If one were a holder of a Senior Debt security of a Spanish bank on Friday, you would end up with a functionally subordinated debenture after the bailout transaction on Monday.


Should the bailout of Spanish banks be accomplished via the issuance of new debt (versus equity), then damn near every bank in the EU will have a run on the debt portion of its capital structure. It will happen first with the Italian banks, from there, it will head to Paris.

Holders of senior bank debt have few options faced with this scenario. They could (1) dump their holdings, or attempt to hedge some of the risk. The only hedges available are (2) CDS, or (3) a short of the common stock. A combination of 1,2&3 would be devastating to the EU banking system.

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