What you're describing with LUNA is a scenario called a "death-spiral" (term originating from convertible bonds I believe, which can create similar effects on a stock's price).

The reason Hive has the haircut limit is to prevent infinite death spirals of the type that it sounds like is happening to LUNA from what you've said. If they didn't put in some protection of this sort, that's pretty dumb (or maybe not, since I don't know who wound up benefiting from this, but if it wasn't dumb, it was unethical), considering we've had it for many years.