Public workers protested government plans for austerity measures with demonstrations Wednesday in Athens. Agence France-Presse/Getty Images


The concern is that by rescuing a country that for years flouted fiscal discipline, the European Union would be encouraging such behavior rather than discouraging it. One of the strengths of the euro was the idea that when a country joined the European Union it was a one-way trip that came with strict fiscal responsibilities. A loan-backstop program could change that perception.

The moral hazard problem "is real," says John Taylor, chief investment officer at currency managers FX Concepts. "Any rescue has to be nasty enough that nobody wants to be in a position to be rescued."

But that puts European officials in a bind. If a loan bailout became necessary and was imposed with the kind of harsh measures that would eliminate moral hazard, it could do significant damage to local economies, especially already-fragile banks.

In the end, officials may not have a choice but come up with a plan that can be seen as creating some kind of moral hazard, analysts say.

Given signs that the troubles in Greece and other Mediterranean countries were beginning to infect markets in the relatively healthy core of Europe, the lack of a debt-guarantee program could set the markets right back on the path to contagion. Some argue that in the end, averting a debilitating financial crisis will matter more to investors than moral hazard.

Financial markets spent Wednesday in a waiting mode, whipsawed between conflicting news stories about the likelihood of a loan bailout. On Tuesday the euro rebounded strongly from below $1.37 on news that a plan was in the works. But as some reports cast doubt on the idea that a plan was imminent, the currency fell back toward $1.37 before recovering to $1.3730.

In the short run, a guarantee plan is seen by most as a positive for the euro. Amid fears that the problems in Greece would spread, investors had been pulling money out of European financial markets and buying U.S. dollars or yen.

"While there's still a question about how things will proceed … to alleviate the potential default of a member country–that would be a good thing," says Robert Lynch, currency strategist at HSBC Bank in New York.

But the longer-term implications are less clearly positive.

"A bailout implies 'moral hazard'," analysts at BNP Paribas wrote last week. "Lack of market-driven discipline due to the '(European Monetary Union) umbrella' has certainly been one of the factors contributing to the buildup of imbalances in Greece and elsewhere. Bailing Greece out would give a signal to other countries, limiting the incentives to undergo the needed adjustment as they gain fiscal 'impunity'."

In addition, if a bailout leads to the euro resuming the climb it enjoyed last year, the result could actually be a negative for European economies. In November the euro was changing hands just shy of $1.50.

"It's a catch-22," says David Gilmore, economist at Foreign Exchange Analytics. The recent declines in the euro "are doing wonders for European competitiveness at a time when they are crawling out of recession," he adds.

In turn, eventually a bailout would be negative for the euro as it would weaken the overall economic strength of the region, said Tim Backshall, chief strategist at Credit Derivatives Research, an independent research firm in New York. Debt levels would rise across the euro zone and forced austerity measures would reduce overall economic growth, he said.

Others, however, say that in the current circumstances, the benefits of a bailout won't necessarily come with the unwanted baggage.

One reason is that it is no longer seen as just a problem facing a single economy—Greece—and instead as something that poses a challenge for all members of the European Union, says Mark Schofield, global head of interest-rate strategy at Citigroup in London. In addition, the current government in Greece appears to be taking the situation seriously. A loan-guarantee plan "is not Greece trying to take the easy way out," Mr. Schofield says.

The idea, he says, "would be to try and make a decent fix of it in the near term and at least get some time to deal with the structural problems."

And for the governments that would be helping Greece, he adds, "you can argue that provided you are conscious of (moral hazard) and going into it with your eyes open, you can deal with that going forward."

Laurence Mutkin, chief European interest-rate strategist at Morgan Stanley, says investors don't have to look far for an example of bailouts that avoid moral hazard—for example, those by the International Monetary Fund.

"If you look at what the IMF does, it gives support on a contingent basis," he says. But for the countries that get rescued, it comes with an "economic and political cost."

Write to Tom Lauricella at