Greetings!
LOL! Remathillis! That was pretty funny! Cynical and jaded seems to be the path that many DM's want their paladin players to go down, huh?
Tonym--indeed. I liked your post, too. I suppose, like you say, if the campaign sessions previous made such a situation reasonable, then it might be somewhat *ok* but if such is the case, and it seems from what the original poster said it was merely a hypothetical scenario, it seems to boil down to a grim, paladin-gets-screwed situation. Either his wife dies, his child dies, or the town dies; or the town is saved, but his wife and child die, or maybe some other permutation, all of which means that the paladin is screwed, one way or the other. In the bargain, of course, the paladin's god must find some way to strip the paladin of his powers, too. That also seems to the next train down the pike, so to speak.

I don't generally like such situations, because they have all the appearances of purposely screwing the player's character.
Now, on another point, don't get me wrong--I like a certain degree of realism, and consequences, and ruthless villains and so on. But to be honest, if such a scenario does come down, the DM has to expect that the player may not have the character respond well. I tend to play such characters with an eye towards realism, rather than meta-gaming, so consequently my earlier scenario--facetiously presented--but still decidedly a potential response, because the *character* may indeed respond in such manner--whether that is actually the best course of action for the character isn't the point--and such a course of action may be quite inconvenient for the DM, the rest of the party, and any potential campaign effects, if you see what I'm saying. Such grim, cynical no-win situations can often provoke frustrated responses of ruthless despair and fatalism.
Semper Fidelis,
SHARK