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 prompted investors to abandon higher-yielding assets for the safety of the shortest-term government securities.

Investors pushed the rate as low as 0.233 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. The rate banks charge each other for short-term loans relative to Treasury bills rose to the highest since the stock market crash of 1987.

``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 fell 32 basis points to 0.38 percent at 10:26 a.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 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.

Money Markets

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 in Reserve Primary Fund 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.

``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.''

Borrowing in Dollars

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 today. The increase is the biggest since Sept. 29, 1999, during the run-up to the new millennium.

The difference between what the U.S. government and banks pay to borrow in dollars for three months, the so-called TED spread, widened to the most since the October 1987 stock-market crash as bill rates tumbled. The spread widened as much as 64 basis points to 283 basis points. It was as low as 75 basis points on May 27.

``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.''

`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. ``At least the Lehman saga has gone some way toward a clean-up. 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; Agnes Lovasz in London at alovasz@bloomberg.net

Last Updated: September 17, 2008 10:29 EDT