Pending doom for Lehman Brothers Holdings Corp. (LEH) garnered plenty of headlines Sunday and heading into Monday, but it’s another possible failure that could send larger waves through financial markets: The American International Group (AIG) is said to have appealed to the Federal Reserve for a $40 billion bridge loan to avert pending ratings downgrades that would spell its doom, according to a report in the New York Times. The insurer turned down a possible private-equity investment from a group led by J.C. Flowers & Co., the Wall Street Journal reported separately, citing unnamed company sources that said such an investment would have entailed giving up control of the company. Instead, AIG is hoping to play a historic crisis on Wall Street to its advantage by making the request to the Fed. AIG has already raised $20 billion this year, but is reportedly looking to raise $40 billion more in an effort to stave off an immediate threat of ratings downgrades that would likely spell the end of the company. Various media reports suggested that major rating agencies had warned the insurer that downgrades would be coming as early as Monday sans some sort of plan to find capital. The company reported a Q2 loss of $5.36 billion as mortgage-related exposure continued to chew away at the bottom line. AIG wrote down the value of credit-default swaps by $5.56 billion before taxes in the second quarter; it also absorbed $6.08 billion in pre-tax write-downs to RMBS and other structured securities in the company’s investment portfolio, citing “severe, rapid declines in fair values.” AIG holds $77.5 billion in primarily U.S. RMBS, with $60.9 billion of that total in non-agency securities; and in looking at the investment portfolio, it’s clear that more losses could be in the offing. The company holds $23.6 billion in par value of subprime RMBS, which it had written down to $16.3 billion in fair value at the end of Q2; likewise, $24.6 billion in par of Alt-A RMBS had been written down to $16.4 billion in fair value. Like everything else on the Street this past weekend, it appears investors are hedging nearly every bet to invest against a possible backstop from the federal government; the Journal reported that other private equity firms are willing to take a stake in AIG should the Fed backstop the insurer with a bridge loan until a restructuring of the firm can be completed. While it was unknown if the government would step in at the time this story was published, the Fed did on Sunday announce a broad expansion of its liquidity facilities via the Primary Dealer Credit Facility, which was introduced in March after the collapse of Bear Stearns. In particular, the Fed said it will accept equities as collateral under the facility, saying the expansion was designed to “closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks.” According to the Times’ report, should the Fed provide funding to AIG, it can expect more troubled non-investment banks to come knocking, including both General Electric Co. (GE) and GMAC. One source, an bank analyst that asked not to be named, told HW on Sunday that he would be surprised to see the Fed step in. “We’re reaping what was sown when Bear Stearns was facing the edge, and the government first stepped in,” said the source. “If the government intends to stay out, it must stay out; otherwise deals simply aren’t going to get done.” Disclosure: The author held no relevant positions when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.