committee on its way to the floor.52 33. In my earlier declaration, I examined the negative effects on AmBase's stock of

the increased expectation of the elimination of supervisory goodwill based on the beginning of an OTS examination report on May 22, 1989 and the defeat of the Hyde amendment on May 24,

51. Matt Yancey, Some House GOP Members Want S&L Bill Changes, ASSOCIATED PRESS, May 23, 1989; Kathleen Day, S&L Supporters Plan Offensive To Retain `Goodwill' as Capital, WASH. POST, May 24, 1989, at F1. 52. Nathaniel C. Cash, Some in G.O.P. Deserting Bush On Savings Plan, N.Y. TIMES, May 25, 1989, at A1.

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1989.53 The defeat of the Hyde amendment occurred early enough in the development of FIRREA that it constituted important news about what would be included in the final legislation. As I discussed in my earlier declaration, the narrow defeat of this amendment was a significant negative signal to the market about the increased risk posed by the legislation. Table 4 shows the cumulative abnormal returns of AmBase over the one, three, five, seven, and eleven-day windows surrounding the defeat of the Hyde amendment on May 24, 1989.54 TABLE 4: CUMULATIVE ABNORMAL RETURNS FOR AMBASE FOR DEFEATED HYDE AMENDMENT
(Cumulative Abnormal Event Window Cumulative Return) x (Market Value on Around May 24, Abnormal Daily Day Preceding Event Window) 1989 Stock Returns Z-Statistic 1-Day ­1.3% ­0.75 ­$5.6 million 3-Day ­6.8%** ­2.09 ­$30.2 million 5-Day ­7.5%* ­1.70 ­$33.6 million 7-Day ­10.0%* ­1.88 ­$45.1 million 11-Day ­10.2% ­1.52 ­$47.0 million Note: * Significant at 10 percent level ; ** Significant at 5 percent level; *** Significant at 1 percent level. Sources: Federal Reserve Statistical Release H.15, 30-year Treasury constant maturities (nominal); CRSP, Center for Research in Security Prices. Graduate School of Business, The University of Chicago 2006.

As Table 4 shows, AmBase experienced a negative abnormal return of ­1.3 percent (a $5.6 million reduction in market value) on the date of the defeated Hyde amendment. In the elevenday window around May 24, AmBase experienced a negative abnormal return of ­10.2 percent (a $47.0 million reduction in market value). To account for any subsequent news about FIRREA's evolution prior to its passing the House of Representatives that likely affected AmBase's market value, I also considered an expanded event window that began on May 15 and ended on June 15, 1989 (the day FIRREA passed the House of Representatives). Cumulative abnormal returns over this extended window totaled ­8.6 percent, implying a loss of value of $40.0 million.55

53. Declaration of Charles W. Calomiris of July 14, 2006, at 85-89. 54. I discussed the methodology for estimating these abnormal returns in my earlier declaration. Id. 55. Id. at 88.

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34.

In spite of all the negative effects of FIRREA, the market did not believe that

Carteret faced a significant risk of failing because of the high value associated with Carteret's franchise. In addition, general economy trends were important. Both the stock market as a whole and the thrift industry were increasing in value between the time of AmBase's merger with Carteret and the date of the breach, as shown in Figure 2. FIGURE 2: AMBASE STOCK RETURNS VERSUS S&P 500 AND SNL THRIFT INDEX RETURNS
160 140 120 Index (8/8/1988) 100 SNL Thrift Index 80 60 40 20 0 10/8/1988 11/8/1988 12/8/1988 10/8/1989 11/8/1989 12/8/1989 8/8/1988 9/8/1988 1/8/1989 2/8/1989 3/8/1989 4/8/1989 5/8/1989 6/8/1989 7/8/1989 8/8/1989 9/8/1989 1/8/1990 2/8/1990 3/8/1990 4/8/1990 5/8/1990 6/8/1990 5/24/1989 Hyde amendement defeated 8/9/1989 FIRREA is enacted AmBase S&P 500

Sources: CRSP, Center for Research in Security Prices. Graduate School of Business, The University of Chicago 2006; SNL Securities Database; Yahoo! Finance.

As Figure 2 shows, AmBase's cumulative return from August 8, 1988 to the date that FIRREA was enacted was not substantially different from the cumulative returns in the S&P 500 and the cumulative returns in the SNL Thrift Index, a stock index of thrifts maintained by SNL Financial. Figure 2 shows the substantial decline in AmBase's stock price relative to the S&P 500 around the date of the defeat of the Hyde amendment. By the time FIRREA passed in August 1989, AmBase's stock price had recovered to its earlier levels. However, soon after

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FIRREA passed, both AmBase and the thrift industry as a whole substantially declined relative to the S&P 500 as the market reacted to the ramifications from FIRREA. The fundamental values of AmBase and Carteret were rising over time, but FIRREA more than negated that historical rise in value for Carteret and other similarly situated thrifts as the bill was developed in Congress and in the months and years after its enactment. C. 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 35. The market value of Carteret on any particular date represents the expected future

profits of the bank discounted back to present value as of that date. Legal counsel has instructed me not to compute compound interest on but-for cash flow damages occurring prior to the time of trial. Accordingly, I calculate the expected annual non-compounded profits implied by Carteret's market valuation. In Appendix A, I estimate Carteret's cost of capital to be between 12.34 percent and 13.40 percent as of August 9, 1989. To perform the calculation of Carteret's undiscounted cash flows, I have assumed the lower discount rate of 12.34 percent. This assumption is conservative, especially in light of the fact that AmBase issued $150 million in 147/8 percent senior subordinated notes in June 1988.56 A higher cost of capital would lead to a higher estimate of undiscounted cash flows. Furthermore, for simplicity, I have assumed a stabilized earnings growth path over time, and I have assumed that earnings in the first year after the breach would have been equal to Carteret's average net income between 1982 and 1988-- $20.5 million--as shown in Table 5.

56. The Home Group, Inc., Quarterly Report (Form 10-Q), at 8 (CAM4150081).

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TABLE 5: CARTERET'S NET INCOME, 1982 - 1988
Fiscal Year ended September 30: Net Income ($Million) 1982 (23.228) 1983 34.809 1984 7.521 1985 25.222 1986 46.091 1987 33.417 1988 19.988 Average 20.546 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).

The estimate of $20.5 million in net income in the first year following the breach is conservative in light of the actual net income of $43.0 million for the year ending December 31, 1989, and because the average is depressed due to the negative earnings in 1982.57 36. Given (1) my estimate of the market value of Carteret of $251.4 million as of the

date of the breach when using the increase in market-to-book ratios for other thrifts, (2) the discount rate of 12.34 percent, and (3) but-for earnings in the first year after the breach of $20.5 million, I calculate the implied stabilized annual growth rate in earnings to be 4.2 percent.58 Again, this is a conservative assumption; profits in the banking industry have reached historic highs over the last 15 years.59 Next, I assume that Carteret would have paid out 31.7 percent of its earnings each year in dividends. This ratio is equal to the mean annual dividend payout ratio

57. Carteret Bancorp, Inc., 1989 Annual Report (C-AM-A-0394515). 58. I estimate the stabilized growth rate by using the Gordon model of a constantly growing perpetuity, P0

=

E1 , where P0 is the market value of the institution at time 0, E1 is the earnings in year 1, i is the i-g

discount rate, and g is the stabilized annual growth rate in earnings. 59. One may argue that the initial annual earnings of approximately $20 million are aggressive in light of Carteret's actual net losses of $160.25 million in 1991 and $131.84 million in 1990. See Carteret Savings Bank FA, 1991 Annual Report, at 2 (KH053774). However, those losses are breach-affected. For example, Carteret took provisions for losses on loans and real estate of $122.349 million in 1990 and $171.634 million in 1991. Id. As I discuss later in this report, those writedowns were made as part of an aggressive effort by Carteret to raise capital from outside investors--capital that Carteret needed to raise as a direct result of not being able to treat supervisory goodwill as regulatory capital. In any event, as the commercial real estate market in the Northeast rebounded, many of these provisions for loan losses could have been reversed.

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for all publicly traded thrifts with data available in Compustat from August 1989 through December 2006.60 Therefore, the undiscounted earnings from August 9, 1989 to December 31, 2008 are equal to $595.6 million. Table 6 summarizes projected earnings, projected dividends, and annual earnings net of dividend distributions. In summary, the market value of Carteret as of August 9, 1989 implies a conservatively estimated earnings stream that would have delivered $188.7 million of dividends plus $406.9 million of accumulated retained earnings for Carteret over the period from August 9, 1989 to December 31, 2008. Those accumulated retained earnings of $406.9 million would have substantially increased the value of the bank's book capital. The book value of Carteret at the end of 2008 would have been equal to the book value as of the breach, less amortized goodwill through the end of 2008, plus the earnings retained from the time of the breach through the end of 2008. This book value at the end of 2008 would have been equal to $493.7 million. Stockholders of Carteret, in the but-for world, would have received the $188.7 million of dividend payments and would have retained an ownership interest in the surviving bank. On a non-compounded book-value basis, $595.6 million would be an estimate of damages based on a 2008 book value. But damages should be calculated on a market value basis, and market values remain above book values during the relevant period. In my subsequent analysis, I take market value appreciation into account in calculating damages. A

60. To estimate the mean, I collect each monthly observation of thrifts in Compustat with data available for the thrift's annual dividend payout ratio. I then calculated the mean of these annual dividend payout ratios across all thrifts in Compustat and all months from August 1989 to December 2006. I use December 2006 as the latest date throughout my report because it is the latest date for which almost all companies had results reported in Compustat at the time of the writing of this report. I also estimated the mean dividend payout ratio to be 29.5 percent for thrifts that survived as standalone thrifts with stock price data available for every month between July 1989 and December 2006. I estimated the mean dividend payout ratio to be 23.9 percent for thrifts that survived as standalone thrifts with market-to-book ratio data available for every month between July 1989 and December 2006. Note that when institutions distribute a higher share of earnings as dividends, book values are lower and the institution does not have the chance to use those retained earnings to grow the institution. Furthermore, because of the legal restrictions on compounding interest in computations of damages, dividends, once paid, do not accrue interest in the damages calculation. Therefore, the high dividend payout ratio assumption of 31.7 percent is conservative.

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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proper measure of damages due in 2008 would include the sum of dividends received in the butfor world that were not received in the actual world through 2008, and the 2008 but-for market value of the bank. TABLE 6: BUT-FOR UNDISCOUNTED CASH FLOWS FROM AUGUST 9, 1989 TO DECEMBER 31, 2008
Net Income (Million $) [A] $20.5 $21.4 $22.3 $23.2 $24.2 $25.2 $26.2 $27.3 $28.5 $29.7 $30.9 $32.2 $33.5 $34.9 $36.4 $37.9 $39.5 $41.1 $42.8 $17.7 $595.6 Dividends Distributed (Million $) [B] = 31.6% × [A] $6.5 $6.8 $7.1 $7.4 $7.7 $8.0 $8.3 $8.7 $9.0 $9.4 $9.8 $10.2 $10.6 $11.1 $11.5 $12.0 $12.5 $13.0 $13.6 $5.6 $188.7 Cash Flows Net of Dividends (Million $) [C] = [A] ­ [B] $14.0 $14.6 $15.2 $15.9 $16.5 $17.2 $17.9 $18.7 $19.5 $20.3 $21.1 $22.0 $22.9 $23.9 $24.9 $25.9 $27.0 $28.1 $29.3 $12.1 $406.9

Period 8/9/1989 - 8/8/1990 8/9/1990 - 8/8/1991 8/9/1991 - 8/8/1992 8/9/1992 - 8/8/1993 8/9/1993 - 8/8/1994 8/9/1994 - 8/8/1995 8/9/1995 - 8/8/1996 8/9/1996 - 8/8/1997 8/9/1997 - 8/8/19