It's almost an iron law of financial crises: Private debt becomes public debt. So it has been in Ireland. The ratio of Ireland's government debt to the size of its economy stood at 25% at the end of 2007. At the end of 2010, according to Finance Minister Brian Lenihan, it will be 98.6%.

Most of that increase comes from the fact that the Irish government has chosen to pay the creditors of its decrepit, mostly state-owned banks in full.

Shareholders have already been hammered. In a decision over who should suffer the pain of covering the remaining losses caused by years of excessive and evidently foolish lending by its banks, the government has decided that that burden should fall on the shoulders of Irish taxpayers.

Depositors will be kept whole. More controversially, so will the holders of the bonds the banks issued to fuel their lending spree, as well as other creditors. The only exceptions are a minority of holders of subordinated bonds.

It's a gamble. Swelling the government's own debts instead of allowing the banks to default on payments to creditors increases the risks that the government itself will default.

The government's "guarantee of most of the unsecured bank liabilities cannot but create doubt about the ability of the Irish state to prevent default on the sum total of its own debt and the bank debt," said Willem Buiter, Citigroup's chief economist, in a research article last month.

The government, however, decided it would pay creditors in full. The reason, as described by Mr. Lenihan: Allowing the banks to default would be almost as bad as the government itself defaulting.

"We have to fund ourselves as a state with senior debt. And other banks have to fund themselves with senior debt. … You cannot send out a message in an economy like Ireland that senior debt can be dishonored. We're far too dependent on international investment," Mr. Lenihan said.

"Any alternative strategy as advocated by some creates a significant risk of jeopardizing the banking system's and indeed the state's access to international debt markets and cannot be countenanced on that basis," he added.

In the latest financial crisis, most governments in Europe have taken a similar course. Finance ministers never want to be responsible for defaults, says Daniel Gros, director of the Centre for European Policy Studies in Brussels, so if one is on the cards, they have every incentive to push it into the future and the responsibility on to the shoulders of successors.

One European central-bank governor said Thursday that even in large countries, banks' outsize political clout influences government decisions in their favor. In small countries, he said, the matter gets even more complicated because many decision-makers will be close to other important players.

In the Irish case, most of the losers will be Irish, one way or another. With shareholders largely wiped out, they will be either Irish taxpayers, as currently planned; Irish pension funds, likely the biggest holders of the bonds; or Irish depositors.

Only one European government has chosen to impose significant losses on unsecured creditors in the latest crisis: Iceland. "In retrospect, Iceland looks pretty good compared to Ireland," says Mr. Gros.

The size of Iceland's banks dwarfed its economy more even than Ireland's did. Bank assets in Iceland were equivalent to 10 times annual economic output, compared with seven times in Ireland.

But Reykjavik had something else going for it: A large proportion of its bank creditors were outside the country. Iceland changed the rules of the game, promised to pay the banks' domestic creditors in full and allowed the banks to default on liabilities to foreign creditors. Iceland's taxpayers saved huge sums.

Iceland did pay a penalty: Its access to international markets was closed and remains so. Mr. Lenihan says that for Ireland that would be too high a price.

Mr. Gros says there are probably other factors influencing the Irish decision. A default on Irish bank debt would push funding costs higher for banks across the euro zone. He says other euro-area governments would be strongly urging Dublin not to let this happen.

But he disputes the idea that allowing the banks to default would hurt the Irish government's ability to borrow. "A government can still make a clear distinction between its own obligations and the entities that it owns which are limited-liability companies."

Bailing out bank creditors provides no incentive for them to undertake proper due diligence among banks. The European Union is currently grappling with this moral-hazard problem as it debates setting up national resolution funds to bail out troubled institutions.

Mr. Gros says the issue could be solved by offering creditors a menu of options to swap their claims—for example, for bonds with a lower face value, bonds paying less interest with later final maturities, or even an equity stake in the bank—that would more fairly share the pain.