In 1992, J.P.Morgan went into the energy trading business by creating a venture company called Mahonia Limited. At least, that is how things appeared on paper. Mahonia was actually a type of tax shelter for energy-trading companies. Mahonia would buy large amounts of gas or oil at the end of the tax year with the request that they be delivered in increments over the following calendar year. The pre-paid sale would then be recorded as a debt on the seller's financials because the goods had not been delivered yet. By doing transactions like this at the end of every year, the companies dealing with Mahonia could defer their taxes and decrease their taxable income in good times.

Although devilishly clever, there is nothing outright illegal about these tax-deferral transactions as long as the goods are delivered. Unfortunately for Mahonia, more than half of its business was with Enron. Enron started doubling the value of its trades by recording the sales as cash flow in its financials and as debt on its taxes. As Enron's financial troubles increased, they asked Mahonia to buy more. Instead of being a tax haven, Mahonia became a lender to Enron when the goods weren't being delivered.

Mahonia (J.P.Morgan in all but name) wanted to cut ties with Enron but they were already on the hook for a significant chunk of change - a single sale in 1999 was for $650 million. Enron agreed to take out insurance on the delivery of the sales, perhaps knowing it was already so deep in fraud that a little more wouldn't hurt. The goods were, of course, never delivered. When Enron imploded, Mahonia was owed billions in bad sales.

The insurance firms refused to pay up when the financial wizardry was exposed and it turned out that, although Mahonia had lost heavily, J.P.Morgan had made millions on fees for brokering deals between Enron and Mahonia. The insurers alleged that the trades were actually high risk loans meant to prop up the floundering energy giant. J.P.Morgan took the insurers to court on the charge that the insurance policy Enron had drawn was unconditional despite suspicions of fraud. J.P.Morgan won a Pyrrhic victory, getting less than half of the $1.1 billion it sought and doing considerable damage to its reputation in the process.

For more information, read our related articles: The Kingpin Of Wall Street: J.P. Morgan and Enron's Collapse: The Fall Of A Wall Street Darling.

This question was answered by Andrew Beattie.

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