In early 2008, Libya’s sovereign-wealth fund, controlled by Moammar Khadafy, gave $1.3 billion to Goldman Sachs Group to sink into a currency bet and other complicated trades that eventually lost 98 percent of their value, according to internal Goldman documents cited Tuesday by The Wall Street Journal.

In an effort to make up for the losses, Goldman offered Libya the chance to become one of its biggest shareholders, according to documents and people familiar with the matter.

Negotiations between Goldman and the Libyan Investment Authority stretched on for months during the summer of 2009 but later fell apart, and nothing more was done about the lost money.

Libya was furious at Goldman over the nearly total loss of the $1.3 billion it invested in nine equity trades and one currency transaction, people involved in the matter said. A confrontation in Tripoli between a top fund executive and two Goldman officials left the bankers so rattled that Goldman arranged for a security guard to protect them before they left Libya the next day, people familiar with the matter claimed.

Goldman offered the fund an opportunity to invest $3.7 billion in the securities firm. Between May and July of 2009, Goldman executives made three proposals that would have given Libya preferred shares or unsecured debt in Goldman, according to documents prepared by the investment bank for the fund. Each proposal promised a stream of payments that would eventually offset the losses.

The Libyan Investment Authority launched in Tripoli in June 2007 with about $40 billion in assets. Libya approached 25 financial institutions, offering each of them a chance to manage at least $150 million, recalled a person familiar with the fund’s plans.

Goldman seized the opportunity. In May 2007, several Goldman partners met with the Libyans at Goldman’s London office and subsequently offered the Libyans the opportunity to invest $350 million in two funds run by Goldman’s asset-management unit, according to people involved in the transactions. The Libyans accepted.

Goldman soon carved out a new business with the Libyans, in options — investments that give buyers the right to purchase stocks, currencies or other assets on a future date at stipulated prices. Between January and June 2008, the Libyan fund paid $1.3 billion for options on a basket of currencies and on six stocks, all from companies in the financial and energy sectors.

But that fall, the credit crisis hit with a vengeance as Lehman Brothers failed and banks all over the world faced financial crises. The $1.3 billion of option investments were hit especially hard. The underlying securities plunged in value and all of the trades lost money, according to an internal Goldman memo reviewed by the WSJ that said the investments were worth just $25.1 million as of February 2010 — a decline of 98 percent.

After four meetings in July 2009, the two sides agreed to a reworked deal that would make back Libya’s losses in 10 years. Such a deal, which also could have left the fund with a Goldman stake, would have needed to be run past the Federal Reserve, which left both Goldman and fund officials worried about its viability. Goldman changed its mind a week later, according to a person familiar with the situation.

A variety of other options were later proposed to Libya, including a special-purpose vehicle in the Cayman Islands that would own $5 billion of corporate debt, according to a Goldman document prepared for the fund. That deal would have paid Libya an annual return of six percent for 20 years, plus a promise of a $50 million payment to an outside fund adviser run by the son-in-law of the head of Libya’s state-owned oil company. Officials from Goldman and the sovereign-wealth fund met about the deal in June 2010, but it was never completed.

Efforts to reach Libyan officials for comment were unsuccessful.

As of last June, the Libyan Investment Authority had assets of about $53 billion, according to a document reviewed by the WSJ. This year, US officials froze about $37 billion in Libyan assets, including some funds still managed by Goldman.

For more on this story, please go to The Wall Street Journal.