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Politicians weighing a bailout of the hugely indebted Greek government face a grim choice that looks ominously like the one that U.S. policy makers confronted in the days before Lehman Brothers Holdings Inc. failed.

German Chancellor Angela Merkel and others who hold the keys to the rescue funds can either help Greece and accept the fact that a bailout creates a so-called moral hazard that encourages other nations such as Portugal, Spain and Italy to ask for handouts of their own. Or they can cut Athens loose to default on its debt, and risk a freezing of credit markets like the one that followed Lehman's collapse, causing damage that spreads into the banking system and other key financial markets.

As much as some investors and politicians would like to make an example of Greece by forcing it to essentially declare national bankruptcy as a deterrent to other spendthrift nations, the odds of a ripple effect are too large to ignore, analysts say.

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For example, should Greek debt be downgraded by a second rating agency, it will create huge problems for the nation's banks. That's because Greek bonds will no longer be acceptable as collateral for loans from the European Central Bank that banks use for emergency funding.

A full-scale default would also hammer other debt owners, including banks elsewhere in Europe. As of the end of 2009, European banks held $193-billion of Greek government debt, with most of it on the balance sheets of French and German lenders. That could create losses that eat into bank capital, reducing their ability to lend and slowing economic growth across the region, a prospect that could force governments to aid banks yet again.

"I can't dismiss concerns that a contagion of sovereign debt defaults from Greece to Portugal to Spain might have the same consequences as the collapse of Lehman and AIG," Ed Yardeni, president and chief investment strategist at Yardeni Research, told clients on Wednesday. " Apocalypse Now might have severe unexpected consequences, as occurred during Apocalypse Then. This time, however, the stress will be much greater on European banks than on American ones."





The result is that for all the talk of moral hazard, a bailout attempt is almost certain.

"For me it's always been about when, not if," said Craig Wright, chief economist at Royal Bank of Canada. Without support for Greece, the result is higher borrowing costs for Europe, "then pain for the banks, then further pressure on credit, which feeds back to the economy" in a worsening loop.

The most likely proposal remains one that combines aid from the International Monetary Fund and the European Union.

Still, the tough-love camp is vocal and includes well-known emerging markets investors Jim Rogers and Mark Mobius.

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Mr. Rogers said last month that "if Greece went bankrupt, everybody would say the Euro [Union]is serious" about enforcing fiscal discipline on its members. Mr. Mobius more recently told a European newspaper that "if we pour piles of cash into a country where corruption extends to top government officials, we won't see any reforms," and that "there is no other solution than to stop financing Greece with creditors taking responsibility and suffering damages."

Canadian Finance Minister Jim Flaherty said members of the G20 are working closely together on the issues surrounding the Greek economy.

"It's a significant concern. It was the primary concern during our meetings in Washington over the weekend," he told reporters following a meeting of the Conservative caucus. "We want to get the situation in Greece resolved. The European Commission has a team on the ground. So does the IMF.… It's necessary that there be some fiscal measures taken by the Greek government in order to move forward with the package that will assist Greece. ... The markets are demonstrating a lack of confidence in the fiscal management of the [Greek]government."

In the long term, the Greek situation may lead to a stronger European Union, Mr. Wright said. That's because it's forcing the union to create a way to transfer wealth from rich regions to poorer ones, something that helps countries like Canada hold together even though regional economies within the country are vastly different.

In the meantime, though, the parallels to Canada are more ominous.

"You have got to feel some sympathy. Canada had its Greek tragedy in the 1990s, and what it takes to get out is some pretty tough medicine. What you need to start is a wakeup call and you're getting that now," said Mr. Wright.

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With files from reporter Bill Curry in Ottawa

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