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

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

Civil Action No. 92-550C Judge Williams

PLAINTIFF'S POST-TRIAL REPLY BRIEF

Charles J. Cooper COOPER & KIRK, PLLC 555 Eleventh Street, N.W., Suite 750 Washington, D.C. 20004 (202) 220-9600 (202) 220-9601 (fax) Counsel of Record Of Counsel: Michael W. Kirk Vincent J. Colatriano David H. Thompson David Lehn COOPER & KIRK, PLLC 555 Eleventh Street, N.W., Suite 750 Washington, D.C. 20004 (202) 220-9600 (202) 220-9601 (fax)

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TABLE OF AUTHORITIES ...................................................................................................... iii INTRODUCTION......................................................................................................................... 1 ARGUMENT................................................................................................................................. 7 I. A. Northeast has satisfied all of the legal requirements for its lost profits claim. ........... 7 Northeast's lost profits claim is not inconsistent with its performance record....... 7 The evidence establishes definitively that the breach caused Northeast to lose profits. .................................................................................................................... 7 2. Northeast's performance record supports the award of lost profits.................. 11 3. Northeast had a record of profits. ......................................................................... 12 4. The "focus" on net interest income follows from the nature of Northeast's structure and the impact of the breach............................................................. 13 5. The government's use of Return on Assets as a measure of profitability is not meaningful. .......................................................................................................... 14 6. Northeast's actual wholesale banking experience was positive. ......................... 17 7. The experiences of Northeast's so-called "peers" are not indicative of Northeast's experience absent the breach. ....................................................... 18 1.

B. Northeast would have been permitted to pursue and would have pursued wholesale activities absent the breach............................................................................... 19 1. Northeast wanted and expected to continue engaging in wholesale banking.... 20 2. The regulators would not have prevented Northeast from engaging in wholesale banking. .............................................................................................. 24 3. Globe supports Dr. Baxter's use of a wholesale incremental portfolio. ............. 25 C. 1. 2. The government's breach caused Northeast to lose profits. ................................... 26 The breach caused Northeast to shrink below $6.7 billion in tangible assets. .. 26 Shrinking to mitigate the breach caused a reduction in profits. ........................ 32

D. Losing profits was a foreseeable and foreseen consequence of the government's breach................................................................................................................................... 37 E. Northeast has proved the amount of lost profits with reasonable certainty. ........ 39 Dr. Baxter's damages calculation is not speculative............................................ 40 Glendale and CalFed do not stand in the way of awarding lost profits to Northeast.............................................................................................................. 40 3. Dr. Baxter has fully accounted for credit risk...................................................... 41 4. The but-for bank's interest-rate risk profile is justified and appropriate. ....... 44 5. Dr. Baxter has adequately accounted for the G&A required by the incremental portfolio. ......................................................................................... 48 1. 2.

II. Northeast is entitled to the cost of raising capital through the DEPCO transaction. .............................................................................................................................. 50

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A.

Northeast's DEPCO claim is consistent with and supported by the evidence. ..... 50

B. Dr. Baxter's calculation of the cost of raising replacement capital is well-founded. ....................................................................................................................... 52 C. The costs of the DEPCO transaction were not the remote consequences of the breach................................................................................................................................... 55 D. E. F. 1. 2. 3. 4. III. A. B. The costs of the DEPCO transaction are not hypothetical. .................................... 57 Northeast Savings bore the economic costs of the DEPCO transaction. ............... 58 It is appropriate to gross up the DEPCO damages.................................................. 59 The DEPCO damages will be taxable. .................................................................. 59 Grossing up the DEPCO damages would not be premature. ............................. 63 The tax gross-up is not barred as a matter of law. .............................................. 64 The tax rates have been proved with reasonable certainty................................. 66 Northeast's claim for out-of-pocket damages is well-founded................................ 70 Rights-offering expenses............................................................................................. 71 SAIF deposit insurance premiums. ........................................................................... 71

IV. Dr. Baxter's damages calculation has fully accounted for any benefits from the breach....................................................................................................................................... 74 A. Northeast would not have paid dividends absent the breach. ................................ 75

B. Northeast would have securitized its loans and eliminated recourse even absent the breach. ........................................................................................................................... 77 C. Northeast would have reduced its higher-risk lending activities even absent the breach................................................................................................................................... 79 V. A. B. Northeast would not have written off its supervisory goodwill absent the breach... 80 The supervisory goodwill writeoffs were caused by the breach. ............................ 81 GAAP does not control Northeast's treatment of its supervisory goodwill. ......... 88

CONCLUSION ........................................................................................................................... 93

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TABLE OF AUTHORITIES Cases Page(s)

American Fed. Bank v. United States, 72 Fed. Cl. 586 (2006) .......................................................34, 35, 39, 53, 54, 56, 60, 61, 64, 69 American Sav. Bank, F.A. v. United States, No. 92-872C, 2006 U.S. Claims LEXIS 398 (Fed. Cl. Dec. 18, 2006) ...................................54 Bank of Am., F.S.B. v. United States, 67 Fed. Cl. 577 (2005) ...........................................54, 58, 62 Bluebonnet Sav. Bank, F.S.B. v. United States, 266 F.3d 1348 (Fed. Cir. 2001) ............1, 4, 34, 57 California Fed. Bank v. United States, 395 F.3d 1263 (Fed. Cir. 2005) .....................33, 34, 35, 53 Caroline Hunt Trust Estate v. United States, 470 F.3d 1044 (Fed. Cir. 2006)..............................74 Centex Corp. v. United States, 55 Fed. Cl. 381 (2003)..................................................................63 Citizens Fed. Bank v. United States, No. 05-5173, 2007 U.S. App. LEXIS 1472 (Fed. Cir. Jan. 24, 2007) ...............................................34, 57, 65 Citizens Fed. Bank, F.S.B. v. United States, 59 Fed. Cl. 507 (2004).......................................62, 69 Coast Fed. Bank, F.S.B. v. United States, 323 F.3d 1035 (Fed. Cir. 2003).............................90, 91 Coast Fed. Bank, F.S.B. v. United States, 48 Fed. Cl. 402 (2000) ................................................38 Commercial Fed. Bank, F.S.B. v. United States, Nos. 04-5075 & 04-5076, 2005 U.S. App. LEXIS 6802 (Fed. Cir. Apr. 8, 2005) ........3, 32, 38 Commercial Fed. Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004) ...........................................................................3, 15, 32, 35, 36, 38, 63 Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955) ........................................................60 Cucuras v. Secretary of DHHS, 993 F.2d 1525 (Fed. Cir. 1993) ........................................................25 Dana Corp. v. United States, 174 F.3d 1344 (Fed. Cir. 1999) ......................................................60 Diesel Sys., Ltd. v. Yip Shing Diesel Eng'g Co., 861 F. Supp. 179 (E.D.N.Y. 1994)....................58 DPJ Co. Ltd. v. FDIC, 30 F.3d 247 (1st Cir. 1994).......................................................................54 Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed. Cir. 2002)...................................8, 34 Erickson Air Crane Co. of Wash., Inc. v. United States, 731 F.2d 810 (Fed. Cir. 1984) ..............59 Fifth Third Bank v. United States, 71 Fed. Cl. 56 (2006) ..............................................................64 First Hartford Corp. Pension Plan & Trust v. United States, 194 F.3d 1279 (Fed. Cir. 1999) ....59 First Heights Bank, F.S.B. v. United States, 422 F.3d 1311 (Fed. Cir. 2005) .........................35, 39 First Heights Bank, F.S.B. v. United States, 57 Fed. Cl. 162 (2003).............................................63 First Nationwide Bank v. United States, 56 Fed. Cl. 438 (2003).........................................................37 Flora v. United States, 357 U.S. 63 (1958) .............................................................................65, 66

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Franconia Assocs. v. United States, 61 Fed. Cl. 718 (2004) ...................................................35, 39 Glendale Fed. Bank, F.S.B. v. United States, 378 F.3d 1308 (Fed. Cir. 2004) ...............................1 Glendale Fed. Bank, F.S.B. v. United States, 239 F.3d 1374 (Fed. Cir. 2001) ...............................2 Globe Sav. Bank, F.S.B. v. United States, No. 06-5001, 2006 U.S. App. LEXIS 18417 (Fed. Cir. July 20, 2006) ..................1, 26, 32, 34 Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005) ...............1, 3, 26, 32, 34­36, 39 Granite Mgmt. Corp. v. United States, 416 F.3d 1373 (Fed. Cir. 2005) .................................58, 59 Hanover Shoe, Inc. v. United Shoe Mach. Corp., 392 U.S. 481 (1968) ........................................65 Home Sav. of Am., F.S.B. v. United States, 399 F.3d 1341 (Fed. Cir. 2005)......................................1, 33, 36, 54, 56, 60, 61, 67, 69, 88, 90 Home Sav. of Am., F.S.B. v. United States, 57 Fed. Cl. 694 (2003) ............................60, 61, 67, 69 Home Sav. of Am., F.S.B. v. United States, 50 Fed. Cl. 427 (2001) ........................................88, 89 Hort v. Commissioner, 313 U.S. 28 (1941) ...................................................................................60 Hughes Commc'ns Galaxy, Inc. v. United States, 271 F.3d 1060 (Fed. Cir. 2001) ......................56 Landmark Land Co. v. FDIC, 256 F.3d 1365 (Fed. Cir. 2001) .........................................53, 57, 59 LaSalle Talman Bank, F.S.B. v. United States, 462 F.3d 1331 (Fed. Cir. 2006)...........................56 LaSalle Talman Bank, F.S.B. v. United States, 64 Fed. Cl. 90 (2005) .........................................1, 33, 36, 54, 56, 57, 60, 61, 64, 67, 69, 88, 90 LaSalle Talman Bank, F.S.B. v. United States, 317 F.3d 1363 (Fed. Cir. 2003)............................................................................1, 3, 12, 34, 67 LaSalle Talman Bank, F.S.B. v. United States, 45 Fed. Cl. 64 (1999).........................................4, 38 Local Okla. Bank, N.A. v. United States, 59 Fed. Cl. 713 (2004)..................................................63 Long Island Sav. Bank v. United States, No. 06-5029, 2007 U.S. App. LEXIS 2135 (Fed. Cir. Feb. 1, 2007)............................................................................................................34 Long Island Sav. Bank v. United States, 67 Fed. Cl. 616 (2005) .................................................34, 35, 39, 53, 54, 56, 58, 60, 61, 62, 69 Norfolk & W. Ry. Co. v. Liepelt, 444 U.S. 490 (1980) ............................................................67, 69 Northeast Sav. v. United States, 63 Fed. Cl. 507 (2005) ...............................................................89 Oddi v. Ayco Corp., 947 F.2d 257 (7th Cir. 1991) ..................................................................63, 69 Old Stone Corp. v. United States, 450 F.3d 1360 (Fed. Cir. 2006) .........................................36, 51, 55 Picture Lake Campground, Inc. v. Holiday Inns, Inc., 497 F. Supp. 858 (E.D. Va. 1980) ...........59 Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110 (1st Cir. 1944).........................................60 Shore v. United States, 9 F.3d 1524 (Fed. Cir. 1993) ....................................................................66 United States v. Johnson Controls, Inc., 713 F.2d 1541 (Fed. Cir. 1983).....................................59

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United States v. United States Gypsum Co., 333 U.S. 364 (1948).......................................................25 United States v. Winstar Corp., 518 U.S. 839 (1996)....................................................................66 Webster v. Fall, 266 U.S. 507 (1925) ............................................................................................64 Westfed Holdings, Inc. v. United States, 407 F.3d 1352 (Fed. Cir. 2005)...............................34, 57 Statutes and Regulations 26 U.S.C. § 61(a) .....................................................................................................................60, 61 26 U.S.C. § 111 .............................................................................................................................61 28 U.S.C. § 1346(a)(1)...................................................................................................................66 28 U.S.C. § 1920............................................................................................................................65 28 U.S.C. § 2412............................................................................................................................65 Treas. Reg. § 1.61-1(a) ............................................................................................................60, 61 Secondary Authorities E. ALLAN FARNSWORTH, CONTRACTS § 12.14 (3d ed. 1999) ............................................34, 53, 57 RESTATEMENT (SECOND) OF CONTRACTS § 351 (1981).................................................................34

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INTRODUCTION The government offers only token resistance to the proposition that Northeast was harmed by the breach. The evidence presented in the opening briefs is overwhelming on this point: the contemporaneous documents of both Northeast and the government uniformly conclude that FIRREA pulled the rug out from under Northeast. No other conclusion is plausible--it is undisputed that the breach eliminated overnight more than two-thirds of Northeast's regulatory capital, which is, after all, the lifeblood of any financial institution. The elimination of this magnitude of regulatory capital establishes the fact of harm. This conclusion is significant because the Federal Circuit has made clear that "if a reasonable probability of damage can be clearly established, uncertainty as to the amount will not preclude recovery, and the court's duty is to make a fair and reasonable approximation of damages." Glendale Fed. Bank v. United States, 378 F.3d 1308, 1313­14 (Fed. Cir. 2004) (quotation marks omitted); see also LaSalle Talman Bank, F.S.B. v. United States, 317 F.3d 1363, 1374 (Fed. Cir. 2003); Bluebonnet Sav. Bank, F.S.B. v. United States, 266 F.3d 1348, 1355 (Fed. Cir. 2001). All of the government's arguments are aimed at the "uncertainty of the amount" of damages sustained by Northeast, but that cannot serve as a basis for denying a recovery here. Rather, Northeast is entitled to damages so long as it adheres to a proper legal framework, and that is the case here. Dr. Baxter's method of calculating lost profits carefully tracks the approach outlined by Judge Lettow in Globe Savings Bank, F.S.B. v. United States, 65 Fed. Cl. 330, 352­57 (2005), aff'd in relevant part and vacated in part on other grounds, No. 065001, 2006 U.S. App. LEXIS 18417 (Fed. Cir. July 20, 2006). The quantification of the cost of capital in the DEPCO transaction follows the teaching of the Federal Circuit in Home Savings of America, F.S.B. v. United States, 399 F.3d 1341, 1352­1355 (Fed. Cir. 2005), and LaSalle, 317

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F.3d at 1374­75. And the out-of-pocket damages are very similar to a small subset of those awarded in Glendale Federal Bank, F.S.B. v. United States, 239 F.3d 1374, 1380 (Fed. Cir. 2001). The nature of the harm inflicted by the breach is fairly straightforward, fully documented in both Northeast's and the regulators' contemporaneous records, and, indeed, largely undisputed. The breach deprived Northeast of a substantial portion of its regulatory capital. As a result, Northeast was forced to shrink its balance sheet in order to comply with the minimum regulatory capital requirements. It accomplished the shrink by divesting wholesale assets-- primarily mortgage-backed securities ("MBSs") and collateralized mortgage obligations ("CMOs")--and paying down wholesale liabilities. As a result, Northeast lost the net interest income that these wholesale assets produced. The government's experts admit that wholesale assets like MBSs and CMOs carry very little credit risk, and they have not challenged Dr. Baxter's opinion that the incremental G&A expense associated with maintaining the divested wholesale portfolio would not have exceeded 5 basis points. Thus, the loss of net interest income that Northeast suffered as a result of the breach translated directly into a lost of net earnings. We address the government's many arguments in the body of the brief below, but the government's most prominent arguments warrant special mention here. Several of these arguments amount to nothing more than a thinly veiled attack on the concept of lost profits. Specifically, the government objects that Northeast's calculations of lost profits are "speculative" because it is impossible to know what a non-breach world would look like. Of course, this argument is equally applicable in all breach of contract cases involving expectancy damages, where a world without a breach must be measured. But the Federal Circuit in LaSalle made clear

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that the "burden of imprecision" rests with the government in Winstar cases precisely because it is the government's own breach that necessitates this inquiry in the first place. 317 F.3d at 1374. For this reason, Courts have consistently rejected the government's "speculation" argument in the context of both lost profits and cost of capital cases. The government always argues that lost profits are inherently speculative, but if that were true, then plaintiffs in Globe, Commercial Federal Bank, F.S.B. v. United States ("CommFed"), 59 Fed. Cl. 338 (2004), aff'd, Nos. 045075 & 04-5076, 2005 U.S. App. LEXIS 6802 (Fed. Cir. Apr. 8, 2005) (affirming without opinion), and LaSalle, 64 Fed. Cl. 90, 106 (2005), aff'd in relevant part and vacated in part on other grounds, 462 F.3d 1331, 1335 n.2 (Fed. Cir. 2006), would not have recovered lost profits. Likewise, the government advances its net present value ("NPV") zero theory and argues that no lost profits should be awarded here because Northeast's assets were sold in an armslength transaction. Here again, if this argument were correct, then no lost profits would ever be available in a case such as this one. That is not the law in this or any other Circuit. The government's "core earnings" argument is similar in nature because it too would operate to prevent almost all Winstar plaintiffs from recovering any lost profits. The government's core earnings argument is, however, wrong both as a matter of fact and law. As a factual matter, Northeast had a consistent record of recurring profits in the 1980s. Although the boundaries of the term "core earnings" remain undefined, witness after witness testified that regularly recurring profits should be included. The government tries to gerrymander Northeast's profits into "gains on sales" and other categories. But there is no justification for ignoring recurring gains on sales. Even if the government's narrow conception of core earnings were accepted, the factual background surrounding this transaction shows that a lack of core earnings could not preclude

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Northeast from recovering lost profits. Here, the government firmly believed Northeast would have no earnings--core or any other type of earnings--for years after the 1982 acquisitions. Specifically, the government's viability analysis, which reflected the official government projection of Northeast's profitability after 1982, showed Northeast generating losses from 1982 through at least 1987. Thus, the government well-understood that it would take Northeast's management five years to turn around the ailing thrifts acquired from the government. But the government also concluded that Northeast would in fact be profitable over the long term after this turnaround phase. Surely, if Northeast's performance had simply tracked the government's projections with losses in each of the initial years, then Northeast would not be precluded from recovering lost profits during the period of projected profits. Here, Northeast's management dramatically exceeded the government's expectations and turned the institution around far more quickly than projected. To be sure, there were losses in some years, but Northeast should not be penalized for outperforming the government's own expectations. Tellingly, the government's viability analysis made no reference at all to the concept of core earnings. Moreover, as a legal matter, the government's myopic focus on core earnings is misplaced. It is black-letter law that expectancy damages are supposed to put a plaintiff in the position it would have realized absent a breach. Bluebonnet, 266 F.3d at 1355. As Judge Bruggink acknowledged in LaSalle, "the quantum of plaintiff's actual earnings are irrelevant in a lost profits analysis--actual earnings serve solely as the baseline against which projected earnings are compared. Plaintiff is entitled to lost profits if it can show that its earnings would have been higher absent the breach, regardless of the comparative size of its post-breach actual earnings." 45 Fed. Cl. 64, 89 (1999). Indeed, even in a year in which a plaintiff suffered a loss, it would still be entitled to expectancy damages if the losses were magnified by the effects of a

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breach. The government's own expert witness Professor Fischel acknowledged this point as an economic matter. Fischel, Trial Tr. 2003­04; FF ¶ 464. Beyond these broadside attacks on lost profits, the government launches two more factspecific challenges relating to interest rate risk and credit risk. With respect to interest rate risk, the government portrays Dr. Baxter's lost profits model as resting on a hindsight-based "bet" on interest rates. It is worth noting, however, that the government offers no resistance to statements in Northeast's contemporaneous interest-rate risk policies indicating that the assumption of a degree of interest rate risk it is an inherent part of a thrift's business. Thus, the only relevant question is whether the amount of interest rate risk reflected in Dr. Baxter's damages calculation would have been assumed by Northeast absent the breach. Dr. Baxter's calculations are fully consistent with Northeast's interest-rate risk policies and practices. The government disputes this conclusion by focusing exclusively on the incremental foregone assets, as though the rest of the but-for bank's balance sheet did not exist. Northeast's management, however, never analyzed its interest rate risk by reference to isolated portions of its portfolio. And neither did the regulators. Both management and the regulators were properly focused on the institution's overall level of interest rate risk--not the amount of risk in a particular portfolio. When properly viewed on a whole-bank basis, the but-for bank's level of interest rate risk is well within the permissible gap range established by Northeast's interest-rate risk guidelines. This is hardly surprising, since the divested assets upon which Dr. Baxter calculates lost profits are assets that Northeast had acquired and intended to hold but for the breach. Indeed, under the analysis employed by Dr. Thakor, the but-for bank has even less interest rate risk than the actual bank had. The regulators themselves were comfortable with this level of interest rate risk. Only after supervisory goodwill was no longer viewed as regulatory

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capital did the regulators raise questions about Northeast's interest-rate risk profile; these concerns were thus simply another manifestation of the breach. Finally, the government objects that Dr. Baxter's interest rate risk assumptions are implausible. The centerpiece of the government's argument is the fact that the interest-rate risk profile of the but-for bank is, at times, not positioned to allow Northeast to benefit from its own predicted changes in interest rates. But both Mr. Walters and Dr. Baxter explained that Northeast did not manage interest rate risk solely to take advantage of anticipated future changes in interest rates. Instead, there were other factors that were far more important. Thus, in 1989, when Northeast had to shrink to meet FIRREA's capital requirements as a result of the breach, the bank went from being negatively gapped to positively gapped even though management thought interest rates were going to fall and thus favor a negative gap. And in 1994, Northeast gave up its positive gap to sell its California loans even though management thought that interest rates would go up and favor a positive gap. The record on this point is clear: Northeast did not manage interest rate risk simply to take advantage of anticipated future changes in interest rates. In the end, the government's argument confuses the cause with the effect: the dramatic change in Northeast's gap was the result of the breach-induced shrinkage, not the cause of that shrinkage. The government also complains that Dr. Baxter failed to take credit risk into account in calculating lost profits. The short answer to this criticism is that Dr. Baxter's damages analysis fully accounts for all of the credit losses that Northeast would have had absent the breach. Nonbreaching provisions of FIRREA and other factors unrelated to the breach would have compelled Northeast to exit its higher-risk activities even absent the breach. In the pages that follow below, we demonstrate that Northeast has met its burden of proof and is entitled to recover damages in the amount of $129.286 million.

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ARGUMENT I. Northeast has satisfied all of the legal requirements for its lost profits claim. A. Northeast's lost profits claim is not inconsistent with its performance record.

The government points to Northeast's performance record in an attempt show that Northeast's claim "fails at the outset." Def.'s Br. at 45. The government's arguments are irrelevant and unfounded. 1. The evidence establishes definitively that the breach caused Northeast to lose profits. There can be no serious doubt that the breach-induced shrinkage caused Northeast to lose profits. Myriad contemporaneous documents prepared by both Northeast and the regulators attest to this fact without contradiction. FF ¶¶ 311­321. To cite just one example, Northeast stated in its Annual Report that the "reduction in asset size ... accounts for the Company's decline in net earnings." PX 11 (Northeast 1992 Annual Report) at 4. The government ignores all of this direct evidence concerning the impact of the breach and argues instead that the breach must not have harmed Northeast at all because, it claims, Northeast never had positive "core earnings." Def.'s Br. at 45. The government's arguments concerning "core earnings" miss the point. Whether and to what extent Northeast had "core earnings" before or after the breach does not determine whether and to what extent the breach caused Northeast to lose profits. What matters--the only thing that matters--is the difference between the profits that Northeast would have earned absent the breach and the profits that it actually earned. Pl.'s Br. at 28­29. Judge Bruggink made this clear in LaSalle: "[T]he quantum of plaintiff's actual earnings are irrelevant in a lost profits analysis-- actual earnings serve solely as the baseline against which projected earnings are compared. Plaintiff is entitled to lost profits if it can show that its earnings would have been higher absent

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the breach, regardless of the comparative size of its post-breach actual earnings." 45 Fed. Cl. at 89.1 Professor Fischel echoed Judge Bruggink on this point, admitting that a plaintiff can lose profits even if it had losses during the years for which it seeks damages. Fischel, Trial Tr. 2003­04; FF ¶ 464.2 In this case, the contemporaneous documents and admissions of the government's own experts establish all of the premises necessary to show that the breach caused Northeast to lose profits. 1) As all of the contemporaneous documents and the testimony of Mr. Walters establish, and as Professor Fischel admitted, the breach caused Northeast to reduce its size. Fischel, Trial Tr. 1931 (agreeing that "if Northeast had more regulatory capital, it would not have had to shrink as much"), 1940 ("It's even reasonable to assume that [Northeast] reduced its size as a result of the breach ...."); Pl.'s Br. at 20­28. Specifically, Northeast would not have reduced its size below $6.7 billion in tangible assets. As discussed further below, the government's suggestion that Northeast would have shrunk as much as it did absent the breach is simply wrong. See also Pl.'s Br. at 24­27. 2) As Mr. Bankhead and Professor Thakor admitted, this shrinkage "was accomplished primarily by Northeast divesting wholesale assets and using the proceeds to pay down

In LaSalle, the government argued that the "plaintiff is precluded from recovering any lost profits because its annual earnings after the breach exceeded those before the breach by a substantial degree." 45 Fed. Cl. at 89 (emphasis added). Thus, in the government's view a Winstar plaintiff is damned if it does earn profits and damned if it doesn't. Furthermore, if a record of profits were a necessary precondition of lost profits damages, then lost profits damages could never be recovered by new businesses, since new businesses by definition have no record of profits. The Federal Circuit has held unequivocally, however, that new business may recover lost profits damages just like any other business. Energy Capital Corp. v. United States, 302 F.3d 1314, 1325­28 (Fed. Cir. 2002).
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wholesale liabilities." Bankhead, Trial Tr. 2980­81; Thakor, Trial Tr. 2735; see also FF ¶¶ 332­333; Pl.'s Br. at 22. 3) Absent the breach, Northeast would have retained those wholesale assets and liabilities until they ran off. As we discuss further below, the government is wrong that Northeast would have exited wholesale banking activities absent the breach. Pl.'s Br. at 34­35, 37­38; FF ¶¶ 369­373. In fact, Professor Fischel agreed that "it's reasonable to conclude that Northeast would have maintained some wholesale assets funded by wholesale liabilities, just as they did in the real world." Fischel, Trial Tr. 1997. 4) It is undisputed that after March 31, 1990, the divested wholesale assets earned a positive net interest spread for the rest of the damages period. Pl.'s Br. at 35; FF ¶¶ 307, 324, 345­ 346. 5) Therefore, Northeast's shrinkage necessarily reduced its net interest income, and both Professor Fischel and Mr. Kovac admitted as much. FF ¶¶ 8­10, 325; Kovac, Trial Tr. 1732­33 (agreeing that "the assets that Northeast sold had net interest income associated with it"); Fischel, Trial Tr. 1997­99. 6) As Professor Fischel and Professor Thakor admitted, if net interest income declines, then profits will necessarily decline unless there is an equal or greater accompanying decline in G&A or credit losses. FF ¶¶ 1­7, 326; Fischel, Trial Tr. 2001­02; Thakor, Trial Tr. 2694­ 95. 7) The incremental cost of maintaining Northeast's divested wholesale assets would have been negligible. Pl.'s 35; FF ¶¶ 34, 327, 352­357. Neither the government nor its witnesses have disputed this fact. Indeed, the government has embraced the notion that wholesale banking

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requires little more than "two executives with a computer and a telephone." Sawi, Trial Tr. 148. 8) As Professor Fischel, Professor Thakor, and Mr. Kovac admitted, the wholesale assets that Northeast would have held absent the breach--MBSs, CMOs, and residential purchased loans--would have had little or no credit losses. Pl.'s Br. at 39; FF ¶¶ 32, 387­397, 509­ 15. 9) Therefore, the inescapable conclusion from these premises is that the divestiture of these wholesale assets in response to the breach caused Northeast to lose profits. FF ¶ 329. 10) Further, absent the breach Northeast would have replaced the divested wholesale assets as they ran off with retail assets to the extent that retail assets were available on attractive terms, and otherwise would have replaced them with new wholesale assets. Pl.'s Br. at 37­ 38. 11) To the extent that the replacement assets would have been wholesale, they would have been profitable just as the divested wholesale assets would have been. It follows that by foregoing such wholesale replacement assets, Northeast lost profits. 12) To the extent that the replacement assets would have been retail, they would have been at least as profitable as the wholesale replacement assets would have been, even accounting for any credit losses and additional incremental G&A that the retail replacement assets would have generated. Pl.'s Br. at 38­41; FF ¶¶ 374­381. Thus, by foregoing retail replacement assets, Northeast lost profits.

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2. Northeast's performance record supports the award of lost profits. Contrary to the government's assertions, see Def.'s Br. at 22­24, 45­46, Northeast's performance both before and after the breach fully supports an award of lost profits. Prior to the 1982 supervisory acquisitions, Northeast was a healthy thrift. FF ¶ 41. Northeast found itself in a deep hole as a result of those acquisitions--acquisitions that Northeast undertook at the invitation of the government and that benefited the government by sparing it from having three failed thrifts on its hands. FF ¶¶ 40­41; PX 192 (FHLBB Report of Examination, Dec. 12, 1988) at 2.31 ("This situation reflects in part the effects of an initial large negative net earning asset ratio which has been diminishing with the growth of total assets, almost all wholesale ...."). The regulators themselves believed that it would take Northeast five to six years to overcome the negative consequences of those acquisitions and attain profitability. FF ¶ 45. The regulators nonetheless had sufficient confidence in Northeast's ability to absorb the three failed thrifts and to ultimately achieve profitability that they approved the acquisitions. FF ¶¶ 42­45. Thus, the arguments made by the government in this litigation that Northeast's pre-breach performance in effect precludes a finding that Northeast would have been profitable absent the breach is fundamentally inconsistent with what the government concluded at the time it decided to provide substantial assistance to induce and facilitate the acquisitions at issue. In addition, interest rates rose sharply throughout 1987, 1988, and 1989, narrowing Northeast's net interest spread and consequently squeezing its profits. FF ¶¶ 53­55, 58; PX 2028 (Northeast Annual Spread Data); PX 2059 (Historical 6-Month Constant Maturity Treasury Rate); PX 2061 (Actual vs. But-For Repricing Gap); PX 262 (Board meeting, July 14, 1989) at 234384. Despite these challenges, Northeast exceeded the parties' expectations at the time of the

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contracts and became profitable during the 1980s. FF ¶¶ 50­51. As Northeast stated repeatedly prior to the breach, it fully expected that beginning in 1989 it would achieve stable profitability as it shifted the focus of its large asset base from wholesale banking into retail banking and as interest rates fell--which they did throughout 1990, 1991, and 1992. FF ¶¶ 76, 78­79, 127, 159, 444­445; PX 2061 (Actual vs. But-For Repricing Gap); PX 2059 (Historical 6-Month Constant Maturity Treasury Rate). In other words, just as Northeast's prospects were shaping up, the government breached its contract with Northeast. The government's focus on Northeast's performance prior to the breach, therefore, overlooks these important ways in which the world would have been and in fact was different for Northeast after the breach. And the government's focus on Northeast's actual performance after the breach overlooks the impact of the breach itself. As shown at trial, the breach compelled Northeast to divest billions of dollars in assets that were earning positive net interest income, generating little or no credit losses, and requiring negligible G&A. It is thus hardly surprising that Northeast did not have robust profits after the breach--indeed, that is basis of Northeast's claim for lost profits. The government's arguments are also inconsistent with Judge Bruggink's award of lost profits damages in LaSalle, where the thrift's record prior to the breach was somewhat similar to Northeast's: finding itself in a deep hole as a result of several supervisory acquisitions in 1982, the thrift worked hard and achieved "nominal profitability" in 1986, only to have the rug pulled out from under it by FIRREA. See LaSalle, 317 F.3d at 1367­68. 3. Northeast had a record of profits. Even if a history of core earnings were necessary to recover lost profits damages, Northeast satisfies that requirement because it regularly had core earnings both before and after

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the breach. Pl.'s Br. at 29. The government's contention that Northeast did not have core earnings depends on an unduly narrow and ultimately misleading definition of "core earnings." The precise perimeter of "core earnings" may be open to debate, but the import of the term is, as Mr. Kovac explained, to identify recurring income, which, as Professor Fischel and Mr. Kovac admitted, includes gains on sales of investment securities. With the gains from these recurring sales of investment securities included in core earnings, Northeast's core earnings were regularly positive both before and after the breach. FF ¶¶ 466­469. In addition, Northeast regularly earned bottom-line profits both before and after the breach. FF ¶ 50 (profit of $11.3 million in FY83; profit of $37.8 million in FY86; profit of $33.3 million in FY87; profit of $21.1 million in FY88); PX 28 (Northeast 1994 10-K) at 57 (profit of $11.728 million in FY91; profit of $5.607 million in FY92; profit of $10.966 million in FY94).3 And the regulators were pleased with Northeast's performance prior to the breach. FF ¶ 51. 4. The "focus" on net interest income follows from the nature of Northeast's structure and the impact of the breach. The government objects to our "focus on net interest income" because "positive and even exceedingly large net interest income does not reveal anything about whether the thrift is profitable." Def.'s Br. at 5­6. It is true that having positive net interest income does not necessarily mean that the thrift will have profits. We have never contended otherwise. But net interest income is the primary source of income for thrifts, including Northeast; without net

Northeast's loss in FY89 was driven by several large non-recurring losses that Mr. Rutland took to "clear the decks" upon arriving at Northeast; consequently, the regulators were not troubled by this loss. FF ¶¶ 59­61. Northeast's losses in FY90 and for the 9 months ending December 31, 1992, were driven by the writeoffs of supervisory goodwill, which, as we have shown elsewhere, were a result of the government's breach. See PX 20 (Northeast 1990 Annual Report) at 33 (net loss of $107.136 million in FY90); PX 28 (Northeast 1994 10-K) at 57 (net loss of $59.234 million for 9 months ending Dec. 31, 1992). As Mr. Kovac put it, "Northeast took a massive hit to earnings by writing off the supervisory goodwill." Kovac, Trial Tr. 1625.

3

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interest income, a thrift cannot hope to generate profits. See, e.g., FF ¶ 1. Moreover, as we have explained throughout our briefs, Dr. Baxter fully accounted for all aspects of Northeast's financial position, not just net interest income. What may appear as a "focus" on net interest income is thus the product of the fact that the breach affected Northeast's net interest income by a disproportionately large amount as compared to its credit losses and G&A. Put another way, the breach eliminated substantial income but did not eliminate costs by a comparable amount, and therefore it follows that the breach caused Northeast to lose profits. 5. The government's use of Return on Assets as a measure of profitability is not meaningful. The government's comparison of the rate of return on assets ("ROA") actually earned by Northeast with the ROA earned by "Dr. Baxter's incremental portfolio," Def.'s Br. at 4­5, 45, is not meaningful because it conflates the concepts of "marginal" and "average" earnings. As explained above, absent the breach the incremental portfolio--that is, the divested and replacement assets and liabilities--would have earned a positive net interest income, would have incurred little if any credit losses, and would have required negligible G&A. Consequently, the ROA of the incremental portfolio, which is by definition marginal ROA, necessarily would have been greater than the average ROA of Northeast as a whole before the breach, when Northeast had significant underutilized retail operations (which Northeast would have put to more efficient and profitable use but for the breach, Pl.'s Br. at 60; FF ¶¶ 114­115, 188­189, 505­508). The incremental ROA would necessarily have been greater than the average ROA of the whole bank after the breach, too, when Northeast was missing a substantial proportion of its interest-earning assets as a result of the breach.4

A simple illustration illuminates the fallacy underlying the government's argument and the importance of the difference between marginal and average earnings. Suppose a thrift has 14

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The government asserts that in CommFed, Judge Futey "was at pains to point out that ... the rate of profitability assumed for the alleged foregone assets[] was no higher than that of the actual assets." Def.'s Br. at 45. But Judge Futey was hardly "at pains" to point this out. Rather, he simply stated that he found "credible" the plaintiff's expert's use of the actual average ROA as the marginal ROA on the incremental portfolio. CommFed, 59 Fed. Cl. at 350. The plaintiff's expert's use of the average ROA was hardly objectionable because it almost certainly resulted in an understatement of lost profits for the reasons just explained. Importantly, at no point did Judge Futey so much as hint that he would not have found credible using a higher ROA to calculate lost profits on the incremental portfolio. The government also suggests that by using Northeast's actual net interest spreads to calculate the return on the incremental portfolio, Dr. Baxter overstated the lost profits because "companies make their most profitable investments first, and then make the less profitable ones subsequently." Def.'s Br. at 4. Even if the government's conceptual point is correct, when applied to the divested assets in this case it yields the opposite conclusion from the one that the government seeks to draw. The government's argument treats the divested assets as assets that, absent the breach, Northeast would have gone into the market to acquire. On the contrary, Northeast was already holding these assets and would have continued to do so absent the breach; the breach forced Northeast to sell them. And since, as the government put it, "companies make their most one $100 asset that generates $10 in net interest income, $0 in credit losses, and $10 in G&A. Its net income is $0 and, consequently, its ROA is 0%. Now suppose the thrift adds another $100 asset that will also generate $10 in net interest income, $0 in credit losses, and $0 in G&A (because no additional operations are necessary to acquire or hold the additional, i.e., incremental, asset). The marginal ROA on the new asset is 10% ($10 in net interest income less $0 in credit losses and G&A, divided by $100 in assets), and the thrift's overall average ROA is 5% ($20 in net interest income less $0 in credit losses and $10 in G&A, divided by $200 in assets). Thus, the fact that the marginal ROA on the second asset is greater than the ROA on the first asset standing alone or the average ROA on the two assets together does not at all call into question the validity of the marginal ROA on the second asset.

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profitable investments first," the easiest assets for Northeast to sell to other companies were, as Mr. Walters and Dr. Baxter testified, its best ones, that is, its most profitable ones. FF ¶ 349. As a result, using Northeast's actual wholesale net interest spread after the breach if anything understates the net interest spread that Northeast would have earned on its divested assets. FF ¶ 349.5 Finally, the government contends that Northeast's positive ROA "disguised unprofitability" because "Northeast's wholesale assets ... were $132 million underwater." Def.'s Br. at 5; see also Def.'s Br. at 7. Once again, the government's conclusion does not follow from its premise. First, the wholesale assets' market value at any point in time has nothing to do with Northeast's ROA, since, whatever the unrealized loss on those assets, they still could have earned--and actually did earn before the breach and would have continued to earn but for the breach--positive net interest income, while incurring little or no credit losses and requiring negligible G&A. FF ¶¶ 307, 324, 345­346. Second, the market value of those assets reflected not their inherent value but rather only what they were worth on a market-value basis at a particular point in time. Because these assets had virtually no credit risk, Northeast would have recouped the full principal and interest owed on those loans as long as it held them to maturity, which it would have done absent the breach. Moreover, the reason that the wholesale assets were "underwater" at that time was that interest rates had risen sharply; once interest rates turned around, the market value of those assets would improve. Of course, shortly after the breach interest rates did in fact fall, as Northeast hoped and expected. Using Northeast's actual wholesale net interest spreads understates the lost profits on the divested assets for at least two additional reasons. First, Northeast's purchased loans tended to earn a higher yield than the other types of wholesale assets included in the divested assets. However, Northeast's actual wholesale yields did not account for the higher yields earned on its purchased loans. FF ¶ 348. Second, Northeast's wholesale assets ran off continuously. As they did, they were replaced with assets yielding a market rate. Thus, the actual net wholesale spreads include market rates as well as historical rates. Because interest rates fell more than they rose during the damages period--and especially because that decline occurred at a time when the total balance of divested assets was highest--the divested assets would have had higher yields for much of the damages period than did the actual wholesale assets. FF ¶ 350.
5

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Baxter, Trial Tr. 526­27, 572­75; Walters, Trial Tr. 391; FF ¶¶ 443­445. 6. Northeast's actual wholesale banking experience was positive. The government questions whether Northeast's wholesale activities were profitable. Def.'s Br. at 6. The government's insinuation that it was not is incorrect: although Northeast's wholesale activities were not as profitable as retail operations, they were still generally valuable to Northeast and would have been even more so when rates fell for the three years immediately after the breach. The government points out again that "[t]he RCA portfolio's market value declined by over $130 million during the time Northeast owned it." Def.'s Br. at 6. But as just explained above, the market value of these assets says nothing about whether and to what extent the wholesale portfolio was generating, or absent the breach would have generated, positive earnings. In fact, prior to the breach Northeast's wholesale portfolio consistently generated positive net interest income. FF ¶¶ 49, 53­55. And there can be no question that it would have continued to do so had the breach not compelled Northeast to divest it--particularly, as noted above, as interest rates fell for several years after the breach. FF ¶¶ 324, 345­346. It is the loss of that net interest income, not the market value of the assets, that drives Northeast's lost profits. The regulators' criticism of what they called Northeast's risk-controlled arbitrage ("RCA") activities are not inconsistent with this conclusion. At no point did the regulators say that Northeast's wholesale portfolio was not profitable or would not be profitable. For example, on one page of the June 1989 FHLBB Report of Examination that the government cites, Mr. Kovac stated that the rise in interest rates had "contracted" the margins on the RCA portfolio and as a result had made the RCA program "less profitable." PX 192 (June 1989 FHLBB Report of Examination) at 2.19 (emphasis added). Likewise, the passage from this report that the government quotes says that the RCA may have "hindered earnings." Def.'s Br. at 6 (quoting PX 192 (June 1989 FHLBB

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Report of Examination) at 2.22 (emphasis added). These passages merely indicate that Mr. Kovac believed that Northeast's wholesale activities were profitable but that Northeast could have been more profitable through a different investment strategy.6 The exam report's analysis accords precisely with Mr. Rutland's analysis of the challenges that lay before Northeast upon his arrival and with Mr. Rutland's rationale for shifting Northeast's emphasis from wholesale to retail banking: retail banking would generate better returns than wholesale banking through higher spreads and better utilization of Northeast's extant operations. See, e.g., FF ¶¶ 127, 159. 7 7. The experiences of Northeast's so-called "peers" are not indicative of Northeast's experience absent the breach. The government contends that Northeast's "peers generated huge losses" during the damages period. Def.'s Br. at 7, 46. For starters, the government is wrong to term these thrifts Northeast's "peers." There is no evidence that Northeast ever considered these thrifts its peers. The government's sole basis for calling them "peers" is that Kaplan termed them "peers" in a report that it prepared for Northeast. Kaplan did not explain why it considered these thrifts to be Northeast's "peers," other than that they operated in New England. See PX 66 (Kaplan Smith Special Study, Aug. 19, 1988) at 7. Indeed, the remainder of this second passage, which the government does not quote, explains precisely why the RCA was hindering Northeast's earnings: "Net margins on retail activity have been and continue to be better than those realized on wholesale activity. Furthermore, management indicated that approximately 90% of operating expenses are attributable to supporting the retail bank. Accordingly, the inability to fully exploit its retail franchise is, and has been, the essence of the institution's operational difficulties." PX 192 (June 1989 FHLBB Report of Examination) at 2.22. The government asserts that "prospective purchasers refused to buy Northeast because of its RCA portfolio." Def.'s Br. at 6. The government, however, omits any mention of why the RCA portfolio might have been an obstacle to sale. The only explanation is found in the Board minutes of April 15, 1988: because Canada TrustCo, a prospective purchaser, did not intend to continue with the RCA activities, the presence of the RCA portfolio created "pricing problems" for the acquisition. DX 334 (Board minutes, Apr. 15, 1988) at 1. That RCA was inconsistent with one potential purchaser's plans for Northeast hardly establishes that Northeast's wholesale portfolio would not have been profitable absent the breach.
7 6

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In fact, examination of the structure of these thrifts reveals that they were anything but Northeast's peers. Specifically, these thrifts were exposed to substantially more credit risk than Northeast was exposed to during the damages period: whereas 15 to 40 percent of the so-called peers' total assets were commercial loans, only 3 percent of Northeast's total assets were commercial loans; and whereas 70 to 85 percent of the so-called peers' total assets bore appreciable credit risk, only about half of Northeast's total assets bore appreciable credit risk. Pl.'s Br. at 41; FF ¶¶ 401, 413. Further, absent the breach, Northeast's retail replacement assets would have had even less credit risk than Northeast's actual retail portfolio. Pl.'s Br. at 39­41. Consequently, one cannot legitimately extrapolate from the poor performance of these thrifts during the recession in the early 1990s to any conclusions about how Northeast would have performed absent the breach during that period. B. Northeast would have been permitted to pursue and would have pursued wholesale activities absent the breach.

The government argues that Dr. Baxter's damages calculation is "meaningless speculation" because it is predicated on a purely wholesale portfolio. According to the government, there is not a "scintilla of evidence that Northeast would have been permitted to pursue its RCA model" absent the breach. Def.'s Br. at 46; see also Def.'s Br. at 50. The government's argument is wrong because it ignores entirely what actually happened. Dr. Baxter has not claimed that, absent the breach, Northeast would have gone out and purchased a large wholesale portfolio. Rather, he has accepted Mr. Walters' testimony, the uniform statements in Northeast's financial disclosure documents, and Northeast's pre-breach December 1988 Business Plan, all of which demonstrate that, absent the breach, Northeast would have kept the wholesale portfolio that Northeast already owned at least until it ran off and could be replaced with more profitable retail assets and liabilities.

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1. Northeast wanted and expected to continue engaging in wholesale banking. The government is incredulous that "the regulators [could have] severely criticized an activity, [namely, RCA,] and the bank [could have] agreed that the activity is inappropriate and risky, and yet the regulators [would have] continued to permit the bank to engage in such activity." Def.'s Br. at 47; see also Def.'s Br. at 7. Even if the government's factual account were accurate-- and it is not--its incredulity is misplaced because the inescapable, uncontradicted, and determinative facts are that Northeast actually maintained substantial volumes of wholesale assets and liabilities throughout the damages period and the regulators never suggested that those activities were impermissible. FF ¶¶ 169, 372; Pl.'s Br. at 37­38. Moreover, continuing to engage in wholesale activities was consistent with Northeast's December 1988 Business Plan, which called only for shifting focus away from wholesale banking, not for eliminating it totally. FF ¶ 89; Pl.'s Br. at 20­21. Indeed, as the June 1989 Report of Examination shows, Mr. Kovac fully understood that even under its new strategy--a strategy that Mr. Kovac praised--Northeast intended to continue to engage in wholesale banking, and only gradually to shift its emphasis toward retail assets and liabilities. FF ¶¶ 120­122, 127. Continuing to engage in wholesale activities was also consistent with the practical reality that, as Mr. Walters explained, retail assets would not always be available on attractive terms, and therefore Northeast would continue to invest in wholesale assets until attractive retail assets were available. FF ¶¶ 69, 98­102, 159, 370. None of the evidence cited by the government is to the contrary. The government's contention that "Northeast promised not to pursue" wholesale banking, Def.'s Br. at 7; see also Def.'s Br. at 8, is belied by the fact that Northeast continued to engage in wholesale banking throughout the damages period. The government cites for support a July 1989 memo from a regulator, but the government has consistently mischaracterized the import of that document and

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its companion, the July 1989 board meeting minutes. Those documents quite clearly reflect Northeast's promise to exit only CMO residuals and junk bonds, as Mr. Kovac eventually conceded at trial; they do not so much as intimate that Northeast promised to exit wholesale banking generally. FF ¶¶ 392­394; DX 229 (Mem. from Greeley, July 20, 1989) at WOT144 0080; PX 262 (Board meeting, July 14, 1989) at 2­3; see also Kovac, Trial Tr. 1506­09, 1630­ 32, 1750­52. The government also asserts that Northeast was "eager to exit its RCA business" prior to the breach and would have done so had the regulators not prevented it from doing so at the time. Def.'s Br. at 8. As evidence of this, the government points to a statement on page 4 of the 65-page July 1989 response to the June 1989 FHLBB Report of Examination that Northeast's "experience in [RCA] shows that RCA is an inappropriate, risky activity and should not be allowed as a permissible activity." PX 211 (Northeast July 1989 Response to June 1989 FHLBB Exam Report) at WOJ512 2365, quoted in Def.'s Br. at 7, 46. The government misreads this remark, suggesting that Northeast meant that it would abandon the strategy of holding wholesale assets funded by wholesale liabilities. In fact, the comment was addressing Northeast's hedging activities: Northeast referenced its remark to page 2.1 of the June 1989 FHLBB Exam Report, on which Mr. Kovac expressed concerns specifically about the interest rate swaps that had been used to hedge the wholesale portfolio. PX 192 (June 1989 FHLBB Report of Examination) at 2.1. In any event, it is crystal clear that Northeast was not signaling an intention to eliminate wholesale assets and liabilities because the financial projections later in the very same July 1989 response show Northeast maintaining substantial volumes of both MBSs and other wholesale assets and liabilities, such as FHLB advances and wholesale repos, through at least December 1991 (when the projections stop). PX 211 (Northeast July 1989 Response to June 1989 FHLBB Exam Report) at

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WOJ512 2379. Furthermore, as Dr. Baxter explained, this remark did not mean that Northeast would discontinue wholesale banking, because the December 1988 Business Plan explicitly contemplated continuing to engage in wholesale banking and Northeast in fact did continue to engage in wholesale banking throughout the damages period. See Baxter, Trial Tr. 1154­58. Indeed, Northeast never again repeated this sentiment upon which the government relies so heavily--not in its correspondence with the regulators, not in its public filings, not in its business plans. Moreover, as discussed above, Northeast's wholesale activities consistently generated positive net interest income both before and after the breach, so, regardless of whether those assets were "underwater" in terms of their market value at a given point in time, it is highly unlikely that Northeast was as "eager" to sell them as the government claims. Further evidencing Northeast's desire to exit wholesale banking, according to the government, is a strategy, known as "Option 7" in Kaplan's 1988 study of Northeast, that Northeast considered prior to the December 1988 Business Plan but ultimately rejected based on the regulators' objections. Def.'s Br. at 8, 21­22; see PX 67 (Kaplan Report, Sept. 16, 1988) at 34 (summary of Option 7). For several reasons, the government is wrong about the motivation behind Option 7 and Option 7's import for how Northeast would have behaved absent the breach. First, Option 7 would not have been Northeast's strategy absent the breach because it was superseded before the breach by the December 1988 Business Plan. Although the projections in the December 1988 Business Plan went only through 1989, the strategy embodied in that plan was intended to govern Northeast indefinitely, as the regulators recognized at the time. See PX 192 (June 1989 FHLBB Report of Examination) at 2.3 ("in December 1988 Northeast adopted a

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new business plan for 1989 and beyond") (emphasis added). If, as the government has suggested, Northeast was merely waiting for interest rates to fall, at which point it would unload its wholesale portfolio, then presumably Northeast would have said so in the December 1988 Business Plan, a Board meeting, a revised business plan, an annual report, a 10-K, or correspondence with the regulators. But Northeast never did. In fact, even when Northeast was saying explicitly that a "return to profitability in the short term will require a reduction in the overall level of interest rates," it said nothing about exiting wholesale activities, but rather spoke only of "deemphasi[zing]" them. PX 154 (July 1989 Revised Business Plan) at 1, 3­4; see also PX 19 (Northeast 1989 10-K and Annual Report) at FNE002 0058­59. Second, the primary motivation for the shrinkage entailed by Option 7 was not a desire to exit wholesale banking. After all, the December 1988 Business Plan mapped out a way to shift from wholesale to retail banking without shrinking. Rather, the primary motivation was--as the government itself acknowledges elsewhere in its brief--the need to comply with the FHLBB 4% capital requirement, which was scheduled to take effect on January 1, 1990. PX 250 (Board meeting, Sept. 18, 1988) at 2­3 (assessing the seven options analyzed by Kaplan in terms of their impact on Northeast's regulatory capital ratios); PX 67 (Kaplan Report, Sept. 16, 1988) at 34; see Def's Br. at 21; cf. FF ¶¶ 95­96. Since Mr. Rutland wanted eventually to shift the