In the United States Court of Federal Claims No. 95-39 C (Filed: March 14, 2008) ANCHOR SAVINGS BANK, FSB, Winstar-Related Case; Plaintiff, Foreseeability; Causation; Measure of Damages; Risk v. Assessment; Lost Profits; Mortgage-Backed Securities; Bank Branches THE UNITED STATES OF AMERICA, Defendant. Edwin L. Fountain, Jones Day, Washington, D.C., attorney of record for plaintiff, with whom were George T. Manning, C. Thomas Long, Joseph J. Migas, Adrian Wager-Zito, Debra L. Satinoff and Geoffrey S. Irwin. Patrick T. Murphy and Tarek Sawi, United States Department of Justice, Commercial Litigation Branch, Civil Division, Washington, D.C., with whom were Colleen Hanrahan, Brian J. Mizoguchi, John Todor, Ed Sullivan, Richard Evans, Luke Levasseur, Mark Pittman and Delisa Sanchez. OPINION AND ORDER Block, Judge. I. INTRODUCTION This case is one of the last of the Winstar-related progeny facing this court. It involves a series of contracts in which the government promised to allow the plaintiff, Anchor Savings Bank, FSB (“Anchor”) to account for “supervisory goodwill” as a capital asset that would count toward Anchor’s regulatory capital requirement and be amortized over a 25-to-40 year period. The contracts accompanied Anchor’s acquisition in the 1980s of four failing financial institutions, at the behest and under the supervision of federal thrift regulators. The government hoped those “supervisory” acquisitions would prevent its contingent deposit insurance liability from maturing. Following a change in thrift regulatory policy, however, the 1989 Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”) disallowed substantially all of Anchor’s supervisory goodwill as a capital asset. As a consequence, Anchor immediately became a severely under-capitalized financial institution and was forced to make radical operational changes to avoid being seized and liquidated by its regulators. In a series of earlier opinions, this court concluded that FIRREA breached the government’s supervisory goodwill contracts with Anchor. The issue of damages, alone, remains. Before trial, this court noted that the tales that the parties crafted harken back to Charles Dickens’ A TALE OF TWO CITIES. Anchor portrayed its business and operations in the period leading up to the breach as the proverbial “best of times,” with the bank poised for extraordinary success, but the government countered with a more pessimistic approach, challenging Anchor’s performance as a quintessential “worst of times” in which Anchor was headed towards failure. See Anchor Sav. Bank, FSB v. United States, 59 Fed. Cl. 126, 128 (2003) (summary judgment decision). At the time, the court was in no position to weigh those arguments against one another and decide which version—the best of times, or the worst of times—was more credible. Following an almost month-long trial, it is now more clear what is the real story in play. The extremist arguments proffered by both parties have given way to a truth that lies somewhat in the middle—it was neither the Dickensian “best” of times nor the “worst.” It was, however, a time of remarkable change and innovation in both the savings and loan industry and its progeny, the mortgage-banking industry. Anchor appears to have been one of the institutions most prepared to respond to that change, as its management had deliberately positioned the bank to be a leading player in the evolving mortgage-banking industry. As that industry began to rely more heavily upon thrifts as intermediaries between borrowers and the secondary mortgage market’s capital supply, Anchor was ready to be an industry leader. The abrupt disallowance of most of Anchor’s supervisory goodwill as regulatory capital was a near-fatal blow. It forced Anchor to fundamentally alter its business plan and, in so doing, to sacrifice substantial long-term profits in favor of one-time gains from the sale of assets to prop up the suddenly failing, capital-starved institution. In the aftermath of FIRREA, Anchor’s management was forced to operate the business in a defensive posture that could best be described as triage, with a singular focus on preventing the thrift from falling into receivership and maintaining a stripped- down platform from which a profitable enterprise might someday re-emerge, like a phoenix from its ashes. After the breach, Anchor shrank by more than $1 billion in assets in just two years. It sold geographically diverse branch deposits in a depressed market and abandoned a twenty-year-old plan of geographic expansion and diversification. Anchor also sold a profitable subsidiary that was the leading private player in the secondary mortgage market. This subsidiary was poised for explosive, long-term growth precisely when Anchor was forced to sell it. Indeed, in just the first two years after Anchor sold its subsidiary, the subsidiary earned pre-tax income nearly equaling the entire forced- sale price; in only three years, its after-tax, net income exceeded the sale price. See PX 971 (demonstrative summarizing RFC financials, PX 258–265). On January 13, 1995, Anchor sued the United States for breach of contract, alleging that the provisions of FIRREA and its implementing regulations that disallowed the inclusion of supervisory goodwill as regulatory capital contradicted the terms of Anchor’s contracts for each of its supervisory - 2 - mergers during the 1980s. According to Anchor, the breach left Anchor in a crippled, undercapitalized position that caused considerable losses and harm. In a series of opinions and orders, this court previously concluded that, consistent with the Supreme Court’s decision in Winstar, the United States did in fact breach four contracts with Anchor corresponding to its supervised acquisitions of the Peachtree, Crisp, Sun, and Suburban savings and loan institutions. Anchor, 59 Fed. Cl. at 130–32. Liability established, the government moved for summary judgment on whether Anchor sustained or could prove any compensable damages and the viability of some of Anchor’s proffered damages theories. In a September 29, 2003 opinion, this court granted those portions of the motion addressing Anchor’s restitution theory of recovery, but concluded that Anchor’s expectation and “wounded bank” theories of recovery were legally viable and that genuine issues of fact remained. The government’s motion was therefore denied with respect to the expectation and “wounded bank” damages. Between June 13 and July 20, 2005, the court conducted a trial in Washington, D.C. on the remaining damage issues. This opinion, then, is all about damages. It is about lost profits (a type of “expectation damages”) as a viable measure of damages in the Winstar context. It is about how the doctrines of “foreseeablity” and “certainty” are applied in the lost profit context. It is about the economics of what is of value and exactly how that value is created. And once economic value is determined, it is about what constitutes harm to that economic value in order for a plaintiff to recover under a lost profits theory. The problem thereafter, of course—for both Anchor and other Winstar litigants—is how to quantify that harm in the form of damages. How might the court best account for harm suffered long ago, and apply the appropriate rule of damages law? As the following makes clear, there was indeed harm suffered here. The opinion below constitutes the court’s findings of fact in this case after weighing all the evidence proffered by the parties in light of the relevant context inexorably resulting from the history and the economics of the times, both exceedingly crucial because of the need to determine what factors are “foreseeable” as a matter of law in determining damages. Nevertheless, what is particularly essential are the actions of the main protagonists since “the actions of men,” as John Locke opined, generally constitute “the best interpreters of their thoughts.”1 These findings make up the body of the opinion. The skeleton of that body is the law as applied by the court. Thus the conclusions of law that the court renders serve as another level of context in which to view the facts of this case. In toto, it is the proper interpretation of relevant damages law, and especially that law as it has evolved through other Winstar cases, that the court must apply. 1 The Quotations Page, http://www.quotationspage.com/quote/8002.html. See also Paul Samuelson, A Note on the Pure Theory of Consumers’ Behaviour, ECONOMICA 5:61–71 (1938) (pioneering the concept of “revealed preference,” the theory that consumers’ actions and purchasing decisions, not their statements, are a superior guide to their actual preferences). - 3 - Due to the length of this opinion, the court provides the following table of contents: TOPIC PAGE II. BACKGROUND 6 A. The Plight of the Savings and Loan Industry in the 1970s and 1980s: The 7 Problem of Risk Reduction in a Heavily Regulated Business Model B. The Federal Government Responds to the Industry's Problems: Risk Reduction 12 through Deregulation and Encouraging Thrifts To Become More “Bank-Like” 1. Accounting Forebearances 12 2. Asset Deregulation 15 C. Market Responses: A Primer on the Secondary Mortgage Market 16 D. The Tale of Anchor Savings Bank before the Thrift Crisis 24 E. Anchor’s Expansion 25 F. The Supervisory Mergers that Anchor Used To Grow: Benefits, Costs and 30 Promises G. Anchor’s Performance in the 1980s and the Acute Impact of Anchor's 34 Acquisitions H. Anchor’s Long-Term Business Plans in 1985–87 37 I. Anchor Acquires Residential Funding Corporation 38 J. The Arrival of James Large As CEO and His Vision of a More Efficient Bank 42 K. FIRREA and Its Sudden Impact on Anchor's Capital Compliance and Operations 48 L. The Capital Plan and Anchor’s Efforts To Stave Off Foreclosure: The Sale of the 50 Branch Network and RFC 1.