One US bank after another gets into trouble, how do we stop the chain reaction?

When one of the most powerful people in America says that the biggest uproar surrounding the banking crisis is over and everyone can sleep easy, the banks won’t get into trouble anymore, you can say that. Go out later?

Apparently not. Jerome Powell, chairman of the U.S. Federal Reserve, did not mislead those words of reassurance on Wednesday afternoon.

For example, Bawest Bank, a relatively small bank from Los Angeles, fell more than 70 percent in a few days. Western Alliance, a Phoenix regional bank, also fell more than 50 percent, with a few more to come.

Although these banks partially offset losses in the stock market on Friday, investors and customers remain very uneasy. The turmoil began in March with the collapse of a handful of mid-sized banks, including Silicon Valley Bank. On Monday, the forced acquisition of First Republic Bank came on top of that.

Every rumor leads to a stock market reaction

Each of these banks did not spread their risks properly and invested too much in investments that suddenly fell in value when interest rates rose in the US. Tighter oversight could have prevented this, policymakers are now deciding.

Meanwhile, it’s less and less obvious how well or badly things are going at a bank, and investors are relying more on gut feelings. Every news or negative rumor immediately triggers a huge stock market reaction.

Add to this the behavior of speculators and the crisis was over. They are now hunting down the remaining regional banks, seeing which ones are weak, and then speculating that their stock prices will fall further.

This can be done by going ‘short’ on a stock, for example on PacWest. In fact, short positions in both that bank and Western Alliance have increased significantly in recent times.

It works like a flywheel. Other investors are shocked by these large short positions: if everyone is betting openly that a bank will fail, things will not go well there.

The bank run is complete

That observation automatically triggers a new wave of sales, says Groningen Macroeconomics Professor Steven Brackmann, causing a self-reinforcing effect to quickly arise.

Especially when customers don’t think about moving their savings to another bank and see price drops on the news. No bank can withstand a real ‘bank run’ and then the story is over.

According to Edin Mujakic, Chief Economist at OHV Asset Management, it may take some time for calm to return. There is no easy solution.

Chances can suddenly change

Besides introducing stricter supervision, the government can focus more on the deposit guarantee scheme. In the US, savings up to $250,000 are protected in the event of a bank failure. This should prevent people from continuing to withdraw money if their bank is in bad news.

But does paying more attention to such a safety net really make a difference? Many are aware of its existence, Mujakic believes, but still withdraw their money in an irrational mood.

Both Brockman and Mujakic say investors are now waiting for them and each other to repent. At a certain point, sharply falling stock prices may not be a good reflection of how a bank is actually performing. In fact it is wise to buy them again in bulk.

Thus, the game of dominoes ends as soon as it starts. But the question is when that moment will come.

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The bankruptcy of First Republic Bank is creating new turmoil in the banking industry

First Republic Bank went bankrupt. It was the third US bank to fail in two months.