Trader Talk

Portugal's Banco Espirito Santo got bailed out--why it matters

Portugal bailed out Banco Espirito Santo (BES), its biggest bank. Get used to seeing this.

The stock market, after dropping more than 10 percent in July, is up 1.8 percent today, leading all European bourses higher.

Over the weekend, Espirito Santo was saved by the Central Bank of Portugal, to the tune of roughly $6.5 billion, using the old "bad bank/good bank" model. BES's activity and assets will be transferred to a "good bank," called Novo Banco. Depositors and senior bondholders will not lose any money.

BES finding fresh capital is a 'big ask': Pro
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BES finding fresh capital is a 'big ask': Pro

To be sure, the process is complicated. Where is the money coming from to start this new bank?

Not from private investors—it will come from Portugal's Resolution Fund that was set up to help banks in trouble. Because the amount needed is so large, the Fund isn't big enough. That means they are going to "borrow" money from the state of Portugal.

Bottom line: the Portugese government is still lending money, and the key is how it is recouped. It remains to be seen whether Portuguese citizens will be paying as well. This is supposed to be a short-term bridge loan; Novo Banco is expected to be eventually sold to private investors who will reimburse the government. We'll see.

The old loans will stay with the "bad bank," which is also where existing shareholders and junior creditors will be. It will eventually be wound down.

Two things are supposed to happen: 1) the government will be reimbursed, and 2) the "moral hazard" argument is being addressed because shareholders and junior bondholders are taking a hit.

Who are existing shareholders? Besides the Espirto Santo family, a lot of European banks, including French bank Credit Agricole, which owns 14.6 percent.

Complicated, I know, but it is real progress. This is different than the Greek bailout, which was done at the government level. There, European citizens clearly were paying. With Cyprus, something similar happened: governments stepped in to help, though some depositors did lose money.

This is one of the first example of a genuine "bail-in." I'm not saying it has eliminated moral hazard, but it's progress.

What happens if a really big bank reorganization couldn't be handled by a central bank? Presumably, the central bank would turn to the European Central Bank as a last resort. They would, presumably fund whatever differences are left.

--By CNBC's Bob Pisani