America's janky payment system, explained

You can walk into a supermarket and buy a bag of groceries any number of ways. If you're feeling old school, you can plunk down cash or even write a check. But you can also use debit and credit cards and a thousand-and-one different apps, from Venmo to Apple Pay.

But if you're the supermarket, you can really only acquire those groceries one way. In contrast to the digital revolution in consumer payments, how businesses pay each other has largely remained the same since the 1970s.

That might be about to change. It's mostly flown under the radar, but American businesses and the Federal Reserve are deep in a sweeping and sometimes testy conversation about how to finally overhaul that system for the 21st century.

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First, a little history is in order.

When consumers buy anything that doesn't involve handing over physical cash, what's actually happening is that the banks of the two participants in the trade exchange money with each other. The same thing happens when two businesses conduct a sale, or when businesses and banks exchange loans or fees or whatnot. And before the creation of the Federal Reserve in 1913, the system by which all this money moved was ad hoc, unpredictable, unreliable, and plagued by delays.

The arrival of the central bank created a national system that helped standardize and rationalize that payment system. But it remained paper-based, and by the 1970s the volume of checks was overwhelming the system, creating its own latent threat to the stability of American commerce. Working together, the Federal Reserve and the private sector built the automated clearing house (ACH) system — a national network for settling payments electronically — in 1974.

Today, virtually all the movement of money between businesses and banks necessitated by Americans' economic activity flows through its network. Consumers rarely interact with it directly. But financial apps like PayPal and Venmo rely on its infrastructure, as do all the modern digital payment and transfer services offered by banks themselves. Paychecks, Social Security benefits, recurring utility bill payments, and more all run through it. The ACH handles 90 percent of all electronic transactions in the U.S. — over 25 billion transactions in 2016, with a total money flow of roughly $40 trillion a year. Over 25,000 institutions participate in it and jointly fund its operations. The ACH is jointly overseen by the Fed and NACHA (the National Automated Clearing House Association), an organization of the private banks and firms that rely on the ACH.

But at 40 years old, the ACH is beginning to show its age. It's closed on weekends and holidays, for example. While it's electronic, it still settles payments in batches, meaning a payment can take several days to show up in the receiver's account. Despite the arrival of the internet and ubiquitous digital technologies, "there has been relatively little change to the back-end processes that actually move value throughout the financial system," the Treasury Department recently observed.

That's a problem not just for businesses, but for the many millions of Americans who live paycheck to paycheck. The consequences of a paycheck not clearing fast enough can range from overdraft fees to life-altering financial turmoil. "This adds up to a billion dollars a year in costs borne by middle- and lower-income families," Aaron Klein, a Brookings Institution fellow, told Politico.

Plenty of businesses also live "paycheck to paycheck," and delayed payment settlements can mean they don't always have the money on hand to meet payroll obligations or make necessary investments. Those are obviously problems for smaller businesses, but even major players like Walmart and Target are calling for an overhaul of the ACH system.

The goal is pretty straightforward: A new national payments system that operates 365 days a year, 24 hours a day, and that settles payments instantaneously.

The Fed has had a taskforce with hundreds of participants going on this subject for the last five years. There was that aforementioned Treasury Department report that the agency issued recently. Fed officials are increasingly vocal about the project. And at the start of October, the Fed requested public comments on a new push to build a real-time, 24-7 payment settlement system.

Everyone agrees we have the ability to do this. Indeed, several countries around the world are arguably ahead of the U.S. in this regard. But exactly how we should do it is in dispute.

Over the last few years, NACHA has actually been gradually rolling out updates to the existing ACH system to test a real-time 24-7 system in limited settings. If that continues, the new system will develop much like the original ACH did — a cooperative effort by private businesses and banks that also happens to involve the Federal Reserve. But the central bank is also fiddling with the idea of just building its own new national payments system, run by the Fed branches, that serves as both an alternative and a competitor to the system NACHA is rolling out.

Needless to say, that's making the private banking industry somewhat nervous. They obviously have a self-interest here, but they also argue a Fed-built system would only confuse and delay the launch of NACHA's system. "More competition" always sounds good in a capitalist context, but this does seem to be a situation that trends towards natural monopoly, similar to roads and utilities. There's only been one ACH and there will likely only be one real-time 24-7 version of the ACH as well. But smaller businesses, local and community banks, and consumer advocates all like the idea of the Fed getting involved, because it would mean the new system operates more as a public service that treats all comers equally.

Another thing to consider is whether consumers should be able to use this new system as well. There's an overwhelmingly pressing need for a public banking option of some sort, both to provide payment system access to less privileged Americans, and to provide them reasonable and affordable credit. An effort by the Fed to build a new, super-fast, available-at-all-times payment system could naturally gel with those larger efforts, should they happen.

The future of America's payment system needs to be nimbler, faster, and more convenient. But it arguably needs to be more democratic as well.