NEW YORK (Reuters) - In a seeming game of hot potato, Wall Street's top firms were stuck with short-term U.S. government debt that no one wanted before Washington struck an 11th-hour deal last week to avert a default.
U.S. primary dealers - the 21 Wall Street investment banks who do business directly with the Federal Reserve - ended up absorbing much of the Treasury bills that money market funds and other investors were dumping, according to data from the New York Federal Reserve.
Their net holdings of Treasury bills jumped to $59.5 billion on October 16, one day before the government was expected to exhaust its $1.7-trillion borrowing limit. This was more than double what they had held a week earlier, according to data from the New York Fed released late Thursday.
In the days heading into the "drop dead date" on the debt ceiling, money market funds and a host of other investors were dumping T-bills that mature in late October and the first half of November because their repayment would be the most likely to be delayed if President Barack Obama and Congress were unable to agree to raise the government's borrowing capacity.
Interest rates on these T-bill issues had soared above 0.70 percent, levels not seen since the height of the global credit crisis five years ago. They were also higher than the yield on a two-year Treasury note.
"With many large money managers attempting to trim their exposure to the maturities most at risk of a technical default, dealer balance sheets likely became one of the few places bills could go as liquidity conditions substantially deteriorated," said Gennadiy Goldberg, interest rate strategist at TD Securities in New York.
From Oct 1 to 16, investors pulled $71.79 billion from money funds, which are major holders of T-bills, according to data firm iMoneynet.
Since the temporary debt ceiling extension, money market funds recouped $34.64 billion in the week ended Tuesday, raising their total assets to $2.64 trillion, iMoneynet said.
The current pact fully funds the government until January 15 and raises the debt ceiling until February 7
It is unclear whether the jump in dealers' T-bill holdings stemmed from absorbing supply from their customers who didn't want them or bets on a last-minute debt deal, analysts said.
The primary dealers also ended up buying more than their average share of T-bill supply at auctions as other investors shied away before the debt ceiling deal, analysts said.
"Whether this was the result of liquidity provision or speculation that 'everything will be okay' and Treasury would pay all of its obligations on time, dealers bought a lot of bills," Thomas Simons, money market strategist with Jefferies & Co., wrote in a research note.
Interest rates on one-month T-bills fell back to their pre-debt ceiling fight levels in the 0.01 to 0.02 percent range.
(Editing by Bernadette Baum)