The U.S. Treasury Department and the Federal Reserve need to stop using the benchmark interest rate known as Libor in financial rescue programs because it might not be reliable and could put taxpayer dollars at risk, a federal watchdog said Thursday.

The special inspector general for the Troubled Asset Relief Program, the bailout vehicle launched during the financial crisis, recommended that the Treasury and the Fed change some initiatives to ensure participating U.S. firms use alternatives to Libor — which stands for the London inter-bank offered rate — in pricing billions of dollars in loans.

Libor is intended to measure the rate at which banks lend to one another and is used as a benchmark to set borrowing costs on financial instruments, including derivatives and mortgages.

It has faced heightened scrutiny since Barclays, the London-based financial giant, agreed to pay more than $450 million in fines to U.S. and British authorities to settle charges its employees rigged the rate to increase profits.

The Treasury and the Fed should “cease using Libor in TARP programs,” the special inspector general said in the report. “American taxpayers who funded TARP may have been at risk and continue to be at risk from the manipulation of Libor.”

Libor was set as the base interest rate in many government bailouts from 2007 to 2009. More than three years after the launch of TARP, the federal government still has bailout programs in operation, and some will last until 2015 or 2017.

“The scale of what has erupted over Libor is significant,” Christy Romero, the special inspector general for TARP, said in an interview.

The Treasury and the Fed have said they had no choice but to use Libor in designing the lending programs that propped up the financial sector when credit seized up. In letters to Romero, both argued it was not in the taxpayers’ interest to pursue changes now.

The watchdog’s report focused on two TARP programs.

One, known as the Term Asset-Backed Securities Loan Facility, or TALF, was begun to jump-start the securitization market for credit cards, auto loans and small-business loans. The second, the Public-Private Investment Program, or PPIP, was intended to use taxpayer money and private capital to get bad assets off the books of major banks.

There is $598.6 million in outstanding TALF loans and $5.685 billion in outstanding PPIP debt with interest tied to Libor, the report said.

“If we sought to renegotiate the rate, it is likely that borrowers either would not agree to a rate change or would agree only to a change that would result in a lower payment to the taxpayers,” Treasury Assistant Secretary Timothy Massad said of the TALF loans in a letter to Romero dated Oct. 9.

As for TALF, the Fed wrote that neither it nor the Treasury had the “authority to unilaterally change the interest rate.”