Checks in America

The history of checks as a method of payment is fascinating and old. In fact, it is almost certainly true that checks, as a method of payment, are older than bills.

Ovid

It is very likely that checks existed in one form or another during the reign of the Roman empire since the idea of checks appears in early Latin poetry. Ovid, who died in 17 AD, wrote about a day when a rich man is trying to impress his wife.

But when she has her purchase in her eye,
 She hugs thee close, and kisses thee to buy;
 “Tis what I want, and ’tis a pen’orth too;
 In many years I will not trouble you.”
 If you complain you have no ready coin,
 No matter, ’tis but writing of a line;
 A little bill, not to be paid at sight:
 “Now curse the time when thou wert taught to write.”

While they were likely invented in ancient Rome, checks became popular in Holland, where, in the 1500s, merchants and international shippers would deposit their gold and silver coins with a counterparty in exchange for a cashier’s note. This way, the gold and the silver would not have to make a long trek home and become hunted bounty for pirates.

Between the early 1500s and the late 1600s, not much changed in the world of checking. Checks were used with some frequency among international shippers and some merchants, but the general public and even most merchants looked at checks with suspicion.

Boston in 1681

That all changed in Boston in 1681.

Map of Boston Harbor dated 1694

Boston, in the early 1600’s, was an odd town. It was part of the new world, yet desperately trying to be anything but new. It was ruled by the most religious puritans to land in the new world.

But by 1681, Boston had started modernizing and had a growing business population. The city reversed a 20-year old ban on celebrating Christmas, put in place originally to stop the dancing associated with the holiday, and began building itself as a center of both commerce and religion.

It was this growth in Boston that caused a shortage of currency. People wanted to buy and sell things — but they didn’t have enough gold and silver coins.

To remedy this situation, in September 1681 a group of Boston businessmen got together and crated The Fund at Boston in New England. These businessmen mortgaged their land to this Fund, received credits for the value of the land and then drew checks against this fund to buy and sell things.

This was a fascinating development since the Bank of England, in well old England, would not be founded for another decade and would not offer services similar to The Fund at Boston in New England for another two decades.

As The Fund at Boston in New England grew in popularity, other similar funds were started in other cities and towns in the United States.

These funds bought checks from local merchants without charging any fees; local checks, therefore, were cleared at par. In other words the funds paid the check holder the full amount of the check.

The funds, however, did charge a fee for checks that were mailed to them from out of town for settlement. This fee originally was meant to cover the costs of sending gold coins, frequently via horse carriage, to the fund or the bank that had received the check from one of its customers.

As US merchants began to travel more and more, these out of town check fees became more and more common.

To gain a competitive edge in the local market and to receive more business from local merchants, many local banks developed a network of relationships with out-of-town banks. These networks would allow banks to cash checks between each other without any fees.

Frequently meeting in local restaurants or train stations, employees from these banks would simply batch a week’s worth of checks and exchange them at pre-set meeting destinations, so-called clearing houses. These clearing houses were frequently placed close to train stations so that travel by rail would be easier for those making the trips every week. (Interestingly, to this day in an homage to the early days the term “payment rails” is used to refer to a system over which payments can be settled.)

At the meetings in the clearing houses, the banks would simply exchange checks and settle the difference in gold coin or letters of credit.

Under this ad hoc system, banks began sending checks to their network partners rather than the original bank. For example, if Bank A in Boston had a relationship with Bank B in Philadelphia, and was presented with a check from the Bank C in Philadelphia, Bank A would send the check to Bank B , and an employee from Bank B would then simply physically walk up to a branch of Bank C in Philadelphia and clear the check at par.

As these networks became more complicated, the routing of checks became more complicated as well. Checks would frequently travel hundreds of miles more than they needed to in order to be cleared at par.

While banks reduced the fees they paid using this clearance method, they did not reduce the fees they charged to their customers. This meant that starting in the 1700s, banks were making a significant amount of money from check interchange.

This created some very odd incentives for banks. Obviously reducing the cost of clearance led to an increase in time of settlement. A check that had to exchange hands 10 or 12 times would likely land in an account weeks after it was written. This meant that by the time the check was ultimately settled, the customer might no longer have sufficient funds in their account.

In one example, a check drawn from a Sag Harbor, New York bank travelled more than 1,200 miles through nearly ten cities before being deposited in Hoboken, New Jersey, which is less than 100 miles away from Sag Harbor.

In another example, a check deposited in an Alabama bank that was written from a bank merely a few city blocks away was routed nearly 2,500 miles, through Jacksonville and Philadelphia before returning to Alabama a week later.

In addition to increasing the credit risk, this system increased the risk of error. A check traveling 2000 miles might be lost, might be recorded incorrectly, or might be stolen by bandits along the way — a non-trivial risk in those days.

Spike in Popularity

For much of the two centuries between 1681 and the Civil War in 1861, checks lagged in usage behind government backed currency and private bank currency (the type that were taxed out of existence by the National Bank Act in 1870s).

By the 1850s, however, as private banks flourished and as free banks spread across the United States, checks became more and more popular. By the end of the Civil War, given all the trouble with the devaluation of greenbacks and shortage of gold and silver, checks were the most popular method of payment in the United States. This growth, incidentally, did not slow down until the late 1990s.

By the early 1940s, Americans were writing nearly four billion checks each year. That means that each American was writing on average a check every 11 days. By the 1950s, Americans were writing nearly eight billion checks each year. This works out to each American writing at least one check every week.

By 1979, nearly 90% of all payments in the United States were made by check.

Americans wrote checks for nearly every purchase — writing a total of 33 billion checks in 1979. That’s one check written every other day by each man, woman and child in the United States.

Interestingly, as the usage of checks in every day life grew the shape and the design of checks did not change much. The only major difference between a check written in 1860 and a check written in 1960 would have been the introduction of the magnetic ink character recognition code (MICR Code) at the bottom of the check in 1959.

Federal Reserve to the Rescue — Again

The system developed in 1681 for clearing a few dozen checks was collapsing by the late 1800s.

As checks became more popular and more fees were incurred, the US merchant population began lobbying Congress to fix what the merchants considered a banking racket.

The merchants, and some banks, began lobbying Congress to create a central bank. The US. Congress was skeptical. Two previous efforts to create a central bank (in 1791 and in 1816) had not ended well. Thomas Jefferson and Andrew Jackson had both spent a significant part of their political lives opposing such banks, arguing that they were unconstitutional and unnecessary.

But in 1913, spurred by the Panic of 1907 as discussed in the previous chapter, Congress finally relented and passed the Federal Reserve Act, giving the new Federal Reserve Board the specific task of getting rid of expensive check fees.

The Federal Reserve took up this task with gusto, and began to force — frequently by threat of forcing a bank into effective insolvency — an at-par check clearance system on US banks. By 1920, nearly 20,000 banks in the United States had signed up for the “voluntary” at-par clearance system. A few hold-outs sued the Federal Reserve. In the famous Am. Bank & Trust Co. v. Fed. Res. Bank of Atlanta case, the Supreme Court ruled in favor of the bank, and against the Federal Reserve.

The Supreme Court ruled that the Federal Reserve had been acting unconstitutionally and illegally by forcing banks to join its at-par clearance system.

“Congress did not in terms confer upon the Federal Reserve Board or the federal reserve banks a duty to establish universal par clearance and collection of checks; and there is nothing in the original act or in any amendment from which such duty to compel its adoption may be inferred. ”

Immediately after this decision, the number of banks charging check interchange went up. In the long run, however, the damage had been done. So many merchants had found banks willing to clear their transactions at par that the remaining banks wanting to charge interchange gave up their fight and waived their fees as well.