The panic in world credit markets reached historic intensity yesterday prompting a flight to safety of the kind not seen since the second world war.

Barometers of financial stress hit record peaks across the world. Yields on short-term US treasuries hit their lowest level since the London Blitz. Lending between banks effectively halted and investors scrambled to pull their funding from any institution or sector whose future had been called into doubt.

The $85bn emergency Federal Reserve loan for the troubled insurance giant AIG, announced on Tuesday night, failed to curb the surge in risk aversion. Instead, markets were hit by a new wave of anxiety.

One cause for fear came when shares in a supposedly safe money market mutual fund fell below par value – or “broke the buck” – due to losses on Lehman Brothers debt. This raised the risk that retail investors in other such funds could panic and pull out their money.

All thought of profit was abandoned as traders piled in to the safety of short-term Treasuries, with the yield on three-month bills falling as low as 0.03 per cent – rates that characterised the “lost decade” in Japan. The last time they were this low was January 1941.

Shares in the last two largest independent US investment banks left standing – Morgan Stanley and Goldman Sachs – fell 37 per cent and 21 per cent respectively as the cost of insuring their debt soared, threatening their ability to finance themselves in the market.

Repercussions were felt far beyond the US. There was turbulent trading in HBOS, a huge UK mortgage lender, which was forced – at the prompting of the UK government – to enter into merger talks with fellow retail bank Lloyds TSB after drastic falls in its share price.

Lending between banks in Europe and the US effectively halted. The so-called Ted spread – the difference between three-month Libor and Treasury bill rates, which measures fear over banks – moved above 3 per cent, higher than the record close after the Black Monday stock market crash of 1987.

The US authorities fired back with the Treasury announcing that it would borrow money to give to the Fed to use for its emergency lending operations – essentially removing any balance sheet constraint on the size of this assistance.