How a Portuguese banking mess took down a dynasty

Paul Ames

The rise and ongoing fall of Portugal's most powerful banking family reads like the script of a particularly breathless telenovela.

Local lore has it that the saga began with an unidentified baby abandoned in a Lisbon church and named in honor of the Holy Spirit by the nuns who raised him.

Ricardo Salgado, chief executive officer of Banco Espirito Santo SA.
Mario Proenca | Bloomberg | Getty Images

Over the next century and a half, his descendants, the Espirito Santo family, built a global financial empire that survived revolution and exile to exert an oversized influence over the economic and political life of their homeland.

Now the dynasty is tottering amid a financial scandal that's threatened to re-ignite Europe's financial crisis, sending shockwaves from Luxembourg to Luanda, Berlin to Brasilia.

More from Global Post:
Two advances may pave new ways for combating malaria
Turkish women are laughing in public because a politician told them not to
Is this the man who broke Iraq?

No less a figure than German Chancellor Angela Merkel has warned the Espirito Santo family's debt woes have revealed the "fragility" of the euro zone's recovery after revelations of the Portuguese banking group's problems sent markets tumbling across Europe earlier this month.

Although international markets have since calmed, the Espirito Santo soap opera rumbles on.

Last week, family patriarch Ricardo Espirito Santo Silva Salgado was arrested on suspicion of fraud, money-laundering and document falsification.

On Tuesday, Banco Espirito Santo again dragged down the Lisbon stock market amid reports the bank was poised to announce half-year losses of around $4 billion. An emergency shareholders' meeting scheduled for Thursday was canceled after the authorities in Luxembourg put two of the group's holding companies under administration.

Read MorePortugal's troubled bank braced for earnings

Salgado was released after paying bail of $4 million. He underwent hours of questioning in connection with an alleged tax scam that reportedly involved suitcases packed with banknotes being driven to Switzerland at an estimated cost to the state of $269 million.

With such sums being thrown about, it's easy to see why there's fascination — and a degree of schadenfreude — with Espirito Santo's sudden fall from grace among the citizens of Western Europe's poorest country. Portugal's annual minimum wage is just $9,125 and years of recession have pushed unemployment to 14 percent.

Salgado, 70, was one of the country's most powerful men.

Until last month, he headed Banco Espirito Santo (BES), Portugal's second largest bank and the hub of a multinational empire that included interests in oil, construction, tourism, healthcare, insurance, power generation and agriculture, as well as global network of banks from Macao to Miami.

Read MoreHere's what's happening in Portugal

In business circles, Salgado's nickname was DDT, standing for "dono disto tudo" — "owner of all this."

Should you short Portugal?
Should you short Portugal?

The arrest followed Salgado's resignation as BES executive chairman last month amid a spate of revelations, starting with news of accounting irregularities at the Luxembourg-based holding company Espirito Santo International.

His departure after three decades in charge marked the end of the family's control over the financial group set up almost 150 years ago by Salgado's great-grandfather, the abandoned orphan Jose Maria do Espirito Santo e Silva.

"The implosion of the Espirito Santo Group is the end of an era," commentator Luis Marques wrote Saturday in the weekly Expresso newspaper. "The detention of Ricardo Salgado is the moment that underscores that, it's a date that will go down in history."

Repercussions were swift as it became clear that the complex web of companies surrounding the family had been used to hide billions of dollars in debts that could no longer be paid.

Three family companies have been forced to seek bankruptcy protection. The authorities in Luxembourg, Panama and Portugal are investigating suspicions of further irregularities.

Read MorePortugal banks are the least of euro zone's problems

A planned $17-billion merger between Portugal Telecom and Brazil's biggest phone operator Oi had to be revised to the Portuguese company's disadvantage after an Espirito Santo sub-holding called Rioforte defaulted on a loan to PT worth more than $1 billion.

Doubts about BES's local unit in Angola led the government there to issue a state guarantee of $5.7 billion to cover 70 percent of loans issued by Banco Espirito Santo Angola, a major player in the oil-rich African state.

In Europe, initial revelations of BES's troubles led to market panic. The bank's own shares have tumbled more than 70 percent since April. Fears a BES collapse could have a systemic impact on the euro zone hit markets in Spain, Italy and beyond.

However, the swift appointment of a new management team that's not linked to the Espirito Santo family has calmed concerns. Reassurance has also come from the news that Goldman Sachs and New York-based hedge fund D.E. Shaw bought into the bank last week. On Friday, the ratings agency Moody's upgraded Portugal, saying the BES scandal would not add to the country's credit risk.

"The new management has calmed markets," says financial journalist Maria Joao Gago, co-author of a book on the BES story that's topping best-seller lists. "BES has a long way to go to get back in shape, but there's a feeling that the damage will be limited to BES."

Read MoreHow the 'teflon euro' has stayed resilient

In the old days, the Espirito Santos might have used their extensive political connections to wriggle out of their hole.

This time, scandal erupted as Portugal's crisis-hit economy was under scrutiny by European Union and International Monetary Fund officials. The Bank of Portugal was anxious to show its adherence to new EU rules on bank supervision at a time that fresh technocratic government ministers aren't part of the family's old-boy network.

More revelations are expected.

There are reports of ongoing investigations into alleged insider trading relating to recent sales of Portuguese utilities to Chinese buyers — deals in which a BES unit served as financial advisor. Another investigation concerns suspicions of bribery in the 2004 sale of German submarines to the Portuguese navy.

Whatever happens, it looks like the end for a banking dynasty that mingled with kings and presidents, courted showbiz stars and shocked opinion in recession-hit Portugal last year when one member told a magazine how much the clan enjoyed "playing at being poor people" while slumming it at their rustic-chic beach retreat south of Lisbon.

Read MorePortugal's bank woes just got more complicated

The Espirito Santos were one of a handful of families that ran the Portuguese economy under the long dictatorship of Antonio Salazar. They suffered imprisonment, nationalization and exile in 1975 after a leftist revolution toppled the regime, then deployed influence with the White House, French presidents and European royals to secure the release, return and eventual repurchase of their nationalized bank.

This time, it appears any comeback would be even harder.

"It will be difficult for them to recover," Gago says. "It's like the nationalization in '75, but back then, the family hadn't lost the credibility of their name. Now, as well as being on the edge of losing the bank, they've lost the credibility of the Espirito Santo name. That will be very hard to get back."

—By Paul Ames, Global Post