Free Post Trial Brief - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS No. 92-550C (Judge Williams) ______________________________________________________________________________ NORTHEAST SAVINGS, F.A., Plaintiff, v. THE UNITED STATES, Defendant. ______________________________________________________________________________ DEFENDANT'S POST TRIAL BRIEF ______________________________________________________________________________ STUART E. SCHIFFER Deputy Assistant Attorney General DAVID M. COHEN Director JEANNE E. DAVIDSON Deputy Director

Of Counsel: SCOTT AUSTIN MELINDA HART ELIZABETH HOSFORD JEFFREY INFELISE SAMEER YERAWADEKAR Trial Attorneys Department of Justice

TAREK SAWI Trial Attorney Commercial Litigation Branch Civil Division Department of Justice Attn: Classification Unit, 8th Floor 1100 L Street, N.W. Washington, D.C. 20530 Tele: (202) 616-0320 Fax: (202) 305-7643 Attorneys for Defendant

January 22, 2007

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TABLE OF CONTENTS PAGE TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v DEFENDANT'S POST TRIAL BRIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Proposed Findings of Fact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 I. Northeast's Track Record A. B. C. D. II. ................................................2

Using A Return On Assets As A Measure Of Profitability . . . . . . . . . . . . . . . . . . 4 The Focus On Net Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Northeast's Real World Risk Controlled Arbitrage . . . . . . . . . . . . . . . . . . . . . . . 6 Northeast's Peers Also Showed A Track Record Of Losses, Not Profits . . . . . . 7

Northeast Did Not Want To Engage In Risk Controlled Arbitrage And Its Regulators Would Not Have Permitted Such A Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 All Of Dr. Baxter's Alleged Profits Result From A Hindsight Driven Bet That Interest Rates Would Fall . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Dr. Baxter's Model Generates Its Income By Taking More Interest Rate Risk Than Northeast Wanted To Take . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Dr. Baxter's Model Generates Its Alleged Profits By Betting On Falling Rates At A Time When Northeast Actually Expected Rates To Rise . . . . . . . . . . . . . 14 Northeast Did Not Need Any Goodwill To Place The Same Bet On Falling Rates; It Could Have Placed The Same Bet And Generated The Same Alleged Profits In The Real World If It So Desired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Dr. Baxter Insulates His Model From The Effects Of The Recession By Assuming That His Portfolio Would Have Zero Credit Risk . . . . . . . . . . . . . . . . . 18 Dr. Baxter Erroneously Assumes Almost Zero General And Administrative Costs For The Alleged Incremental Forgone Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Dr. Baxter's Assumptions About The Size Of The Forgone Assets Are Speculative And Contrary To Fact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 -i-

III.

IV.

V.

VI.

VII. I.

VIII.

IX.

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X.

The Phase Out Of Goodwill Benefitted Northeast . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 A. The Phase Out Of Goodwill Benefitted Northeast By Causing it To Eliminate Dividend Payments To The Government And Allowing It To Redeem The Government's Preferred Stock at A Steep Discount . . . . . . . . . . 24 The Phase Out Of Goodwill Benefitted Northeast By Causing It To Securitize Its Loans And To Eliminate Recourse . . . . . . . . . . . . . . . . . . . . 26 The Phase-Out Of Goodwill Benefitted Northeast By Causing It To Reduce Higher Credit Risk Lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

B.

C.

XI.

Northeast's Acquisition Of Rhode Island Credit Unions In 1992 Caused It No Harm And Was Unrelated To The Breach . . . . . . . . . . . . . . . . . . . . . . . . 29 Northeast's Wounded Bank Claim Is Premised On Its Lost Profits Claim And Is Otherwise Flawed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Northeast Was Required To Write Off The Goodwill For Non Breach Reasons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 A. B. Northeast's Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Contractual Documents Relevant To Northeast's Accounting Of Its Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Northeast's Actual Accounting Of Its Goodwill . . . . . . . . . . . . . . . . . . . . . . . . 37 Northeast Advised The Public That Its Goodwill Was Written-Down For Reasons Unrelated To The Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

XII.

XIII.

C. D.

ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 I. Northeast's Lost Profits Claim Cannot Meet Any Of The Legal Requirements . . . . . . 44 A. Northeast's Lost Profits Claim Fails At The Outset Because Neither Northeast Nor Its Peers Have A Track Record Of Profitability . . . . . . . . . . . . 45 Northeast's Lost Profits Claim Fails At Its Inception Because There Is Not a Scintilla Of Evidence That Northeast Would Have Been Permitted To Pursue Its RCA Model In The No Breach World . . . . . . . . . . . . 46 Causation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

B.

C.

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D. E. II.

Foreseeability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Reasonable Certainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

Northeast Is Not Entitled To Recover As Damages Any Costs Associated With Its Acquisition Of Rhode Island Credit Unions In 1992 . . . . . . . . . . . . . . . . . . . 56 A. B. C. Northeast's DEPCO Claim Is Based On Counterfactual Assumptions . . . . . . . 57 Dr. Baxter's Model For Measuring The Alleged Costs Is Wrong . . . . . . . . . . . 59 Any Costs Associated With The Issuance Of Preferred Stock When It Acquired Rhode Island Credit Unions In 1992 Are Not Recoverable Because They Are The Result Of Remote Consequences . . . . . . . . . . . . . . . . . 61 Northeast Is Not Entitled To Recover Hypothetical Costs Associated With The Acquisition Of The Rhode Island Credit Unions . . . . . . . . . . . . . . . . . . . . 62 Northeast Is Not Entitled To Recover Costs Incurred By Its Holding Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 Northeast's Request For A Tax "Gross-Up" Fails . . . . . . . . . . . . . . . . . . . . . . . 65 1. Northeast Has Not Shown With Reasonable Certainty That The DEPCO-Related Damages Would Be Taxable . . . . . . . . . . . . . . . . . . . 66 Awarding A "Gross-Up" At This Juncture Would Be Premature . . . . . 68 Tax "Gross-Up" Barred As A Matter Of Law . . . . . . . . . . . . . . . . . . . . 69 Tax Rate To Be Applied In Calculating A "Gross-Up" Uncertain . . . . 71

D.

E.

F.

2. 3. 4. IV.

Northeast's Alleged "Wounded Bank Damages" Are Premised Upon Its Flawed Lost Profits Model And Are Factually And Legally Infirm . . . . . . . . . . . . . . . . . . . . . . . . . 72 Northeast Greatly Overstates The Amount Of Contractual Goodwill To Which It Was Entitled Absent The Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 A. GAAP Controls Pursuant To The Plain Language Of The Contract Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 As Northeast Told The Public, GAAP Required The Write-Down Of Its Goodwill For Reasons Unrelated To The Breach . . . . . . . . . . . . . . . . . . . . . 79

V.

B.

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CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

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TABLE OF AUTHORITIES FEDERAL CASES American Federal Bank, FSB v. United States, 68 Fed. Cl. 346 (2005) .................................... 61 Bank of America, FSB v. United States, 67 Fed. Cl. 577 (2005) ............................................... 66 Bluebonnet Sav. Bank, F.S.B. v. United States, 266 F.3d 1348 (Fed. Cir. 2001) ...................... 44 Bucklew v. Hawkins, Ash, Baptie & Co., LLP, 329 F.3d 923 (7th Cir. 2003) .......................... 47 California Federal Bank v. United States, 54 Fed. Cl. 704 (2002), aff'd, 395 F.3d 1263 (Fed. Cir. 2005) ........................................................................................... passim Centex Corp. v. United States, 55 Fed. Cl. 381 (2003), aff'd, 395 F.3d 1283 (Fed. Cir. 2005) . 66 Citizens Fed. Bank, F.S.B. v. United States, 59 Fed. Cl. 507 (2004) ......................................... 66 Clark v. Comm'r, 40 B.T.A. 333 (1939), acq., 1957-1 C.B. 4 .................................................... 68 Coast Fed. Bank, FSB v. United States, 48 Fed. Cl. 402 (2000), aff'd, 323 F.3d 1035 (Fed. Cir. 2003) .................................................................................................................... passim Commercial Federal Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004), aff'd, 125 Fed. Appx. 1013 (Fed. Cir. 2005) .................................................................................. 45, 66 Concord Instruments Corp. v. Comm'r, T.C. Memo. 1994-248 (May 31, 1994) ....................... 68 Corbetta Const. Co. v. United States, 461 F.2d 1330 (Ct. Cl. 1972) .......................................... 75 DPJ Co. Ltd. Partnership v. FDIC, 30 F.3d 247 (1st Cir. 1994) ................................................. 60 Diesel Systems, LTD. v. Yip Shing Diesel Eng'g Co., Ltd., 861 F. Supp. 179 (E.D.N.Y. 1994) 64 Eleven Line, Inc. v. North Texas State Soccer Assn., Inc., 213 F.3d 198 (5th Cir. 2000) ......... 45 Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed. Cir. 2002) .................................... 53 Erickson Air Crane Co. of Wash, Inc. v. United States, 731 F.2d 810 (Fed. Cir. 1984) ............ 64 Fifth Third Bank of W. Ohio v. United States, 402 F.3d 1221 (Fed. Cir. 2005) .................. 44, 63 First Hartford Corp. Pension Plan & Trust v. United States, 194 F.3d 1279 (Fed. Cir. 1999) .. 65 -v-

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First Heights Bank, F.S.B. v. United States, 57 Fed. Cl. 162 (2003), aff'd, 422 F.3d 1311 (Fed. Cir. 2005) .................................................................................................. 66 Flora v. United States, 357 U.S. 63 (1958) ................................................................................. 70 Freeman v. C.I.R., 33 T.C. 323 (1959) ....................................................................................... 68 Glendale Federal Bank, F.S.B., v. United States, 43 Fed. Cl. 390 (1999) ........................... passim Glendale Federal Bank, F.S.B., v. United States, 378 F.3d 1308 (Fed. Cir. 2004) .................... 44 Gould, Inc. v. United States, 935 F.2d 1271 (Fed. Cir. 1991) .................................................... 75 Granite Mgmt. Corp. v. United States, 416 F.3d 1373 (Fed. Cir. 2005) .............................. 62, 64 Hercules Inc. v. United States, 24 F.3d 188 (Fed. Cir. 1994) ..................................................... 61 Hillside Enters. v. Carlisle Corp., 69 F.3d 1410 (8th Cir. 1995) ................................................ 47 Home Sav. of America v. United States, 399 F.3d 1341 (Fed. Cir. 2005) ..................... 66, 78, 79 Hughes Communications Galaxy, Inc. v. United States, 271 F.3d 1060 (Fed. Cir. 2001) ......... 62 LaSalle Talman Bank, FSB v. United States, 317 F.3d 1363 (Fed. Cir. 2003) .......................... 60 LaSalle Talman Bank, F.S.B. v. United States, 462 F.3d 1331 (Fed. Cir. 2006) ....................... 66 Landmark Land Co. v. F.D.I.C., 256 F.3d 1365 (Fed. Cir. 2001) .................................. 51, 64, 65 Library of Congress v. Shaw, 478 U.S. 310 (1986) .................................................................... 70 Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151 (1934) .............................................. 48 Local Oklahoma Bank, N.A. v. United States, 59 Fed. Cl. 713 (2005), aff'd, 452 F.3d 1371 (Fed. Cir. 2006) ......................................................................................... 66 Murphy v. I.R.S., 460 F.3d 79 (D.C. Cir. 2006) ......................................................................... 68 Myerle v. United States, 33 Ct. Cl. 1 (1897) .............................................................................. 70 Northeast Savings v. United States, 63 Fed. Cl. 507 (2005) ...................................................... 76 Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) . 64 -vi-

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Old Stone Corp. v. United States, 450 F.3d 1360 (Fed. Cir. 2006) ..................................... passim Picture Lake Campground, Inc. v. Holiday Inns, Inc., 497 F. Supp. 858 (E.D. Va. 1980) ........ 64 Porter v. United States Agency for Int'l Development, 293 F. Supp. 2d 152 (D.D.C. 2003) ..... 70 Raytheon Prod. Corp. v. C.I.R., 144 F.2d 110 (1st Cir. 1944) ................................................... 67 Roseburg Lumber Co. v. Madigan, 978 F.2d 660 (Fed. Cir. 1992) ............................................ 54 Rumsfeld v. Applied Cos., 325 F.3d 1328 (Fed. Cir. 2003) ................................................. 45, 53 San Carlos Irrigation & Drainage Dist. v. United States, 111 F.3d 1557 (Fed. Cir. 1997) ........ 53 Schiller & Schmidt, Inc. v. Nordisco Corp., 969 F.2d 410 (7th Cir. 1992) ................................ 47 Shore v. United States, 9 F.3d 1524 (Fed. Cir. 1993) ................................................................. 70 Southern California Fed. Sav. & Loan Ass'n v. United States, 422 F.3d 1319 (Fed. Cir. 2005) 64 Southern Pacific Co. v. Darnell-Taenzer Lumber Co., 245 U.S. 531 (1918) ....................... 61, 70 United States v. Gotcher, 401 F.2d 118 (5th Cir. 1968) ............................................................. 68 United States v. Johnson Controls, Inc., 713 F.2d 1541 (Fed. Cir. 1983) .................................. 65 United States v. Winstar Corp., 518 U.S. 839 (1996) .......................................................... passim Webster v. Fall, 266 U.S. 507 (1925) ......................................................................................... 69 Wells Fargo Bank, N.A. v. United States, 88 F.3d 1012 (Fed. Cir. 1996) ................................. 54 Westfed Holdings, Inc. v. U.S., 407 F.3d 1352 (Fed. Cir. 2005) ............................................... 63 Yankee Atomic Elec. Co. v. United States, 112 F.3d 1569 (Fed. Cir. 1997) ............................. 71 FEDERAL STATUTES Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), of 1989, Pub. L. No. 101-73, 103 Stat. 183 (1989) ................................................................................................. 7 28 U.S.C. § 1491 ......................................................................................................................... 70 28 U.S.C. § 2412(a) .................................................................................................................... 70 -vii-

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MISCELLANEOUS IRS Gen. Couns. Mem. 38150, 1979 WL 52907 (IRS GCM) (Oct. 31, 1979) .......................... 68 IRS Gen. Couns. Mem. 38569, 1980 WL 131604 (IRS GCM) (Nov. 26, 1980) ....................... 68 IRS Field Serv. Adv. 685, 1993 FSA .......................................................................................... 68 IRS Chief Couns. Adv. 200114044, 2001 WL 334245 (IRS CCA) (Apr. 6, 2001) ................... 68 IRS Priv. Ltr. Rul. 200328033, 2003 WL 21599200 (IRS PLR) (July 11, 2003) ..................... 68 IRS Priv. Ltr. Rul. 8447076, 1984 WL 268267 (IRS PLR) (Aug. 22, 1984) ............................. 68 IRS Priv. Ltr. Rul. 8604065, 1985 WL 295739 (IRS PLR) (Oct. 30, 1985) .............................. 68 IRS Priv. Ltr. Rul. 200511006, 2005 WL 629938 (IRS RRU) (Mar. 18, 2005) ........................ 68 IRS Priv. Ltr. Rul. 200513011, 2005 WL 737889 (IRS PLR) (Apr. 1, 2005) ............................ 68 IRS Priv. Ltr. Rul. 9743035, 1997 WL 660719 (IRS PLR) (Oct. 24, 1997) .............................. 68 IRS Priv. Ltr. Rul. 9041072, 1990 WL 700653 (IRS PLR) (Oct. 12, 1990); Rev. Rul. 72-341, 1972 WL 29956 (IRS RRU), 1972-1 C.B. 32 (1972) ................................................................. 68 IRS Priv. Ltr. Rul. 9131023, 1991 WL 779286 (IRS PLR) (Aug. 2, 1991) ............................... 69 IRS Priv. Ltr. Rul. 9211015, 1992 WL 801180 (IRS PLR) (Mar. 13, 1992) ............................. 68 IRS Priv. Ltr. Rul. 9211029, 1992 WL 801194 (IRS PLR) (Mar. 13, 1992) ............................. 68 IRS Priv. Ltr. Rul. 9226032, 1992 WL 808823 (IRS PLR) (June 26, 1992) .............................. 68 IRS Priv. Ltr. Rul. 9335019, 1993 WL 333673 (IRS PLR) (Sept. 30, 1993) ............................. 68 IRS Priv. Ltr. Rul. 9343025, 1993 WL 436114 (IRS PLR) (Oct. 29, 1993); Priv. Ltr. Rul. 8923052, 1989 WL 597600 (IRS PLR) (June 9, 1989) .............................................................. 68 Rev. Rul. 57-47, 1957 WL 11946 (IRS RU), 1957-1 C.B. 23 (1957) ........................................ 68 Rev. Rul. 76-171, 1976 WL 36903 (IRS RRU), 1976-1 C.B. 18 (1976) ................................... 68 Rev. Rul. 81-277, 1981-48 I.R.B. 5, 1981 WL 165965 (IRS RRU), 1981-2 C.B. 14 (1981) .... 68 Rev. Rul. 96-65, 1996-53 I.R.B. 5, 1996 WL 745129 (IRS RRU), 1996-2 C.B. 6 (1996) ........ 68 -viii-

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IRS Tech. Adv. Mem. 8438004, 1984 WL 267567 (IRS TAM) (June 4, 1984) ........................ 68 IRS Tech. Adv. Mem. 8438005, 1984 WL 271466 (IRS TAM) (1984) .................................... 68 IRS Tech. Adv. Mem. 200214001, 2002 WL 542157 (IRS TAM) (Apr. 12, 2002) .................. 68 Dunn, Recovery of Damages For Lost Profits § 5.5 (4th ed. 1992) ........................................... 45 11 William Meade Fletcher, Cyclopedia of the Law of Private Corporations § 5096, at 72 (Perm. Ed. 2003) ......................................................................................................................... 64 Financial Accounting Standards Board Pronouncement No. 72 ("FAS 72") ............................. 36 Restatement (Second) of Contracts §§ 347, 351, 352 (1981) .............................................. passim Treatment of Goodwill Acquired in Mergers, 46 FR 42274 (Aug. 20, 1981) ............................ 77

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS NORTHEAST SAVINGS, F.A., Plaintiff, v. THE UNITED STATES, Defendant. ) ) ) ) ) ) ) ) ) )

No. 92-550C (Judge Williams)

DEFENDANT'S POST TRIAL BRIEF Pursuant to this Court's order at trial, defendant respectfully submits its post trial brief, composed of proposed findings of fact and the application of governing legal principles to those findings. As we demonstrate below, plaintiff Northeast Savings, F.A. ("Northeast") did not generate core earnings during the years before or after the breach. Its lost profits model generates hypothetical profits, by the use of hindsight. History tells us that in the early 1990s interest rates declined substantially and the areas in which plaintiff operated suffered from a severe and prolonged recession. Thus, real estate lending that involved higher credit risk, i.e., risk that the borrower will default, resulted in losses. While betting heavily on falling rates resulted in profits.1 Dr. Baxter, plaintiff's expert, builds a portfolio that bets heavily and consistently on falling rates and contains zero credit risk. This was the opposite of plaintiff's actual strategy, behavior and expectations.

Interest rate risk is the risk that the income or value of a portfolio will change based upon changes in interest rates. Tr. 916-17 (Baxter).

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Remarkably, this Court has previously rejected a conceptually identical model from Dr. Baxter. Glendale Federal Bank v. United States, 43 Fed. Cl. 390, 401 n. 3 (1999). "In the end Glendale's [Dr. Baxter's] model is premised upon the acquisition of low credit risk assets and the ability to accurately manage high interest rate risk." Id. The Court rejected the model in its entirety because "the forgone portfolio would have entailed far greater interest rate risk than the bank otherwise was taking." Id. Moreover, the portfolio was "premised upon interest rates falling" which was "inconsistent with Glendale's expectations that interest rates would rise." Id. Finally, contrary to Dr. Baxter's model "Glendale believed at the time that it should continue to invest in higher [credit] risk-weighted lines of business." Id. at 400; California Federal Bank v. United States, 54 Fed. Cl. 704, 708 (2002) (expert "used a funding proxy in his model that repriced frequently because he knows that interest rates declined during the early 1990's. In reality, the bank thought interest rates were going to rise during that period, and would not have taken such a gamble."), aff'd, 395 F.3d 1263 (Fed. Cir. 2005). PROPOSED FINDINGS OF FACT I. Northeast's Track Record Core earnings are the income from the assets and other operations less the cost of liabilities, general and administrative costs and loan losses. Tr. 863-65 (Baxter). Core earnings exclude non-recurring events such as accounting adjustments and one-time gains or losses on the sale of assets. Tr. 1785-86 (Fischel). As Northeast itself recognized, core earnings are the appropriate measure of profitability and value. PX 211 at 2362-63; see also Tr. 1782-85 (Fischel).

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Dr. Baxter admitted that the lost profits that he alleges in his model "would fit anybody's definition of core earnings." Tr. 863. Core earnings result when "the income from the assumed assets is large enough to cover the costs of the liabilities funding them, the general and administrative expenses, and any loan losses." Tr. 865. "Not one penny" of Northeast's alleged lost profits result from gains on sales or from accounting adjustments. Tr. 864. Yet Northeast in real life never generated any core earnings. Dr. Baxter does not dispute that Northeast never generated core earnings during any five year period in the real world. Tr. 867-68; 873-74; 87678 (Baxter). In August 1991, Northeast noted that it had "achieved sustainable core earnings for the first time since the mid-1970s before Northeast was formed." PX 161 at 0003; Tr. 869-70 (Baxter). Northeast reported negative core earnings every year from 1985 through 1988. PX 161 at 0021; Tr. 870-71 (Baxter). Indeed, Northeast's core earnings - as defined, calculated and reported by Northeast itself - were negative $39.9 million from March of 1985 to March of 1989. DX 3000; Tr. 1781-82 (Fischel). Northeast's regulators noted that it sustained core losses every year from 1982 to 1988 with the exception of 1986, where it had core earnings of $600,000. PX 192 at 2252; Tr. 874 (Baxter). Dr. Baxter does not dispute that Northeast had negative core earnings from December 1989 to March 1995. Tr. 877 (Baxter); DX 3001; Tr.1786-87 (Fischel). He does not dispute that Northeast reported negative core earnings from the time of the contract in 1982 until the breach; nor does he dispute that it reported negative core earnings during the seven years prior to the 1982 contract. Tr. 876-78 (Baxter). Indeed, he does not dispute that Northeast always reported

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negative core earnings during every five year period from the mid -1970s until it was sold to Shawmut Bank ("Shawmut") in 1995. Tr. 876-78 (Baxter). A. Using A Return On Assets As A Measure Of Profitability

At times Northeast argued that the meaningful measure of profitability should be return on assets ("ROA") as opposed to core earnings. Return on assets includes both the core earning and any gains on the sale of assets. Tr. 880. (Baxter). Northeast's return on assets from 1982 to 1991 was 2.7 basis points. PX 1401 at 2441; Tr. 881-82 (Baxter). By comparison, Dr. Baxter's incremental portfolio had profits of 81 basis points. Tr. 883 (Baxter). Thus, Northeast's ROA provides no support for Dr. Baxter's model, because Dr. Baxter projects lost profits far in excess of Northeast's actual results, even using an ROA as the measure of profitability. See DX 5041 and DX 5016 and DX 4026. Moreover, as basic economics and the testimony of Northeast's own treasurer demonstrate, incremental assets would have a lower return than Northeast's actual assets had. This is because companies make their most profitable investments first, and then make the less profitable ones subsequently. Brenner Dep. at 140-42; Tr. 3157-58 (Fischel).2 Similarly, they borrow their cheapest funds first, and when those are exhausted they resort to more expensive sources of funds. Tr. 3159-62 (Fischel); Brenner Dep. at 172-73; 175-76. "Banks like all of the firms exploit their best opportunities first." Tr. 2491-92 (Thakor). Thus Northeast's puny actual ROA does not support the premise that any incremental investments would have yielded any positive returns. Tr. 3167-68 (Fischel).

All cites to depositions herein are part of the deposition designations that the Court admitted into evidence. 4

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More fundamentally, Northeast's positive, though minuscule, ROA was not a result of profitability, but of thinly disguised unprofitability. Northeast had some assets that increased in value and many more that decreased in value. To mask its operating losses, it intentionally selected for sale the assets that appreciated in value. It used the gain on sale to mask the operating losses. See PX 192 at 2237. Northeast's wholesale assets, however, were $132 million underwater. PX 250 at 3505; Tr. 1061 (Baxter). That is, the value of the assets decreased since Northeast acquired them by the amount of $132 million. PX 67 at 33095. Northeast itself recognized and stated that core earnings were the true measure of value and performance: "A review of the [board] minutes of the period in question indicates a pervasive understanding that core earnings, rather than gains on sale, support a stock price." PX 211 at 2363; see also Tr. 1783-85 (Fischel); Tr. 2450-53 (Thakor). Its regulators also agreed that core earnings are the more meaningful measure of viability. Tr. 1467-68 (Kovac). Finally, Dr. Baxter's model is based entirely upon core earnings - not gains on sales. In order to show a real world track record that supports its model, Northeast would have to show a track record of core earnings. That is the only "apples to apples" comparison. Tr. 1782 (Fischel). Northeast's core earnings, however, were undisputedly consistently negative. Tr. 867-68; 873-74; Tr. 876-78. (Baxter). B. The Focus On Net Interest Income

Net interest income does not account for loan losses. Indeed, every 10-K includes a consolidated statement of operations. The statement has one entry for "net interest income" and another, smaller one for "net interest income after provision for loan losses." PX 25 at 1580; Tr. 854-857 (Baxter). Nor does the net interest income figure account for general and administrative

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costs. Not surprisingly, positive and even exceedingly large net interest income does not reveal anything about whether the thrift is profitable. In fact, as Dr. Baxter admitted, any failed thrift would have a positive net interest income number, "yet [failed thrifts] lost so much money that they failed." Tr. 860 (Baxter). For example, Northeast reported positive, indeed very large, net interest income figures in 1989, 1992 and 1993. Yet it lost money every one of those years. Tr. 859; 862 (Baxter). Dr. Baxter admits that approximately 30 to 35 of the largest one hundred thrifts in the country in 1990 failed, and their consolidated statements of operations on the day they failed would show "a positive and in fact very large net interest [.]" Tr. 860-61. (Baxter). C. Northeast's Real World Risk Controlled Arbitrage

Risk controlled arbitrage ("RCA") refers to a portfolio of wholesale assets funded by wholesale liabilities. Tr. 888 (Baxter); Tr 1465-66 (Kovac). Dr. Baxter's model is based entirely on such a portfolio of wholesale assets and liabilities. Tr. 887-88 (Baxter). Northeast had an RCA portfolio from 1984 to 1989. See PX 192 at 2224 Dr. Baxter admits that he does not know if that portfolio made any money during that period. Tr. 910 (Baxter). The RCA portfolio's market value declined by over $130 million during the time Northeast owned it. PX 67 at 33095; see PX 192 at 2202. Northeast's regulators severely criticized the RCA portfolio. PX 192 at 2224; 2232. After examining the results of the RCA strategy, the regulators concluded "the foregoing data clearly suggests that the institution's expansion into wholesale activities have not helped but rather hindered earnings." PX 192 at 2228; Tr. 1480, 1485-86 (Kovac). Moreover, prospective purchasers refused to buy Northeast because of its RCA portfolio. PX 192 at 2233; DX 334 at 1.

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D.

Northeast's Peers Also Showed A Track Record Of Losses, Not Profits

Northeast presented no peer analysis to justify or support its lost profits claim. Northeast's peers had track records of staggering losses during the period of Dr. Baxter's lost profits model. DX 3003; Tr. 1788-91 (Fischel). In 1988, Northeast's own consultant listed eleven thrifts as comprising Northeast's "retail peer group." PX 66 at 4003. Professor Fischel traced the performance of this "retail peer group"during the time period covered by Dr. Baxter's model. He found that ten of the eleven thrifts lost money during that period. The combined net results of all eleven thrifts during that period was a loss of $743 million. DX 3003; Tr. 1788-91 (Fischel). II. Northeast Did Not Want To Engage In Risk Controlled Arbitrage And Its Regulators Would Not Have Permitted Such A Strategy Dr. Baxter's model is admittedly based entirely upon an RCA portfolio. Tr. 887-88 (Baxter). Yet Northeast itself announced that it had a bitter experience with such activity and had no interest in pursuing it in the future. Prior to the Financial Institutions Reform, Recovery and Enforcement Act, of 1989, Pub. L. No. 101-73, 103 Stat. 183 (1989) ("FIRREA") its board of directors unanimously informed the regulators that "the company's experience in this activity shows that RCA is an inappropriate risky activity that should not be allowed as a permissible activity." PX 211 at 2365. Thus, Dr. Baxter's model is based entirely upon an activity that Northeast promised not to pursue because it had a very unhappy experience with it in the real world, and because it deemed it "inappropriate" and "risky." See Tr. 2217-18 (Bankhead); Tr. 2525-2535 (Thakor). Moreover, Northeast's regulators would not have permitted it to continue to engage in RCA activity even if Northeast had any desire to do so. The regulators found Northeast's RCA 7

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activity and the risks inherent in it to be "grossly unacceptable," and they would not have permitted it. Tr. 1486-87 (Kovac). This was because the RCA "didn't work and it was threatening the existence of the institution." Tr. 1487 (Kovac). Because an immediate exit from RCA would have forced Northeast to recognize a $132 million loss, the regulators wanted Northeast to postpone such an exit until a decline in interest rates would permit Northeast to divest its wholesale portfolio without taking such a large loss. "We [the regulators] wanted them to get out of it as quickly as possible, without causing a threat to capital, so the answer is no, they would not have been permitted to loiter in the RCA program and let it hang around. We wanted it closed out." Tr. 1489 (Kovac); Tr. 1069-70 (Baxter). Northeast was even more eager to exit its RCA business than were the regulators. It wanted to exit the business even before such a hoped-for decline in rates, and it was willing to absorb the massive loss that such an exit, at that time, would have entailed. PX 1156. See Tr. 2513-2536 (Thakor). Northeast planned to sell some of its best branches to obtain a gain to compensate for the loss from its RCA portfolio. PX 1156; Tr. 1069-70 (Baxter). When the regulators told Mr. Rutland, Northeast's Chief Executive Officer ("CEO"), that he must postpone the exit from RCA until a hoped-for decline in rates would allow him to exit without taking such a huge loss, Mr. Rutland threatened to resign. PX 1156. Thus, Northeast had no interest to "loiter in the RCA program" past the moment it could exit without taking a loss and its regulators would not have permitted it to do so. Tr. 1487; 1489 (Kovac). Indeed, the only reason the regulators did not force Northeast to cease the RCA activity is because Northeast promised to do so on its own. DX 229 at 0080; Tr. 1752-53 (Kovac). Northeast's lack of interest in an RCA model, and the regulators' decision not to permit

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Northeast to pursue such a strategy, are inconsistent with Dr. Baxter's RCA model and with any other RCA model that Northeast may suggest as a "jury verdict." See Tr. 2513-2536 (Thakor). The testimony of Northeast's only expert witness, is inconsistent with its claim. Dr. Baxter admitted that he does not know whether the regulators would have permitted Northeast to pursue an RCA strategy: Q: Sir, do you believe that the regulators would have permitted this institution to continue with its risk-controlled arbitrage? Yes or no. That's all I am asking? A: I don't know. Tr. 893 (Baxter) (emphasis added). Indeed, Dr. Baxter admitted that in his 40 years in the thrift industry he had never heard of a situation where the regulators severely criticized an activity, and the bank agreed that the activity is inappropriate and risky, and yet the regulators continued to permit the bank to engage in such activity. Tr. 908-09 (Baxter). The testimony of Northeast's only fact witness on damages is also inconsistent with its claim. Mr. Walters, admitted that Mr. Rutland was always honest and candid with the regulators. Tr. 363, 364. (Walters). Mr. Walters was directed to Northeast's statement in its response to an examination report stating that RCA was too risky and inappropriate an activity. PX 211 at 2365. Then, he was asked the following questions: Q: Right. The second [sentence] says after we have done it and had an experience in it [the RCA activity], we realize not only should we get out of it, we probably shouldn't have been allowed in the first place? A: That is what it states here. Tr. 405 (Walters). Since this was Northeast's "honest accurate and candid" view no RCA model whether Dr. Baxter's or any one else's, can have any relevance.

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III.

All Of Dr. Baxter's Alleged Profits Result From A Hindsight Driven Bet That Interest Rates Would Fall In Dr. Baxter's model, Northeast simply borrows money in the wholesale markets and

uses that money to purchase assets at market prices from the wholesale markets. Thus, according to the model, Northeast is not performing any services or producing any products. It is simply hoping to maintain a positive spread between the rate it pays upon the money it borrowed and the yield it receives from the assets it purchased. See DX 285, Ex 6 line (62). Dr. Baxter states in his report that "wholesale assets and liabilities are always available at prevailing market prices." DX 285 ¶ 44. Thus, the "Wall street" providers of funds to Northeast, could have, instead of lending the money to Northeast, used that money to purchase wholesale assets for themselves. "Wholesale assets were always available;" "[y]ou can always call Salomon Brothers and get five times as much as you want." Tr. 696-97 (Baxter). Those wholesale lenders chose not to do so, presumably because they did not wish to take the interest rate risk inherent in such a strategy. "To get net interest income the institution has to take risks." Tr. 2456 (Thakor). The risk inherent in Dr. Baxter's RCA model is interest rate risk. Interest rate risk is the risk that the income of a portfolio and/or the value of a portfolio will fluctuate depending upon changes in interest rates. Tr. 916-17 (Baxter). In Dr. Baxter's portfolio, the liabilities re-price much faster than the assets. Tr. 2167-72 (Bankhead). In other words, the liabilities are far more sensitive to changes in interest rates than the assets. Such a "liability sensitive" portfolio is said to have a "negative gap." Tr. 2577-82 (Thakor). Such a portfolio benefits from declining rates, because the liabilities re-price faster at the new and falling rates, while the assets do not re-price and retain the prior, higher interest rate yield. This interest rate movement increases the spread, 10

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or difference, between what the company pays upon its liabilities and the yield it receives from its assets. DX 4001; Tr. 2152-54 (Bankhead); DX 5037; Tr. 2634-36 (Thakor). By his own admission, during the first six months in Dr. Baxter's model, his portfolio has a negative spread. In other words, the cost of the liabilities exceeds the yield from the assets, and consequently the portfolio loses money during that time period. Tr. 942 (Baxter); DX 4003; Tr. 2168 (Bankhead). As Dr. Baxter admitted, if interest rates had stayed as high as they were during that time period, then his model would have continued to show losses during the entire damages period. Tr. 942-43 (Baxter); see also DX 5037; Tr. 2634-36 (Thakor). Moreover, if interest rates had increased, the losses would have been greater. Tr. 942-45 (Baxter). The model generated profits only because interest rates declined dramatically through the early 1990s. Tr. 2634-36 (Thakor). Dr. Baxter admitted that the very same assets and liabilities in his model, would have generated losses, not profits, if rates had not declined. Tr. 942-45 (Baxter). Thus, the entire model represents a bet that interest rates would decline. Tr. 1869 (Fischel). IV. Dr. Baxter's Model Generates Its Income By Taking More Interest Rate Risk Than Northeast Wanted To Take Northeast's interest rate risk exposure was severely criticized in the 1988 exam report and Northeast adopted a new strategic direction "in part, to improve the Association's IRR profile." PX 192 at 2224; PX 211 at 2359. There is far more interest rate risk in Dr. Baxter's incremental portfolio than there was in the real bank. In other words, the income and value of the incremental portfolio is far more sensitive to changes in interest rates than the actual bank. DX 5018; DX 5024; DX 5025; Tr. 2584-87 (Thakor). This is because, by Dr. Baxter's own admission, the gap between how 11

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quickly the liabilities re-price and how quickly the assets re-price is far larger within the incremental portfolio than it is with the rest of the bank. Tr. 922-23 (Baxter). "Every cent of every dollar of [Dr. Baxter's] lost profits calculations comes from exactly these assumptions of financing wholesale assets with mismatched wholesale liabilities." Tr. 1869 (Fischel). Northeast, however, contrary to Dr. Baxter's model, wanted to minimize interest rate risk to protect its income and its value from fluctuations in rates. This was the testimony of Mr. Brenner, Northeast's treasurer and the executive responsible for drafting its interest rate risk policy and for performing its interest rate risk modeling. Brenner Dep. 13-14, 23, 115-16. Q: Is it fair to say that the institution wanted to immunize the value of its portfolio and the income of its portfolio to fluctuations in interest rates to the extent that can prudently be done? A: Absolutely. Brenner Dep. at 136 (emphasis added). Mr. Brenner's testimony is identical to Northeast's statement in its 10Ks. "The Association has a stated policy of limiting its exposure to interest rate changes." PX 21 at 8227. Northeast intentionally reduced its exposure to interest rate risk by trying to match as closely as possible the repricing characteristics of its assets with the liabilities funding them. Id.; Tr. 1038 (Baxter); Tr. 1868-74 (Fischel). Northeast wanted to minimize interest rate risk in order to protect itself "from the potentially catastrophic financial consequences of a change in interest rates on earnings and capital [.]" PX 560, at 4558. Indeed, in its 1989 annual report Northeast attributed the decline in its shareholder value to the interest rate risk inherent in its wholesale portfolio: Q: Why has Northeast's common stock price declined from its high in early 1987? 12

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A: I think there has been a better understanding on the part of the investing public of the earnings dynamics of this Company. There is a recognition by investors that rising interest rates hurt financial institutions wherever there is a mismatch of assets and liabilities, and Northeast has such a mismatch. PX 8 at 0064. Because Northeast viewed such risk as harmful to shareholder value, it sought to reduce it. As Mr. Brenner testified, "in devising our business plans [we] tried to devise them in a way that they were as, if you will neutral to the future course of interest rates as could reasonably be expected . . . the institution never took bets on interest rates because we did not think that was prudent." Brenner Dep. at 130-31. In its November 1989 five-year business plan, Northeast stated that "[it] has historically been exposed to a high degree of interest rate risk, largely as a result of a high proportion of funding liabilities being in the form of wholesale liabilities with very short repricing periods. These liabilities were extremely interest rate sensitive and were not matched with assets of similar sensitivity." PX 156 at 3590. Northeast wanted to reduce such risk and stated that "[t]he reduction in the Association's interest rate risk exposure is a deliberate consequence of Northeast's business strategy. Northeast expects that the successful achievement of its business strategy will be the most effective means of managing interest rate risk." Id. at 3591 (emphasis added). Thus, while Dr. Baxter's model generates all of its profits by increasing interest rate risk by mismatching the re-pricing characteristics of the liabilities and the assets, Dr. Baxter admitted that Northeast had "an intentional strategy to reduce [its] interest rate risk," and it did so by "originating adjustable rate loans with pricing characteristics which match as closely as possible

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the cost of the association's funding base." PX 21 at 8227 (emphasis added); Tr. 1038 (Baxter); DX 3021; Tr. 1869-74 (Fischel). V. Dr. Baxter's Model Generates Its Alleged Profits By Betting On Falling Rates At A Time When Northeast Actually Expected Rates To Rise Not only does Dr. Baxter's model contain far more interest rate risk than Northeast wanted to take, but the risk inherent in the model is in the opposite direction from Northeast's own expectations and behavior. The model generates its profits by assuming that Northeast would bet billions of dollars that interest rates would fall at a time when Northeast believed that rates would in fact rise. DX 3023; Tr.1875-81 (Fischel); DX 4007; Tr. 2172-83 (Bankhead). Northeast regularly recorded its interest rate expectations. Thus its own historical records reveal its expectations at every relevant point in time. DX 3023; Tr. 1875-81 (Fischel); see e.g. PX 161 at 0047-48; PX 581 at 189025. We also know that all of Dr. Baxter's alleged lost profits occurred after March 1991. DX 3023; Tr. 1875-81 (Fischel). During the period in which Dr. Baxter generates every cent of his alleged lost profits by assuming that Northeast would bet on falling rates, Northeast actually did not believe that rates would fall. Rather, in two quarters it believed that rates were as likely to rise as to fall, and in every other quarter it believed that rates were in fact more likely to rise than fall. DX 3023; Tr.1875-81 (Fischel); DX 4007; Tr. 2172-83 (Bankhead); PX 581 at 189025. Thus, not only did Northeast wish to minimize interest rate risk, but it believed that interest rates were going to rise. PX 581 at 189025; Tr. 2197-98 (Bankhead); DX 3023; Tr. 1875-81(Fischel). Consistent with its real world expectations, and contrary to Dr. Baxter's model, Northeast built an asset-sensitive portfolio. In a 10-K filed for the fiscal year ending March 31, 1992, Northeast reported that as a result of its overall strategy of originating 14

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adjustable rate mortgages ("ARMs") for its portfolio and selling fixed rate assets, it was asset sensitive, that is it had a positive gap. PX 23 at 7965. Consequently, Northeast's "interest earning assets can be expected to respond more quickly to changes in interest rates than its interest bearing liabilities, resulting in an increase in net interest income when rates increase and a decrease when rates decrease." PX 23 at 7965. Northeast continued to have this expectation and keep this posture during the relevant time period. PX 24 at 1832; PX 25 at 1563; Tr. 478-85 (Walters). By contrast, Dr. Baxter's incremental portfolio was liability-sensitive that is, it had a negative gap. DX 4007; DX 4009; Tr. 2169-71 (Bankhead). Such a portfolio would make money in the declining rate environment that actually occurred during the early 1990s, but would lose money in the rising rate environment that Northeast actually expected. Tr. 924-25 (Baxter). Northeast's real world portfolio was "well positioned for an increase in interest rates." PX 573 at 0433. Unfortunately, as Northeast observed in its business plans, "interest rates fell to their lowest levels in 30 years during 1993 and adversely impacted the company's business and profitability in several ways." DX 203 at 1365. Yet this drop in interest rates generates all of the profits in Dr. Baxter's portfolio. As Dr. Baxter admitted, the decline in rates that occurred was harmful to the actual bank, because it was positively gapped, but was very beneficial to his incremental portfolio because that portfolio was negatively gapped. Tr. 924-25; 954; 962; 988 (Baxter). "It is counterfactual for Dr. Baxter to have structured the foregone portfolio to benefit from declining interest rates when Northeast restructured its actual portfolio to minimize its interest rate risk exposure. To the extent that Northeast was willing to accept interest rate risk, it

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managed its actual portfolio to take advantage of increasing interest rates." Tr. 2171 (Bankhead). Given Northeast's real world interest rate expectations, there is simply no possibility that Northeast would have pursued the strategy of Dr. Baxter's model. Indeed, as Dr. Baxter himself admitted, "you certainly wouldn't take risk on the other side of what you believed would happen." Tr. 983 (emphasis added). In fact, Dr. Baxter's model would require Northeast to make hundreds of decisions upon a daily basis that are contrary to its expectations and contrary to its own perceived best interest. As Dr. Baxter admitted, a bank the size of Northeast would have many of its liabilities maturing, or coming due on a daily basis. "Most institutions will have on most days liabilities maturing yes." Tr. 1034 (Baxter). Thus, the bank will have to make a multitude of decisions about whether to renew those liabilities and upon the re-pricing characteristics of the replacement liabilities. Tr. 1033-34 (Baxter). The maturity and re-pricing of the replacement liabilities can "var[y] from a few days to several years." Tr. 1033 (Baxter). In order to replicate Dr. Baxter's model, Northeast would have had to acquire daily liabilities that re-priced very quickly at a time when Northeast expected rates to rise. The model also would have Northeast invest those liabilities in assets that did not re-price quickly and, thus, would not benefit from the anticipated rising rates. Thus, the model requires Northeast to make a multitude of decisions that are counter to its own perceived best interest every day. Tr. 258793 (Thakor).

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VI.

Northeast Did Not Need Any Goodwill To Place The Same Bet On Falling Rates; It Could Have Placed The Same Bet And Generated The Same Alleged Profits In The Real World If It So Desired By Dr. Baxter's own admission, even if Northeast had retained the goodwill and used it

to acquire precisely the same assets and liabilities in his model, it would have generated losses not profits, if interest rates had not declined. Tr. 942-45 (Baxter); DX 5037; Tr. 2634-36 (Thakor). Thus, the alleged profits from Dr. Baxter's model do not arise from the goodwill, or even from his assumed assets and liabilities. Rather they are a result of a bet that rates would decline. Tr. 1881-83 (Fischel); Tr. 2476 (Thakor). Again by Dr. Baxter's own admission, Northeast could have placed the very same bet without the goodwill. Indeed, there are many mechanisms by which Northeast could have bet upon falling rates if it had so desired, none of which require any goodwill. Tr. 1206-07 (Baxter); Tr. 2476-86 (Thakor); Tr. 1881-83 (Fischel). Thus, there is no causal connection between the elimination of goodwill and the damages that Northeast alleges. "If in fact Northeast believed after FIRREA that interest rates were going to go down, there is no reason why Northeast could not have taken the same bet on interest rates going down even without the portfolio of divested assets that Dr. Baxter uses to calculate his 112 million in lost profits." Tr. 2476. (Thakor). It is also simply not foreseeable that the elimination of goodwill would prevent Northeast from making a successful bet on falling rates. As Dr. Baxter admitted, one does not need goodwill to bet on the direction of interest rates. He listed a variety of ways by which a thrift can place such a bet without any goodwill. Tr. 120607(Baxter).

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VII. .

Dr. Baxter Insulates His Model From The Effects Of The Recession By Assuming That His Portfolio Would Have Zero Credit Risk Credit risk is the risk that borrowers will default upon their loans. During the early 1990s

Northeast's area of operations suffered from a severe real estate recession. This resulted in significant credit losses. DX 203 at 1364. Northeast reported that its financial results "were dramatically impacted by the recessions" which "resulted in dramatically high levels of foreclosures and charge-offs." Id. In sharp contrast to Northeast's real world experience, Dr. Baxter assumes that his incremental portfolio contains zero credit risk, and consequently suffers zero credit losses. "There are no credit losses [in Dr. Baxter's model]" Tr. 952 (Baxter). Consequently, Dr. Baxter admitted that the recession, which "dramatically impacted" Northeast, had no effect "at all" upon his incremental portfolio. Tr. 962; DX 203 at 1364. As Professor Fischel demonstrated, Dr. Baxter assumes "that his billions of dollars in forgone assets would have had zero credit losses, not one dollar of credit losses at a time when both Northeast and its peer banks in the real world were all losing money." Tr. 1779 (Fischel). This is simply implausible upon its face. Indeed, during the same period that the real world Northeast reports over $117.4 million in loan loss provisions and foreclosure expenses, Dr. Baxter's portfolio does not suffer one cent of such losses. DX 3002; Tr.1787-88. (Fischel). Dr. Baxter's assumptions are all the more erroneous since Northeast's documents and the testimony of its executives make clear that, but for the breach, Northeast would have taken even more credit risk not less. Mr. Brenner, who drafted Northeast's business and capital plans, admitted that, as these plans stated, the phase-out of goodwill caused Northeast to limit business lines with higher credit risk: Q: And this emphasis on lower-risk assets and staying away from higher 18

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risk assets [as discussed in Northeast's 1989 revised business plan] is due to the phase out of supervisory goodwill from the institution's capital? A: That was the major reason. Brenner Dep. at 164; DX 181 at 1433, 1438. Indeed, there are numerous Northeast documents that attribute its decision to reduce credit risk to its shortage of regulatory capital. DX 3005; DX 3009; Tr. 1815-16 (Fischel). Mr. Brenner, referring to the capital plan that he personally drafted, stated that it required the reduction of credit risk in response to the phase-out of goodwill. PX 173 at 1-6. Mr. Brenner testified "that is what the plan was and what the document indicates." Brenner Dep. at 220. Dr. Baxter, by contrast, flatly admitted that his testimony and model is contradicted by Mr. Brenner. Dr. Baxter expressly testified that he "disagree[d]" with Mr. Brenner's testimony. Tr. 1010. "I disagree with his interpretation of the document he wrote, yes." Tr. 1010 (Baxter). Mr. Brenner further admitted that limiting higher credit risk assets was beneficial given the effect of the recession: A: [T]here was a significant economic recession occurred in Connecticut resulting in financial stress on many financial institutions in the state. We felt ourselves fortunate to be positioned the way we were with our balance sheet structure the way it was because we were largely insulated from that economic distress. Q: Because you had fewer of the higher credit risk assets? A: Correct. Brenner Dep. At 180-81. Mr. Brenner's observation is documented by the undisputed data. Ten of Northeast's eleven peers lost money during the period covered by Dr. Baxter's model. DX 3003; Tr. 1788-91 (Fischel). Moreover, 48 large thrifts failed between 1990 and 1994. DX 3012; Tr.1838-39 (Fischel). Even Dr. Baxter does not dispute that limiting credit risk during the 19

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recession was beneficial. Tr. 991; 1020-21 (Baxter). VIII. Dr. Baxter Erroneously Assumes Almost Zero General And Administrative Costs For The Alleged Incremental Forgone Assets Dr. Baxter erroneously assumes that the incremental assets would require no more than .05 percent of general and administrative ("G&A") costs. This assumption is dramatically inconsistent with Northeast's track record. Northeast's whole bank G&A costs exceeded 1.3 percent and its retail G&A costs exceeded 2.7 percent. Similarly Northeast's peers had a G&A cost of over 2.6 percent. DX 3024; Tr. 1887-89 (Fischel). Dr. Baxter admits that Northeast's G&A costs declined significantly after the breach. Tr. 122 (Baxter). However he maintains that the reduction in staff and other expenses had nothing to do with the breach. Dr. Baxter's assumption is incorrect, and is contrary to the testimony of Northeast's own senior executives. Mr. Rutland explicitly stated in his affidavit that Northeast's reduction in assets "resulted in the termination of 253 employees." PX 241 at 9. Dr. Baxter admits that this is contrary to his assumption that the incremental assets would have involved almost no G&A costs. Tr. 1122. (Baxter). In explaining why he disagreed with what Mr. Rutland explicitly stated in his affidavit, Dr. Baxter merely argued that the incremental assets were wholesale assets and thus would not have needed any additional employees. Tr. 1122 (Baxter). But that simply points to another false assumption in Dr. Baxter's model. Contrary to the model, any incremental assets would not have been wholesale because Northeast planned to exit from RCA as soon as a decline in rates allowed it to do so without taking a loss. Thus, any incremental assets would have been retail, not wholesale. and accordingly would have required significant G&A costs.

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IX.

Dr. Baxter's Assumptions About The Size Of The Forgone Assets Are Speculative And Contrary To Fact The preceding sections dealt with Dr. Baxter's claims regarding the profitability of the

alleged forgone assets. The evidence also shows, however, that Dr. Baxter also greatly inflated the alleged amount of forgone assets. Indeed, there is insufficient evidence to conclude that there would have been any forgone assets. "Dr. Baxter's assumption that but-for Northeast would have maintained average tangible assets of $6.7 billion through 1993 is counterfactual." Tr. 2206-07 (Bankhead). "Northeast was undercapitalized pre-FIRREA and, based upon its own pre-FIRREA projections, would have had to shrink (or raise capital) in the but-for world in order to meet the scheduled increase to the pre-FIRREA regulatory capital requirements and the FHLBB proposed risk-based capital requirements." Tr. 2209 (Bankhead). The contemporaneous documents make clear that Mr. Rutland was considering shrinking the bank by unwinding the wholesale portfolio as early as July of 1988. PX 1146 at 0205; Tr. 2211-12 (Bankhead). In 1988, Northeast retained the consulting firm of Kaplan Smith. Tr. 1049 (Baxter). Kaplan Smith's analysis examined seven alternatives for Northeast. Only two of those alternatives would have allowed Northeast to meet pre-FIRREA capital requirements, and both of those alternatives required a significant and immediate shrink in the wholesale portfolio. Tr. 2213-16 (Bankhead); Tr. 1057-58 (Baxter); PX 67 at 3129, 3135. Since this shrink of the wholesale portfolio would have required Northeast to recognize a large loss, both options required the sale of valuable branches, with the hope that the gain upon the sale of those branches would offset the loss necessitated by selling the wholesale assets. Tr. 2216-17 (Bankhead); Tr. 1059-60 (Baxter). 21

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Northeast adopted that option suggested by Kaplan Smith of shrinking the bank and selling valuable branches to generate a gain to offset the loss that would result from selling the wholesale assets. Tr. 2217-18 (Bankhead); Tr. 1065 (Baxter); PX 250 at 7506. The regulators did not approve that option because they did not want Northeast to sell valuable branches. Tr. 1065 (Baxter); PX 251 at 7518. Rather, the regulators told Northeast to keep the wholesale portfolio temporarily and sell it when "market conditions permitted [Northeast] to unwind the risk control arbitrage without taking capital losses." PX 1156. Mr. Rutland was so upset about the regulators' refusal to permit him to shrink immediately by selling wholesale assets that he threatened to resign. PX 1156. Nonetheless, in October 1988 he informed the board that in light of the regulators refusal to permit the immediate sale of the wholesale portfolio, Northeast "must now focus on less desirable strategic alternatives." PX 1156; Tr. 1065 (Baxter). The less desirable option was to sell the wholesale portfolio when interest rates permitted such a sale without a huge loss. The more desirable option, according to Northeast, was an immediate sale of wholesale assets. Tr. 2217-18 (Bankhead); Tr. 2525-2535 (Thakor). In Northeast's response to the 1988 report of examination it projected that it would shrink to $5.8 billion by December 31, 1989, and would shrink further to $5.4 billion by December of 1990. These projections all included the goodwill in the computation of regulatory capital. PX 211 at 2378-80; Tr. 2230-34 (Bankhead). Thus, even with the goodwill, Northeast was still projecting massive shrinkage, well below Dr. Baxter's assumed $6.7 billion no-breach size. PX 211 at 2378-80; Tr. 2230-34 (Bankhead). Moreover, in March 17, 1989, Northeast projected shrinkage to $5.2 billion to comply

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with pre-FIRREA requirements, even with all of the goodwill intact. DX 509 at 0530; Tr. 223535. Numerous Northeast documents showed that it projected shrinkage even without the phase out of the goodwill. DX 179; PX 148A; Tr. 2237-46 (Bankhead). In its capital plan, with full knowledge of the phase-out, Northeast proposed to shrink to $5.2 billion by 1990. PX 173 at 1-6; Tr. 2950 (Bankhead). When Northeast counted all of its goodwill, it projected to shrink to $5.4 billion based upon the pre FIRREA requirements. PX 211 at 2380; Tr. 1081-82 (Baxter). In yet another pre-breach document, Northeast projected to shrink to $5.2 billion with all of the goodwill intact. DX 509 at 0530; Tr. 2235-35. Thus, according to Northeast's own documents, there is little if any difference in its size, whether the goodwill is counted or phased out. Not surprisingly, Northeast stated in its capital plan that if its proposed plan were approved, Northeast would be able to meet the FIRREA's new capital requirements, and doing so would involve only "minimal costs to the association." PX 173 at 16 (emphasis added); Brenner Dep. at 224-27; Tr. 1083-86 (Baxter). X. The Phase Out Of Goodwill Benefitted Northeast Prior to the breach, Northeast wanted to reduce its goodwill and to increase its tangible capital. Tr. 2501-07 (Thakor); DX 334 at 1. On April 15, 1988, Mr. Dixon, Northeast's CEO at the time, stated that the "future strategic direction should have as a foundation the improvement of the balance sheet, by reduction of goodwill and the increase of tangible net worth." DX 334 at 1. Since "reduction of goodwill and the increase of tangible net worth" is precisely what the breach required, there is no reason to assume that the breach caused any damage. Tr. 2502 (Thakor). Similarly, Mr. Rutland, Mr. Dixon's replacement, stated soon after his arrival at

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Northeast that "[g]oodwill is a non earning asset and the faster it can be written off, the greater our increased tangible net worth. Continuing to increase tangible net worth will also be among my goals." DX 513 at 124929. This goal is perfectly consistent with what the breach required. Tr. 2504-07 (Thakor). Northeast's experience demonstrated that its asset growth did not have a positive effect upon its shareholder value. Indeed, as its assets increased, its stock value declined. DX 5011; Tr. 2500-01 (Thakor). The "ultimate goal of Northeast" was to "maximize shareholder value." Tr. 364-65 (Walters). That is the ultimate goal of all companies. Tr. 1041-42 (Baxter). Consistent with its goal of maximizing shareholder value by increasing tangible net worth, in fiscal year 1988, well before the breach, Northeast voluntarily wrote off a portion of its goodwill and reduced the amortization period. Tr. 2505-08 (Thakor); PX 7 at 213015. A. The Phase Out Of Goodwill Benefitted Northeast By Causing it To Eliminate Dividend Payments To The Government And Allowing It To Redeem The Government's Preferred Stock at A Steep Discount As a result of the phase out of goodwill, Northeast decided to conserve its capital by terminating dividend payments. Brenner Dep. at 46, 57. Mr. Brenner explicitly testified that absent the phase-out of goodwill, Northeast would have continued to pay dividends. Id. Dr. Baxter admits that his model assumes, contrary to Mr. Brenner's testimony, that Northeast would have terminated dividend payments in the no-breach world. "That's an assumption correct." Tr. 1116 (Baxter). Dr. Baxter also adm