There is, of course, a circularity involved, since liquidity depends on valuation, fair value must be based on a market price, and the ability to price an asset itself depends on sufficient liquidity in the market. The difficulty to get out of this circularity in periods of stress is currently creating significant uncertainty. Another example is risk measurement. In a securitized world, investors heavily depend on rating agencies for information about the risks attached to various instruments. These agencies have been strongly criticized recently. It is not my purpose to enter into any blame game. Suffice it to say that there has been a deep misunderstanding between investors and rating agencies as to the scope and true meaning of ratings. Most investors were not fully aware that rating did not encompass liquidity risk; nor did they realize that ratings for structured products were intrinsically more volatile than for more simple "plain vanilla" securities. The use of identical metrics for rating what are fundamentally different categories of assets certainly did not help and may have contributed to the confusion. Some observers have argued that investors should be faulted for relying too much on ratings. Instead, the argument goes, they should do their homework and put themselves in a position to directly assess risks. But it is doubtful that we can dispense of the rating process. If each and individual investor had to carry their own due diligence, the costs of gathering information would be prohibitive and this would introduce important frictions in the functioning of the market.

Their relationships with sponsor banks are sometimes very ambiguous. There may be a gap between the legal commitments taken by the banks through liquidity support and credit enhancements, and the “true” level of responsibility they felt obliged to take to protect their reputation. This conjunction of complexity and fragility may have been too much for the system to bear. So it is worth to pause and ask ourselves whether we can eliminate those vulnerabilities and still keep the benefits associated with securitization, especially in terms of financial innovation. One good starting point is to look at the economic and financial rationale for securitization. Securitization is meant to perform two functions: the first, and most "advertised" in recent years, is to allocate and distribute risks, hopefully to those agents and investors best equipped and most willing – to carry it. The "slicing and tranching" process allowed banks to offload credit risk from their balance sheets and transfer it to other financial investors. But, historically, securitization is borne out of the more simple desire to shortcut banking intermediation by using markets to directly match the needs of lenders and borrowers. Since both have different liquidity preferences, this usually involves the issuance of tradable – i.e. liquid-securities which can be sold to the ultimate investors. Thus, a well functioning securitized system would meet two characteristics: (1) allow for a permanent reallocation of risk between market participants according to their preferences, expectations and risk aversion; and (2) make liquidity (market liquidity) permanently available throughout the system.