Yes, letting everything crash and burn in 2007 would have been the best long-term solution. Sure the short-term pain would have been a lot worse, and it would have been a political nightmare for Obama to support such a policy coming into office, but it would have allowed the shit companies to wither away and die, it would have allowed the strong companies to come back stronger, and it would have encouraged new companies to be formed the right way. Instead, we provided all these band-aids on top of companies that had a horrible balance sheet, and we kicked the can down the road further and further. Sure, it quelled the storm on a short-term basis, and the markets loved all of this liquidity, but as you allude the Mother of all Financial Collapses is just waiting in the wings.
While it is certainly possible that nothing spectacular will hapen that will not be a function of many thinking it will. The mindset that you can predict the market always to run counter to various opinions is not realistic.
It is just waiting, it could take 1 or 2 years, it could take 3 or 5 or even 12 for that matter but it will come, they always do, this one though is going to take a little longer than usual, all I know is if the dow gets to 18k, or 20k or even 30k, the next collapse will literally take these markets down 50% or more, its going be quite a scene when it happens, but until that time these markets are only going higher based off the free worthless trillion BUBBLE ben bernanke is using to prop up the entire economy!
I have other potential scenarios but since there has been no help in working out what could happen, I will reserve them. It is very hard to speculate, but it is really hard without sound feedback. It is certain that nothing is certain. I think it is a useful exercise to speculate and plan scenarios even if they don't happen this time. If one concludes that a debt default is unavoidable, then it can only happen quickly (less than 1 year) or slowly (decades). The real key to what is most probable is working out who actually gets stuck with the bill of the implied lost currency and thereby loses wealth (suddenly or quickly). If devaluation is under government control, then friends of the government will benefit, if not, then a new society organizing principle is more likely in my opinion. For example, an easy target is criminal organizations and shadow banking. Another target could be rogue states (rogue could be those outside of the G20 for example). Another potential target are companies that are deemed to have not paid their fair share of taxes to any G20 nation based on their reported revenues, or reported income or those ratios. Another are those with incomes/ wealth outside the G20. Another consideration is an estimate how much debt must be wiped out to restart GDP growth. Is the 1991 debt level sufficient, or the 1971 world debt level, or something else. In the end, one can't fight reality and perception is not reality no matter how many TV shows tell you it is.
The US, EU, UK and Canada recently wrote (and in some cases, passed) legislation that explicitly forbids the bail out of too big to fail institutions. Cyprus is the model going forward = bail-ins (depositor and bond holder confiscation). Governments and CB's are telegraphing clear intent to get ready. As for a catalyst, it could be anything - widespread EU defaults. US debt at Greek levels (3 years out). Japanese default. FED selling off it's balance sheet. There's over 700 trillion in derivatives floating around, mostly sold by Tier 1 banks, mostly insuring against black swan type events. Every major corporation/bank/sovereign debt market are connected in some way by this vast chain of derivatives. Think AIG. When it goes next time, it'll be bad.
Why is there no inflation? Because the Fed buildings have free cafeterias, so nobody at the Fed knows that food costs a lot more. Out of sight, out of mind....