The Church has been in a bind. When the number of priest candidates dropped, they lowered the standards and let practicing homosexuals in. Once the standards were lowered, and the priesthood gained a reputation as a "gay" vocation, recruitment suffered even more as strong heterosexual candidates were "called" to other vocations (marriage or other churches). This made the recruiting crisis worse, led to even lower standards, more gay priests, etc., etc... It is a downward spiral.
Although it would hurt in the short term, the best thing the Church could do is reaffirm its commitment to celibacy, kick out those who have habitually (no pun intended) broken their vow of chastity (hetero- or homosexual), and restore the priesthood to the place of respect it once occupied.
The second-best thing the Church could do is allow married men to join the priesthood. Right now, heterosexual men are not willing to give up their sexuality to join the Church when they know that the Church is completely hypocritical on the topic of celibacy. "I can't enter the sacrament of marriage and live a sexual life that is good in God's eyes, but I can join the priesthood and then sin all I want." It is such a contradictory message that it is no wonder the numbers of priests are critically low.
The Church is not hypocritical. There are hypocrites within it. The Church does not teach that priests can sin all they want. The shortage of priests is due in a large part to dissenters, heretics, and the like who have taken control of chanceries and seminaries in order to try to change the Church to their vision of what it should be. If you want the real scoop, read Goodbye! Good Men.
My gut feeling is that when they lowered the standards -- in the general post-VII loosening -- the number of priest candidates dropped. But your "downward spiral" comment in on the money -- there has been a definite synergistic effect.