mysql> show databases; ERROR 1018 (HY000): Can't read dir of '.' (errno: 13)
this could be one of two issues, firstly a permissions issue which you should take a look http://dev.mysql.com/doc/refman/5.0/en/installing-binary.html - from point 6 down.
or indeed it could be that your client is using old style password hashes and your mysql server is using newer style password hashes. easy option is to use the new style password on your client which is normally a question of upgrading the client. however, since this seems to be access on a local db server I would try the first suggestion above.