- Luckily, government chose the winners and the losers and saved us from a downward credit spiral.
During the crisis most of the losers and winners were easily identifiable (Bear Stearns, Washington Mutual vs JP Morgan; Countrywide Financial, Merrill Lynch vs Bank of America; Wachovia vs Wells Fargo etc.). Of course, government having another chunk of "extra" money to loan, could and — in the worst traditions of crony socialism — did disperse some of that money to their friends (which was well documented here on FR at the time), but using the natural government corruption to deny the need for TARP-like injection if liquidity to financial system so the consumers' and business deposit accounts can be backed and then trickled down to businesses and customers is ridiculous. The lenders of last resort did exactly what the lenders of the last resort were supposed to do, faced with the credit and liquidity crisis.
1. Do downward credit spirals really happen?
You betcha. Persistent depression / compression and deflation are two of the examples that basically self-perpetuate themself, aka the vicious cycle.
2. If yes, are the caused or cured by government?
Could be either. It depends on the government. For example, take Greece... (please!) People there just elected the government that told them what they wanted to hear (stop "austerity," restart higher government spending paid for by higher taxes on the rich and clamp-down on tax evasion / "cheaters," even though it's exacty what caused the current problems and is the wrong prescription for Greek economy. Germany, on the other hand, weathered the storm relatively unscathed and is the main engine of the EMU and EU economy.