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.”
