poor CRO from Andrew Lo's "Regulatory reform"

Quote:
"
Consider, for example, the case of a CRO of a major investment bank XYZ, a firm
actively engaged in issuing and trading CDOs in 2004. Suppose this CRO was
convinced that US residential real estate was a bubble that was about to burst, and
based on a simple scenario analysis, realized there would be devastating consequences
for his firm. What possible actions could he have taken to protect his shareholders? He
might ask the firm to exit the CDO business, to which his superiors would respond that
the CDO business was one of the most profitable over the past decade with
considerable growth potential, other competitors are getting into the business, not
leaving, and the historical data suggest that real-estate values are unlikely to fall by
more than 1 or 2 percent per year, so why should XYZ consider exiting and giving up
its precious market share? Unable to convince senior management of the likelihood of a
real-estate downturn, the CRO suggests a compromise – reduce the firm’s CDO
exposure by half. Senior management’s likely response would be that such a reduction
in XYZ’s CDO business will decrease the group’s profits by half, causing the most
talented members of the group to leave the firm, either to join XYZ’s competitors or to
start their own hedge fund. Given the cost of assembling and training these
professionals, and the fact that they have generated sizable profits over the recent past,
scaling down their business is also difficult to justify. Finally, suppose the CRO takes
matters into his own hands and implements a hedging strategy using OTC derivatives
to bet against the CDO market[4]. From 2004 to 2006, such a hedging strategy would
likely have yielded significant losses, and the reduction in XYZ’s earnings due to this
hedge, coupled with the strong performance of the CDO business for XYZ and its
competitors, would be sufficient grounds for dismissing the CRO.
"