What makes you think you are loosing muscle and not fat? How do you know your lack of strength isn't from muscle fatigue? If you cut calories, but work out a lot, your workout may suffer because you don't have enough engery (calories) to push the weight up.

Are you trying to loose fat or weight? If you have a lot of muscle mass you will burn fat quicker. If you are working hard in the gym, loosing a lot of weight, loosing muscle strength, and eating less, you may be quickly burning fat by not providing your body with enough outside calories. This might explain the rapid weight loss and loss of muscle strength. I'm guessing that if you are tossing around a couple hundred pounds, you are a big guy and are probably going to need a decent amount of calories.