Correspondent Clearing & Bank Collapse
Over on Paul Kedrosky’s Infectious Greed blog, he has a link in the research he is catching up on regarding how check clearing through correspondent banks may have contributed to bank collapses during the depression.
As I commented on his post, the research in question reminded me of an interesting article I read on The Fed’s Entry into Check Clearing Reconsidered, which discussed a time when the check clearing system and associated costs were market driven, and in fact, checks were regularly settled via correspondents and often not at “par” value. This article resonates with the link at Paul’s blog when it mentions that:
“A key perceived defect of the previous system was the “pyramiding” of reserves in financial centers, which left the latter vulnerable to sudden widespread withdrawals. Through rediscounting the Reserve Banks would provide an elastic supply of balances in response to rapid demand shifts, preventing financial panics.”
While the conventional wisdom is that the Fed’s entry into check clearing was to eliminate non market based inefficiencies in the clearing system, this link provides perhaps a better rationale for a system that, for a time at least, had tax payers subsidize the clearing of checks.
