American Insurance Group, the insurance giant that is 80-percent owned by the US government, is in discussions with the government to secure additional funds so it can keep operating after next Monday, when it will report the largest loss in U.S. corporate history, CNBC has learned.
Sources close to the company said the loss will be near $60 billion due to writedowns on a variety of assets including commercial real estate.
That massive loss is likely to spur downgrades in its insurance and credit ratings that will force AIG to raise collateral that it doesn't have.
In addition, if AIG's book value falls below a certain level, as it seems certain to do, it will trigger default in certain of its debt instruments, say people familiar with the situation.
All of this adds up to a huge headache for the Federal Reserve and Treasury, which have already provided over $150 billion of assistance to AIG.
Talks between the government and AIG are focussed on how the company can swap some of the debt held by the government for equity in AIG.
The problem is that the government's ownership stake cannot exceed its current 79.9 percent, leaving officials to try and find a creative way to transfer value to the US in exchange for AIG reducing its debt so that it can then borrow more from the government to meet its collateral calls.
AIG has borrowed roughly $40 billion from a $60 billion credit facility provided it by the Federal Reserve Bank of New York. If it can find a way to pay that down by swapping equity, it hopes to take it back up to a level that will allow it to meet its collateral and capital calls.
AIG's board is scheduled to meet this Sunday night in hopes of hammering out an agreement with the government. But in case it can't, AIG's lawyers at Weill Gotschal are preparing for the possibility of bankruptcy.
(Watch the accompanying video for more...)
That seems unlikely, but last November, the government took control of many of AIG's credit default swaps and so a bankruptcy of the holding company might not pose the systemic risk it once did.
AIG said in a statement it had not yet reported results and would provide an update when it does so in the near future.
"We continue to work with the U.S. government to evaluate potential new alternatives for addressing AIG's financial challenges," AIG said. U.S. Treasury officials declined to comment.