Treasuries and three-month bill yields dropped to less than 3 percent amid great concerns over banks' willingness to lend that led investors to relative safety of U.S. government debt.

There was a high increase in the interest rate that banks charge each other for borrowing in dollars per month being the highest for over a decade as most of the banks sought to cover their commitments through the start of 2008.

However monthly bill yields fell as traders increased bets that Federal Reserve will cut borrowing costs by half percentage point next month to prevent recession.

People are looking for funding over the next few weeks and through year-end, said Michael Franzese, head of government bond trading in New York at Standard Chartered.

The three-month bill's yield dropped by 0.06 percent point to 2.97 percent.

On five year and ten year notes, the yield dropped by 3.38 percent and 3.92 percent respectively.

This made the Treasury $13 billion auction of five year notes to draw the weakest demand since July.

The difference between three-month bill yields and the London interbank offered rate became too wide in three months as a result of banks' reluctance to lend to each other.

This year August, the money market funds dumped assets linked to a collapsing U.S. mortgage market in favor of the shortest maturity government debt but the spread has more than doubles this month.