The big picture

The credit world is a never-ending cycle of borrowing and lending money people don't have but expect to have in the future. Because of the credit system, our society has a lot more 'buying power" than "cash." As long as you faithfully repay what you borrow, you'll allow your lender to faithfully repay what he or she borrowed, which will allow the lender's lender to do the same, and so on. It's a delicate system: Each time someone breaks a promise or loses faith in someone else, the system suffers because the entire system is based on trust and credibility.

1. Buyers (businesses and people like you) often want a product or service that costs more than they're willing or able to pay with cash. So, they find a lender (such as a credit card issuer or hank), or ask the seller to arrange a loan for them (as is common in car purchases).

2. Sellers (e.g., store owners, service providers need to make sales to slay in business. Therefore, some offer loans to customers. Others arrange for their customers to get a loan from an outside lender (arid take a commission for arranging the deal). Still others allow third parties (e.g. credit card issuers) to "front" the money for buyers. In any case, at the time of the sale, little or no cash changes hands, but the sellers can record a sale and lenders can record new loans.

3. Lenders make loans based on the trust that their borrowers will repay faithfully. 'then they need to raise more cash to he able to make more loans and stay in business. So, lenders also borrow money from other lenders, and if they're a bank, they can also borrow directly from the federal government.

4. The federal government's bank, called the Federal Reserve Bank. lends money to banks specifically to supply them with enough cash to stay in business. The "Fed" makes the loans based on their trust that the banks will repay faithfully (which partly depends on the bank's borrowers-like you repaying them faithfully), the Fed, however, must also get money from somewhere. They can print more, get it from taxes, and borrow it.

5. Business and Individuals (like you) lend money to the government every time it auctions treasury bonds. (When you buy a Loud," you are actually lending the bond issuer money and expecting to he repaid on a schedule with interest.) The government adds an incentive: The interest is exempt from state income taxes. This means you may actually earn interest from loans you made to the government (for example, through Treasury bonds), and use that money to help repay motley you may have borrow.

Playing by different rules. People who repay faithfully and don't "overextend" themselves will build better credit and make it easier to borrow again. The Federal Reserve, however, is different. It can borrow as much as it wants because it's backed by a guarantee to all lenders called the "full faith and credit" of the federal government. In other words, we're asked to have complete faith in the government's credit that it will repay what we lend.

Terms:

• Prime rate. Lenders, particularly banks, charge their best customers (typically wealthy individuals and major companies) an interest rate called the "Prime Rate." They charge other customers higher rates, depending on the type of loan and each customer's own credit profile.

• Discount rate. This is the interest rate that the Federal Reserve Bank charges banks. It's always lower than the Prime Rate so that banks are assured of borrowing at a lower rate and lending at a higher rate.