Global financial meltdown spreads

But concerns intensified that AIG, once the world8217;s largest insurer by market value, could be the next victim after a ratings downgrade, causing a rout in stock markets already battered on Monday after Lehman sought bankruptcy protection.

8220;We expect near-term weakness for the European banks as markets digest the systemic consequences of the failure 8230; we are undeniably more cautious following the weekend8217;s events,8221; Keefe, Bruyette 038; Woods said in a note.

Leading European stock indices were down between 1.4 and 2.2 per cent in morning trading. The Dow Jones Stoxx banking index was 3 per cent weaker by 4:09 a.m. EDT. UBS fell 9.6 per cent, HBOS lost 11.5 per cent, and Barclays was 2.9 per cent lower.

AIG8217;s illiquid shares on the Frankfurt stock exchange were 4.8 per cent off.

Asian share markets, many of them closed for a holiday on Monday, tumbled as investors absorbed the weekend8217;s dramatic events on Wall Street, where Merrill Lynch agreed to be sold to Bank of America for 50 billion.Shares in AIG plunged nearly 61 per cent on Monday and the US Federal Reserve hired investment bank Morgan Stanley to review options for the firm, a person familiar with the situation said on Monday.

AIG has lost 92 per cent of its value this year.

BRITS STEPS IN

Barclays 8212; which quit frantic talks over the weekend to rescue Lehman after US authorities failed to guarantee trading obligations 8212; is now looking to buy Lehman8217;s US broker-dealer business, including equity, fixed income, M038;A advisory and other parts, the sources said.

The talks mainly involve the core US business, with 8,000 to 10,000 staff, but could include some of its global businesses, the sources said, and a deal could save thousands of jobs and many of the core investment bank operations.

There is an urgency to the talks, as a deal would need to be struck before staff and clients leave and damage the franchise, the sources also said.

But markets focused on AIG8217;s ratings downgrade, which could force it to post more collateral and nullify insurance contracts, possibly setting in motion a chain reaction that could threaten its survival.

8220;You don8217;t just have a potential impact on the reinsurer side, you have it on the institutions that might be holding AIG paper,8221; said Lorraine Tan, director of research for Asia at debt rating agency Standard and Poor8217;s in Singapore.

8220;This would have a much bigger impact than a bank going down like Lehman or Bear Stearns or even a Wachovia or WaMu in the US AIG has a much bigger presence globally. Their reach to a global customer base is quite sizable,8221; she said.

Top US savings and loan Washington Mutual Inc saw its rating cut to 8220;junk8221; status by Standard 038; Poor8217;s amid concerns about mortgage losses. Its shares slid in after-hours trading after a 27 per cent drop in the regular session.

Moody8217;s Investors Service cut AIG8217;s rating to A2 from Aa3, a two-notch downgrade. S038;P lowered the rating to A-minus from AA-minus, a three-peg reduction, and Fitch Ratings reduced its standing to A from AA-minus, a two-notch cut.

AIG8217;s ratings are still investment grade, although all three agencies said more downgrades could follow.

Again seeking a private solution to Wall Street8217;s woes, the Fed had asked JPMorgan Chase 038; Co and Goldman Sachs Group Inc to explore arranging 70-75 billion in loans to support AIG, among other financing options, another person familiar with the situation said.

AIG turned to the Fed late on Sunday after failed talks with several buyout firms and Warren Buffett8217;s Berkshire Hathaway. The company has also said it was exploring asset sales.

MARKETS TUMBLE

European credit spreads widened sharply early on Tuesday, surpassing last session8217;s high, after AIG8217;s downgrade.

By 0900 GMT, the investment-grade Markit iTraxx Europe index

was at 143.5 basis points, according to data from Markit, 18.5 basis points wider versus late on Monday.

8220;The second leg of the subprime crisis has begun,8221; Jun Kwang-woo, head of South Korea8217;s Financial Services Commission said. 8220;It could be painful but a recovery, once in place, may be rapid.8221;

Asian stocks tumbled across the board, with Tokyo down more than 5 per cent at a three-year low.

Japanese government bond futures jumped by their daily limit of three full points as investors fled to safe havens, while Japan8217;s central bank said it would strive to maintain stability in financial markets.

Darkening one of the few bright spots from the weekend8217;s mayhem, Bank of America 8212; which would surpass Citigroup Inc as the largest US bank by assets with the planned takeover of Merrill 8212; saw its shares plunge by 21 per cent.

8220;The concern for Bank of America is the debt that they are acquiring,8221; said Marc Pado, US market strategist at Cantor Fitzgerald 038; Co in San Francisco.

The state of New York, where AIG is based, sought to bolster the stricken insurer with a complex asset swap giving it a 20 billion lifeline, but its longer-term rescue depended on additional funding.