AIG struggles to survive financial tsunami

By Christian Plumb

NEW YORK (Reuters) - Insurer American International Group Inc struggled for survival a day after a financial tsunami swept away investment bank Lehman Brothers and forced the sale of rival Merrill Lynch in the biggest financial industry shake-up since the Great Depression.

AIG scrambled for a financial lifeline on Monday after investment bank Lehman Brothers Holdings Inc failed to find a rescuer and Merrill Lynch & Co Inc agreed to be taken over by Bank of America Corp.

The U.S. Federal Reserve has hired investment bank Morgan Stanley to review options for AIG -- which has lost some 92 percent of its value so far this year -- a person familiar with the situation said Monday.

AIG's precipitous stock decline has led ratings agencies to threaten downgrades that could force it to post more collateral and nullify insurance contracts, possibly setting in motion a chain reaction that could threaten its survival.

In an ominous sign, two ratings agencies went ahead with downgrades after the market closed on Monday.

"AIG seems to be the next guy on the chopping block," said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey.

Again seeking a private solution to Wall Street's woes, the Fed had asked JPMorgan Chase & Co and Goldman Sachs Group Inc to explore arranging $70 billion to $75 billion in loans to support AIG, among other financing options, another person familiar with the situation said.

Fearing a financial meltdown, the U.S. presidential candidates sparred Monday over who could best restore the system's health, with Republican John McCain pledging reform and Democrat Barack Obama saying hands-off Republican policies were the problem.

U.S. stocks tumbled across the board, with the Dow Jones industrial average dropping 504 points as Wall Street had its worst day since markets reopened after the September 11 attacks.

There was speculation that Wall Street's worsening meltdown could prompt the Fed to act.

U.S. short-term interest rate futures rose sharply Monday, reflecting the higher prospects for a rate cut at or before Tuesday's Federal Reserve policy meeting.

And there were signs of widening macroeconomic shockwaves that could see a worsening of the credit crunch that has already threatened to worsen the housing downturn at the root of Wall Street's troubles.

"Capital markets have been quite difficult, and this is just going to make it more so," General Motors Corp President and Chief Operating Officer Fritz Henderson told the Reuters Autos Summit in Detroit.

Darkening one of the few bright spots from the weekend's mayhem, Bank of America -- which would surpass Citigroup Inc as the country's largest bank by assets with the planned takeover of Merrill -- saw its shares plunge.

"The concern for Bank of America is the debt that they are acquiring," said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco.