What does this mess mean for my finances?

John W. Schoen Senior producer • Profile • E-mail

Where to begin? An extraordinary week in the financial markets brought a flurry of questions from readers about their personal finances: from the price of gold to the outlook for the Fed to the safety of annuities issued by failed insurance giant AIG

Amidst current financial turmoil, why are gold prices shooting up? And why are T-bill rates dropping?
— Bernice, Singapore

Throughout history, strong demand — combined with limited new supply — has made gold a favorite “safe haven” during times of financial crisis. It’s also viewed by many as a hedge against inflation or the devaluation of paper assets. That’s why demand is surging, forcing prices higher. But it’s not entirely safe: Gold prices can, and do, fall from spikes like this.

The same is true of T-bills. Since it’s highly unlikely that the U.S. government will ever default (make that unthinkable — we don't want to think about it), T-bills are one of the safest places to stash cash. The recent financial panic has created so much demand for the safety of Treasuries that investors are willing to buy T-bills with little or no interest — just for the peace of mind they’ll get their money back.

At one point this week, short-term Treasuries briefly had a negative yield: Investors were willing to get back a little less of their money in return for knowing they’d get most of it back.

If no one buys American debt, what will happen?
— Randy C., Mesa, AZ

If no one bought American debt, the government would have to shut down.

Send us your questions Senior producer John W. Schoen answers questions about the financial crisis and how it affects you. Click here to ask your question.

Because our government spends more than it charges its citizens for the services it provides, it has to borrow the money from investors and countries that live within their means and have money left over to invest. For the moment, it looks like growth in the global economy will keep producing plenty of surplus cash that needs to be invested somewhere. And, also for the moment, the U.S. Treasury is about the safest place to stash that cash. That’s because even though our government is running huge deficits the U.S. economy is still the largest and most diversified in the world.

But the recent move by the Treasury to take over hundreds of billions in bad debts from private lenders creates more risk for anyone who decides to lend their money to Uncle Sam. Before they stop buying Treasury debt altogether, investors will demand higher interest rates to make up for that added risk.

That’s a real worry right now: If interest rates on Treasuries rise, it will raise the cost of borrowing on all forms of debt. With money already getting tougher to borrow, any increase in the cost of borrowing would only make matters worse — for the financial system and the global economy.

AIG annuitites: Are they insured? What happens with them?
— Maureen, Va.

Annuities are not insured. In effect, they’re a form of insurance — a promise of lifetime income. In return for a chunk of money, the insurance company invests that money and agrees to pay you an agreed-upon amount, no matter how long you live.

While they’re not insured, the insurance companies that offer annuities and other insurance policies are heavily regulated, state by state. Each state enforces rules and restrictions designed to make sure insurance companies based in that state keep enough money invested safely to back all the promises they’ve made. 

The problems that sank AIG were risky bets made by the parent company. AIG's 70-odd subsidiaries that back insurance policies are in good shape. Some of them may be sold to other insurance companies, which will assume responsibility for the claims of policyholders — not unlike what happens to your savings account if your bank gets bought out by another one.

States also maintain guaranty funds, backed by a pool of money paid by insurers, that can be tapped if an insurance company goes bust and can’t pay all its claims. There are limits (which vary state by state) on how much the fund will pay to cover any individual claim. The Fed’s rescue of AIG makes it even less likely that any policyholder would lose money.

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