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Goldman's CFO: Short Truth or Long Ego?

By Seth Jayson – Updated Nov 14, 2016 at 11:24PM

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How many 25-sigma events does it take to screw up a market?

Every once in a while, we Fools come across an example of Wall Street "Wisdom" so perfect in its hubristic idiocy that we choke each other's email inboxes with missives of incredulity, contempt, and spray-the-keyboard-with-coffee amusement.

The one we've got today comes straight from the CFO of Goldman Sachs (NYSE:GS), courtesy of a Monday article in the Financial Times. In it, David Viniar attempts to excuse the implosion of Goldman hedge funds by claiming, "We were seeing things that were 25-standard deviation moves, several days in a row."


The subprime meltdown led to an Alt-A meltdown that led to credit tightening that has killed dozens of lenders such as American Home Mortgage; crippled survivors like Impac Mortgage Holdings (NYSE:IMH); busted funds at other braniac banks like BNP Paribas and Bear Stearns (NYSE:BSC); persuaded consumers to stop buying so much at places like Wal-Mart (NYSE:WMT) and Home Depot (NYSE:HD); and therefore inflicts great havoc on the equities markets. These possibilities were so easy to see, for so long, that some of us Cassandras have, in fact, been calling them probabilities for some time now.

But even if we could accurately describe what has happened as "unlikely," could it be a 25-sigma event?

My stats is a bit rusty, but here's what I've got: On one side of a normal distribution, a one standard-deviation (or "sigma") event occurs about 1 in 6 times. A two-sigma event one in 44 times. A three-sigma event? Try once every 741 chances. (As you can see, this isn't a linear function.) I can't actually find a calculator that will give me the numbers past 8 sigmas, which is 6.61 x 10 ^-16.

Given the way that curve runs, a 25-sigma event is best described as something that is "impossible;" never going to happen; way, way, way beyond the fabled "black swan." In fact, I feel 100% confident in saying (with apologies to Wayne and Garth) that we are far more likely to see a real black swan fly out of Mr. Viniar's posterior than we (or he) are to see a single 25-sigma event, much less several of them in a row. (My colleague Bill Mann, who sent this quotation my way, figures the odds are just as good that he will catch an asteroid in his hand.)

Clearly then, this is a ludicrous, ridiculous assertion. Why, would someone like Viniar make such a dumb statement?

I am going to presume that he's not a complete idiot. To my mind, that leaves only a couple of other explanations: He's exaggerating (to the point of lying, in my opinion) to try and save his skin, and/or he's too egotistical to believe that he and his Goldman team could have had their precious "quant" models wrong.

My moneys' on a big dose of both.

Remember that the fate of Mr. Viniar's paycheck, like the bonuses of all those other folks at record-setting Goldman, depends on record profits at Goldman, and those depend on keeping investors confident, so that the money-bags out there will keep their assets at Goldman, use Goldman's trading desk, patronize its investment banking services, and otherwise keep its Wall Street wheels nice and greasy. The Financial Times quote indicates to me that Mr. Viniar will say anything to convince jittery investors that, contrary to the evidence, Goldman has everything under control.

Current market conditions, therefore, must be once-in-the-universe rarities. Clearly, they're not. That's why jittery Goldman investors should get even more jittery, because the other problem looks likely to be ego.

The folks at Goldman have had it so good for so long, that Mr. Viniar is apparently convinced that their success couldn't have anything to do with random chance. It must have been smarts all along, and wise decision-making. Otherwise, how could they have lost? Anything that breaks the winning streak, well, it would have to be an insane outlier -- maybe a 25-sigma event! Better yet, three, four, or five in a row!

If Mr. Viniar really believes this, it's a typical, but pathetic and dangerous rookie mistake. Learning the difference between luck and skill is vital to real investors, and knowing the difference, plus talking straight about it, is the kind of thing we would expect to find at the highest level of Goldman Sachs' management.

Maybe Mr. Viniar's lips moved before his brain could hit the kill switch. Maybe he knows better, but figures he can fool us Fools. Or, maybe he actually believes in what he said. If so, someone ought to sneak into his office, sweep away the black feathers, and put a copy of Nassim Taleb's Fooled by Randomness on his desk chair. If he and his Goldman quants don't recalibrate their understanding of black swans, the next few months are going to seem an awful lot like Hitchcock's The Birds.

At the time of publication, Seth Jayson was a top-ten CAPS player, and was perfectly willing to attribute his success to luck. He had shares of Home Depot, but no shares of any other company mentioned here. See his latest CAPS blog commentary here. View his stock holdings and Fool profile here. Home Depot and Wal-Mart are Motley Fool Inside Value recommendations. Fool rules are here.


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