TREASURIES-Demand for safety pushes yields down

* T-bill yields sink in scramble for cash

* Global stock sell-off adds to safe-haven bids

* Money market funds seen as key buyers

* Fall below par by one money market fund spurs safety bid (Updates prices, comment, changes byline)

By Ellen Freilich

NEW YORK, Sept 17 (Reuters) - U.S. Treasuries rallied and bill rates plummeted on Wednesday as unrelenting financial market upheaval fed demand for cash and ultra-low-risk investments.

Money market funds were big buyers of Treasuries as they anticipated heavy redemption by investors worried about money market funds' exposure to securities issued by struggling insurer AIG (AIG.N), and by Lehman Brothers LEH.N, which filed for bankruptcy two days ago, they said.

Late Tuesday the Reserve Primary Fund, a money-market mutual fund, fell below $1 a share in net asset value due to losses on debt issued by Lehman LEH.P. The fund held $785 million in Lehman securities, which it revalued to zero.

Analysts at IDEAglobal said the Reserve Primary Fund was known as the industry's safe-haven money market fund. The fact that it fell below $1 a share in net asset value "is likely to cause investors to transfer their funds to bank money market accounts or Treasury securities," IDEAglobal said.

One-month T-bill yields US1MT=RR traded at 0.18 percent, down 47 basis points from late Tuesday. It briefly slipped below zero percent, according to analysts, the lowest since the one-month bill was reintroduced in 2001.

The risk-aversion move also pushed longer Treasury note yields lower despite a brief sell-off after the government made a special $85 billion loan to American International Group Inc (AIG).

Two-year Treasury notes US2YT=RR rose 9/32 in price to 101-13/32. Their yield, which moves inversely to price, was 1.64 percent, down from 1.79 percent late Tuesday.

Benchmark 10-year debt US10YT=RR rose 7/32 in price for a yield of 3.41 percent, down from 3.43 percent on Tuesday.

"Treasuries traded up because it's nearly impossible for people to assess where the risks lie in the securities they own so they go to the de facto risk-free securities which are Treasuries," said Lance Pan, director of credit research at Capital Advisors Group in Newton, Massachusetts. "In this market, no one wants anything other than Treasury bills."

Treasury bills were in such demand that the U.S. Treasury Department said it would sell $40 billion in cash management bills on Wednesday to help the Fed finance a rescue plan for AIG under which the New York Fed offered $85 billion in loans in return for an AIG stake of nearly 80 percent.

The cash-management bills will allow the New York Fed to advance $85 billion to AIG without putting downward pressure on the benchmark federal funds rate, which the Fed is holding steady at 2 percent, and "has the additional benefit right now of satisfying the strong demand for bills that exists in the marketplace," said Michael Moran, chief economist at Daiwa Securities America in New York.

A renewed sell-off in global equities also drove safe-haven bids for U.S. government bonds, analysts said.

U.S. stocks .DJI fell more than 3 percent on Wednesday as a spike in interbank lending rates fanned fears about the health of global markets. Investors dumped financial shares. Morgan Stanley (MS.N) shares fell 35 percent and the other remaining major U.S. investment bank, Goldman Sachs (GS.N), fell 24 percent. (Additional reporting by Richard Leong and Chris Reese; Editing by James Dalgleish)