Sept. 17 (Bloomberg) -- U.S. Treasury three-month bill rates dropped to the lowest since at least 1954 as a loss of confidence in credit markets worldwide prompted investors to abandon higher-yielding assets for the safety of the shortest- term government securities.

Investors pushed the rate to 0.0304 percent on concern that credit market losses will widen after the bankruptcy of Lehman Brothers Holdings Inc. and the federal takeover of American International Group Inc. In a sign of banks' reluctance to lend, the rates charged for short-term loans relative to Treasury bill rates rose to the highest at least since the stock market crash of 1987.

``It's scary,'' said E. Craig Coats Jr., who co-heads fixed income at Keefe, Bruyette & Woods Inc. in New York and started trading bonds in 1969. ``This is the worst it's ever been since I've been in the business. Nobody knows what's really going on. Systemic risk is here and there and everywhere.''

Three-month bill rates fell 66 basis points to 0.0304 percent at 12:36 p.m. in New York. They had dropped to 0.3867 percent on March 20, after the Fed and Treasury engineered the takeover of Bear Stearns Cos.

Bills briefly pared their gains after the Treasury said it will sell $40 billion in 35-day securities through a series of special auctions at the request of the Fed so the central bank can expand its balance sheet after the takeover of AIG. The securities will be similar to cash management bills, securities issued on an as-needed basis at varying maturities.

Money Markets

``People are extremely cautious with respect to who they're lending money to at the moment,'' said Richard Bryant, a Treasury trader at Citigroup Global Markets Inc., one of the primary dealers that trade government securities with the Federal Reserve. ``They're willing to buy very short-dated Treasury instruments and forgo returns and in some cases pay for the privilege of knowing their money is safe.''

Three-month bill rates may be the lowest since the 1930s based on monthly figures on the Fed Board of Governors' Web site. Daily figures go back as far as 1954.

Reserve Primary Fund, the oldest U.S. money-market fund, yesterday became the first in 14 years to expose investors to losses after writing off $785 million of debt issued by Lehman.

Shareholders pulled more than 60 percent of the fund's $64.8 billion in assets in the two days since Lehman folded. Losses on the securities firm's debt forced the fund to break the buck, meaning its net asset value fell below the $1 a share price paid by investors.

Borrowing in Dollars

``The panic going round the money market world is what they've been investing in is not as safe as they thought it would be,'' said Dominic Konstam, the head of interest-rate strategy in New York at Credit Suisse Securities USA LLC, another primary dealer. ``If the banks don't want to lend to each other they don't want to lend to the banks. That means where else are they going to put their money -- they're going to put it in T-bills for safety.''

The cost of borrowing in dollars for three months jumped the most since 1999 as banks hoard cash. The London interbank offered rate, or Libor, rose 19 basis points to 3.06 percent, the British Bankers' Association said. The increase is the biggest since Sept. 29, 1999, during the run-up to the new millennium.

The jump in Libor and rising demand for bills widened the gap between what the U.S. and banks pay to borrow in dollars for three months to the most since the October 1987 stock-market crash. The so-called TED spread soared 85 basis points to 303 basis points. It was as low as 75 basis points on May 27.

Credit Default Swaps

``I'm extremely worried about what is happening to the money market mutual funds that have announced they've broken the buck,'' said Ajay Rajadhyaksha, head of fixed-income strategy at Barclays Capital Inc. in New York. ``That unfortunately can spiral in the sense that it makes it more difficult for all companies to raise short-term money because the money-market funds tend to be buyers of short term debt.''

The cost of protecting against a default by Wall Street firms Morgan Stanley, Goldman Sachs, Wachovia Corp. and Citigroup Inc. approached or surpassed record highs reached yesterday, trading in credit default swaps shows.

The Treasury's $31 billion sale of four-week bills yesterday drew a high discount rate of 0.3 percent, the lowest in the four-week auction's history.

In another sign of risk aversion, yields on emerging-market bonds have soared as investors moved money into Treasuries. The yield on Russia's 7.5 percent dollar bonds due in 2030 has jumped 91 basis points to a four-year high of 6.97 percent, according to JPMorgan Chase & Co. data. Yields on Venezuela's 9.25 percent bonds due in 2027 have surged 2.24 percentage points this week to 13.53 percent, the highest since May 2003.

`Under the Carpet'

Treasuries had declined earlier as the Fed's $85 billion loan to AIG allayed concern that a collapse of the insurer would destabilize the financial system. Barclays Plc, the U.K.'s third-biggest bank, will acquire Lehman's North American investment-banking business for $1.75 billion, three days after abandoning plans to buy the entire firm.

Central banks around the world pumped more than $280 billion into the financial system this week as they sought to ease a credit-market seizure. The Fed made the loan to AIG, the biggest U.S. insurer by assets, in exchange for control.

The AIG rescue ``smacks of sweeping the problem under the carpet rather than solving it in a structural sense,'' said Padhraic Garvey, head of investment-grade debt strategy at ING Bank NV in Amsterdam, in a note to clients. ``We are still in the midst of the flight-to-quality environment.''

HBOS Plc, the U.K.'s biggest mortgage lender, slid as much as 52 percent today on speculation it may not have access to funding. The shares rebounded, surging as much as 18 percent, as HBOS said it's in ``advanced'' takeover talks with Lloyds TSB Group Plc.

To contact the reporters on this story: Sandra Hernandez in New York at shernandez4@bloomberg.net;

Last Updated: September 17, 2008 12:37 EDT