Wheels within wheels

Like most oil companies, Enron created partnerships - with the assistance of banks, accounting firms, and law firms - for its projects, such as oil wells and pipelines. These partnerships - not Enron - borrowed money, purchased assets, and entered into contracts.

By using partnerships (or other legal entities, such as trusts or corporations), Enron could create non-recourse financing - meaning that the company could borrow for a project based solely on the assets of the partnership; investors in the partnership could not hold Enron responsible for debts.

So long as Enron controlled no more than 50% of the partnerships, accounting rules did not require that Enron consolidate the partnerships' assets and liabilities, any debts belonged to the partnerships, not to Enron, and they would appear only in a footnote to Enron's financial statements. By keep ing debt off its books, Enron would appear healthier, and the credit rating agencies would give it a higher rating.

Enron began using offshore special purpose entities to do various over-the-counter derivatives deals, including swaps, that enabled Enron to borrow money without recording the debt. For example, in 1992 Enron and Chase Manhattan did a swap using a company called Mahonia, which had been incorporated in 1986 in Jersey. Chase effectively controlled Mahonia, so in reality Enron was doing the swap with Chase (the legal independence of Mahonia potentially protected Chase from liability).

At first, Enron used Mahonia to do deals that reduced its taxes. After several years, Enron also borrowed billions of dollars in prepaid swaps with Mahonia, organised by Chase and - after Chase's merger with JP Morgan - JP Morgan Chase.