Q. I have always heard that the deficit spending by the federal government was a primary cause for increasing interest rates. I've also heard that if the federal government started repaying its outstanding debt, interest rates would go down. Would the use of the present and projected government surplus cause a decline in interest rates? What effect would this have on the many retirees who supplement their Social Security with income from interest bearing securities such as Treasury Notes, money market accounts and certificates of deposit?

---J.T., Houston, TX


A. You've put your finger on a significant debate. The basic theory is that interest rates rise and fall with demand for credit. When government borrowing is added to private sector borrowing the total can exceed the pool of savings available for investment. Take the government out of the borrowing pool and interest rates should fall.

Whether Federal debt should be eliminated altogether is another matter. Some hold that risk-free government debt has served so long as a benchmark for other debt that our financial markets would function better if we continued to have a significant amount of public debt. Still others argue that paying off the federal debt would take money out of the private sector where it could be used more effectively. Given some of the excesses we've seen in private sector financing in recent years, I find the last argument hard to swallow.

Whatever the theories, we are entering a period that will be very difficult for people who depend on investment income. Treasury obligations with maturities under one-year now yield less than 3.7 percent. In the Northeast, where CD yields tend to be lower than elsewhere, 3-month bank CDs now average 3.19 percent.

While it is still possible to find high credit quality mutual funds that have yields just over 7 percent, we can expect yields to decline as corporations and homeowners refinance. Older Americans are heading for a big-time "coupon panic."


Q. I married a few months ago and my husband, who is less conservative than I am, entered the marriage with 3 condominiums. We live in one and rent two others out for slightly more than they cost us each month. My husband believes this is a good investment strategy for retirement, stating that the interest on the mortgage is written off and that we can sell them for more than their purchase price.

He wants to continue to buy condominiums. Although I lack expertise in real estate investment (I am 24 and lived at home prior to marriage) I question his method of investing. My parents saved the "old-fashioned" way by paying off all debts ahead of time and watching their pennies. I have always done the same, but am I wrong about this one?

---E.G., by e-mail from Ohio


A. Remember the old bumper sticker, "One nuclear bomb can spoil your whole day?"   Well, there is a corollary--- one tenant can trash your entire condo. Most people like real estate because it can be seen and touched. They also like it because it can be leveraged with debt. Debt leverage raises the potential return substantially.

The limitation of real estate, particularly for small investors, is that it presents a lot of risk if the flow of rent slows or stops. Professional investors look for large properties where they hope to keep the vacancy rate to 5 percent or less. This usually means a minimum of 20 units. With two rental condos, one vacancy means a 50 percent vacancy rate.

To measure your personal level of risk, check the monthly expenses on one of your condos and compare it to your lowest checking account balance in a month or your savings account balance. How many months can you hold on if you lose a tenant? Find out if your husband has created a reserve for replacing things like stoves, refrigerators, and dishwashers. You should have the cash to survive a tough tenant.

Some readers will interpret this as being negative about real estate. That would be wrong. The important difference between traditional financial investments and small rental real estate is that your stocks will never need you to pay their bills.

That's a big difference.

My suggestion: since one or both of you works for a living, take advantage of any tax deferred investments you can make before you acquire more real estate.