Greece Bailout Seems Likely, but Why Are Markets Rallying?

(MoneyWatch)  European Union officials on Tuesday dropped their strongest hint yet that a bailout of Greece was in the works. The Dow Jones industrial average rose nearly 200 points and the euro gained about 1.5 cents against the dollar over the next hour.

It's hard to justify that much buying or any buying at all. By coming to the rescue of the fiscally incontinent Greek authorities, Europe shows again that politics trumps economics.

When the euro was introduced in 1999 there were explicit and strict guidelines for debt and inflation to which countries that adopted the currency agreed to adhere. The penalties for noncompliance were hefty fines and the possibility of being forced out of the euro zone.

The rules have been breached many times, usually with impunity. It looks as though the same thing, only more so, is about to happen.

How is yet another free pass for a profligate European country good for the euro or for stocks? Even if it allows the crisis to pass today, it raises the likelihood of moral hazard tomorrow.

The euro was set up in a way that gives governments of countries on the fringes of Europe a free ride. Without the threat of currency devaluation, they could borrow at low rates and pump money into their economies. Think of it as a perpetual stimulus package.

That raised the likelihood of credit-fueled booms turning into busts. But that's a risk that the peripheral free-spenders were willing to take because violations of euro zone rules were routinely ignored.

The result is economic and political bungling that has left Ireland, Spain and Portugal struggling, not just Greece, and Italy isn't in great shape either. What incentive do these countries have to get their economies and finances in order if they can reasonably expect a bailout from Brussels if things go horribly wrong?

Greece is the present object of global investors' interest, but if the mismanagement continues in Europe, who will be left to bail out all the others?