I assume (for I think obvious reasons) this is most popular in mountain towns or communities with large hills. But in my state particularly, it seems like every town with a high school has the big white letter on the hill. Most universities have one as well.
It was a fad that spread among college towns in the western US from 1905 to around 1915. The earliest block letters were initially the results of inter-class rivalries. The first was the University of California, Berkeley, in 1905, then Brigham Young University in 1906, and then their rival the University of Utah the following year, and it spread from there in popularity.
In the case of BYU, the juniors started to build a "1907" on the mountainside to show up 1906's graduating seniors. The seniors retaliated by grabbing a bunch of juniors, shaving their heads and throwing them into the Botany Pond near campus. To prevent any further trouble, the school administration decided to have the entire school build a "BYU" on the mountain as a project to unite all of the classes. They surveyed out the letters and hauled up rock and managed to build a "Y" before they all got tired and quit. Every year since, it has been a tradition to whitewash the Y once a year, just as it is a tradition for most schools who maintain a block letter on their mountain. Typically you'll see block letters in university towns in the western US, but some high schools carry on the tradition too.
This article (James J. Parsons, "Hillside Letters in Western Landscapes," Landscape, 30, no. 1 [1988]) explains the history of college block letters in wonderful detail.