The financial crisis from 2007-2008 would not have been prevented if banks had more liquidity. Debt insurance help, but that just moves the problem to the insurer.
Subprime mortgages, toxic assets, and excessive risk-taking is about trust and risk. When the government becomes the debt insurance, then that risk get managed through stricter banking regulations. Liquidity do not make a bad debt less bad. At best it can hide the problem as the bank tanks the loss, but that only works as long the bank is profitable.
An other interesting example was the Icelandic financial crisis, where the Sovereign debt defaulted on loans from UK and Netherlands. This caused diplomatic problems, including threats of cutting of the Icelandic banks from the global banking network. The value of the Icelandic currency sharply dropped in relation to other currencies, and the Central Bank of Iceland became unable to act as a lender of last resort. The solution in the end was a international bailout support program, including securing more debt from other nations to pay existing debt. This renewed trust in the sovereign debt, but also the trust in the currency and the government.
Subprime mortgages, toxic assets, and excessive risk-taking is about trust and risk. When the government becomes the debt insurance, then that risk get managed through stricter banking regulations. Liquidity do not make a bad debt less bad. At best it can hide the problem as the bank tanks the loss, but that only works as long the bank is profitable.
An other interesting example was the Icelandic financial crisis, where the Sovereign debt defaulted on loans from UK and Netherlands. This caused diplomatic problems, including threats of cutting of the Icelandic banks from the global banking network. The value of the Icelandic currency sharply dropped in relation to other currencies, and the Central Bank of Iceland became unable to act as a lender of last resort. The solution in the end was a international bailout support program, including securing more debt from other nations to pay existing debt. This renewed trust in the sovereign debt, but also the trust in the currency and the government.