As for liquidity is concerned, I don't think there is much liquidity at least that is what is stated in lot of articles and papers. To the extent, I understand the issue it was mainly because everyone was just looking on the brighter side. A lot of non-banking companies were pooling in money for backing up mortgages. Credit checks were minimal (if any in lots of cases. Hedge funds were assisting banks in freeing up credit lines.
If the valuation part you mentioned was in reference to investment banks who are the main players when it comes to setting up of such structures (CDO, CLO, etc.) then why it is possible that they were pricing on market based indexes which are not very liquid thus creating the lag between slowing down of housing markets and its effect on the market based index (that is what liquidity does mainly) markets in such cases are not leading but lagging indicators (similar to how ratings are more of a lagging indicators - FORD, GM) but still why an ABS based index!
You are right on the front that ABS includes commercial loans etc, but the reason why the ABX index should be looked at and not the MBS index because its not only the mortgage backed securities that have suffered from the meltdown in the US housing market.
The asset backed commercial paper (short term funding for corporate) also suffered, which resulted in the AAA of the ABX index showing a decline of 20% in their values. This is the starting of a potential spillover from the mortgage market to other various asset-backed markets, so to view the cumulative effect the ABX index is the perfect one. I hope you get my point. MBS is a subset of ABS.
As far as I know, CDO by definition means pooling different kinds of debt and selling it further to suit various risk profile while such CDO are backed by debts in the various markets, so a CDO may contain tranchées of ABS and MBS. The AAA tranch would generally consist of the commercial loans and the agency loans in the US housing market, followed by Alt-A loans and sub prime loans in decreasing order of liquidity and risk.
Also there are CDO's based only of mortgages but it would not tell you as to how much impact the sub prime debts have suffered because it would also consist of tranches of other housing loans like Alt-A and agency loans (loans to borrowers with better credit histories).
Here is where valuing the mortgage securities at different stages of its life becomes difficult because of complex pooling of these securities into further complex securities.
As pointed out in the FT newspaper, the only index to view losses in the sub prime sector is to follow the BBB rating section of the ABX index which has decreased in value by about 60-80 percent, so the increasing inventory of the sub prime debts underwritten by banks initially have to be written down because of the defaults in this sector and the consequent decrease in demand for the sec backed by such mortgages.
Banking system in India. Why banks in India are facing difficulty in getting deposits?