Beleaguered U.S. insurance giant American International Group may allow the U.S. government to take control of certain assets should the sale of stakes in various units fail to produce attractive offers, according to a source close to the matter.

Another option under discussion is for Washington to convert $40 billion worth of preferred stock into common shares, said the source, who was not authorized to speak on the record.

AIG, facing the prospect of a third round of government aid and the largest quarterly loss in U.S. corporate history, is trying to sell off assets to stay afloat and help pay back part of the $150 billion it borrowed after being driven to the brink of collapse last year.

Deadlines for bids for the Asian assets, sales of which could raise tens of billions of dollars for AIG, are due on Friday, according to sources. AIG is also selling off stakes in U.S. subsidiaries.

An AIG spokeswoman did not immediately respond to requests for comment.

The major Asian assets on the block are AIG's American Life Insurance (Alico), a unit that generates more than half of its revenues from Japan, and a 49 percent stake in Hong Kong-based life insurance group American International Assurance Co (AIA).

Analysts originally expected the units to fetch more than $10 billion each, but the value of the assets has likely fallen since the auction began. With the auction in its last phase, AIG has signaled it's willing to give up control of AIA, sources said.

The AIA sale process has been hampered by weakening economic conditions and suitors dropping out, though hope of China's interest in the asset was re-kindled by an official on Thursday.

Chinese firms' potential bids would be solely a corporate decision, said Li Kemu, vice chairman of the China Insurance Regulatory Commission, suggesting Beijing would not block involvement by a Chinese firm.

Asked whether China Life <2628.HK> <601628.SS> or Bank of China <3988.HK> <601988.SS> might bid for the American insurer's assets, Li said Chinese companies were holding discussions with AIG about a possible deal.

The discussion is still going on, and we are paying high attention to it, Li said.

STATE STAKES?

Also under consideration is a plan that would allow the U.S. to take stakes in AIG assets like Alico and AIA, and either spin them off or sell them later if the current auctions fail, according to one of the sources.

The details of the plan are not yet settled and talks are fluid, the source said.

Plans to sell AIG assets across the globe were put in place last fall shortly after the U.S. government saved AIG from bankruptcy with a rescue that has since ballooned to around $150 billion.

On the sale of Alico, insurance companies AXA SA and MetLife have expressed an interest, according to sources. They appear to be the most likely bidders, though the sources could not say how much the companies were willing to bid.

Media reports have said that MetLife made a preliminary offer of $11.2 billion, though the offer may drop to $8 billion given the deterioration in the business.

Another major deal AIG is hoping to close is the sale of its aircraft leasing business, International Lease Finance Corp. (ILFC). Reuters reported last week that at least two consortia are emerging to bid for the $8 billion business, though two large potential suitors lost interest.

AIG is also selling its U.S. auto insurance unit, a business said to be worth around $2 billion. Reuters reported earlier this month that Swiss insurer Zurich Financial Services AG was close to buying it. A source close to the matter told Reuters on Thursday that the deal is close to falling apart, due to market conditions.

Separately, the U.S. Senate Banking Committee has scheduled a hearing on March 5 to examine government aid to AIG, a source familiar with the hearing said on Wednesday.

(Editing by Lincoln Feast)

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