Central banks labor to calm markets in Lehman storm

By Marc Jones and Yoko Nishikawa

FRANKFURT/TOKYO (Reuters) - Central banks mobilized worldwide on Monday to reassure financial markets after Lehman Brothers filed for bankruptcy protection and news that Merrill Lynch, another Wall Street giant long seen as too big to fail, was being sold.

"We hope that we don't see a crisis which pushes the global economy to the brink of ruin," German Economy Minister Michael Glos said.

Central bankers had their work cut out. Share prices sank and demand soared for extra short-term lending which they offered in an attempt to keep going the system that oils the wheels of modern capitalism.

On the interbank market, overnight dollar borrowing costs surged almost one percentage point to their highest in nearly three months, showing that banks are hoarding cash rather than lending it on.

The central banks' response started on Sunday when the U.S. Federal Reserve announced that central banks, regulators and supervisors were in close contact internationally and were monitoring events as they unfolded.

It announced emergency measures for lending operations which effectively relax the terms on which commercial banks can borrow from the U.S. central bank.

In Europe, the European Central Bank, as well as the German, French, British and Swiss authorities all responded in turn.

The ECB held a money market operation where it allotted 30 billion euros in one-day liquidity to banks, only a third of the level demanded.

NOT ENOUGH?

Economists Jacques Cailloux and Gareth Claase at Royal Bank of Scotland said this high level of demand, similar to that seen when the credit crunch first forced the ECB into emergency mode in August 2007, showed how fragile the situation was.

"The ECB will likely take note that the financial system remains starved of cash and that it might thus be forced to step in again," they said.

The Bank of England put an extra 5 billion pounds into the financial system after receiving bids of nearly five times the amount of three-day funds available. The Swiss National Bank also provided extra liquidity to the money market.

The bank-to-bank premium paid for overnight dollar funds was fixed at 3.10625 percent, according to the British Bankers Association's latest daily fixing, up nearly a percentage point to hit its highest level since late June.

In Asia, officials at Japan's central bank confirmed that the authorities were monitoring the situation closely, and the message was the same in Europe.

Stocks fell in Asia, then in Europe and finally in the United States as markets in each region opened. Safe-haven debt soared after emergency weekend talks failed to save 158-year-old Lehman from becoming the latest victim of the credit crisis.