Sell First, Ask Questions Later: Fraud Fears Hit U.S. Regional Banks, Sparking Broad Market Sell-Off

TradingKey - Investors were already under strain this week amid persistent lack of economic data transparency and renewed escalation of U.S.-China trade tensions when two regional banks' disclosure of loan fraud allegations acted like a stone dropped into an already fragile market, triggering a major wave of panic and turmoil.

Credit Fraud Allegations

Zions Bank, headquartered in Salt Lake City, disclosed that it has filed lawsuits against Cantor II and Cantor IV investment funds to recover over $60 million in loans.

The bank stated that these funds used revolving credit lines to purchase distressed commercial mortgage loans, with approximately $50 million potentially unrecoverable. Zions has filed legal proceedings against two unnamed borrowers but emphasized that this is an isolated incident.

Almost simultaneously, Western Alliance, based in Phoenix, revealed that it had also extended loans to the same borrowers.

In response to the allegations from both banks, attorneys representing Andrew Stupin and Gerald Marcil of Cantor Fund Group, Brandon Tran, issued a statement strongly denying all allegations of misconduct.

“These claims are unfounded and misrepresent the facts,” Tran said. “We are confident that once all the evidence is presented, our clients will be fully vindicated.”

Panic Spreads Through Fragile Market

Despite the relatively modest scale of these incidents — amounting to tens of millions of dollars, which is small compared to other recent credit blow-ups — the market reaction was disproportionately severe.

Zions and Western Alliance saw their stock prices plummet 13% and 11% respectively following the news, becoming direct victims of market panic.

This panic quickly spread across the entire regional banking sector, with the S&P Regional Banks Select Industry Index crashing 6.3% on Thursday — the worst single-day performance since April. Even larger financial institutions weren't spared, as the S&P 500 Financials sector fell 2.8% on Thursday, marking its largest single-day decline since April, with all major financial stocks closing lower that day.

The market's extreme reaction stems from deepening investor concerns about a broader credit crisis. These concerns had been accumulating amid recent economic data uncertainty and escalating trade tensions, and this incident served as the spark that ignited the powder keg.

JPMorgan CEO Jamie Dimon's "roach" warning — that "when you see one roach, there are likely more" — seems particularly prescient now.

“So far these seem one-offs, but you get enough one-offs and people start looking for more,” said Mike Mayo, managing director at Wells Fargo. “There’s not too much margin for error when you had this sort of exuberance in credit markets — very good times are when bad loans are made. And so I think it is caution winning today over optimism.”

Banking Investment Characteristic: "Sell First, Ask Questions Later"

This cumulative effect of "isolated incidents" has sharply increased investor risk aversion, with the "sell first, ask questions later" mentality rapidly spreading among market participants, leading to a flood of selling pressure.

JPMorgan analysts have noted that banking is inherently a sector where investors tend to "sell first and ask questions later." Once negative signals emerge, the rapid deterioration of market sentiment and collective irrational selling become greater concerns than the actual risks facing bank balance sheets.

For many investors, the painful memory of regional bank failures like Silicon Valley Bank in 2023 remains vivid, and the market turbulence and impact on financial system stability from that crisis have yet to fully subside.

Steve Sosnick, Chief Strategist at Interactive Brokers, pointed out that it's precisely this deep-seated memory of historical lessons that may be a significant factor behind investors' strongly panicked reaction and the substantial stock market decline on Thursday.