[Help-gnu-radius] Radius DOES NOT work with MD5 hashed password

[List User]

My MySQL running on Win32, hence ENCRYPT() is not avialable.

According to radius docs
(http://mail.gnu.org/archive/html/help-gnu-radius/2003-03/msg00012.html) I
generate a password using MD5 function: "Test" ->
0cbc6611f5540bd0809a388dc95a615b. According to Network sniffer this exact
passsword is returned to radius, however Radius does not accept it, from
log:

Jul 24 15:11:27 Auth.notice: (AUTHREQ local 17 md5): Login incorrect
[md5/{chap-password}], CLID unknown.

User file is configured:
    DEFAULT         Auth-Type = SQL,

If I change it to use clear text password:
  Auth-Type = Local,  Password-Location = SQL,

Radius works perfect with mySql.

Questions:
1. Is there something wrong with my radius, so it does not use some crypt
libraries maybe?
2. What do I need to do to AVOID using clear passwords on the wire?

Here is radiusd info and OS info:

address@hidden raddb]# ldd /usr/local/sbin/radiusd
        libm.so.6 => /lib/tls/libm.so.6 (0x4002c000)
        libc.so.6 => /lib/tls/libc.so.6 (0x42000000)
        libnss_files.so.2 => /lib/libnss_files.so.2 (0x4004e000)
        libnss_dns.so.2 => /lib/libnss_dns.so.2 (0x4005a000)
        libresolv.so.2 => /lib/libresolv.so.2 (0x4005e000)
        libz.so.1 => /usr/lib/libz.so.1 (0x40070000)
        libcrypt.so.1 => /lib/libcrypt.so.1 (0x4007f000)
        libnsl.so.1 => /lib/libnsl.so.1 (0x400ac000)
        /lib/ld-linux.so.2 => /lib/ld-linux.so.2 (0x40000000)

Linux 2.4.20-8 #1 Thu Mar 13 17:18:24 EST 2003 i686 athlon i386 GNU/Linux

address@hidden raddb]#  /usr/local/sbin/radiusd --v
radiusd: GNU Radius version 1.0 (i686-pc-linux-gnu)
Compilation platform: linux
Debugging flags:
Compilation flags: PWD_SHADOW USE_SQL_MYSQL
Compilation defaults:
Ports in use:
 AUTH: 1812
 ACCT: 1813
Paths:
 configuration directory: /usr/local/etc/raddb
 logging directory:       /var/log
 accounting directory:    /var/log/radacct
 pidfile directory:       /var/run

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