Despite the latest efforts to shore up financial markets, analysts say that the crisis is only deepening.

Yesterday, the U.S. government stepped up to takeover trouble insurance giant American International Group. “The company was in dire straits and faced a liquidity crisis, as rating agencies downgraded AIG liabilities,” explains Global Insight Inc. in a research note. “The sheer size of AIG, with about US$1 trillion in assets and liabilities at the end of 2007, with extensive and intricate financial linkages to domestic and overseas markets, dictated a different approach than the one taken for Lehman Brothers.”

“This takeover of AIG forestalls to some extent the recent dangerous escalation of the crisis in the U.S. financial markets—a crisis that has been seriously harming the performance of the economy for over a year now. Nevertheless, the risks to the country’s financial system and the economy remain massive, and downward pressure on financial asset prices –and the value of their underlying collateral — continues to mount,” the firm says.

Indeed, the rating agency Standard & Poor’s is predicting that the world’s financial institutions will face more securities writedowns combined with rising loan losses in the second half. “We believe that turbulent capital market conditions and continuing negative news from the U.S. mortgage market will lead to another large wave of writedowns in the second half of 2008,” it said.

“The overlap of these two phases may prove to be the most difficult test yet for the battered global financial sector,” said Standard & Poor’s credit analyst Scott Bugie. It adds that the financial industry was able to raise a huge amount of capital over the past year, but “financial institutions face this next wave of write-downs with reduced opportunities to raise additional capital.”

“The success in future capital raising, through issues or asset sales, to compensate for additional securities write-downs, will be the key factor driving the credit ratings on many global financial institutions in the second half of this year,” said Bugie.

The AIG intervention is designed to give the firm breathing room so that it can conduct asset sales. BCA Research comments that the decision to prevent the disorderly failure of AIG, “indicates that authorities are still willing to use other policy initiatives to prevent a collapse of the financial system”, beyond monetary policy.

“That said, the Fed and Treasury have not yet provided a panacea, but merely avoided another imminent disaster. They have not yet found a fiscal solution targeted at ending the underlying rot (i.e. putting a floor under the housing market and economy),” BCA says. “Congress is now starting to consider a system wide solution (similar to the Resolution Trust Corporation) but any initiative may have to wait for the next Administration. In the interim, it seems that the Fed and Treasury will be left to deal with distressed firms on a case by case basis, keeping uncertainty and financial stress elevated.”

Global Insight stresses that the economic backdrop during these latest financial system stresses is “troubling”.

“Industrial production is on track to decline sharply in the third quarter (for the second consecutive quarter), consumption spending is expected to contract, and the unemployment rate is ramping up sharply. Perhaps even more troubling, credit conditions continued to tighten during the summer months, and the growth of credit has slowed down to recessionary levels. Major downside risks to the economy, with diminishing inflation risks, are plain for anyone who has eyes to see,” it concludes.