No Win Situation
I love moral dilemmas, as that's a part of the whole character development. We all make choices, and the consequences of those choices follow us through life. Some of these choices are excruciatingly difficult, and those should be rare, if only to make them stand out from the lesser ones.
As for the no win situation, I don't believe in it. Sure, maybe in real life, but not in a game. There always has to be a way out, a way to achieve victory, though that victory might have a cost. For a hero, that cost may be his life, but that's a price worth paying if it means saving innocent lives.
The paladin faced with the choice of saving the town (immediate danger) or stopping the evil wizard (longterm danger) is given a moral dilemma. It may be that he won't find a way to accomplish both tasks simultaneously; it sounds like the GM decided to set up the two as mutually exclusive. Either way, innocent lives will be lost. If he stops the evil wizard, the people of the village will die. If he saves the village, the evil wizard escapes to wreak more harm and destruction in the world, imperiling even more lives than those in the village.
Now, a paladin may find it hard to forgive himself for being unable to do both. He may hold himself to an impossibly high standard that even he cannot meet. He may feel it necessary to atone for his self-perceived failure, engaging in metaphysical self-flagellation (or the physical kind). It depends on the character. It may even be that the church might hold him accountable for it, deeming him lacking for failing to both save the village and stop the villainous wizard.
But D&D is a game where the gods are real, and have a tangible impact on the game. A paladin loses his status and powers when the deity that he champions deems it so. Indeed, evil has been wreaked, whether upon the village immediately, or upon the untold victims of the wizard later on. Has the paladin done wrong to choose one over the other? Morally and ethically, I say no. It was made evident that he could not accomplish both tasks. That left him with three choices: stop the wizard, save the village, or agonize indecisively and do neither. So long as he accomplished one task or the other, he has done GOOD. The evil that remained was not of his making.
Should the Power that the paladin serves determine that one task was more right than the other, the paladin may be admonished for judgment, and may be given further lessons in weighing the decisions that he makes. But to strip him of his paladin status is definitely wrong, since from the description of the scenario, ANY decision would result in this outcome.
Sometimes the moral lessons are colored by the one giving the lesson. A follower of St. Cuthbert of the Cudgel might be told that stopping the evildoer is more important than stopping the evil that he does. A follower of Pelor might be told the opposite.
Basically, I believe in moral choices, but I don't put in no win situations. Even when it looks like there's no way to win, I always leave an out. The PCs may not find it, and they may not win, but they've always got a fighting chance. And that's the way it ought to be.
Kradlo