When Jose Manuel Barroso unveiled EZ bank recap guidelines last October – see my blog: Is Barroso's bank recap plan workable?  – of Oct. 13, 2011, he very clearly articulated the order in which recaps should be conducted (even if the overall plan was not well thought through and contradictory in places). Banks that fell below the minimum 9 percent Core Tier 1 Basel 2.5 capital adequacy ratio would be required to seek capital from the market first. If private creditors were unwilling to step in, banks would have capital provided to them by their governments.

Only if governments were unable to provide funds would the EFSF or ESM to provide funds. The latest scam clearly points to a government without the resources to fund its own bank bailout, a situation that should surely have triggered a sovereign rescue.

In the circumstances, how pathetic and weaselly that both Rajoy and de Guindos said the bailout was good for the euro and refused to consider the up-to-€100 billion ($125 billion) of external aid a bailout or a rescue, choosing instead to refer to it as a credit line for the banks (that by the way bears the same interest rate as Greek, Irish and Portuguese bailouts).

By the same token, how pathetic and irresponsible that Rajoy has so far refused to seek EU funds for a bailout that almost everyone else sees as inevitable not because he reckons Spain can pull through on the back of his policies but because of the stigma that comes with it. And what on earth happened to make Angela Merkel, that most inflexible and obstinate austerity merchant and a stickler for the rules, go along with this charade? I do wonder.

The positive market moves were as much if not more driven by short covering and short-term momentum buying than by fully-blown risk-on asset-buying. No one believes the bank bailout will be the end of the Spain story or that the cash will prevent Spain from seeking a formal bailout. The country is committed to taking on up to €100 billion of additional debt at the same time as €100 billion has fled the country so far this year and when central and regional government debt redemptions in the next year are in excess of €100 billion.

And here’s the most dangerous aspect of the bailout: because the Spanish government hasn’t been bailed out, it will still be dependent on the bond market to fund it. If the rescue funds come – as expected – from the European Stability Mechanism, existing bondholders will be contractually subordinated, just when Spain needs them the most. All EZ sovereign debt issued post-ESM will contain CACs that will force bondholders into PSI debt write-downs in the event of a bailout.

So who gets the money?

So who will get the EZ bailout funds? That’s a big question since Spain’s banking sector is in disarray. The government has been forced to rescue a series of banks since the crisis hit in 2008 and still has to return Banco de Valencia, CatalunyaCaixa and NCG Banco to private hands. The sale of the first two was scheduled to take place this month but has been postponed pending the results of the bank audit being conducted by Oliver Wyman and Roland Berger.

NCG, the result of a merger between Caixa Galicia and Caixanova (Caixa de Aforros de Vigo, Ourense e Pontevedra), is typical of the regional and multi-regional bank up-scaling forced through by the previous government. Of course, the most egregious example of how this strategy can fail if management fails to take proper steps and regulators and central bank turn a blind eye, is the case of Bankia, a seven-way shotgun marriage fronted by CajaMadrid that went bust 10 months after going public.

Elsewhere, the sector is in the midst of a series of mergers that are by no means guaranteed to succeed. In fact, recent and in-process Spanish bank mergers involve close to 30 underlying constituent entities and I’ve yet to see any reliable write-down or write-off forecasts.

Eyes are currently on a forced mega-merger that’s a little murky (well to me at any rate). Ibercaja Banco (aka Caja Zaragoza, Aragon y Rioja) had already agreed to acquire Banco Grupo Cajatres (Caja Aragón, Caja Burgos, and Caja Badajoz). Liberbank (Grupo Cajastur, Caja Extremadura and Caja Cantabria) has since joined the merger party, and speculation is that Unicaja (originally Caja Ronda; Caja Cádiz; Caja Almería; Caja Málaga and Caja Antequera); and Banco Mare Nostrum (CajaMurcia, Caixa Penedès, CajaGranada and Caixa Balears) could be added to the mix so that the ultimate parent company will be able to meet higher provisioning requirements. The end result from this is far from clear.

Elsewhere, Unnim Banc (a merger of Caixa Manlleu, Caixa Sabadell; and Caixa Terrassa) was acquired by BBVA in March so will be off the hook, but observers aren’t so confident that Banco Sabadell (which recently acquired failed lender Caja de Ahorros del Mediterráneo), Bankinter, or Banco Popular Espanol (a front-runner to acquire Banco de Valencia) will be in the clear.

So where do we go from here? Well, when it becomes clear that the Spanish economy is still shrinking and unemployment is still rising; and when it becomes clear that because many of the banks have willfully refused to recognize the full extent of their bad loans to real estate developers, infrastructure companies and regional authorities, have not marked their repossessed property properly to market or created sufficient levels of provisioning against bad mortgage-related consumer debt, the extent of the losses has yet to be fully exposed, the market rally will reverse.

I’d be short Bonos and stock index futures and hammer the Germany-Spain or Spain-Italy spread for all it’s worth. Spain could be a one-way bet. But my guess would be that that way ain’t up.