Here's the plot, as far as I could suss it out from the dialogue and the commentary. Forgive the repeated use of the word "somehow;" not all these plot turns are completely logical.
Some 20 years ago, there was a self-help group that met in the basement of the Grace Church; hence its name, the Grace Group. Unfortunately, the Grace Group was actually a front for a man named Benjiro, who was the same type of energy vampire as Gavin in the last game. He tried to use his powers to benefit them all -- enable the members of the group to get their lives in order, and in return he fed off the positive energy they then generated. Unfortunately, this somehow made them spiritually weak because they reached their life goals without going through the intermediate suffering and pain they were supposed to go through to get there. This made them an easy target for Madeline.
Madeline had been a spirit guide for centuries, and she was sick of it. Her last host, Jocelyn Contis, banished her right after they saved the spirit of Joey Mallone in 1931, and Joey then became a spirit guide in her place. As for Jocelyn, severing the bond with her spirit guide drove her insane, and she started calling herself the Countess (presumably because the last thing she heard was Madeline screaming her last name, "Contis!"). Jocelyn managed to replace her bond with Madeline with a bond with Joe Gould, then Joseph Mitchell, and went around murdering the people those men wrote about before she was killed by Lauren in 1973. Meanwhile, Madeline was stuck in the formless void for the next 80 years and became desperate to return to earth so she could live out a normal life and then die for real. She tried to possess first Patricia (Rosa's grandmother) and then Lauren (Rosa's aunt), but it didn't work; they both went insane and died, and Madeline was still stuck in the void.
When Joey met up with Madeline in the void (in the last game), she used him to return to the real world. Since then, she acquired and then lost two hosts (they both died). When she bonded with Michael, she discovered the special vulnerability of the Grace Group members and decided to somehow consume them to make herself stronger. She used Michael to systematically kill all of the members so she could absorb the energy from their spirits. It was Michael who shot George while under Madeline's control, and he may have unwittingly had a hand in the other deaths too. (Kendra, Lia's daughter, died from blood loss after being shot; who shot her is not explained, but the odds are that it was Lia who shot her, possibly to save her from Madeline. But Kendra was never at risk of Madeline's destruction because she was not a member of the Grace Group, and she made it to the afterlife safely.)
Madeline then used Joey and Rosa to gather in the last two people by making them aware, bringing them into Michael's circle so they couldn't escape, and then consuming all three of them at once. (She could not take them before they were aware, as she explained at one point.) She then had the power to take over Rosa's body to further her goal of living out a normal life so she could finally die and move on. She was foiled in this attempt by her inability to move too far away from Michael's lifeless body, and Joey was able to evict her from Rosa's body. However, in the process, Rosa's mind was blown open so that the entire universe entered it all at once, and she went insane, like her aunt and grandmother before her.
While Joey watched over Rosa's heavily sedated body in Bellevue, Rosa's spirit was in Limbo with her aunt Lauren. After a brief conversation died out into listless silence, Rosa heard Joey's voice trying to wake her up, and she made Lauren help her up and out of limbo back into the void. Rosa returned to her body in the padded cell to discover that Madeline, thwarted of her goal to live out a normal life, was in the process of trying to end her own existence in some fashion that somehow was about to destroy every soul, alive or dead, for ten miles around. (Suicide by apocalypse?) Using the same techniques Madeline used to corral the Grace Group spirits, Joey and Rosa forced her into the void, where she and Lauren both finally went into the light.
Rosa, realizing that the apocalypse hadn't stopped, did something magical and messianic (what isn't quite clear) that closed the rip and saved all the lost spirits in the world. (Did this include George, Lia, Michael, Peter, and Heather? I'm going to say yes.) But for some reason, Joey still couldn't move on. The world happily saved, Rosa and Joey left the church and were about to ride off into the sunset -- but Rosa collapsed, unable to live with the gaping hole in her mind. Her last conscious act was to somehow give Joey back a physical body, after which she died. Joey made a last desperate attempt to connect with her with his tie, but there was no ghost, which means Rosa went directly into the white light.
And Joey rode off into the sunset alone, having gotten back the life that was taken from him in 1931. Somehow.