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Why bondholders are scared about Spain

NEW YORK (MarketWatch) -- One of the big questions making investors more nervous about the bank-bailout deal Spain announced over the weekend boils down to who will pay for it.

This is always the key issue, to some degree. But it merits repeating that in a debt crisis, what matters more is what holders of debt think and do, rather than what investors in other assets think.

On Monday, they sold Spanish and even Italian debt, pushing yields higher. Part of that stems from worries about exactly where the bailout for Spain will come from, since that'll have implications about bondholder seniority in the case of a default -- like perhaps with Greece.

"Spanish bond yields rose to their highest level since the end of May, as investors digested the prospect they may not get all of their money back in the event of a Spanish default," said Kathleen Brooks, research director at Forex.com.

Spain's 10-year yields (10YR_ESP) rose 23 basis points to 6.42%. A basis point is one-hundredth of a percentage point. Read more on Spain market reaction.

One of the details unknown at this point is whether the money for Spain will come from the European Financial Stability Facility -- the region's bailout fund known as EFSF that was started first -- or the European Stability Mechanism, the permanent bailout fund known as ESM. Read more about Spain's bailout.

There are pros and cons of both, for both Spain and Europe. But all bondholders care about is that there are differences in whether they get paid first in case of a default, or get pushed to the back of the line. Without knowing that, they're simply selling their holdings.

"Where the aid comes from, ESM or EFSF, will determine which bondholders rank higher and who will absorb the most losses," according to Kathy Lien, director of currency research at GFT.