This story was originally published in the Newark Star-Ledger

After making millions selling New Jersey bonds to investors, Wall Street giant Goldman Sachs told other wealthy clients they could profit by betting the Garden State may not be able to pay off its bonds as scheduled, according to a confidential presentation made two months ago.

The advice would cost state taxpayers if investors believe New Jersey bonds appear riskier than they actually are -- and force the state to pay higher interest rates on future bonds.

While not illegal, it is troubling Goldman Sachs almost simultaneously marketed New Jersey bonds to one set of investors, while suggesting to others they would be smart to buy insurance from the investment bank because those bonds may not be repaid, according to Geoffrey M. Heal, professor of public policy and business responsibility at Columbia University.

"That's not a good way to do business," he said. "They've got a conflict of interest and they're acting against the interest of their customers.

"You act in the interests of your clients. You don't screw them, to put it bluntly."

Goldman's strategy of "shorting municipal credit," or essentially betting the state bonds would decline in value, was outlined in a 58-page report obtained by ProPublica, a New York-based nonprofit group specializing in investigative reporting. ProPublica assisted The Star-Ledger in reporting this story.

This summer, Goldman, which once employed Gov. Jon Corzine as its chairman, shared in $1 million in fees for helping New Jersey sell $345 million in highway improvement bonds to investors. The fees are among $15 million Goldman has earned since 2002 for selling investors hundreds of millions of dollars in New Jersey debt.

With the September pitch, Goldman was essentially casting doubt on many of those bonds by suggesting New Jersey and five other states might be considered ripe for default on their bond payments because of huge shortfalls in pensions and other public employee retirement benefits.

Michael DuVally, a spokesman for Goldman Sachs, denied there was anything untoward about the firm's roles as a seller of bonds and a provider of insurance against their default, saying the advice came from different divisions separated by "a Chinese Wall."

"There is absolutely no conflict," he said in an e-mail response to written questions. "The material was prepared by a group within the Securities Division on the public side of the 'Chinese Wall' and does not represent the views of Goldman Sachs as a firm."

Tom Vincz, a spokesman for the New Jersey Treasury Department, declined to comment. Douglas Love, a member of New Jersey's State Investment Council, which sets investment policy for the state's pension funds, said he was not troubled.

"Research is research; it's supposed to be independent," said Love, chief investment officer for an insurance fund. "That is proof they're independent."

In the 58-page proposal, Goldman said it identified 11 states where prospects for a default might be on the upswing.

Six of those states, including New Jersey, Connecticut and Massachusetts, were judged as vulnerable because of "significant unfunded pension and OPEB (post-retirement health insurance) costs."

New Jersey's pension problems have been known for years and are getting worse.

Experts said that as of July 1, 2007, the fund set up to cover long-term pension payments contained about $28 billion less than is needed to pay the benefits already promised to the 700,000 workers and retirees it covers.

At the time, the funds held investments worth about $82 billion. Since then, the global economic crisis has drained at least $23 billion from the accounts, officials said last week. On top of that, New Jersey has promised its retirees $50 billion in medical benefits, for which no funds have been set aside.

According to the Goldman report, New Jersey is one of just 15 states that has both unfunded medical expenses and a pension system that is at least 20 percent underfunded.

Goldman's confidential presentation outlined various potential strategies for investors to consider in light of unprecedented instability in worldwide credit markets. The material was only presented to investors with at least $10 million in assets, according to a footnote.

Goldman recommended that investors could take positions against New Jersey bonds by buying complex financial instruments called credit default swaps.

The swaps are like an insurance policy, where an investor pays a bank -- like Goldman -- a premium in exchange for protection against the risk that New Jersey could default or, more likely, make a late or lesser payment than scheduled. Goldman and other bankers routinely sell such insurance to investors who do not hold the bonds being insured, despite the fact such investors have no direct stake in whether or not the bonds are repaid.

Selling the swaps could, if done properly, help New Jersey by reassuring nervous investors who would not buy the bonds without insurance. But the swaps have also drawn criticism for their role in the near-collapse of insurance giant AIG in September, and for their propensity to be used by speculators in a market that remains unregulated.

Goldman acknowledged in its document that the firm "may have potential conflicts of interest" and that it may "by virtue of its status as an underwriter, advisor or otherwise, possess or have access to non-publicly available information," which it would not disclose to its credit default swap customers.

Goldman's foray into the business of "shorting municipal credit" proved short-lived.

DuVally said Goldman was no longer giving the trading advice to clients "in any meaningful way," and that the traders who came up with the idea are now promoting new investment ideas.

Nevertheless, this incident shows the growing intricacies of the financial markets, according to professor Heal. "For a company that's dealing with many entities, big firms, local and state governments, it's actually quite hard to avoid conflicts," he said. "And it's getting more difficult as the market gets more concentrated. But you know, if I was New Jersey, I might want to look for someone else to issue my bonds."