I think you are basically correct. There is no way to re-inflate housing without going back to irresponsible lending standards. That means home prices will continue to drop until they return to prices supported by traditional fundamentals. (Reasonable price to income ratio, or price to rent ratio)
If you have significant inflation, you could keep nominal prices from going down, but real prices are going to drop regardless. (And right now, deflation seems to be more relevant than inflation)
And as to what the government does? Yes, at best, the only end result of what they do will be to prolong the adjustment period. However, there is a more ominous possibility. With the government forcing banks to rewrite loans, they are making writing and issuing new mortgages all the less attractive to investors. That will mean fewer and harder to get mortgages in the future. That will only increase the amount that the decline in housing overshoots the traditional fundamentals.
