- Financial markets remain in a precarious condition this morning as AIG teeters on the edge of bankruptcy and investors await the FOMC rate decision later this afternoon. Indices have rallied in mid morning trading after the Nasdaq opened -1.4% and the DJIA dropped 1.5% from the bell. In a sign of concerns over liquidity, the Fed pumped $50B into markets in its repo operation, more than twice the $20B slated for the day. The VIX index broke above yesterday's highs this morning, while the USD LIBOR fixing was the highest since early 2001. Traders are waiting to exhale.

- Reports circulated yesterday evening and overnight that the Federal government was asking Goldman and JP Morgan to lead a $70-75B lending facility for AIG, which had plunged dramatically throughout recent sessions. A New York Fed official confirmed this morning that talks regarding the deal were ongoing. All three major ratings firms cut AIG's credit ratings yesterday after the close yesterday. S&P cut AIG's ratings to A- from AA-, putting them on negative watch. Fitch downgraded the firm's ratings to A from AA-, leaving them on watch negative. Moody's cut to A2 from Aa3. An S&P credit analyst cited the chief reason behind the move was that reduced flexibility in meeting additional collateral needs and concerns over residential mortgage losses were undermining confidence in the company. S&P further noted that mark-to-market losses from mortgage-related investments and swap exposures have placed significant pressure on AIGs ability to access capital and liquidity. Fitch said its downgrade also reflect the benefits derived from New York Governor Patterson's granting AIG's subsidiaries the authority to exchange $20B of assets with AIG in order to promote liquidity. Moody's noted that further downgrades are likely if liquidity and capital concerns are not fully addressed. Note that all agencies kept AIG within investment grade range. This morning AIG founder and former CEO Hank Greenberg told CNBC that if AIG cannot get a bridge loan from either the Federal government or private sources, or a capital injection from sovereign wealth funds, the firm may go bankrupt, tartly remarking that if the rating agencies held off for 90 days, then AIG could conduct a solid rights offering. New York Governor Patterson noted just before the open that AIG has "one day to resolve its problems"; echoing statements that AIG had until Wednesday to secure necessary capital. After loosing 60% of its value yesterday, AIG opened down a further 25% this morning; the name is headed straight up in early trading.

- Other financial names are equally volatile along with AIG: Morgan Stanley opened down more than 25% and is now only down 5%, while JP Morgan is up more than 5% after opening down 2-3%. MER is trading up 15%. Goldman Sachs remains down 5% after opening -12% in the wake of reporting Q2 results before the bell, coming in ahead of earnings estimates but missing on revenue. The firm's tier 1 capital ratio stands at 11.6%, while assets under management fell by $32B to $863B during quarter due to market depreciation, primarily in equity assets. Goldman's CFO noted that merging the firm with a commercial bank is "off the table," emphasizing that its access to liquidity remains good. While he declined to elaborate on Goldman's relationship with AIG, he did say that firm would aid the financial system if possible and such as move would be in the best interests of shareholders.

- Washington Mutual opened -15% and fell below -20% in early action; the name is up 5% mid morning. S&P cut the firm's ratings to junk (BB- from BBB-) just after the close, noting that WaMu's weak equity pricing remains a concern, and it increasingly appears that market conditions could overtake credit fundamentals and leave the company with greatly diminished financial flexibility. WaMu responded by pointing out that none of its unsecured debt is subject to ratings-based financial covenants that would result in acceleration or early maturity events or defaults, noting that it does not expect the impact of S&P's actions on borrowings, collateral or margin requirements to be material. Reports have been circulating that the bank remains a takeover target; the UK's Daily Mail wrote that JP Morgan may be considering an approach

- In other movers oil and commodity names continue to weigh on the market with HES -8%, FCX -7% with oil down approx 5% and nearing that $90/barrel level and silver down more than 4%. RTP and PCU are both down more than 4% on the morning.

- In currencies, the USD remains mixed in an emotional session ahead of the FOMC policy decision. Financial sector concerns remain highly elevated, as evidenced by the USD LIBOR fixing for overnight lending rates at 6.44% compared to yesterday's 3.11% fixing. The Sterling Libor was fixed at 6.79% versus 5.49% yesterday. Treasury prices are once again benefiting from the safe haven bid, as well as hopes the Fed will cut rates later today. The 10-year yield traded as lows as 3.25% early in the session while the Fed funds rate traded as high as 4%. The Fed undertook a very large overnight repo operation in the amount of $50B to bring the Fed Funds rate bank towards its 2% target. The Oct fed fund futures is fully pricing in a 25 basis point cut this afternoon and at one point put nearly 30% odds on a 50 basis point cut. Both Fed funds and the futures have backed off as equity markets attempted to recover on hopes the Government was set to step in and facilitate an AIG bailout.

- Risk aversion forced steep losses on European equity markets for the second straight day, with the FTSE testing below the 5,000 level for the first time since June 2005. Russia's MICEX exchange was off by almost 20% following a one-hour suspension of trading to calm frayed trading nerves. The USD/JPY cross is holding the 103.60 line where dealers say "good names" are buying USD, corresponding with the equity markets rebounding from session lows. EUR/USD continues to hover around the 1.42 handle. The US TIC data indicated the recent concerns over the GSEs as foreign investors dumped almost $50B in those securities.