Bank-to-bank lending freezes; bankers ask "who's next?

By Mike Dolan and Kirsten Donovan

LONDON (Reuters) - Financial trading and interbank lending almost ground to a halt on Monday as banks grew fearful of dealing with each other following Friday's near collapse of U.S. investment firm Bear Stearns, prompting talk of another round of coordinated central bank aid.

As banking stock prices and the U.S. dollar plummeted, banks' access to unsecured borrowing from other banks fell to a relative trickle and dealers said the over-the-counter market had become highly discriminatory, depending on the bank name.

The seizure in money markets was reflected in a dramatic 80 basis point surge in overnight dollar London interbank offered rates, the biggest daily increase since the attacks of September 11, 2001.

"Banks and institutions are just scrambling for cash, any cash they can get their hands on," said a money market trader at a European bank.

"And it's seen as a U.S. market problem for the moment, or a dollar problem anyway," he said, noting the relatively modest increase in overnight euro and sterling Libor.

Published dealing rates were unreliable and analysts said any bank that had not already secured funding further than a week or so would struggle to raise cash at all.

"Bear's near-collapse and takeover accelerates the liquidity crunch and the money market crisis," Dresdner Kleinwort analyst Willem Sels told clients in a note.

"Banks' risk aversion and sensitivity to counterparty risk should rise even further, leading to more pressure on hedge funds. Money markets are having a brutal wake-up call."

As various pockets of the global short-term credit market froze, investors flocked into Treasury bills and cash-like investment to shelter their money from the credit turmoil.

For example, the three-month T-bill yield, seen as a "risk-free" return on U.S. assets, briefly fell below 1 percent to its lowest level in about five decades.

COMING TO TERMS

Bankers said they were struggling to assess developments since the New York Federal Reserve said on Friday it was propping up the stricken firm via Wall St bank JP Morgan, and intense concerns about the stability and solvency of financial counterparties caused dealing volumes in lending markets to seize up.

In an effort to minimize the fallout and in conjunction with the fire sale of Bear Stearns to JP Morgan, the Fed on Sunday cut its discount lending rate by a quarter percentage point to 3.25 percent and announced another series of liquidity measures.

But with concerns about whether other firms may meet a similar fate to Bear Stearns, nerves on every trade were jangled.

"It's quite illiquid this morning. If you want unsecured cash you're really going to have to pay up for it. It's really quite an intense situation," said Calyon analyst David Keeble.